                     T.C. Memo. 1998-225



                UNITED STATES TAX COURT



     RICHARD J. AND CAROL C. SPERA, Petitioners v.
      COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 130-97.                         Filed June 25, 1998.



     C, the wholly owned corporation of H, constructed
a building on land owned by H and W (Ps). R determined
and argues that the expenditures for this building are
constructive dividends to Ps. Ps argue that the land
was leased to C and that the expenditures were not
constructive dividends to them.
     Held: Because the expenditures were made with the
primary intention and result of conferring a benefit on
Ps, C's expenditures are constructive dividends to Ps
to the extent of C's earnings and profits.
     Held, further, Ps are liable for the accuracy-
related penalties determined by R under sec. 6662(a),
I.R.C., to the extent described herein.



James J. Mahon, for petitioners.

Monica E. Koch and Andrew Mandell, for respondent.
                                 - 2 -




                MEMORANDUM FINDINGS OF FACT AND OPINION

   LARO, Judge:     Respondent determined deficiencies in the

respective amounts of $60,907, $72,128, $77,072, and $8,243 in

petitioners' 1989 through 1992 Federal income tax, an addition to

tax under section 6651(a)(1) for 1989, and accuracy-related

penalties under section 6662(a) for 1989 through 1992.    Following

concessions by both parties, we must decide:    (1) Whether

petitioners received constructive dividends in the amounts of

$27,941, $160,780, $53,001, and $15,585 in 1989 through 1992,

respectively, as a result of expenditures made by General

Refining and Smelting Corp. (GRC), Richard J. Spera's (Mr. Spera)

wholly owned corporation; and (2) whether petitioners are liable

for accuracy-related penalties under section 6662(a) for 1989

through 1992.    Unless otherwise stated, section references are to

the Internal Revenue Code in effect for the years in issue.     Rule

references are to the Tax Court Rules of Practice and Procedure.

Dollar amounts are rounded to the nearest dollar.

                           FINDINGS OF FACT

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

The stipulation of facts and the attached exhibits are

incorporated herein by this reference.     When the petition was

filed, petitioners resided in Northport, New York.     For the years
                                - 3 -


in issue, petitioners filed Forms 1040, U.S. Individual Income

Tax Return, using the filing status of "Married filing joint

return".

     In 1980, petitioners acquired title to approximately 140

acres of real property (the Ashland property).    The property is

located in Ashland, New York, in the Catskill Mountains and

within 15 minutes of a ski area called Ski Windham.    At the time

of purchase, a small farmhouse and garage were located on the

property.    Petitioners have since used the house as a vacation

home.

     Mr. Spera, a metallurgical chemist by trade, was the sole

shareholder of GRC.    During the years in issue, GRC's operations

were located in a building in Hempstead, New York (the Hempstead

Building).    GRC, incorporated on August 2, 1977, was in the

business of assaying and melting precious metals.    GRC's assaying

business consists of ascertaining the weight and the purity of

gold and silver.    The melting business consists of liquefying

metal.   GRC also conducts a sweeps operation out of the Hempstead

Building.    The sweeps operation services customers in the

manufacturing, jewelry, and electronics fields.    These businesses

use precious metals and create a byproduct of waste materials.

GRC burns, crushes, sieves, assays, and sends these waste

materials to a smelter.    GRC filed its 1987 through 1994 Forms
                                 - 4 -


1120, U.S. Corporation Income Tax Return, based on a taxable year

ended on July 31.

     In or around 1987, Mr. Spera and GRC entered into a lease

agreement.    In 1990, petitioners ascertained that they had lost

their copy of the original lease and that Larry Gardner (Mr.

Gardner), the attorney who prepared the original lease, had also

lost his copy.    Petitioners asked Mr. Gardner to prepare a

replacement lease that embodied the terms of the original lease,

and he did.    Under the replacement lease, dated June 11, 1990,

petitioners leased approximately 1.28 acres of the Ashland

property to GRC from September 1, 1987, to August 31, 2037, for

an annual rent of $1,200 payable in equal monthly installments.

GRC is obligated to pay, as additional rent, "all sums required

for Town Taxes, School Taxes, land scaping [sic], building

maintenance and snow removal."    Under the terms of the lease, GRC

is given an option to renew the lease upon the same terms as set

forth therein for an additional term of 50 years, and an option

to purchase the property at a price to be agreed upon.    The

replacement lease also provided that GRC "shall be allowed to

construct a two story building with basement upon the subject

premises".    The building's purpose is not identified in the

replacement lease.    Petitioners signed the agreement as the

lessors, and Lori Romandi (Ms. Romandi), an employee of GRC,
                                 - 5 -


signed in an unidentified capacity for GRC, the lessee.    Neither

the original lease nor the replacement lease was recorded.

     On August 20, 1987, an application, signed by Mr. Spera, was

made to the building department, Town of Ashland, for the

issuance of a building permit.    The application identifies the

address of the proposed building as "1 Mile North - Mail Route

Road - West Side".   The application identifies the intended use

of the building as "farm and storage", the total cost of

construction at $65,000, and "Huntersfield" as the contractor.

The Town of Ashland approved the building permit application and

issued a building permit on August 31, 1987.

     Sometime thereafter, Huntersfield, Ltd. d/b/a/ Lewis Creek

Group (Huntersfield), incorporated on October 8, 1987, started

construction on the Ashland Building.1   For 1989 through 1992,

GRC paid $27,941, $160,780, $53,001, and $15,585, respectively,

for construction-related expenses on the Ashland Building.    All

construction, including electrical work, was completed on the

Ashland Building as of August 1995, and a certificate of

occupancy was issued by the Town of Ashland on August 22, 1995.

The certificate of occupancy identifies the type of property as

"commercial and residential year round".    The Ashland Building

consists of three floors.   Each floor is approximately 2,400


     1
       From 1987 to 1992, Mr. Spera and Timothy Abresch
(Mr. Abresch) were each 50-percent owners of Huntersfield.
                               - 6 -


square feet:   The first floor is primarily of concrete

construction; the second floor is of timber construction; and the

third floor is of timber construction on the outside with cedar

interior wood.   From August 1996 to date, petitioners have

resided in the Ashland Building's third floor living quarters;

and as of February 1998, the first floor of the Ashland Building

is being used as an operational precious metals melting facility.

     Petitioners did not report any rental income on their 1987

through 1995 tax returns.   From 1987 through 1990 and 1992

through 1997, petitioners paid all property tax bills on the

Ashland property as follows:   $221 in 1988; $2,116 in 1989;

$2,422 in 1990; $3,326 in 1992; $3,446 in 1993; $3,448 in 1994;

$3,487 in 1995; $3,409 in 1996; and $3,538 in 1997.   For the

period July 1, 1988, through June 30, 1990, petitioners paid

$1,247, $2,419, and $2,803, respectively, for school taxes on the

Ashland property.

     For its taxable years ended July 31, 1988 through 1990,

GRC's Forms 1120 report other assets relating to construction in

progress in the respective amounts of $233,784, $281,785, and

$381,300.   For the taxable year ended July 31, 1991, GRC reported

only $7,059 in other assets relating to construction in progress.

Its buildings and other depreciable assets were increased from

$397,591 to $860,328.   Under its depreciation summary, GRC showed

a building placed in service on August 1, 1990, with a basis of
                                 - 7 -


$462,737.   For the taxable year ended July 31, 1992, GRC reported

an increase in its buildings and other depreciable assets to

$925,865, of which $60,755 was attributable to a building

improvement placed in service on January 2, 1992.    For the

taxable year ended July 31, 1993, GRC reported an increase in its

buildings and other depreciable assets to $927,448, of which

$1,538 was attributed to building improvements placed in service

on January 1, 1993.   For the taxable year ended July 31, 1994,

GRC reported a decrease in its buildings and other depreciable

assets to $923,115; however, $6,124 was shown expended for

building improvements placed in service on February 15, 1994.     On

its returns for the taxable years ended July 31, 1988 through

1993, GRC deducted the following amounts for real estate taxes

paid:   $0; $0; $0; $510; $6,314; and $6,934.

     During the years in issue, GRC made the following payments

to Mr. Spera:   In 1990, $4,786 for taxes on the "barn"; in 1991,

$3,005 for reimbursement of taxes paid on the "barn"; in 1992,

$8,054 for taxes on "Ashland".    From 1989 through 1998, GRC

maintained insurance coverage with Hartford Fire Insurance Co.

On various applications for insurance, insurance policies,

amendments, and riders, the Hempstead Building was identified as

a refining operation and/or a precious metals refinery, and the

Ashland Building was identified as an office building and/or

other eligible professional offices.
                              - 8 -


     The parties failed to stipulate to GRC's earnings and

profits during the years in issue.    GRC's retained earnings for

the taxable years ended July 31, 1987 through 1994, were

$369,761, $373,543, $364,065, $319,616, $172,301, $209,367,

$251,649, and $336,591, respectively.   The retained earnings do

not account for constructive dividends in the respective amounts

of $101,725 and $162,384 imputed to petitioners in their 1987 and

1988 tax years, or for petitioners' concession that they received

constructive dividends in 1989, 1990, and 1992 in the respective

amounts of $117, $1,735, and $445.    Other than the constructive

dividends imputed to petitioners in 1987 and 1988 and

petitioners' concession, GRC did not pay any dividends from 1987

through 1992.

     In the notice of deficiency, dated October 7, 1996,

respondent determined, among other things, that petitioners

received constructive dividends based on building additions in

the amounts of $28,058, $170,801, $133,541, and $16,009,

respectively, for 1989 through 1992.    The expenditures, emanating

from the building additions, which remain in dispute for 1989

through 1992 are $27,941, $160,780, $53,001, and $15,585,

respectively.

                             OPINION

     The primary issue we must decide is whether construction

expenditures made by GRC constituted constructive dividends to
                               - 9 -


petitioners.   Respondent argues that the purported lease

agreement between petitioners and GRC was not negotiated at arm's

length, that the lease should be disregarded, and that the money

GRC expended on the Ashland Building should be treated as

constructive dividends to petitioners.    Petitioners argue that

section 109 specifically removes the expenditures at issue from

the definition of gross income, and that GRC's expenditures are

thereby not income to petitioners.     Petitioners bear the burden

of proving respondent's determination wrong.    Rule 142(a);

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

I.   Economic Reality and The Lease Agreement

     As a general rule, improvements made by a lessee to a

leasehold estate do not result in the realization of income by

the lessor in the year of the improvement or upon termination of

the lease.   Sec. 109; M.E. Blatt Co. v. United States, 305 U.S.

267 (1938); Bardes v. Commissioner, 37 T.C. 1134 (1962); Weigel

v. Commissioner, T.C. Memo. 1996-485.     However, this rule and the

case law developed thereon do not apply where the lease agreement

is determined to be a subterfuge or a sham.     Commissioner v.

Court Holding Co., 324 U.S. 331 (1945); Jaeger Motor Car Co. v.

Commissioner, T.C. Memo. 1958-223, affd. 284 F.2d 127 (7th Cir.

1960).   Therefore, as an initial matter, we must ascertain

whether the lease arrangement between GRC and petitioners has any

economic reality and should be respected for tax purposes.
                              - 10 -


Because transactions between shareholders and their closely held

corporations are easily manipulated, we examine such a

transaction with special scrutiny.     See Electric & Neon, Inc. v.

Commissioner, 56 T.C. 1324, 1339 (1971), affd. without published

opinion 496 F.2d 876 (5th Cir. 1974).    We evaluate the realities

or substance of the transaction and are not bound by the form the

transaction may take.   Commissioner v. Court Holding Co., supra;

Higgins v. Smith, 308 U.S. 473 (1940).    Specifically, when

evaluating a lease arrangement between a taxpayer and his wholly

owned corporation, we consider not only the lease itself, but

also the testimony of witnesses and the surrounding

circumstances.   See Weigel v. Commissioner, supra.

     Based on our detailed review of the record, we conclude that

there was no economic reality behind petitioners' and GRC's lease

agreement and that section 109 and M.E. Blatt Co. v. United

States, supra, are inapposite.   First, we find that the terms of

the lease are not commercially reasonable.    We do not believe

that a lessee dealing at arm's length would agree to rent

property worth approximately $4,000 for 50 years of equal

payments totaling $60,000.   Indeed, such a stream of payments

would constitute a 30-percent annual return to the lessor over

the 50 years, exclusive of any appreciation on the underlying
                                - 11 -


land and without consideration of any improvements made thereon.2

Further, the option to rent the land for an additional 50 years

contains no provision for a corresponding increase in rent or

reference to establishing the rent in accordance with a then-

current fair rental value, and the option to purchase the land

contains no terms or objective measurement by which to do so.      We

also find that Mr. Spera and GRC did not take adequate steps to

determine the fair rental value of the 1.28 acres of land.     Among

other things, Mr. Spera made no effort to determine what the

prevailing rental rate was for similar parcels of property in the

same locale.   See Weigel v. Commissioner, supra.

     Second, we find that GRC and petitioners did not intend to

honor the terms of the lease.    GRC did not pay and petitioners

did not receive any rent during the years in issue.3   We also

note that, contrary to the lease, petitioners paid all town

taxes, school taxes, and other expenses for 1987 through 1992.4

     2
       We have calculated this 30-percent return using basic
present value formulae.
     3
       Petitioners argue that the parties to the lease never
intended for rental payments to commence prior to the issuance of
the certificate of occupancy. Further, petitioners claim that
GRC began making rent payments in 1995, after the certificate of
occupancy was issued on Aug. 22, 1995. Given the fact that no
rental receipts were reported on petitioners' 1995 Federal income
tax return, we are not persuaded by petitioners' argument.
     4
        Although the record shows that GRC did make a series of
payments to Mr. Spera during 1990 through 1992 for the stated
purpose of paying taxes on a "barn" and "Ashland", we are unable
                                                   (continued...)
                              - 12 -


     And third, we reject petitioners' argument that numerous

business reasons and corporate meetings demonstrate that there

was a valid lease between GRC and petitioners.   For example, Mr.

Spera cited numerous business reasons for the relocation of GRC's

refinery operations to include:   Rental and utility costs

incurred by GRC for the business premises located in Hempstead,

New York, were extremely high relative to rental and utility

costs in other areas in New York outside of the New York

metropolitan area; and GRC could operate much more efficiently

and profitably by moving to an upstate New York location.

However, for the years at issue and thereafter, GRC continued to

pay rent for the Hempstead Building.   Mr. Spera testified that

this fact is not inconsistent with the stated business purpose;

but instead naturally arises from the fact that the completion of

the Ashland Building was delayed due to a severe economic

downturn in GRC's business.   We do not assign any weight to

petitioners' argument.   Although GRC's gross receipts declined

from the taxable year ended July 31, 1988, to taxable year ended

July 31, 1994, GRC's gross profits and taxable income increased

significantly.   Mr. Spera's proffered business reasons are


     4
      (...continued)
to find that these payments were indeed payment of taxes under
the terms of the lease. GRC's Federal income tax returns do not
reflect a corresponding deduction for real estate taxes paid, and
petitioners have not demonstrated that GRC's deductions for rent
paid include payment of taxes on the Ashland Building.
                               - 13 -


nothing more than after the fact self-serving espousals designed

to make the lease seem bona fide.

II.   Constructive Dividends

      As a result of our finding that there was no economic

reality behind GRC's and petitioners' lease agreement, we now

turn to the question of whether GRC's construction expenditures

constitute constructive dividends to petitioners.    Section

61(a)(7) includes dividends in a taxpayer's gross income.

Section 316(a) defines dividends as any distribution of property

made by a corporation to its shareholders out of its earnings and

profits.    Section 1.317-1, Income Tax Regs., provides that "the

term 'property' * * * means any property (including money,

securities, and indebtedness to the corporation) other than

stock, or rights to acquire stock, in the corporation making the

distribution."    Where a corporation confers an economic benefit

on a shareholder without the expectation of repayment, that

benefit may be a constructive dividend, taxable to the

shareholder.    See sec. 61(a)(7); Fields v. Commissioner, T.C.

Memo. 1996-425.

      Construction services performed by a corporation which

improve property owned by its shareholder may constitute a

constructive dividend.    Magnon v. Commissioner, 73 T.C. 980

(1980).    Likewise, transfers between related corporations can

result in constructive dividends to their common shareholder if
                              - 14 -


they were made primarily for his or her benefit and if he or she

received a direct or tangible benefit therefrom.     Gilbert v.

Commissioner, 74 T.C. 60, 64 (1980); Schwartz v. Commissioner,

69 T.C. 877, 884 (1978).   The amount of the constructive dividend

reflects the benefit conferred on the shareholder.     Nicholls,

North, Buse Co. v. Commissioner, 56 T.C. 1225, 1238 (1971).

     The crucial test of the existence of a constructive dividend

is whether "the distribution was primarily for shareholder

benefit."   Loftin & Woodard, Inc. v. United States, 577 F.2d

1206, 1215 (5th Cir. 1978); Sammons v. Commissioner, 472 F.2d

449, 452 (5th Cir 1972), affg. in part, revg. in part, and

remanding T.C. Memo. 1971-145; Truesdell v. Commissioner, 89 T.C.

1280, 1295 (1987); Magnon v. Commissioner, supra at 994.     To make

this determination, we look at all the facts and circumstances

surrounding the expenditures, including the nature of the

building improvements and evidence that the shareholder benefited

from the corporate expenditures.

     Based on the record at hand, we conclude that petitioners

received a direct economic benefit from GRC's construction

expenditures.   First, as to the nature of the improvements, each

party presented an expert to opine on whether the Ashland

Building was constructed for use as a metals refinery.    We were

unimpressed with both experts and do not accept either expert's

characterization of the nature of the improvements as
                              - 15 -


dispositive.   See Helvering v. National Grocery Co., 304 U.S.

282, 294-295 (1938); Estate of Cloutier v. Commissioner, T.C.

Memo. 1996-49.   They both based their opinions on personal

observations which were made at least 3 years after the last year

in issue, and subsequent modifications may have altered the

building's features.5   Both experts also made key concessions on

cross-examination.

     Certain features of the Ashland Building indicate that the

building was not constructed for the benefit of GRC, but was

instead constructed for purposes that are personal to

petitioners.   The first floor has no bathrooms, and one must exit

the building to use the restroom facilities on the third floor.

Petitioners have failed to show how this design adequately

accommodates industrial workers who must have ready access to

wash basins and restroom facilities.   The third floor contains a

balcony, a wine storage facility, and four bedrooms with four

bathrooms (each equipped with its own bathtub).   Among other

things, we conclude that there was no business purpose to be

served from the installation of a wine storage facility.

Mr. Spera also conceded at trial that petitioners have resided in


     5
       GRC's current use of the Ashland Building for its melting
operation does show that the building was indeed adaptable for
use as a refinery. It does not demonstrate that the parties
intended to use it as such. Our inquiry focuses on petitioners'
intent and use during the years in issue, and later modifications
which adapt the building's use are not persuasive.
                              - 16 -


the Ashland Building's third floor living quarters from August

1996 to date.   This fact is relevant to the extent it sheds light

on petitioners' intent to use the Ashland Building as a personal

residence during the years in issue.   Therefore, we find that the

nature of the improvements indicates that the Ashland Building

was built, in part, for petitioners' personal benefit.6    Cf.

Weigel v. Commissioner, T.C. Memo. 1996-485 (improvements made to

obtain necessary rezoning for business).

     Second, the record is replete with evidence that

corporations other than GRC utilized the Ashland Building as

their principal place of business during the years in issue, and

petitioners have failed to show that they were not benefited

directly from this use.   Documents generated by Huntersfield show

its principal place of business as the Ashland Building.    For

example, Huntersfield issued invoices to Hi-Tek Chemical Corp.7

(Hi-Tek) in late 1988 and early 1989 showing accounts receivables

of $7,004, $860, $250, $660, $431, and $323 for work done on "the

farm".   The invoices identify both Huntersfield's and Hi-Tek's

address as Rd 1, Box 70, Prattsville, NY 12468, the Ashland

     6
       We recognize that part of the Ashland Building is suitable
for industrial usage. However, we have no basis for apportioning
the construction expenditures.
     7
       Hi-Tek, incorporated on Jan. 28, 1980, is the manufacturer
of an antifouling coating system used in conjunction with marine
and fresh water fouling problems. Mr. Spera was originally its
sole shareholder; since 1990, he and Joseph M. Wentzell are each
50-percent shareholders in Hi-Tek.
                               - 17 -


Building's address.   In addition, Mr. Spera made representations

to third parties that the Ashland Building was Huntersfield's

primary place of business:    On a December 8, 1987, application

package to New York State Electric & Gas for electric service to

the Ashland Building, signed by Mr. Spera, the business and

customer name identified for billing purposes is Huntersfield; in

a petition for the judicial dissolution of Huntersfield, Mr.

Spera stated that the principal place of business of Huntersfield

was the Ashland Building.    An admission by Mr. Spera also

supports respondent's argument that other entities used the

Ashland Building.   Peter Toporowski, a revenue agent, testified

that in July 1993 he inspected a three-story building on the

Ashland property, and that on the first floor he observed

leftover construction equipment, a bulldozer, a workbench, and

tools.   In response to Mr. Toporowski's inquiry as to who owned

the aforementioned equipment, Mr. Spera stated that the equipment

belonged to a couple of dissolved corporations.    At trial,

Mr. Spera claimed, among other things, that GRC charged

Huntersfield rent for the storage of construction materials and

that Huntersfield's offices were located elsewhere.    However,

other than Mr. Spera's unsubstantiated testimony, petitioners

presented no supporting documentation or testimony.    Moreover,

while GRC's depreciation of the Ashland Building is seemingly

consistent with its ownership and use of the Ashland Building,
                               - 18 -


the timing of the depreciation deductions raises questions

regarding GRC's intended use of the Ashland Building and who was

actually using the building during the years in issue.

Depreciation deductions may not be claimed until an asset is

placed in service.    Rybak v. Commissioner, 91 T.C. 524, 561

(1988); sec. 1.167(a)-10(b), Income Tax Regs.   An asset is first

placed in service when it is placed "in a condition or state of

readiness and availability for a specifically assigned function".

Sec. 1.167(a)-11(e)(1)(i), Income Tax Regs.; see also Cooper v.

Commissioner, 542 F.2d 599, 601 (2d Cir. 1976), affg. per curiam

T.C. Memo. 1975-320; Piggly Wiggly S., Inc. v. Commissioner, 84

T.C. 739, 745-746 (1985), affd. on another issue 803 F.2d 1572

(11th Cir. 1986).    The Ashland Building was apparently placed in

service, substantially complete and available for occupancy, on

August 1, 1990, with later related building improvements placed

in service on January 2, 1992, January 1, 1993, and February 15,

1994.   However, petitioners claim that GRC has utilized the

Ashland Building as its corporate headquarters and for record

storage since 1995, and that GRC has used the building as an

operational precious metals melting facility since February 1998.

Given these facts, we conclude that an entity, other than GRC,

utilized the Ashland Building during the years in issue.

     And third, we find numerous inconsistencies between GRC's

stated intent to use the Ashland Building as a refinery and other
                              - 19 -


evidence in the record.   First, the building permit application

identifies the intended use of the Ashland Building for farm and

storage.   Second, the August 22, 1995, Certificate of Occupancy

identifies the type of property as "commercial and residential

year round".   Third, the insurance records for the Ashland

Building do not reflect an intent to use the structure as a

melting facility.   Nancy Weingartner, an employee of the Hartford

Insurance Co. and underwriter for the Hempstead and Ashland

properties, testified that the business listed for the Hempstead

property is that of general refining and smelting and the

business listed for the Ashland property was that of an office.

     Petitioners attempt to explain these inconsistencies.    As to

the building permit application, Mr. Spera stated in a sworn

affidavit that, in obtaining the building permit, the builder

misidentified the intended use of the Ashland Building as farm

and storage.   He further testified that he did not complete the

building permit application, nor did he enter the total cost of

the building or its intended use.   Instead, it was Mr. Abresch,

the builder and co-owner of Huntersfield, who completed the

application after Mr. Spera affixed his signature.   As to the

Certificate of Occupancy, Mr. Spera testified that the reference

to "residential" referred only to the occasional use of an

apartment.   And as to the intended use of the Ashland Building as

identified in insurance records, petitioners claim that the
                              - 20 -


records presented at trial do not reflect a change in

classification resulting from the Ashland Building's use as an

operational metals refinery as of February 1998.   Taken

individually, many of petitioners' explanations appear

reasonable; however, there are just too many inconsistencies, and

we do not find Mr. Spera's testimony persuasive.

     Under current law, the burden is on petitioners to show that

GRC, and not petitioners, was the primary beneficiary of GRC's

expenditures.   For the aforementioned reasons, petitioners have

failed to carry that burden, and we therefore conclude that the

payments for the costs associated with the construction of the

Ashland Building were made by GRC with the primary intention and

result of conferring a benefit on petitioners.   Accordingly, we

find that GRC's expenditures in constructing the Ashland Building

were section 301 distributions to petitioners.   These

distributions are taxable dividends to the extent of GRC's

earnings and profits.   See sec. 301(c)(1).   The amounts received

in excess of earnings and profits are a nontaxable return of

capital to the extent of Mr. Spera's basis in his stock, with any

excess treated as a gain from the sale or exchange of property.

See secs. 301(c)(2) and (3), and 316.   The parties shall apply

this tripartite classification in arriving at their computation

under Rule 155.
                                   - 21 -


III.       Section 6662

       Respondent determined that petitioners are liable for

section 6662(a)'s accuracy-related penalty for 1989 through 1992

because there was a substantial understatement of income tax

liability.       See sec. 6662(b)(2) and (d).   In the alternative,

respondent determined that petitioners are liable for the

negligence penalty under section 6662(a), (b)(1), and (c).8

       Section 6662(a) imposes an accuracy-related penalty equal to

20 percent of the portion of an underpayment that is due to a

substantial understatement of tax or negligence.        A substantial

understatement means an understatement which exceeds the greater

of 10 percent of the tax required to be shown on the return or

$5,000.       Sec. 6662(d)(1).   The understatement is reduced by that

portion of the understatement for which the taxpayer had

substantial authority or for which the taxpayer adequately

disclosed the relevant facts in the return.        Sec. 6662(d)(2)(B).

In order to avoid the negligence penalty, petitioners must show

that they made a reasonable attempt to comply with the provisions

of the Internal Revenue Code and that they were not careless,

reckless, or in intentional disregard of rules or regulations.

       8
       In brief, respondent argues only for the imposition of the
accuracy-related penalty under sec. 6662(a) and (b)(1) for
negligence or disregard of rules or regulations. We do not
interpret this to be a concession by respondent as to the penalty
for any substantial understatement of income tax and proceed
accordingly.
                              - 22 -


Sec. 6662(c); see also Allen v. Commissioner, 925 F.2d 348, 353

(9th Cir. 1991), affg. 92 T.C. 1 (1989) (negligence defined as a

lack of due care or a failure to do what a reasonable and prudent

person would do under similar circumstances).   As to both

accuracy-related penalties, no penalty is imposed with respect to

any portion of an understatement as to which the taxpayer acted

with reasonable cause and in good faith.   Sec. 6664(c)(1).

Petitioners must prove that respondent erred in determining that

the accuracy-related penalty applied to the years in issue.

Rule 142(a); Monahan v. Commissioner, 109 T.C. 235 (1997);

Bixby v. Commissioner, 58 T.C. 757, 791-792 (1972).

     We primarily address respondent's determination of the

accuracy-related penalty for negligence because our decision on

that issue is dispositive.   Because petitioners presented no

evidence or argument to support a finding that they exercised due

care and did what a reasonable and ordinarily prudent person

would have done under the circumstances, we find that they are

liable for negligence under section 6662(a).    We also note that

petitioners presented no evidence or argument to support a

finding that they relied on substantial authority, adequately

disclosed relevant facts, or acted with reasonable cause and in

good faith.   Therefore, to the extent that petitioners had not

been liable for the accuracy-related penalty for negligence, they
                             - 23 -


would have been liable for section 6662(a)'s penalty for a

substantial understatement of tax to the extent that the Rule 155

computation indicated that petitioners' understatement of tax

exceeded the greater of 10 percent of the amount of tax required

to be shown on the return or $5,000.

     We have considered all other arguments made by petitioners

and found them to be either irrelevant or without merit.

To reflect the foregoing and concessions,

                                        Decision will be entered

                                   under Rule 155.
