                         T.C. Memo. 1996-296



                       UNITED STATES TAX COURT



       TERRY R. HARDTKE AND NANCY HARDTKE, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 13669-92.1                     Filed June 26, 1996.

     Terry R. Hardtke, pro se.

     Allan D. Hill, for respondent.


             MEMORANDUM FINDINGS OF FACT AND OPINION

     CHIECHI, Judge:    Respondent determined the following defi-


1
   The proceedings herein were automatically stayed after the
trial herein when petitioners filed a petition for bankruptcy
with the U.S. Bankruptcy Court for the Northern District of
California on Sept. 30, 1993. On Oct. 18, 1995, after peti-
tioners' bankruptcy proceeding was discharged, the Court lifted
the automatic stay and ordered the parties to file simultaneous
opening briefs by Dec. 18, 1995, and simultaneous answering
briefs by Jan. 12, 1996. Petitioners did not file an opening
brief. On Jan. 17, 1996, petitioners submitted a document that
the Court had filed as their answering brief. On Jan. 18, 1996,
the Court ordered that petitioners were not allowed to file any
additional briefs in this case and that respondent was allowed to
file a reply to petitioners' answering brief, which she did on
Feb. 16, 1996.
                                  - 2 -

ciency in, and additions to, petitioners' Federal income tax:

                          Section            Section       Section
Year     Deficiency    6653(a)(1)(A)2     6653(a)(1)(B)    6661(a)
1987     $13,912.00      $695.60                *         $3,478.00

* 50 percent of the interest due on the portion of the underpay-
ment due to negligence. Respondent determined that the entire
underpayment was attributable to negligence.

       The issues for decision are:

       (1)   Did petitioners have unreported income for 1987 attrib-

utable to services provided by petitioner Terry R. Hardtke (Mr.

Hardtke) to T.R. Hardtke Insurance Agency, Inc. (Agency)?         We

hold that they did.

       (2)   Are petitioners liable for self-employment tax for

1987?    We hold that they are.

       (3)   Are petitioners liable for 1987 for the additions to

tax for negligence under section 6653(a)?       We hold that they are.

       (4)   Are petitioners liable for 1987 for the addition to tax

for a substantial understatement of income tax under section

6661(a)?     We hold that they are.

                           FINDINGS OF FACT

       Some of the facts have been stipulated and are so found.

       Petitioners resided in New Almaden, California, at the time

the petition was filed.

       During 1987, Agency was a California corporation that


2
   All section references are to the Internal Revenue Code in
effect for 1987. All Rule references are to the Tax Court Rules
of Practice and Procedure.
                               - 3 -

operated a general agency specializing in brokering small group

medical insurance plans.   Throughout 1987, Mr. Hardtke owned 75

percent of the common stock of Agency, and Stuart Michell (Mr.

Michell) owned the remaining 25 percent of the common stock of

Agency.   During 1987, Mr. Hardtke, who already was serving as

Agency's chief executive officer (CEO), was elected its president

during a special meeting of its board of directors (board of

directors) held on March 3, 1987 (March 3, 1987 Agency board

meeting).

     During 1987, Dinan, Inc. (Dinan) was a California corpora-

tion that specialized in pension administration and in the

production and marketing of computer software that compared the

costs and benefits of various group medical plans.   Mr. Hardtke,

who served as CEO of Dinan during 1987, owned 42 percent of the

common stock of Dinan throughout that year until December 8,

1987, when he purchased an additional 33 percent of that stock

from Russell M. Meusy (Mr. Meusy), thereby increasing his common

stock ownership of Dinan to 75 percent.   In addition to that

common stock ownership of Mr. Hardtke and Mr. Meusy, during 1987,

Mr. Hardtke's mother owned three percent, Mr. Michell owned 15

percent, and an unidentified individual owned seven percent of

Dinan's common stock.

     The minutes of the March 3, 1987 Agency board meeting

provided in pertinent part:

     Compensation will be earned by Mr. Hardtke and Mr.
                              - 4 -

     Michell and shall be paid directly to Dinan, Inc. as
     follows:

          $7,000.00 each month is payable to Dinan, Inc. as
          a consulting fee for the services of Mr. Hardtke
          and Mr. Michell. It will be accounted as $4,000
          for Mr. Hardtke and $3,000 for Mr. Michell.

The only persons present at the March 3, 1987 Agency board

meeting were Mr. Hardtke, Mr. Michell, and petitioner Nancy

Hardtke (Ms. Hardtke).

     Agency's books of account for the period February 28, 1987,

through February 28, 1988, show entries reflecting that Agency

paid a total of $74,000 to Dinan as "consulting fees".3   Its

books of account for the period January 1, 1987, through December

31, 1987, do not contain any entries showing that compensation

was paid to Mr. Hardtke during 1987.

     The books and records of Dinan for the period January 1,

1987, through December 31, 1987, do not contain any entries

showing that compensation was paid to Mr. Hardtke during 1987.4

     Mr. Hardtke received the following compensation from Agency

and Dinan for the years 1986 and 1988:

                  Year      Agency        Dinan

                  1986      $3,000       $56,500
                  1988      65,600        38,535


3
   It is not clear from the record whether all of those payments
were made during 1987.
4
   Although during all relevant times Dinan used a fiscal year
that ended on the last day of February, the parties stipulated to
Dinan's books and records for the period Jan. 1, 1987, through
Dec. 31, 1987, when agreeing that those books and records do not
show any compensation paid to Mr. Hardtke during that year.
                                 - 5 -


                                OPINION

     Petitioners bear the burden of proving that respondent's

determinations in the notice of deficiency are erroneous.       Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).

Unreported Income

     Respondent determined that Mr. Hardtke had $44,000 of

unreported compensation income from Agency during 1987.    Although

Agency made no payments to Mr. Hardtke during that year, respon-

dent argues that the amounts that Agency paid to Dinan during

1987 with respect to services provided by Mr. Hardtke were income

earned by Mr. Hardtke that is includible in petitioners' income

for that year.   Petitioners argue that during 1987 Mr. Hardtke

provided services to Agency as an employee of Dinan pursuant to a

consulting agreement between Agency and Dinan and that he did not

provide services to Agency in any other capacity.

     It is well established that income must be taxed to the

actual earner of that income.     Lucas v. Earl, 281 U.S. 111

(1930).   "In the corporate context, however, the actual earner

test may be inadequate because a corporation can earn income only

through the personal services of its employees and agents."       Haag

v. Commissioner, 88 T.C. 604, 611 (1987), affd. without published

opinion 855 F.2d 855 (8th Cir. 1988).     "In numerous instances, a

corporation is hired solely in order to obtain the services of a

specific corporate employee."     Johnson v. Commissioner, 78 T.C.

882, 891 (1982), affd. without published opinion 734 F.2d 20 (9th
                                - 6 -

Cir. 1984).    As a result, this Court applies a two-prong test to

determine whether a corporation or its employee is the actual

earner of the income in question:

     First, the service-performer employee must be just
     that--an employee of the corporation whom the corpora-
     tion has the right to direct or control in some mean-
     ingful sense. Second, there must exist between the
     corporation and the person or entity using the services
     a contract or similar indicium recognizing the corpora-
     tion's controlling position. [Id.; citations omitted.]

     With respect to the first prong of the foregoing test,

although Mr. Hardtke was an employee of Dinan during 1987, he

also was an employee of Agency during that year.    Thus, not only

Dinan, but also Agency, had the right to control or direct Mr.

Hardtke in some meaningful sense as its employee.

     With respect to the second prong of the test set forth in

the Johnson case, we find that petitioners failed to prove that a

contract existed between Dinan and Agency during 1987 under which

Dinan was to provide its services to Agency through its employee,

Mr. Hardtke.   Except possibly for the minutes of the March 3,

1987 Agency board meeting, the only evidence of the existence of

such an agreement between Dinan and Agency is the self-serving

testimony of Mr. Hardtke on which we are unwilling to rely.

     With respect to the March 3, 1987 Agency board minutes, they

provide in pertinent part:

     Compensation will be earned by Mr. Hardtke and Mr.
     Michell and shall be paid directly to Dinan, Inc. as
     follows:

          $7,000.00 each month is payable to Dinan, Inc. as
          a consulting fee for the services of Mr. Hardtke
                               - 7 -

          and Mr. Michell. It will be accounted as $4,000
          for Mr. Hardtke and $3,000 for Mr. Michell.

The first clause of the March 3, 1987 Agency board minutes quoted

above unequivocally provides that Mr. Hardtke was to earn compen-

sation and that that compensation was to be paid by Agency to

Dinan.   Although those minutes further provide that Agency was to

pay Dinan for Mr. Hardtke's services, they do not establish that

a contractual relationship existed during 1987 for Dinan to

provide its services to Agency through its employee, Mr. Hardtke.

     Even assuming arguendo that we were to read the second

clause of the March 3, 1987 Agency board minutes quoted above as

providing that Dinan was to earn compensation for rendering its

services to Agency through its employee, Mr. Hardtke, --a reading

that we find to be quite strained--we would be left in equipoise

as to the intended meaning of those minutes.   This is because, on

the one hand, they provide that Mr. Hardtke was to earn compensa-

tion and that that compensation was to be paid to Dinan, and, on

the other hand, under that assumed reading, they provide incon-

sistently that Dinan was to earn compensation for rendering its

services to Agency through its employee, Mr. Hardtke.   Conse-

quently, petitioners would have failed to establish that Dinan,

and not Mr. Hardtke, was to earn the compensation in question.

     Based on the entire record before us, we find that petition-

ers failed to prove that Mr. Hardtke did not earn the income that

Agency paid to Dinan with respect to Mr. Hardtke's services to
                                 - 8 -

Agency during 1987.    We therefore sustain respondent's determina-

tion on that issue.5

Self-Employment Tax

     Respondent determined that petitioners are liable for self-

employment tax of $5,387 for 1987.       In order to refute that

determination, petitioners rely on the evidence they presented

and the argument they make with respect to whether Mr. Hardtke

had compensation income from Agency for 1987.       We have found that

petitioners failed to satisfy their burden of proof on the

compensation issue.    Consequently, they have failed to meet their

burden of proving error in respondent's determination regarding

petitioners' liability for self-employment tax for 1987.       See

Rule 142(a); Welch v. Helvering, 290 U.S. at 115.       Accordingly,

we sustain that determination.

Additions to Tax

     Respondent determined that petitioners are liable for 1987

for the additions to tax for negligence under section


5
   Although respondent argues that certain amounts that Mr.
Hardtke received during 1987 from Dinan that were characterized
on the books and records of Dinan as "Loan Payable-Officers"
actually represented, at least in part, indirect payments of
compensation from Agency and petitioners argue that those amounts
were in fact repayments of loans, and not compensation, we need
not decide that dispute. This is because resolution of that
dispute is not necessary to our conclusions herein. All that is
necessary is whether the compensation that Agency paid during
1987 to Dinan for services performed by Mr. Hardtke was earned by
Mr. Hardtke, rather than by Dinan, under the two-prong test
enunciated in Johnson v. Commissioner, 78 T.C. 882, 891 (1982),
affd. without published opinion 734 F.2d 20 (9th Cir. 1984).
                                 - 9 -

6653(a)(1)(A) and (B) and the addition to tax for a substantial

understatement of income tax under section 6661(a).       Petitioners

presented no evidence and make no argument regarding the addi-

tions to tax under section 6653(a)(1)(A) and (B) and section

6661(a) for 1987.   Consequently, petitioners have failed to

satisfy their burden of proof on those issues.       See Rule 142(a);

Niedringhaus v. Commissioner, 99 T.C. 202, 220-222 (1992); Crown

Income Charitable Fund v. Commissioner, 98 T.C. 327, 339 (1992),

affd. 8 F.3d 571 (7th Cir. 1993).    Accordingly, we sustain

respondent's determinations that petitioners are liable for 1987

for the additions to tax under section 6653(a)(1)(A) and (B) and

section 6661(a).

     To reflect the foregoing,

                                         Decision will be entered

                                 for respondent.
