                       T.C. Memo. 2002-202



                     UNITED STATES TAX COURT



  VICTOR GRIGORACI AND JUDITH A. GRIGORACI, ET AL.,1 Petitioners
         v. COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 7628-00, 7890-00,      Filed August 12, 2002.

                 9573-00.




     Victor Grigoraci, pro se in docket No. 7628-00.

     Charles W. Wright (an officer of the tax matters partner),

for petitioners in docket Nos. 7890-00 and 9573-00.

     Mary Ann Waters and T. Keith Fogg, for respondent.




     1
        Cases of the following petitioners are consolidated
herewith: Trainer, Wright & Associates, Charles William Wright
CPA Accounting Corp., Tax Matters Partner, docket No. 7890-00;
and Grigoraci, Trainer, Wright & Paterno, Charles William Wright
CPA Accounting Corp., Tax Matters Partner, and Victor Grigoraci
CPA Accounting Corp. and Donald E. Trainer CPA AC, Partners other
than the Tax Matters Partner, docket No. 9573-00.
                                  2

             MEMORANDUM FINDINGS OF FACT AND OPINION

     LARO, Judge: These cases were consolidated for trial,

briefing, and opinion.    In docket No. 7628-00, Victor and Judith

A. Grigoraci (separately Mr. Grigoraci and Mrs. Grigoraci,

respectively, and collectively the Grigoracis) sought

redetermination under section 6213 of a deficiency for tax on

self-employment income and a negligence accuracy-related penalty

under section 6662(a).2   Respondent determined a deficiency of

$12,670 and an accuracy-related penalty of $2,534 for 1996.

     In docket numbers 7890-00 and 9573-00, petitions were

brought under section 6226 by the Tax Matters Partners of two

partnerships: Trainer, Wright & Associates (TWA) and Grigoraci,

Trainer, Wright & Paterno (GTWP).3    The petitioners in these

cases sought readjustment of certain adjustments made by

respondent to the partnerships’ 1996 tax returns.

     Both partnerships reported on Schedules K-1, Partner’s Share

of Income, Credits, Deductions, Etc., that the partners in each

partnership were corporations.    Respondent determined that the

partners of record were not the true and actual partners, but




     2
        Unless otherwise indicated, section references are to the
Internal Revenue Code applicable to the subject years. Rule
references are to the Tax Court Rules of Practice and Procedure.
     3
        Paterno is not a partner to GTWP. The partnership
adopted the use of the Paterno name after purchasing a firm by
the name of Howell and Paterno.
                                     3

that the actual partners were the individuals who owned the

corporations.

       We decide the following issues:

       1.   Whether our decision as to the identity of the partners

must be made at the partner level or at the partnership level.

We hold that our decision must be made at the partner level.

Accordingly, pursuant to the request of respondent, we shall

dismiss the proceedings to the extent that they apply at the

partnership level.

       2.   Whether we have jurisdiction to review the notice of

deficiency issued to the Grigoracis.         We hold that we have

jurisdiction to review a portion of the notice of deficiency.

       3.   Whether the Grigoracis are liable for self-employment

tax.    We hold they are not.

       4.   Whether the Grigoracis are liable for an accuracy-

related penalty under section 6662(a).         We hold they are not.

                           FINDINGS OF FACT

       Some facts were stipulated.       We incorporate by this

reference the parties’ stipulation of facts and accompanying

exhibits.

       TWA is a partnership, and its principal place of business is

in Huntington, West Virginia.    TWA provides public accounting

services to its clients.    A notice of final partnership

administrative adjustment (FPAA), dated April 14, 2000,
                                   4

determined adjustments to TWA’s 1996 partnership return.      The

notice was issued to Charles William Wright CPA Accounting Corp.

(Wright S Corp.), as Tax Matters Partner of TWA.      The FPAA

described the disputed adjustment to TWA’s partnership return as:

     It has been determined that the following individuals
     are the actual partners of the partnership: Donald E.
     Trainer (with a profits interest of 50 percent), and
     Charles W. Wright (with a profits interest of 50
     percent). It has also been determined that the
     following pass-thrus [sic] are not actual partners of
     the partnership: Donald E. Trainer, CPA, A/C (also
     known as Donald E. Trainer Accounting Corp.), and
     Charles William Wright, CPA, A/C (also known as Charles
     William Wright, CPA, Accounting Corp.).[4]

     GTWP is a partnership with its principal place of business

in Charleston, West Virginia.5   GTWP also is in the business of

providing public accounting services to its clients.      An FPAA,

dated April 14, 2000, determined an adjustment to GTWP’s 1996

partnership return.   The FPAA was issued to Wright S Corp., as

the Tax Matters Partner of GTWP.       The FPAA described the disputed

adjustment to GTWP’s partnership return as:

     It has been determined that the following individuals
     are the actual partners of the partnership: Donald E.
     Trainer (with a profits interest of 23 percent),
     Charles W. Wright (with a profits interest of 23
     percent), and Victor Grigoraci (with a profits interest
     of 54 percent). It has also been determined that the
     following pass-thrus [sic] are not actual partners of
     the partnership: Donald E. Trainer, CPA, A/C (also


     4
        Respondent also made an adjustment to TWA’s deductions,
but this adjustment is not in dispute.
     5
       The parties have agreed that GTWP and TWA were separate
partnerships in 1996.
                                   5

     known as Donald E. Trainer Accounting Corporation),
     Charles William Wright, CPA, A/C (also known as Charles
     William Wright, CPA, Accounting Corporation), and
     Victor Grigoraci, CPA, A/C (also known as Victor
     Grigoraci, CPA, Accounting Corporation).

     In 1996, Wright S Corp. was an S corporation under section

1361.    Its sole shareholder was Charles Wright, an individual.

Mr. Wright is a certified public accountant and has been

affiliated with TWA or its predecessors, since 1972.6

     In 1996, Donald E. Trainer, CPA, A/C was also an S

corporation (Trainer S Corporation).     Trainer S Corporation’s

sole shareholder was Donald Trainer, an individual.     Mr. Trainer

is a certified public accountant and has been affiliated with TWA

or its predecessors since 1972.7

     In the later part of 1994, TWA operated offices in

Huntington and Charleston, West Virginia.     It planned to add

another partner to its Charleston office and was in negotiations

with Mr. Grigoraci.    For the prior year Mr. Grigoraci had

operated his accounting practice as a sole proprietorship.      In or

about November 1995, TWA reached an agreement with Mr. Grigoraci,

under which a partner was added to the Charleston office and a

new partnership, GTWP, was formed.     From negotiations with

Messrs. Trainer and Wright, Mr. Grigoraci and his attorney had


     6
        We make no finding as to whether Mr. Wright or Wright S
Corp. was a partner in TWA during 1996.
     7
        We make no finding as to whether Mr. Trainer or Trainer S
Corporation was a partner in TWA during 1996.
                                  6

understood that the other partners to GTWP were corporations;

namely, Wright S Corp. and Trainer S Corporation.    Mr.

Grigoraci’s attorney advised him that he should not become a

member of the partnership in his individual capacity because he

would be the only partner in GTWP with unlimited liability.     To

avoid being the only noncorporate partner in GTWP, Mr. Grigoraci

formed Victor Grigoraci, CPA, Accounting Corporation (Grigoraci S

Corporation) in or about November 1995.    It was Mr. Grigoraci’s

intention that Grigoraci S Corporation join GTWP as a partner.

     During 1996, Mr. Grigoraci was the sole shareholder,

president, and treasurer of Grigoraci S Corporation.    Mrs.

Grigoraci was the corporation’s secretary, but she did not

perform any work for the corporation as an employee.    Mr.

Grigoraci's personal secretary maintained the books and records

of the corporation.    During 1996, the office of Grigoraci S

Corporation was the same as GTWP’s.

     GTWP reported on its income tax return for 1996 ordinary

income of $197,773.    On a Schedule K-1 for 1996, GTWP reported

that the Grigoraci S Corporation’s distributive share was

$106,799.   Grigoraci S Corporation reported on its 1996 Federal

income tax return the distributive share from GTWP and other

income of $21,862.    The record does not disclose the source of

this other income.    After deductions, including a salary of

$32,000 to Mr. Grigoraci, Grigoraci S Corporation reported that
                                  7

Mr. Grigoraci’s share of the corporation’s income was $92,470.

On their joint return for 1996, the Grigoracis reported the

passthrough income from the corporation as well as Mr.

Grigoraci’s salary from the corporation.   The Grigoracis did not

pay any self-employment tax in 1996.

     A notice of deficiency, dated April 14, 2000, was issued by

respondent to the Grigoracis.   Respondent determined therein that

the $92,470 reported by the Grigoracis as their distributive

share of Grigoraci S Corporation’s income was actually their

distributive share of GTWP’s income.   Respondent determined that

the $92,470 was personal service income.   Respondent also

determined that the $32,000 the Grigoracis reported as wages from

Grigoraci S Corporation was actually personal service income.

Respondent further determined that the Grigoracis owed self-

employment tax on the $124,470 ($92,470 plus $32,000) in the

amount of $15,076.   Additionally, respondent determined that the

Grigoracis were liable for a negligence accuracy-related penalty

under section 6662(a) of $2,534 for their failure to treat Mr.

Grigoraci as a partner in GTWP.
                                   8

                                OPINION

    A.    Review of the FPAAs

     In a partnership level proceeding, our jurisdiction is

limited to review of the Commissioner’s adjustments to

partnership items.   Sec. 6226(f).     Thus, we must initially decide

whether a partnership level proceeding is the appropriate method

for us to review respondent’s determination that the partners of

record are not the true and actual partners in the partnerships.

If this is a review to be conducted at the partnership level, we

review the petitions filed by the tax matters partners.       If this

is a partner level determination, we must dismiss the two

partnership proceedings because the only determinations

petitioned by the tax matters partners were the Commissioner’s

determinations to change the identity of the partners.

     1.   TEFRA Procedures

     The unified audit and litigation procedures were enacted as

part of the Tax Equity and Fiscal Responsibility Act of 1982

(TEFRA), Pub. L. 97-248, sec. 401(a), 96 Stat. 648, and are

commonly referred to as the TEFRA procedures.     The TEFRA

procedures provide a method for adjusting “partnership items” in

a single unified partnership proceeding, rather than in multiple

separate actions against each partner.      Maxwell v. Commissioner,

87 T.C. 783, 787 (1986).   Specifically, section 6221 provides
                                 9

     the tax treatment of any partnership item (and the
     applicability of any penalty, addition to tax, or
     additional amount which relates to an adjustment to a
     partnership item) shall be determined at the
     partnership level.

     In general, the Commissioner is precluded from assessing a

liability attributable to a partnership item or any penalty,

addition to tax, or additional amount which relates to the

partnership item, until after the completion of the partnership

level proceedings.   Sec. 6225(a); Maxwell v. Commissioner, supra

at 788.   Conversely, the Commissioner generally must follow the

deficiency procedures before he can assess a deficiency related

to affected items or other nonpartnership items.   Sec. 6230(a);

Maxwell v. Commissioner, supra at 787-788.

     If the Commissioner makes an adjustment to a partnership

item under section 6221 and a petition is filed with this Court

in accordance with section 6226(a) or (b), we have jurisdiction

to review the Commissioner’s adjustment to the partnership item.

The scope of our review is defined by section 6226(f) as follows:

     A court with which a petition is filed in accordance
     with this section shall have jurisdiction to determine
     all partnership items of the partnership for the
     partnership taxable year to which the notice of final
     partnership administrative adjustment relates, the
     proper allocation of such items among the partners, and
     the applicability of any penalty, addition to tax, or
     additional amount which relates to an adjustment to a
     partnership item.

Thus, in a TEFRA proceeding, the Court has authority to

“determine all partnership items” and to determine “the proper
                                  10

allocation of such items among the partners”.    Sec. 6226(f).   In

such a proceeding, the Court’s jurisdiction extends only to

redetermining adjustments of partnership items.    N.C.F. Energy

Partners v. Commissioner, 89 T. C. 741, 743 (1987) Maxwell v.

Commissioner, supra at 787-788.

     2.   Definition of Partnership Items

     Section 6231(a)(3) defines a partnership item as:

          (3) Partnership item.–-The term “partnership item”
     means, with respect to a partnership, any item required
     to be taken into account for the partnership’s taxable
     year under any provision of subtitle A to the extent
     regulations prescribed by the Secretary provide that,
     for purposes of this subtitle, such item is more
     appropriately determined at the partnership level than
     at the partner level.

Only items that are “required to be taken into account for the

partnership’s taxable year under *** subtitle A” can be

partnership items.   Dial USA, Inc. v. Commissioner, 95 T.C. 1, 3

(1990).   Of these items, only those that are “more appropriately

determined at the partnership level” are partnership items.

N.C.F. Energy Partners v. Commissioner, supra at 743.     Section

301.6231(a)(3)-1, Proced. & Admin. Regs., identifies those items

that are partnership items because they are more appropriately

determined at the partnership level.   Some items that are

required to be taken into account by the partnership under

subtitle A are not partnership items because the items are more

appropriately considered at the partner level.
                                  11



     3.   Is the Reallocation of Partnership Items From the
          Partner of Record to the Allegedly True and Actual
          Partner a Partnership Item?

     Our precedent establishes that the hallmark of a partnership

item is that it affects the distributive shares reported to the

other partners.   Blonien v. Commissioner, 118 T.C. 541, 551-552

n.6 (2002).   In Katz v. Commissioner, 116 T.C. 5, 12 (2001), the

issue before the Court was “once a partnership has allocated

partnership items in respect of the interest of a partner who has

commenced a bankruptcy proceeding during the partnership taxable

year, whether the subdivision of those items between the partner

and his bankruptcy estate constitutes a partnership item”.       In

Katz, the Court viewed this inquiry as tantamount to determining

whether a partner in bankruptcy and his bankruptcy estate should

be treated as separate partners.       Id.   We concluded that “from

the perspective of the partnership in its determination of each

partner’s distributive share of partnership tax items, a partner

in bankruptcy and his bankruptcy estate are properly considered

as one and the same” partner.     Id. at 13.    The reallocation of

the distributive share between the partner and his bankruptcy

estate had no impact on the partnership’s aggregate income or

loss, nor did it have any impact on the distributive shares

reported to the other partners.    Accordingly, we held that the
                               12

determination was more appropriately made at the partner level

and was, therefore, not a partnership item.

     Similarly, in Hang v. Commissioner, 95 T.C. 74, 80 (1990), a

setting closely analogous to the instant case, we held that the

determination of whether a father was the true and beneficial

owner of shares in an S corporation that were held in the name of

his sons is properly made at the individual shareholder level.8

The Court reasoned that determining the true and beneficial owner

of the shares was more appropriately determined at the individual

level because the determination depends upon factors that cannot

be determined at the corporate level and requires participation

of the allegedly true owner of the shares.    Hang v. Commissioner,

Id. at 80-81.

     We find our decisions in Hang and Katz highly persuasive

because the effect of the determinations at issue in Hang and

Katz are strikingly similar to the effect of respondent’s



     8
       Under the S corporation audit and litigation procedures (S
Corporation procedures), secs. 6241 through 6245, a “subchapter S
item” is defined as “any item of an S corporation to the extent
regulations prescribed by the Secretary provide that, for
purposes of this subtitle, such item is more appropriately
determined at the corporate level”. Sec. 6245. The tax
treatment of a subch. S item generally must be determined in an
entity level proceeding. See sec. 6241.

     The S Corporation procedures were enacted shortly after the
TEFRA procedures as part of the Subchapter S Revision Act of
1982, Pub. L. 97-354, sec. 4(a), 96 Stat. 1691. The S
Corporation procedures were repealed as of Dec. 31, 1996, by the
Small Business Job Protection Act of 1996, Pub. L. 104-188, sec.
1307(c)(1), 110 Stat. 1781.
                                 13

determinations in these cases.   The determinations in Hang and

Katz had no impact on the entity’s aggregate income, gain, loss,

deductions, or credits.   In the cases at hand, respondent’s

alteration of the partners in GTWP and TWA had no impact on

either partnership’s aggregate income, gain, loss, deductions, or

credits.   The determination in Katz also had no impact on the

other partners’ shares of the income, gain, loss, deductions, or

credits of the partnership.   Similarly, in these cases,

reallocation of the distributive share of any corporate partner

of record to the individual who owns such Corporation has no

impact on the other partners’ shares of the income, gain, loss,

deductions, or credits.

     Respondent claims that section 301.6231(a)(3)-1, Proced. &

Admin. Regs., mandates that items that are required to be taken

into account under Subtitle A by the partnership are, by

definition, more appropriately determined at the partnership

level and are, therefore, partnership items.   We disagree.    The

regulation provides a list of items that are more appropriately

determined at the partnership level from the larger universe of

items that are required to be taken into account under Subtitle

A.   See Harris v. Commissioner, 99 T.C. 121, 125 (1992).     It does

not state that all items that must be taken into account under

Subtitle A are ipso facto more appropriately determined at the

partnership level.
                                  14

     Respondent also claims that two portions of the regulation

support his argument that a reallocation of partnership items

from the partners of record to the allegedly true and actual

partners is a partnership item.    First, respondent claims that

section 301.6231(a)(3)-1(a)(1)(i), Proced. & Admin. Regs.,

includes as a partnership item a determination of the

partnership’s aggregate and each partner’s share of “income,

gain, loss, deduction, or credit of the partnership”.    Sec.

301.6231(a)(3)-1(a)(1)(i), Proced. & Admin. Regs.    We disagree

with respondent that a determination of whether the corporate

partners in TWA and GTWP were shams is a partnership item under

this section of the regulations.

     The aggregate income, gain, loss, deductions and credits of

the partnership are not in dispute.9   Moreover, for GTWP and TWA,

the determination of whether a partner is a corporation or an

individual has no impact on the partnership level issues covered

by the regulation.   There is also no dispute about the amount of

the allocations made to the partners, whether they be

corporations or individuals.   In fact, a determination that any

of the partners is an individual--rather than a corporation--for

Federal tax purposes does not require an adjustment to the



     9
        As stated previously, adjustments to TWA and GTWP’s
income, gain, loss, deductions and credits are not in dispute.
The only liability created by the disputed adjustments is to
create self-employment tax liability for the individual partners.
                                15

allocable shares of the other partners as reported by the

partnerships.   Instead, it merely affects the Federal tax

liability of the specific partner whose status was changed from a

corporation to an individual.   Items that merely affect the tax

liability of a specific partner, but not the other partners, are

not partnership items.   Hambrose Leasing v. Commissioner, 99 T.C.

298, 308-309 (1992) (holding that a determination of the

partner’s amount at risk was not a partnership item because it

affected only the status of the partner and not the partnership);

N.C.F. Energy Partners v. Commissioner, 89 T.C. at 741 (holding

that penalties and additions to tax to be asserted against the

partners were not partnership items); Gustin v. Commissioner,

T.C. Memo. 2002-64 (holding that a partner’s basis in his

partnership interest is not a partnership item).   Accordingly,

determining the identity of the partners is not a partnership

item under this regulation because it has no effect on either the

partnership’s aggregate or each partner’s share of income, gain,

loss, deductions, or credits of the partnership.

     Second, respondent claims that section 301.6231(a)(3)-

1(a)(4), Proced. & Admin. Regs., includes as partnership items

any items relating to contributions to the partnership,

distributions from the partnership, and transactions between the

partnership and a partner not acting in his capacity as a

partner.   Such items are only partnership items “to the extent

that a determination of such item can be made from determinations
                                16

that the partnership is required to make with respect to an

amount, the character of an amount, or the percentage interest of

a partner in the partnership, for purposes of the partnership

books and records or for furnishing information to a partner”.

Sec. 301.6231(a)(3)-1(a)(4), Proced. & Admin. Regs.

     Respondent argues that a determination of the identity of

the partners relates to contributions to the partnership and

distributions from the partnership.   However, the regulation

classifies an item as a partnership item only “to the extent that

a determination of the item can be made” by the partnership.       In

this case, the identity of the partners is not a partnership item

because the partnerships cannot conclusively make such a

determination.   Hambrose Leasing v. Commissioner, supra at 311.

The partnership cannot determine whether its corporate partners

should be respected for Federal tax purposes without

consideration of information that is not available at the

partnership level.   For example, such a determination requires

consideration of the manner in which the corporation’s activities

were conducted, whether it was properly formed, whether it has a

valid purpose, and whether it actually conducts business.     Moline

Props., Inc. v. Commissioner, 319 U.S. 436 (1943).     Moreover,

most of the evidence relevant to determining whether the

corporation or the individual is the partner centers on the acts,

motives, and intentions of the individuals and not on actions

taken by the partnership.
                                17

     Additionally, the determination of whether the corporation

before us should be respected for Federal tax purposes has no

impact on the partnerships, their books and records, or any other

aspect of the partnerships.   The determination also has no impact

upon the amount or character of a distribution, or percentage of

the other partners’ interests in the partnerships.    The

determinations’ sole impact is on the liability for self-

employment tax and related penalties.   A determination of the

identity of the partners in GTWP and TWA is not a partnership

item under this section of the regulations.

     There are circumstances in which the determination of the

status of a partner is a partnership item.    In Blonien v.

Commissioner, 118 T.C. 541 (2002), for example, we held that a

determination that an individual was a partner in a partnership

was a partnership item because such determination affected the

distributive shares of the other partners.    See also Oceanic

Leasing v. Commissioner, T.C. Memo. 1996-458.    A determination of

this nature is more appropriately made at the partnership level

because it alters the number of partners and decreases the

distributive shares of the other partners.    Conversely,

resolution of the issue in this case does not change the number

of partners, their allocable shares, or in any way affect the

partnership or the other partners.

     Under the circumstances of this case, we hold that a

determination that the partners of record were not the true and
                                18

actual partners is not a “partnership item” under section 6221

and cannot be addressed in a partnership level proceeding.    We do

not have jurisdiction under section 6226 to determine the

identity of the partners in the two partnership level

proceedings.   Maxwell v. Commissioner, supra.   In the absence of

a justiciable claim for relief in the petition for review, we

shall dismiss each case for failure to state a claim upon which

relief can be granted.

     B.   The Notice of Deficiency Issued to the Grigoracis

     Next we consider the Grigoracis’ request that we review

respondent’s determination of a deficiency for the Grigoracis’

1996 tax year and a related penalty.   Respondent initially

adopted the position that the notice of deficiency was issued

pursuant to section 6212.   After the Court requested additional

briefing by the parties, respondent claimed that the notice of

deficiency is entirely an affected items notice of deficiency

under section 6230(a)(2).   Respondent argues that the notice was

issued before the close of the partnership proceedings and should

be dismissed pursuant to GAF Corp. v. Commissioner, 114 T.C. 519

(2000).

     1.   Is the Notice of Deficiency an Affected Items
          Notice of Deficiency?

     Pursuant to section 6230(a)(2), the Commissioner will issue

an affected items notice of deficiency to the taxpayer when a

deficiency is attributable to an affected item that requires a
                                   19

“partner level determination”.10    An affected item is defined as

any item “affected by a partnership item.”     Sec. 6231(a)(5).   The

Grigoracis’ liability for self-employment tax on the distributive

share from GTWP under section 1402(a) requires a determination

that Mr. Grigoraci was the true and actual partner in GTWP - a

partner level determination.    Accordingly, any deficiency

attributable to self-employment tax on the distributive share

from GTWP requires respondent to issue an affected items notice

of deficiency.    The deficiency determined by respondent is only

partially attributable to self-employment tax on the distributive

share from GTWP.

          In the notice of deficiency respondent recharacterized the

$92,470 distributive share the Grigoracis reported as being from

Grigoraci S Corporation as actually being from GTWP.     Respondent

then determined that the $92,470 was personal service income

subject to self-employment tax.     In addition, respondent

determined that the $32,000 of wages the Grigoracis reported as

earned from Grigoraci S Corporation was actually “personal

service income” subject to self-employment tax.     Thus, the


     10
       We agree with respondent that affected item notices of
deficiency can only be issued to a partner. For these purposes,
sec. 6231(a)(2) defines a partner as either (1) a partner in the
partnership or (2) any other person whose income tax liability is
determined directly or indirectly by taking partnership items
into account. As so defined, Mr. Grigoraci is a partner in GTWP.
Either he is an actual partner in GTWP or Grigoraci S Corporation
is the partner and Mr. Grigoraci is its sole shareholder. In the
latter case, Mr. Grigoraci’s income would be determined
indirectly by taking partnership items into account.
                                  20

deficiency determined by respondent was composed of the self-

employment tax on the $124,470 and an accuracy-related penalty

for the Grigoracis’ failure to treat Mr. Grigoraci as a partner

in GTWP.

     The deficiency is not solely attributable to affected items

because respondent determined that the Grigoracis owed self-

employment tax on income that was not earned by GTWP.     The self-

employment tax respondent determined that the Grigoracis owed on

the $92,470 is an affected item, while the self-employment tax

owed on the $32,000 is not an “affected item”.

     Pursuant to GAF Corp. v. Commissioner, supra, we dismiss for

lack of jurisdiction and strike the Grigoracis’ petition to the

extent the deficiency is related to the self-employment tax on

the $92,470 of income or the accuracy-related penalty.     As to the

portion of the deficiency that is self-employment tax on the

$32,000 of income, the notice was issued pursuant to section

6212.     As to this portion of the notice of deficiency, we have

jurisdiction to review respondent’s determination under section

6213.

     2.      Review of the Section 6212 Notice of Deficiency

     The notice of deficiency does not clearly articulate the

reason for recharacterizing the $32,000.     On brief, respondent’s

sole argument in support of collecting self-employment tax on

this income is that Grigoraci S Corporation is a sham that should

not be recognized for Federal tax purposes.     Accordingly, the
                                 21

wages reported by the Grigoracis as being from Grigoraci S

Corporation would actually be income derived from providing

personal services directly to the end-user.   The Grigoracis claim

that Grigoraci S Corporation is a valid entity for Federal tax

purposes and that the corporation is the partner in GTWP.    We

agree with the Grigoracis.

     There is no dispute that Grigoraci S Corporation was validly

organized under West Virginia law.    For Federal tax purposes, a

validly organized corporation is usually respected, but it may be

disregarded in instances where it is found to be a sham.     Moline

Props., Inc. v. Commissioner, 319 U.S. 436 (1943); Higgins v.

Smith, 308 U.S. 473, 477-478 (1940); Gregory v. Helvering, 293

U.S. 465 (1935).   Under the test defined in Moline Properties, we

do not disregard a corporation for Federal tax purposes if it (1)

served an intended business function or purpose or (2) engaged in

business.   The corporation’s existence as a taxable entity will

be recognized if it satisfies either prong of the test.     Carver

v. United States, 188 Ct. Cl. 202, 412 F.2d 233, 236 (1969).      The

degree of corporate business purpose or the quantum of business

activity required for recognition of the separate existence of a

corporation is rather minimal.   Hosp. Corp. of Am. v.

Commissioner, 81 T.C. 520, 579-580 (1983); Strong v.

Commissioner, 66 T.C. 12, 24 (1976).    A corporation is a separate

and distinct entity even if the corporation is wholly owned by
                                 22

one shareholder.    Burnet v. Commonwealth Improvement Co., 287

U.S. 415, 420 (1932).

     The Grigoracis claim that the corporation was established

for the purpose of limiting Mr. Grigoraci’s potential liability

from the partnership.    According to respondent, the corporation’s

primary purpose was to allow the Grigoracis to avoid the payment

of Federal employment tax.    We find no evidence in the record to

support respondent’s position and agree with the Grigoracis.

     The evidence clearly establishes that the primary, if not

the sole, reason Mr. Grigoraci formed the corporation was to

limit his potential, personal liability upon entering the GTWP

partnership.    Mr. Grigoraci had practiced accounting for many

years either as a general partner in other partnerships or as a

sole proprietorship.    There is no evidence he had a history of

avoiding liability for employment tax.    Not until he considered

joining GTWP did Mr. Grigoraci begin to use the corporate form.

Mr. Grigoraci claimed that he chose the corporate form because he

did not want to be the only partner in GTWP who was personally

liable for GTWP’s liabilities.    It was Mr. Grigoraci’s

understanding that his potential future partners were both

corporations.    Specifically, his partners were to be Trainer S

Corporation and Wright S Corp.    Upon seeking the advice of

counsel, Mr. Grigoraci’s attorney advised him that he should use

the corporate form to limit his potential liability.
                                 23

     Use of the corporate form to limit the personal liability of

a taxpayer has long been recognized as a valid business purpose

for incorporating.    Davis v. Commissioner, 64 T.C. 1034, 1044

(1975) (citing Siegel v. Commissioner, 45 T.C. 566 (1966));

S. Dredging Corp. v. Commissioner, 54 T.C. 705 (1970); Doe v.

Commissioner, T.C. Memo. 1993-543, affd. in part and revd. in

part on other grounds 116 F.3d 1489 (10th Cir. 1997); Aagaard v.

Commissioner, T.C. Memo. 1985-194, affd. sub nom. Gran v.

Commissioner, 664 F.2d 199 (8th Cir. 1981).

     We find Mr. Grigoraci’s reasons for forming Grigoraci S

Corporation believable and logical.   The formation of the

corporation to limit his personal liability is a valid business

purpose.    Accordingly, the Grigoracis satisfy the first prong of

the test of Moline Props., Inc. v. Commissioner, supra, and we

shall recognize the existence of the corporation for Federal tax

purposes.

     Respondent has advanced no other argument to support the

determination that the Grigoracis owe self-employment tax on the

$32,000 of income.   Accordingly, we hold that the Grigoracis do

not owe self-employment tax on the $32,000 of income that

respondent determined was personal service income and not wages.

Moreover, we determine that the Grigoracis properly reported this

income as wages from Grigoraci S Corporation.
                            24

To reflect the foregoing,

                                 An appropriate order will be

                        issued and decision will be entered

                        for petitioners in docket No. 7268-

                        00; an appropriate order will be

                        issued and decision will be entered

                        in docket No. 7890-00; and an

                        appropriate order of dismissal for

                        lack of jurisdiction will be

                        entered in docket No. 9573-00.
