                         T.C. Memo. 2004-272



                       UNITED STATES TAX COURT



             ERIC B. BENSON, ET AL.,1 Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent




     Docket Nos.     585-98, 19416-98,   Filed November 29, 2004.
                   19417-98, 19421-98,
                   12967-00, 14171-01.




     John M. Youngquist, for petitioners.

     Michael E. Melone and Charlotte Mitchell, for respondent.




     1
      Cases of the following petitioners are consolidated
herewith: Brad D. Benson, docket No. 19416-98; Mark D. Benson,
docket No. 19417-98; Eric B. Benson, docket No. 19421-98; Burton
O. and Elizabeth C. Benson, docket Nos. 12967-00 and 14171-01.
                                 - 2 -

                MEMORANDUM FINDINGS OF FACT AND OPINION


     RUWE, Judge:     These cases were consolidated for purposes of

trial, briefing, and opinion.        Respondent determined deficiencies

in petitioners’ Federal income taxes, additions to tax pursuant

to section 6651(a)(1),2 accuracy-related penalties, and additions

to tax/fraud penalties pursuant to sections 6653(b) and 66633 for

the docket numbers, taxable years, and in the following amounts

as stated:

Eric B. Benson, Docket No. 585-98:
                                 1
                                  Additions to Tax/Penalties
     Year         Deficiency     Sec. 6651(a)    Sec. 6663(a)

     1993          $236,997           $59,793         $177,748
            1
           Respondent asserts the accuracy related penalties as
     an alternative in the event that the Court does not find
     fraud.

Brad D. Benson, Docket No. 19416-98:

                                    Penalty
     Year         Deficiency     Sec. 6662(a)

     1994          $43,906            $8,781




     2
      All section references are to the Internal Revenue Code in
effect for the taxable years at issue, and all Rule references
are to the Tax Court Rules of Practice and Procedure.
     3
      In the notices of deficiency, respondent took an
alternative position that accuracy-related penalties pursuant to
sec. 6662(a) for the tax years 1989, 1990, 1993, and 1994 apply
to the extent additions to tax/fraud penalties do not. See also
infra note 70.
                                          - 3 -

Mark D. Benson, Docket No. 19417-98:

                                             Penalty
       Year         Deficiency            Sec. 6662(a)

       1994              $50,158            $10,032

Eric B. Benson, Docket No. 19421-98:

                                             Penalty
       Year         Deficiency            Sec. 6662(a)

       1994              $36,853            $7,370

Burton O. and Elizabeth C. Benson, Docket No. 12967-00:
                                      1
                                       Additions to Tax/Penalties
Year        Deficiency       Sec. 6651(a)    Sec. 6653(b)     Sec. 6663(a)

1988         $125,578             –               $100,654.50         –-
1989           168,666        $42,173.50              –-         $126,499.50
             2
1990           113,559         28,390.25              –-           85,169.25
           3
1993        1,500,523             –-                  –-        1,125,392.25
       1
      Respondent asserts the accuracy related penalties as an
alternative in the event that the Court does not find fraud.
       2
      In his second amendment to answer to petition as amended,
docket No. 12967-00, respondent asserted an increase in the
deficiency amount, addition to tax, and fraud penalty for 1990 of
$122,930, $30,733, and $92,197.50, respectively. See infra p. 5,
table, note 2.
       3
      In his second amendment to answer to petition as amended,
docket No. 12967-00, respondent decreased the amount of the
deficiency and fraud penalty for 1993 to $1,499,627 and
$1,124,720.25, respectively.

Burton O. and Elizabeth C. Benson, Docket No. 14171-01:

                                             Penalty
       Year         Deficiency            Sec. 6663(a)
                         1
       1994               $118,429        $88,821.75
       1
      In his amendment to answer, docket No. 14171-01, respondent
asserted an increase in the deficiency amount and fraud penalty
                                 - 4 -

for 1994 of $129,902 and $97,426.50, respectively.     See infra p.
5, table, note 2.

     In the notices of deficiency, respondent asserted many

alternatives and whipsaw positions.      For ease of explanation, we

address only those issues which we decide.     Additionally, there

are numerous computational issues which we omit from our

discussion.    Because of the interconnected nature of these cases,

our findings and holdings as to some petitioners will have

ramifications to other petitioners.      As a result, there will be

extensive adjustments made by the parties under a Rule 155

computation.

     After numerous concessions by respondent and petitioners,4

the issues remaining for decision are as follows:

     1.   Whether petitioners Burton O. and Elizabeth C. Benson

(the Bensons) received and failed to report constructive

dividends.    The transactions still at issue for the years and the

amounts are listed as follows:




     4
      Because of their number, a summary of the parties’
concessions is attached hereto and incorporated herein as an
appendix.
                                    - 5 -

                                            Tax Year
    Description         1988       1989       1990        1993         1994

ERG-Recreation acct.     –-          –-        –-         $8,000     $2,698
Transfers ERG to NPI $180,000    $483,098      –-      3,600,000   160,063
143 Alice Lane           –-          –-     $336,500        –-         –-
Prop. taxes Alice Ln.    –-          –-        –-          3,879      8,196
Check ref: Carroll       –-        96,749      –-           –-         –-
Automobile deductions    9,465     10,624      8,676      14,808     14,723
Charitable deduction     –-          –-        –-         50,000       –-
Excess rent--Stanford1   –-          –-      2
                                              40,067      46,560     63,444
                                                                    3
Rent--Lowell plant      31,850     29,400     29,400      31,020     41,376
Director’s fees
  Elizabeth Benson       –-        3,000      12,000      12,000    12,000
  Related parties        –-        3,000      11,000      30,000    25,000
  Esther Benson check    –-         –-         –-           –-      12,000
Townsend check           –-         –-         –-           –-      15,000
Travel expenses          –-         –-         –-           –-       6,690
Legal expenses           –-         –-         –-           –-       4,159
Employee relations       –-         –-         –-           –-       4,027
  Total                221,315   625,871     437,643   3,796,267   369,376
      1
       The record and briefs contain inconsistencies with respect to
respondent’s determinations for the Stanford and Lowell plants. Indeed,
generally, the notices of deficiency list the amounts stated above for
Stanford as that for Lowell, and vice versa. For example, on one page of the
Bensons’ notice of deficiency for 1994, the adjustment for “Excess rents for
Stanford plant” is listed as $41,736 and for “ERG’s payments for Lowell plant”
as $35,316. On the very next page, the excess rent for Stanford is listed as
$35,316 and for Lowell as $41,736. Respondent’s answers, amendments thereto,
and brief mimic the amounts stated above. We assume a clerical error and
assign no substantive significance to this error.
      2
        On brief, respondent explained that he amended his answers in docket
Nos. 12967-00 and 14171-01, which amendments caused respondent to assert
increased deficiencies for the Bensons, for tax years 1990 and 1994. See
supra p. 3, tables, notes 1 & 2. However, for 1993 his amendment caused a
decrease in the amount determined; respondent determined in the notice of
deficiency that the Bensons failed to report $48,758 in rent for the Stanford
plant. See supra p. 3, table, note 3.
      3
       Clearly, there is a clerical error in the amount stated in respondent’s
brief, $41,376, as the amount listed in the notice of deficiency is $41,736.


      2.   whether the Bensons received and failed to report other

income.    The transactions still at issue for the years and in the

amounts are as follows:

                                            Tax Year
Description             1988       1989       1990       1993          1994

Dividend income          –-         –-         –-         –-       $1,072
                                                                   1
Discharge debt           –-         –-         –-         –-       88,291
                                     - 6 -

     1
        Respondent alternatively argues that this amount is includable in 1988.


     3.     whether the Bensons are entitled to deduct expenses with

respect to a ski cabin owned by the Baden Spiel Haus partnership

in the amount of $2,635 for 1994;

     4.     whether the Bensons are entitled to claim a deduction

for residential rental expenses in excess of the amounts allowed

by respondent;

     5.     whether Burton Benson is liable for fraud penalties for

the years at issue;5 or

             (a) alternatively, whether the Bensons are liable for

accuracy-related penalties for the years 1989, 1990, 1993, and

1994;

     6.     whether Eric B. (Eric), Brad D. (Brad), and Mark D.

(Mark) Benson are liable for accuracy-related penalties as

determined;

     7.     whether the Bensons and/or Eric are liable for additions

to tax for failure to file a Federal income tax return pursuant

to section 6651(a)(1) as determined;

     8.     whether the period of limitations bars assessment of the

Bensons’ taxes reported on their 1988, 1989, 1990, 1993, and 1994

Federal tax returns;




     5
      We use the term “fraud penalties” to include the addition
to tax for 1988 under sec. 6653(b).
                                 - 7 -

      9.    whether Eric, Brad, and Mark received and failed to

report distributions from an S corporation in excess of their

stock basis;

      10.   whether Eric, Brad, and Mark are subject to the passive

loss rules with respect to passthrough rental losses from an S

corporation.

                           FINDINGS OF FACT

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

The stipulation of facts, the supplemental stipulations of facts,

the stipulations of settled issues, and the attached exhibits are

incorporated herein by this reference.     At the time of filing the

petitions, each petitioner’s legal residence was Orinda,

California.

1.   Background

      Burton O. Benson (Burton) served 9 years as an officer in

the U.S. Navy and 23 years as an officer in the U.S. Naval

Reserve, retiring with the rank of Rear Admiral.     Burton earned a

B.S. degree in mechanical engineering from the University of

Minnesota.     Eric, Mark, and Brad are the sons of the Bensons.6

Glendon M. Benson (Glendon) is the elder brother of Burton.

Esther V. Benson (Esther) was the mother of Burton and Glendon.




      6
      Eric, Mark, and Brad were born on July 24, 1974, Aug. 26,
1976, and Aug. 11, 1981, respectively.
                                 - 8 -

     Energy Research & Generation, Inc. (ERG) is a corporation

incorporated by Glendon, his wife, Janet Benson, and Burton in

California on January 5, 1967.    During the years at issue, ERG

utilized the accrual method of accounting for tax purposes.

     ERG is the only company in the world that manufactures

various forms of foam metal and foam metal baffles.7   Duane Walz

and Glendon invented the process known as foam metal which

Glendon then developed into a product.    However, Walz was given

sole credit as the inventor in the patent, and on March 23, 1976,

he assigned his patent rights to ERG.

     On each of the tax returns filed by ERG for 1988 through

1994, Burton is listed on Schedule E, Compensation of Officers,

as owning 100 percent of the common stock of ERG.    Throughout the

years 1988 through 1994, Burton was a director of ERG.

Throughout the years 1988 through 1994, ERG maintained a money

market account with Merrill Lynch Pierce, Fenner & Smith, Inc.,

account No. 280-07888-2 (ERG’s bank account).

     New Process Industries, Inc. (NPI) was originally

incorporated in Minnesota in 1922 by Burton and Glendon’s father

under the name New Process Laundries, Inc.    On January 6, 1967,

the name was changed to NPI.   During the years at issue, NPI




     7
      Foam metal baffles are used in the U.S. Navy’s fleet of
ballistic missiles.
                                    - 9 -

utilized the cash method of accounting for tax purposes and was

an S corporation.

     The Benson family’s percentage of ownership in NPI was

listed on its tax returns for the individuals, for the years, and

in the amounts as stated:

                                    Year of NPI Return
Individuals          1988    1989     1990 1991 1992      1993   1994

Burton               66.7    66.7    66.7   66.7   50.0   66.7   50.0
Esther               33.3    33.3    33.3   33.3   50.0    –-     –-
Eric                  –-      –-      –-     –-     --    11.1   16.7
Brad                  –-      –-      –-     –-     –-    11.1   16.7
Mark                  –-      –-      –-     –-     –-    11.1   16.7

     Throughout the years at issue, there was no written

agreement between ERG and NPI relating to engineering, design, or

management services, NPI did not treat anyone as an employee, and

no Form 941, Federal Payroll Tax Returns, was filed or Form 1099

was issued.   During this same period, NPI maintained a money

market account with Merrill Lynch Pierce, Fenner & Smith, Inc.,

account No. 280-07017-8 (NPI’s bank account).

     During the years at issue, NPI owned three parcels of real

property located in Oakland, California:       (1) 952 57th Street

(Lowell plant); (2) 900-960-962-964 Stanford Avenue (Stanford

plant); and (3) vacant land adjacent to 900 Stanford Avenue

fronting on Lowell Street.    Before and after July 1, 1987, ERG

conducted its foam metal manufacturing operations from the

Stanford Plant.
                               - 10 -

     In the mid-1980s, a dispute arose between Burton and Glendon

over the operation and ownership of ERG.   On April 4, 1985, the

Bensons filed a lawsuit against Glendon, his wife Janet, and ERG.

In or about September 1985, Glendon convened an ERG board meeting

during which the directors in attendance supposedly voted to

terminate Burton’s employment with ERG.    Immediately thereafter,

Glendon hired security personnel to bar Burton from entering

ERG’s facilities.

     In October 1985, Burton and Glendon executed an agreement

delineating their respective responsibilities concerning

contracts with two major ERG clients, Hercules Aerospace Co.,

Inc. (Hercules),8 and Gas Research Institute (GRI).   Essentially

under that agreement, Burton was granted all rights to and

responsibility for contracts with Hercules, and Glendon was

granted all rights to and responsibility for contracts with GRI.

     In May 1986, Burton and Glendon initiated binding

arbitration.   On July 9, 1986, the arbitration panel issued an

interim decision.   In October 1986, Burton and Glendon entered

into an agreement to adjourn the arbitration proceedings choosing

instead to mediate the dispute with the aid of Winston E. Miller

(Miller or WEM) as mediator.   On June 28, 1987, during the course

of mediation, Burton and Glendon entered into an agreement


     8
      Hercules and all predecessors and successors in interest
will be referred to throughout this opinion as Hercules.
                               - 11 -

entitled “Memorandum Re: Unbundling of ERG”.    Burton and Glendon

executed a document entitled “Supplemental Memorandum Re:

Unbundling of ERG (December 4, 1987)”.    On December 5, 1987,

Burton and Glendon executed a document entitled “Memorandum Re:

Other Commitments made to WEM”.9

     By letter dated March 18, 1988, ERG and NPI, through Burton,

gave instructions to their patent counsel of the firm Townsend &

Townsend to transfer certain patents, patent applications, and

intellectual property to Glendon.   The parties stipulated that on

December 29, 1988, Glendon incorporated Aker Industries, Inc.

(Aker).10   After July 1987, and during all periods relevant to

these cases, Burton exercised almost sole control over the

management and operations of ERG and NPI.

     On March 23, 1993, Glendon and his wife, Janet, filed a

motion asking a California court to enforce the unbundling

agreement as a settlement agreement.    In response to a 1994

petition filed by Burton, the court ordered the parties to

recommence arbitration.   In 1994, arbitration proceedings

recommenced.   On June 7, 1995, a second interim arbitration

     9
      Except as otherwise noted to the contrary, we refer to the
documents executed by Burton and Glendon during mediation
collectively as the “unbundling agreement”.
     10
      On Feb. 29, 1988, Burton signed a City of Oakland Business
Tax Declaration stating that ERG’s research and development
division had been established as a new company, “Acker [sic]
Industries”. However, Glendon testified that Aker was
incorporated in July 1987.
                              - 12 -

decision was issued.   On November 8, 1996, a third interim

arbitration decision was issued.

     On March 5, 1999, a final arbitration decision was issued.

The final arbitration decision comprehensively decided the issues

between the brothers, and the arbitrators found, inter alia,

that:

          During the period from and after July 1, 1987,
     * * * [Burton]/ERG/NPI was extremely successful * * *.
     As a result, in the period from 1988 through 1996,
     * * * [Burton] and his family obtained in excess of
     $6,500,000 in salaries, director’s fees and cash
     distributions from ERG/NPI.

          * * * [F]rom and after July 1, 1987, * * *
     [Burton] had total control over both ERG and NPI * * *

Accordingly, the arbitrators held that Burton became the 100-

percent owner of ERG on July 1, 1987.   The arbitrators found that

Burton owed Glendon a gross amount of $3,119,475 for his interest

in ERG.   The arbitrators awarded the Lowell plant to

Glendon/Aker, for which Burton received a credit of $185,500.

The tribunal found that Glendon/Aker should have paid NPI rent

for the Lowell plant at $2,000 per month for the period July 1,

1987, to December 31, 1994, and $2,500 thereafter.   Accordingly,

Burton was credited with the rent payments plus interest,

$420,650.   The final arbitration decision awarded Glendon a net

$2,412,172 after credits and deductions.
                               - 13 -

2.   Constructive Dividend Issues

      (a) The ERG-Recreation Fund Account

      On or about April 5, 1985, Burton submitted an application

to open an account with the Franklin Group of Funds (Franklin)

under the name “ERG-Recreation Fund”.    The account was opened and

assigned money fund account No. 1110267091-7 (the ERG-Recreation

fund account).    During the years 1988 through 1994, Burton was

the only person with signature authority over the ERG-Recreation

fund account.    Checks written against the account were payable

through Bank of America.

      In 1988, numerous checks were deposited into the ERG-

Recreation fund account aggregating $4,387.34.    Additionally,

checks were written from this account.    For example, check No. 6,

dated September 7, 1988, payable to NPI for the amount of $3,000

was signed by Burton.    This check was deposited into NPI’s bank

account during the period August 27 to September 30, 1988.

      In 1990, numerous checks were deposited into the ERG-

Recreation fund account aggregating $11,097.53.    In 1990, three

checks were written on this account, all signed by Burton, for

example:   (1) Check No. 7, dated April 5, 1990, for $3,128 was

written to Michael’s Reno Suzuki; and (2) check No. 8, dated June

16, 1990, for $597.44 made payable to Anytime Power Sports

Equipment.
                                  - 14 -

      In 1993, numerous checks were deposited into the ERG-

Recreation fund account aggregating $8,819.73.      In 1993, five

checks were drawn on this account, all signed by Burton, for

example:      (1) Check No. 27, dated March 8, 1993, for $9,000 made

payable to ERG; (2) check No. 29, dated June 11, 1993, for $356

made payable to Siegle’s;11 (3) check No. 30, dated July 15,

1993, for $9,000 made payable to petitioner Mark;12 and (4) check

No. 31, dated August 16, 1993, for $8,000 made payable to ERG

Retirement Trust.

      The parties stipulated that in 1994, numerous checks were

deposited into the ERG-Recreation fund account aggregating

$6,068.13      In 1994, eight checks were drawn on this account, all

signed by Burton, for example:      (1) Check No. 32, dated May 13,

1994, for $100 made payable to Mt. Diablo Silverado Council, BSA;

(2) check No. 34, dated August 13, 1994, for $206.38 made payable

to Berkeley Yamaha; (3) check No. 35, dated September 15, 1994,

      11
           In 1993, Siegle’s Guns was a firearms retailer in Oakland,
Ca.
      12
      On July 19, 1993, check No. 30 was deposited into a
custodial account into which Burton deposited his payroll checks
and other checks from ERG.
      13
      The parties stipulated that in 1994 “numerous checks from
various sources were deposited into the ERG Recreation Fund
Account in the aggregate amount of $6,068" and referenced an
exhibit in the record. The referenced exhibit contains copies of
an annual account statement for this account which shows
aggregate deposits of $5,864.42 for 1994. Additionally, the
referenced exhibit contains copies of checks apparently deposited
into this account in the aggregate amount of $4,411.85.
                             - 15 -

for $274.66 made payable to Bobbi Judson; (4) check No. 37, dated

September 24, 1994, for $265 made payable to Marc Dronkers; (5)

check No. 38, dated November 23, 1994, for $650 made payable to

Donald J. Holleran; and (6) check No. 39, dated December 14,

1994, for $724.10 made payable to Marc Dronkers.    Check Nos. 35

and 39 note Risktaker in the memo section of the checks, which

refers to a sailboat partly owned by Burton.

     (b) Payments From ERG to NPI

     During the years 1988 through 1994, Burton caused ERG to

transfer significant funds to NPI on the dates and in the amounts

as follows:

     Date Transferred      Amount       Date Deposited

         12/30/88         $180,000             Unknown
          4/15/93          750,000             4/21/93
          4/15/93          190,000             4/21/93
          4/20/93        2,060,000             4/26/93
         12/30/93          600,000             1/10/94
          4/15/94          129,414             4/19/94
          6/17/94           30,649             6/22/94
           Total         3,940,063

Burton never told his accountant and return preparer, Edward

Bradac (Bradac), about ERG’s 1988 transfer of $180,000 to NPI.

Bradac was unaware of the transfer until late 1995 or early 1996

when he worked on compiled financial statements for ERG.

     All the aforementioned transfers were made from ERG’s bank

account and deposited into NPI’s bank account.
                                 - 16 -

     (c) Payment for Increased Baffle Production

     One of ERG’s principal customers was Hercules.      During the

years at issue, ERG produced a baffle system on behalf of

Hercules with respect to the Trident II D-5 U.S. Navy Fleet

Ballistic Missile Program.14     At some point, Hercules requested

an increase in the production of baffle sets.     ERG, through

Burton, indicated that to increase production ERG would require

additional equipment and materials.

     On or about November 22, 1989, Hercules and ERG entered into

a memorandum of agreement (MOA), whereby Hercules agreed to pay

$483,098 as an add-on cost to increase production of the baffle

sets delivered by ERG.15     The MOA was unique because it called

for Hercules to “facilitize” or fund ERG’s plant and equipment,

the cost of which is normally paid for by the owner of the plant

and equipment.     Attached to the MOA is “schedule 1", which lists

the equipment and their associated prices as contemplated by the




     14
          The baffles were made from ERG’s foam metal.
     15
      Under the MOA, the add-on cost was spread over the
invoicing of the baffle sets delivered. The MOA states in
pertinent part:

     The add-on cost per Baffle per year will be the sum of
     the seven year double declining schedule amount for
     that particular year plus the Cost Accounting Standards
     cost of money, * * * evenly divided among the number of
     Baffles that are scheduled to be delivered within that
     year. * * *
                                - 17 -

MOA.16    Some of the items listed involve proprietary processes.

The projected prices in schedule 1 include the cost of time and

engineering to specify the details of the equipment, to design

the assembly, modifications, and installations of the equipment,

and to do debugging on the production process to make sure the

equipment worked properly.    Some of the equipment was supposedly

to be created by ERG.17

     On or about December 20, 1989, ERG and NPI entered into a

“Plant Equipment & Facilities Purchase Agreement”.    Under this

agreement, in exchange for $483,098, NPI agreed to purchase,

deliver, install, and place into operation as a “turnkey

operation” the items listed on schedule 1 of the MOA, which was

incorporated into the agreement.    On or about December 29, 1989,

ERG issued check No. 20498 to NPI for $483,098.

     On August 8, 1990, Burton, as president of ERG, executed a

document entitled “Certification That Plant

Equipment/Facilitization Items Are in Place and Operational”.

By this document, Burton certified to Hercules that the equipment

listed on schedule 1 of the MOA was in place and operational at

ERG, or would be by December 31, 1990.

     16
      ERG’s chief engineer, Bryan Leyda, testified that he
created the prices on schedule 1 with the help of an associate
engineer.
     17
      Mr. Leyda testified: “There’s no way that you can buy
this kind of * * * [equipment] off the shelf. You might buy
pieces, but not the entire piece of equipment.”
                               - 18 -

     Hercules paid ERG the $483,098 agreed to in the MOA in

increments included in the amounts it paid to ERG for each baffle

set purchase order during the period 1990 through 1997.    However,

neither NPI nor ERG purchased the equipment listed on schedule 1

of the MOA.

     On its original 1989 Form 1120S, U.S. Income Tax Return for

an S Corporation, NPI did not report any portion of the $483,098

payment from ERG.   On its 1989 Form 1120, U.S. Corporation Income

Tax Return, ERG deducted $248,097 of the $483,098 payment to NPI

as a royalty.   On its amended 1989 Form 1120S, NPI reported

income of $248,097 with respect to the $483,098 payment from ERG.

On its original 1990 Form 1120S, NPI reflected the $483,098

payment from ERG as an increase in liabilities; i.e., a security

deposit.   On its 1990 Form 1120, ERG deducted $193,508 of the

$483,098 payment to NPI as a royalty.

     (d) Exclusive Royalty Agreement Between ERG and NPI

     ERG owned and/or was assigned certain patent technologies.

Additionally, Glendon assigned to NPI numerous patents which were

issued for technologies he invented.    On or about March 10, 1990,

Burton executed as president of both NPI and ERG, a document

entitled “Agreement of Sale and Exclusive License” (exclusive

license agreement).18   The document had a retroactive effective


     18
      The agreement also bears the signatures of Elizabeth and
Esther.
                              - 19 -

date of July 1, 1987, and a 40-year term.19    The document

purports to sell certain “patent rights” owned by ERG to NPI and

simultaneously grants ERG an exclusive license to use the patent

rights transferred.   The patent rights are described as the

“technology, technique, show-how, and know-how” relating to foam

metal, RVC foam, and SIC foam.

     Pursuant to the agreement, NPI purchased ERG’s patent rights

for $5,000 and 50 percent of all consideration that NPI received

from the “assignment, licensing, sublicensing, leasing, or other

commercial exploiting” of the patent rights.    Under the

agreement, ERG would pay to NPI, inter alia, 10 percent of its

net sales of any product incorporating the patent rights licensed

to ERG by NPI.

     (e) 143 Alice Lane

     During the years at issue, the Bensons owned, and used as

their principal residence, real property located at 5 Evans

Place, Orinda, California.   The Bensons entered into an agreement

with Dover Construction, dated June 13, 1990, to purchase a

portion of real property adjacent to their residence (the Dover



     19
      During arbitration proceedings, Miller gave testimony
concerning this agreement. On Apr. 7 and 8, 1997, Miller
testified that it was his advice to Burton to create the
agreement. In fact, Miller testified that he gave Burton a
“model” license agreement from which to fashion the agreement
between ERG and NPI. Furthermore, Miller testified that there
was nothing unusual about backdating the agreement.
                               - 20 -

property).20   Abutting the Dover property is the real property

located at 143 Alice Lane, Orinda, California (143 Alice Lane).

     In June 1990, ERG purchased 143 Alice Lane for $335,000.21

ERG took title to the property in the name “Burton O. Benson,

Trustee” of the ERG Retirement Trust.22   The ERG Retirement Trust

neither paid for the purchase nor reflected the property as an

asset on any tax return or financial statement.   ERG’s purchase

of 143 Alice Lane, along with the Bensons’ purchase of the Dover

property, gave the Bensons a large, uninterrupted piece of land

behind and abutting their residence.

     On or about April 10 and December 10, 1993, ERG paid

$1,925.57 and $1,953.14, respectively, for property taxes on 143

Alice Lane.    In 1994, ERG paid $8,196 in property taxes for 143

Alice Lane.

     On October 28, 1997, Burton as trustee of the ERG Retirement

Trust deeded 143 Alice Lane to the Bensons as husband and wife.


     20
      The Bensons were deeded the Dover property on or about May
23, 1991.
     21
      The price paid inclusive of fees and taxes was
$336,410.72.
     22
      During the years at issue, ERG maintained a single plan
qualified under ch. 1, subch. D of the Code, the Energy Research
& Generation, Inc., Profit Sharing Plan (the plan). The plan
assets were invested in a single trust, the ERG Retirement Trust.
ERG maintained Franklin Money Fund accounts under the names ERG
Ford Retirement Trust and ERG Retirement Trust. The ERG Dynar
Retirement Trust and the ERG Ford Retirement Trust are not
separate trusts.
                               - 21 -

The deed shows no consideration for the transfer and indicates

the transfer was a “gift to spouse”.

     (f) ERG Check to Burton (Ref. Carroll)

     On May 17, 1989, a petition for confirmation of arbitration

award and entry of judgment was filed in the California Superior

Court, San Francisco County.   According to that document, Michael

Brooks Carroll (Carroll) provided advice and legal services with

respect to the disagreement Burton had with his brother

concerning the ownership, management, and control of NPI and ERG.

Burton withheld payment for such services.    The arbitrators

rendered a decision that Burton owed Mr. Carroll $96,748.98, plus

interest thereon.

     On May 19, 1989, ERG issued Burton check No. 19888 for

$96,748.98.   The check bears the notation “for Michael B.

Carroll.”   The check was endorsed “For Deposit Only Wells Fargo

Bank 740-6070466," an equity credit line of the Bensons (the

Bensons’ Wells Fargo bank account).     The check was deposited and

accepted for payment on May 24, 1989.23    On or about May 23,

1989, Burton purchased a Wells Fargo Bank cashier’s check No.

13499 made payable to Carroll for $97,467.21 from the Bensons’




     23
      The check was initially presented for payment on May 19,
1989, but not honored because of insufficient funds. On May 24,
1989, the check was again presented for payment.
                                - 22 -

Wells Fargo bank account.24   On their 1989 Form 1040, U.S.

Individual Income Tax Return, the Bensons claimed a deduction for

a portion of the legal fees paid to Mr. Carroll of $77,973.

     (g) Automobile and Truck Deductions

     ERG claimed deductions for automobile and truck expenses for

the following years in the amounts stated:

          Tax Year              Amount of Deduction

            1988                     $9,645
            1989                     10,624
            1990                     23,676
            1993                     28,308
            1994                     14,723

ERG bought a Jeep for Eric for $15,000 in 1990 and a Ford Bronco

for Mark for $13,500 in 1993.    ERG’s claimed deductions included

the cost of purchasing these two vehicles, as well as DMV fees,

insurance, gasoline, and repairs for four family cars.   The

Bensons conceded that the purchase of the automobiles constituted

constructive dividends.   See appendix.

     The Bensons were authorized signators on a First Interstate

checking account No. 804-2-01477, which was used exclusively to

pay for gasoline purchases through Interlink bank debit card(s)

linked to that account.   During the years listed, ERG paid the

following amounts for gasoline:

     24
      The record does not disclose why there is a difference
between the amount of the arbitration award and the amount of the
payment. We assume since the arbitrators’ award included
“interest thereon” that the additional money is accrued interest
from the date of the decision to the date of payment.
                              - 23 -

                 Tax Year               Amount

                   1990              $1,853.00
                   1993               4,194.09
                   1994               4,383.16

     (h) Charitable Contributions

     In 1989, ERG donated $6,000 to the Moraga Valley

Presbyterian Church (MVPC).   On its 1989 Form 1120, ERG claimed

the $6,000 as a charitable deduction.    On their 1989 Form 1040,

the Bensons also claimed a $6,000 charitable deduction for MVPC.

     In 1990, ERG donated $6,000 to MVPC.    ERG did not claim the

donation as a deduction on its 1990 Form 1120; however, the

Bensons did claim the donation as a deduction on their 1990

individual Federal income tax return.

     In 1993, ERG issued checks payable to MVPC totaling $6,000.

ERG issued check No. 23554, dated December 31, 1992, for $50,000

made payable to Bank of America.    The check was negotiated on

March 3, 1993.   On March 5, 1993, Burton purchased cashier’s

check No. 8006822409 for $50,000 from Bank of America made

payable to MVPC.   MVPC deposited the check on March 12, 1993.

ERG’s 1993 Form 1120 contained a deduction for charitable

contributions of $4,800 and no charitable contribution carryover.

On their 1993 personal Federal income tax return, the Bensons

claimed a charitable contribution deduction for the $6,000 paid

to MVPC by ERG and the $50,000 cashier’s check paid to MVPC.
                                - 24 -

     In 1994, ERG paid $13,500 to MVPC and $2,000 to Camp

Timberwolf.     On their personal return, the Bensons claimed a

charitable contribution deduction of $33,374, which included

$2,000 to Camp Timberwolf and $18,000 to MVPC.     ERG’s 1995 Form

1120 reflected charitable contribution carryovers of $102,646

from 1991, $13,200 from 1992, $1,984 from 1993, and $20,000 from

1994.     The $20,000 shown as a carryover from 1994 included a

$10,000 contribution to MVPC and a $2,000 contribution to Boy

Scouts of America (Timberwolf).

     (i) Rent Paid to NPI for Stanford and Lowell Plants

     Throughout 1988-94, ERG occupied the Stanford plant which

was owned by NPI.     In 1988, a commercial lease for the Stanford

plant was prepared but not executed.     Similarly, in 1988, a

commercial lease for the Lowell plant was prepared but not

executed.     The Lowell plant was used by Glendon/Aker.25   During

the period 1988-94, ERG paid monthly rent to NPI for both the

Stanford and Lowell plants.26    The parties stipulated that the




     25
      Glendon testified that he did not pay rent to NPI during
the period July 1987 through December 1994.
     26
      Burton testified that before the arbitrators’ final
decision in March 1999, he considered it ERG’s responsibility to
pay the rent for ERG’s research and development division, Aker
Industries. In the final arbitration decision, the arbitrators
decided that Glendon/Aker was liable to NPI for rent for the
period July 1, 1987, through Dec. 31, 1998, in an amount
including interest, totaling $420,650.
                                  - 25 -

rent was paid and allocated between the properties for the years

as follows:

     Year         ERG Payments to NPI      Stanford        Lowell

     1988              $98,917             $67,067         $31,850
     1989                83,699             56,749          26,950
     1990              137,917             106,067          31,850
     1993              146,400             112,560          33,840
                      1
     1994               168,360            129,444          38,296

          1
            The amounts stated above are those listed in a joint
     exhibit offered by the parties. However, it is clear that
     $129,444 plus $38,296 does not equal $168,360, but instead
     $167,740.

     (j) Director’s Fees27

     As detailed below, ERG paid purported “director’s fees”

during the years at issue.28      ERG did not file Forms 1099 with

respect to payment of any of the director’s fees.

            (i)   Elizabeth C. Benson

     In 1989, ERG issued three $1,000 checks payable to

Elizabeth, which she deposited into the Bensons’ Wells Fargo bank

account.    In 1990, ERG issued twelve $1,000 checks payable to

Elizabeth, of which she deposited seven into the Bensons’ Wells

Fargo bank account and five into Franklin account No. 11100025476

(Franklin account).    In 1993, ERG issued twelve $1,000 checks


     27
      Petitioners concede that amounts that ERG paid should have
been included in the returns of the purported directors.
     28
      Our categorization is based solely upon the stipulations
and characterizations made by the parties. With the exception of
two checks issued to Eric, the ERG checks issued do not indicate
their intended purpose.
                                 - 26 -

payable to Elizabeth, which she deposited into various bank

accounts.29     In 1994, ERG issued twelve $1,000 checks payable to

Elizabeth, which she deposited into the Franklin account.

             (ii) Esther V. Benson

     In 1989, ERG issued three $1,000 checks payable to Esther.

Each check was deposited in 1990 into a Merrill Lynch Ready Asset

account No. 280-72453 (ML RAT account).     In 1990, ERG issued

eleven $1,000 checks payable to Esther.     Those checks were

deposited into various bank accounts.30     In 1993, ERG issued (at

least31) eleven $1,000 checks payable to Esther.    One check,

check no. 23662, was endorsed and deposited into a bank account

held in the names Burton and Elizabeth.32     In 1993, eleven $1,000

checks were deposited into a bank account which Esther held with

Burton as joint tenants with the right of survivorship.33       In


     29
          See infra note 32.
     30
      Seven checks were deposited into the ML RAT account and
four checks were deposited into a First Bank account No. 711-
2005165.
     31
       See infra note 33.
     32
      On brief, petitioners explained that there was a “mix-up”
in the delivery of the director’s fees checks in 1993. Check No.
23661 payable to Elizabeth was deposited into Esther’s account,
and the director’s fee check for Esther was deposited into
Elizabeth’s account.
     33
      There is an inconsistency in the parties’ stipulation.
The parties stipulated that Esther was issued eleven $1,000
checks in 1993, one of which was deposited into an account owned
by Elizabeth and Burton. The parties also stipulated that eleven
                                                   (continued...)
                               - 27 -

1994 ERG issued eight $1,000 checks payable to Esther.34   Esther

did not file Federal income tax returns for 1988 through and

including 1993.

                  Check to Esther V. Benson

     In 1994, Burton took an uncashed check for $12,000 that ERG

had issued to Esther prior to May 1988, altered the date on the

check to indicate a date in August 1994, and deposited the check

into a bank account in September 1994 shortly after his mother’s

death.35   The bank account into which the check was deposited was

held in the names of Burton and his mother as joint tenants.




     33
      (...continued)
$1,000 checks were deposited into an account owned by Esther and
Burton. Indeed, the documentary evidence in the record contains
a bank statement for the Esther/Burton account which shows eleven
$1,000 deposits made in 1993. Additionally, the record contains
copies of eleven $1,000 checks, one of which was apparently,
erroneously deposited into an account owned by Elizabeth and
Burton. Arguably, then, there must have been twelve $1,000
checks issued to Esther, eleven of which were deposited into the
Esther/Burton account and one of which was deposited into the
Elizabeth/Burton account.
     34
      The parties stipulated that ERG issued eight $1,000 checks
to Esther, but the issuing bank was unable to locate a copy of
one check. However, the parties also stipulated that ERG did not
file Form 1099 with respect to the $9,000 paid to Esther. We are
unable to resolve the seeming inconsistency and ascribe a
scrivener’s error to the latter stipulation.
     35
      Burton testified that the check represented director’s
fees, and after his mother died he found the check uncashed among
her papers. He changed the date on the check because he believed
it would be rejected due to its age if negotiated.
                                 - 28 -

             (iii) Eric B. Benson

     ERG issued check No. 23548 for $6,000 to Eric, dated

December 30, 1992, on which “Directors Fee - 6 months” is written

on the memo line.36     On or about February 26, 1993, Burton and

Eric submitted an application to open an account with USAA

Investment Management Co. as joint tenants (the USAA account).

The initial investment into the USAA account was the

aforementioned $6,000 check.     In 1993, ERG issued twelve $1,000

checks to Eric, of which eleven were deposited into the USAA

account in 1993 and one in 1994.

     (k) Townsend & Townsend Check

     Townsend & Townsend, patent attorneys, issued a retainer fee

refund check for $15,000 dated January 14, 1994, payable to ERG.

Burton endorsed the check on behalf of ERG to the order of

Massachusetts Mutual Life Insurance Co.     The $15,000 was credited

on January 27, 1994, as a partial repayment of loans from the

insurance company to Burton relating to insurance policy No.

4506416.37     The parties stipulated that during the years at issue

the primary beneficiary of the insurance policy was Elizabeth.


     36
          Eric turned 19 years old on July 24, 1993.   See supra note
6.
     37
      Burton testified that loans totaling    $15,000 were taken
out in 1975 and 1984 against the insurance    policy and that the
funds were “borrowed from the * * * policy    to be put into ERG to
meet the payroll.” He testified that none     of the loan proceeds
were used for his personal benefit.
                               - 29 -

     (l) Travel Expenses

     On or about February 9, 1994, Burton signed an ERG travel

expense report indicating that he spent $616.47 on behalf of ERG.

Additionally, the following charges were made on the dates

indicated to an ERG BankAmericard credit card, account No. 0109-

733-620:

      Date        Description of Charge       Amount

     2/5/94        Grand Manor Inn #35       $223.82
                   Corvallis, OR
     5/10/94       Hertz Rent-A-Car            91.61
                   St. Paul, MN
     5/10/94       Radisson Hotels            227.32
                   Minneapolis, MN
     5/13/94       Ramada Inns                342.17
                   Falls Church, VA
     5/13/94       Hertz Rent-A-Car           137.46
                   Washington, D.C.
     9/7/94        Karim Cyclery               16.24
                   Berkeley, CA
     9/7/94        Surf Berkeley               56.40
                   Berkeley, CA
     9/10/94       Lowell Inn               1,542.79
                   Lake Elmo, MN
     9/11/94       SuperAmerica 4454            9.23
                   Bloomington, MN
     9/11/94       Hertz Rent-A-Car            89.90
                   St. Paul, MN
     12/18/94      The Claremont Resort     2,504.30
       Total                                5,241.24

ERG paid all these expenses.

     Esther passed away sometime in early September 1994, and

funeral services were held in Still Water, Minnesota.   On or

about October 4, 1994, ERG paid $833.06 for travel expenses

incurred on behalf of Pastor Leroy M. Nelson, Burton and
                               - 30 -

Glendon’s cousin.   Pastor Nelson presided over Esther’s funeral

services.

     (m) Legal Expenses

      The stipulated documentary evidence shows that in 1994 ERG

paid legal expenses of $4,660.19.    The invoices detail the

services provided as, inter alia, “Review: information from Burt

Benson respecting property line dispute”, an appeal to the

unemployment office, “Burton O. Benson v. Westinghouse Electric,”

review of proposed loan agreement, probate questions re: mother’s

estate, etc.

      (n) Employee Relations Expenses

      ERG purchased Oakland baseball tickets for $2,119.50, the

invoice for which was paid on or about February 11, 1994.

Additionally, respondent submitted copies of monthly invoices for

the Lakeview Club for the period December 25, 1993, through

September 25, 1994.   These invoices are addressed to “RADM Burton

O. Benson” and bear his home address.    The total amount shown as

being paid on these invoices is $915.66.

3.   Nonconstructive Dividend Issues

      (a) Dividend Franklin Accounts

      On or about May 1, 1983, Burton submitted an application to

open a joint investment account with the Franklin Money Fund

(Franklin).    The application bears the name “Benson Properties

Unlimited” as owner, Eric or Burton as co-owner, and Eric’s
                              - 31 -

Social Security number.   Franklin opened the account and assigned

it account No. 11102309431 (Franklin account #1).   On or about

December 28, 1983, Burton and Elizabeth submitted an account

revision form to Franklin, changing the signatories to “Burton O

Benson/Elizabeth C. Benson and no others.”

     Throughout 1988, 1989, 1990, 1993, and 1994, rent payments

received from tenants occupying residential real properties owned

by the Bensons were deposited into the Franklin account #1.

Expenses incurred with respect to those properties were also paid

from this account.   During the years 1988, 1989, 1990, 1993, and

1994, dividends were credited to this account in the amounts of

$204, $193, $229, $360, and $1,072.03, respectively.38   For the

years at issue, the Bensons did not report interest or dividend

income from Franklin account #1.   However, on his 1994 return

Eric reported dividend income from Franklin account #1 of $1,072.

     (b)   Forgiveness of Debt Income

     ERG’s 1987 Form 1120, Schedule L, Balance Sheet, reported

under the category assets “Loans to stockholders/officers” of

$88,291 as the balance at the beginning and end of that tax year.

For 1988, ERG’s Form 1120, Schedule L, filed August 1, 1994,

reported no amount for “Loans to stockholders/officers”.   On or



     38
      The parties stipulated that in 1994 $1,072 in dividends
was credited to this account. In fact, the amount credited was
$1,072.03.
                                 - 32 -

about July 29, 1994, accountant Bradac sent Burton a letter which

stated in part:

           Loans to Stockholders cannot be identified from
           our workpapers. If it could be identified, any
           amounts due from stockholders should be shown
           here, and the Corporation should make sincere
           efforts to collect. Any stockholder who has not
           repaid a corporate loan has personal income to
           report if the loan is forgiven by the Corporation.

On October 25, 1995, the Bensons filed their 1994 return.

4.   Transfers From NPI

      In 1993, Burton caused NPI to issue:      (1) Check Nos. 424,

439, and 444, totaling $129,480 from NPI’s bank account made

payable to the California Franchise Tax Board to pay his personal

tax liabilities; and (2) check Nos. 423, 425, 432, and 438 from

NPI’s bank account made payable to the Internal Revenue Service

(IRS) to pay his personal tax liabilities, the aggregate amount

of which was $378,000.39

      In 1994, Burton caused NPI to:      (1) Issue check Nos. 452,

462, and 468 totaling $28,745 from NPI’s bank account made

payable to the California Franchise Tax Board to pay his personal

tax liabilities;     (2) issue check Nos. 446, 451, 455, and 461

      39
      The parties stipulated that check No. 424 for $81,000 and
check No. 444 for $28,480 totaled $129,480, which was obviously
an error since these two sums equal $109,480. It is clear from
the documentary evidence in the record that three checks, Nos.
424, 439, and 444 were written from NPI’s bank account to the
California Franchise Tax Board in the total amount of $129,480.
Additionally, it is clear from the evidence that NPI issued
checks, Nos. 423, 425, 432, and 438 to the IRS in the total
amount of $378,000.
                               - 33 -

totaling $135,869 to the IRS to pay his personal tax liabilities;

(3) issue check Nos. 453 and 457 to himself in the total amount

of $200,000; and (4) wire transfer $1 million to First American

Title Guaranty Co. for the purpose of funding a $2,213,000

secured promissory note with respect to which Burton and

Elizabeth held a 45.188-percent interest as joint tenants.

      In 1995, Burton caused NPI to issue:   (1) Check No. 469 for

$23,331 payable to the IRS to pay his personal tax liabilities;

(2) check Nos. 474, 475, 486 in the aggregate amount of $400,000

to himself and/or his wife; (3) check No. 477 for $1 million

payable to Jack White & Co. to establish an investment account in

the name “Burton O. Benson”; (4) check No. 478 for $1 million

payable to USAA Mutual Fund to establish an investment account in

the Bensons’ names; (5) check Nos. 482 and 485 in the respective

amounts of $5,441.55 and $4,860.81 payable to Insight Capital

Research & Management, Inc., to establish an investment account;

and (6) check Nos. 487, 488, and 489 for $100,000 each to Eric,

Brad, and Mark.

5.   Baden Spiel Haus Partnership

      During the years 1989, 1990, 1993, and 1994, Burton was a

partner owning a 25-percent interest in the Baden Spiel Haus

partnership.   Baden Spiel Haus owned and operated a ski cabin in

California.    The Bensons claimed partner deductions of $1,281,

$1,182, $1,473, and $2,635, for 1989, 1990, 1993, and 1994,
                                - 34 -

respectively, which respondent denied for lack of substantiation.

The Bensons conceded respondent’s determination for all years

except 1994.   See appendix, par. 13.

6. Evelyn Hermsmeier Partnership

      During the years 1988, 1989, 1990, and 1993, Elizabeth was a

partner holding a 50-percent interest in the Evelyn C. Hermsmeier

et al. partnership.     Evelyn C. Hermsmeier, f.k.a. E.C. Ford, is

the sister of Elizabeth.    For the years listed, gross income of

the partnership was as follows:40

               Tax Year             Gross Income

                 1988                 $263,448
                 1989                  274,683
                 1990                  242,700
                 1991                  282,059
                 1992                  202,192
                 1993                  185,770
                 1994                  201,239

7.   The Income Tax Returns

      (a) The Bensons

      On July 25, 1994, the Bensons filed their 1988 Federal

income tax return through respondent’s revenue agent.    The 1988

return was filed after the October 15, 1989, due date, as

extended.   On September 16, 1994, the Bensons filed their 1989

Federal income tax return through respondent’s revenue agent.

      40
      On brief, respondent indicated that facts pertaining to
the Evelyn Hermsmeier Partnership relate “solely to the issue of
substantial omission of income pursuant to” sec. 6501(e). Income
or loss from the partnership was reported on the Bensons’ 1989,
1990, 1993, and 1994 Schs. E as Elizabeth’s distributive share.
                              - 35 -

The 1989 Federal income tax return was filed after the October

15, 1990, due date, as extended.    On October 21, 1994, the

Bensons filed their 1993 Federal income tax return.    On February

14, 1995, the Bensons filed their 1990 Federal income tax return

through respondent’s agent.   The 1990 Federal income return was

filed after the October 15, 1991, due date, as extended.

     On June 29, 1995, respondent issued Burton a notice of

deficiency for the tax years 1991 and 1992.    On October 25, 1995,

the Bensons filed their 1994 Federal income tax return.    On

November 27, 1995, respondent assessed a deficiency against

Burton for the 1992 tax year on the basis of a notice of

deficiency dated June 29, 1995.    On December 13, 1995, the

Bensons filed their 1991 Federal income tax return.    On January

1, 1996, respondent assessed a deficiency against Burton for the

1991 tax year on the basis of a notice of deficiency dated June

25, 1995.   On March 5, 1997, the Bensons filed their 1992 Federal

income tax return.

     (b) Eric B. Benson

     On or about April 15, 1994, Eric requested an extension of

time to file his 1993 Federal income tax return.    On October 17,

1994, Eric filed his 1993 Federal income tax return.    On October

23, 1995, Eric filed his 1994 Federal income tax return.
                              - 36 -

     (c)   Mark D. and Brad D. Benson

     Neither Mark nor Brad filed a Federal income tax return for

1993.   On October 25, 1995, Mark and Brad each filed their 1994

Federal income tax return.

     (d) ERG

     ERG filed its Forms 1120 Federal income tax returns on the

dates and for the years listed:

                  Date              Tax Year

                 5/23/89                1987
                 8/1/94                 1988
                 8/28/94                1989
                 9/18/94                1993
                 11/20/94               1990
                 7/16/95                1991 & 1992

There is a dispute between the parties whether ERG filed a 1994

return.

     (e)   NPI

     NPI filed its Forms 1120S on the dates and for the years

listed:

                  Date              Tax Year

                 1/14/91                1987
                 1/21/92                1988
                 5/22/92                1989
                 7/14/92                1990
                 9/17/92                1991
                 9/20/94                1993
                 9/20/94                Amended 1989
                 12/15/94               Amended 1990
                 7/19/95                1992
                 9/20/95                1994
                 9/18/95                Amended 1991
                                 - 37 -

8.   The Return Preparers

      G.A. “Al” Piepho prepared ERG’s and NPI’s 1987 returns.

Piepho died on or about October 1, 1989.     After Piepho died,

Bradac purchased Piepho’s accounting practice.     For the tax years

beginning in or after 1988 through 1994, Bradac generally

prepared the tax returns for ERG, NPI, and each of the

petitioners.    However, Jill Toibin, C.P.A. (Toibin), prepared the

Bensons’ 1992 Form 1040.

9.   Notices of Deficiency

      On October 15, 1997, respondent issued Eric a notice of

deficiency for his tax year 1993.     On September 10, 1998,

respondent issued notices of deficiency to Eric, Mark, and Brad

for the 1994 tax year.      On September 13, 2000, respondent issued

to the Bensons notices of deficiency for the tax years 1988,

1989, 1990, and 1993.      On September 24, 2001, respondent issued

to the Bensons a notice of deficiency for their 1994 tax year.

      (a)   Examinations

      On November 19, 1996, respondent opened an examination of

the Benson’s 1993 return.     The examination of the Bensons’ 1993

return related to an ongoing examination of ERG, which

examination commenced on August 23, 1995.     On March 11, 1997,

respondent opened an examination of the 1988, 1989, 1990, and

1994 returns of the Bensons.
                              - 38 -

                              OPINION

     The gravamen of respondent’s argument is that due to a

bitter family feud over the control and ownership of ERG, Burton

“formed a fraudulent scheme to divert the earnings and profits of

ERG to himself (either through NPI or directly) and to thereby

lower the reportable profits of ERG.”   Respondent alleges that

Burton labored to reduce ERG’s profits because the unbundling

agreement required him to pay his brother a multiple of ERG’s

profits.   The alleged scheme, respondent argues, was perpetrated

in three ways:   (1) Various transactions to divert cash from ERG

to NPI; (2) ERG’s payment for 143 Alice Lane for the Bensons’

benefit; and (3) ERG’s direct payment of the Benson family

personal expenses.   Respondent alleges Burton’s scheme was also

intended to defraud the Government of income tax due and owing.

     The Bensons seek solace in the circumstances surrounding the

preparation and filing of their income tax returns.   The Bensons

allege that the uncertainties associated with the brothers’ legal

and personal struggle to control the closely held entities, the

pressures of running successful and profitable businesses, and

the death of their longtime accountant and tax preparer caused

their failure to prepare timely and accurate tax returns, not

intentional malfeasance.

     As discussed in detail below, the voluminous record in this

case does not sustain respondent’s burden of proving by clear and
                               - 39 -

convincing evidence that the Bensons fraudulently intended to

evade the payment of their income taxes.     However, respondent has

persuaded us that the Bensons substantially understated their

income.

A.   The Burden of Proof and the Statute of Limitations

      A determination made by the Commissioner in a notice of

deficiency is presumed correct, and the taxpayer bears the burden

of proving that determination incorrect.41    Rule 142(a); Welch v.

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

      Generally, the Commissioner must assess the amount of tax

within 3 years after a return is filed.     See sec. 6501(a).    The

Code provides exceptions to this period of limitations.      One

exception, of course, is for fraud.     See sec. 6501(c).   In

pertinent part, section 6501(c) provides:

      SEC. 6501(c).   Exceptions.--

           (1) False return.–-In the case of a false or
      fraudulent return with the intent to evade tax, the tax
      may be assessed, or a proceeding in court for
      collection of such tax may be begun without assessment,
      at any time.

      41
      Sec. 7491(a)(1) provides that the burden of proof shifts
to the Commissioner if the taxpayer introduces credible evidence
with respect to any factual issue relevant to ascertaining the
tax liability of the taxpayer. Sec. 7491(a)(1) applies to court
proceedings arising in connection with examinations commencing
after July 22, 1998. See Internal Revenue Service Restructuring
and Reform Act of 1998, Pub. L. 105-206, sec. 3001(c), 112 Stat.
726. The record indicates that the examinations of petitioners’
returns began prior to the effective date of sec. 7491. Thus,
sec. 7491 is inapplicable to this case. See Seawright v.
Commissioner, 117 T.C. 294 (2001).
                               - 40 -


     There is an exception for the substantial understatement of

income.   Section 6501(e) provides in pertinent part:

          SEC. 6501(e). Substantial Omission of Items.–-
     Except as otherwise provided in subsection (c)--

               (1) Income taxes.–-In the case of any tax
          imposed by subtitle A–

                      (A) General rule.–-If the taxpayer omits
                 from gross income an amount properly
                 includible therein which is in excess of 25
                 percent of the amount of gross income stated
                 in the return, the tax may be assessed, or a
                 proceeding in court for the collection of
                 such tax may be begun without assessment, at
                 any time within 6 years after the return was
                 filed. For purposes of this subparagraph–

                          (i) In the case of a trade or
                      business, the term “gross income” means
                      the total of the amounts received or
                      accrued from the sale of goods or
                      services (if such amounts are required
                      to be shown on the return) prior to
                      diminution by the cost of such sales or
                      services; and

                          (ii) In determining the amount
                      omitted from gross income, there shall
                      not be taken into account any amount
                      which is omitted from gross income
                      stated in the return if such amount is
                      disclosed in the return, or in a
                      statement attached to the return, in a
                      manner adequate to apprise the Secretary
                      of the nature and amount of such item.

Respondent bears the burden of proving by a preponderance of the

evidence that:   (1) The Bensons omitted from gross income an

amount in excess of 25 percent of the amount of gross income

reported on their return, and (2) that the omitted income was

properly includable in gross income.    Burbage v. Commissioner, 82
                               - 41 -

T.C. 546, 553 (1984), affd. 774 F.2d 644 (4th Cir. 1985); Ghadiri

v. Commissioner, T.C. Memo. 1996-528; Hittleman v. Commissioner,

T.C. Memo. 1990-325, affd. without published opinion 945 F.2d 409

(9th Cir. 1991).   Accordingly, respondent must introduce

affirmative evidence to meet his burden.     Ghadiri v.

Commissioner, supra.    On brief, the parties agree that our

opinion on the merits will determine whether the period of

limitations bars respondent’s assessment for 1989, 1990, 1993,

and 1994.

     For respondent to prevail with respect to the 1988 taxable

year, we must find fraud, which we do not.    However, as discussed

infra, we do find that respondent has proved substantial

omissions of income in 1989, 1990, 1993, and 1994.    The Bensons

argue on brief that the only way respondent can show a 25-percent

omission is by proving that they had constructive dividends.     We

have found that substantial constructive dividends were received.

On brief, respondent refers to this matter as a computational

issue.   A recomputation of the Bensons’ income under Rule 155

pursuant to our findings and holdings herein will control whether

the Bensons omitted from gross income an amount which is in

excess of 25 percent of the amount of gross income stated in the

returns.    If there was such an omission the period of limitations

in section 6501(a) will not bar assessment for those years.    See
                                - 42 -

Garden State Dev., Inc. v. Commissioner, 30 T.C. 135, 142 (1958);

Hulshart v. Commissioner, T.C. Memo. 1955-231.

B.   Constructive Dividends

      The heart of respondent’s imputation of income is that

numerous ERG expenditures and transfers constitute constructive

dividends to the Bensons.     On the contrary, petitioners argue

that if the percentage of NPI’s ownership declared in the final

arbitration decision is considered, petitioners overpaid their

income tax liability.

      The Commissioner is authorized and has great latitude in

reconstructing income in accordance with any reasonable method

that accurately reflects actual income.     Secs. 446(b), 6001;

Petzoldt v. Commissioner, 92 T.C. 661, 687 (1989); Meneguzzo v.

Commissioner, 43 T.C. 824, 831 (1965); see Taglianetti v. United

States, 398 F.2d 558, 562 (1st Cir. 1968), affd. on other grounds

394 U.S. 316 (1969); Ramsey v. Commissioner, T.C. Memo. 1980-59;

Bolton v. Commissioner, T.C. Memo. 1975-373.     The reconstruction

of a taxpayer’s income need only be reasonable in light of the

surrounding facts and circumstances.     Giddio v. Commissioner, 54

T.C. 1530, 1533 (1970); Schroeder v. Commissioner, 40 T.C. 30, 33

(1963).   Furthermore, it is axiomatic that “The Commissioner and

the reviewing courts are permitted to fully examine any

transaction to determine its economic and financial reality.”

Noble v. Commissioner, 368 F.2d 439, 443 (9th Cir. 1966), affg.
                               - 43 -

T.C. Memo. 1965-84.   Those transactions which lack economic

substance may be ignored.    Gregory v. Helvering, 293 U.S. 465,

467 (1935); Muhich v. Commissioner, 238 F.3d 860, 864 (7th Cir.

2001), affg. T.C. Memo. 1999-192.

     Section 61(a) defines gross income as “all income from

whatever source derived”.    The regulations demonstrate the

definition’s expanse:   “Gross income includes income realized in

any form, whether in money, property, or services.”    Sec. 1.61-

1(a), Income Tax Regs. (emphasis added); see Han v. Commissioner,

T.C. Memo. 2002-148 (citing Commissioner v. Glenshaw Glass Co.,

348 U.S. 426, 431 (1955)).    As the Supreme Court explained, a

gain “constitutes taxable income when its recipient has such

control over it that, as a practical matter, he derives readily

realizable economic value from it.”     Rutkin v. United States, 343

U.S. 130, 137 (1952).

     Section 301, however, qualifies the definition of gross

income.   Barnard v. Commissioner, T.C. Memo. 2001-242.

Generally, that section provides that funds distributed by a

corporation over which the taxpayer/shareholder has dominion and

control are taxed under the auspices of section 301(c).    Id.

Pursuant to section 301(c), a dividend is taxed as ordinary

income only to the extent of the distributing corporation’s
                               - 44 -

earnings and profits;42 any excess is nontaxable return of

capital to the extent of the taxpayer’s basis; and any remaining

amount received is taxable as capital gain from the sale or

exchange of a capital asset.   Sec. 301(c)(1),(2), and (3);

Truesdell v. Commissioner, 89 T.C. 1280, 1295-1298 (1987);

Barnard v. Commissioner, supra.   The parties have stipulated

that, to the extent we find constructive dividends, ERG had

sufficient earnings and profits to deem any distributions as

ordinary income.

     “It is well established that transfers between related

corporations may result in constructive dividends to a common

shareholder.”   Speer v. Commissioner, T.C. Memo. 1996-323 (citing

Joseph Lupowitz Sons, Inc. v. Commissioner, 497 F.2d 862, 868 (3d

Cir. 1974), affg. in part, revg. in part on another ground, and

remanding T.C. Memo. 1972-238); see DiLeo v. Commissioner, 96

T.C. 858, 883 (1991), affd. 959 F.2d 16 (2d Cir. 1992).   “A

greater potential for constructive dividends * * * exists in

closely held corporations where dealing between stockholders and

the corporation are commonly characterized by informality.”

Zhadanov v. Commissioner, T.C. Memo. 2002-104.   However, common

ownership alone will not support a finding of constructive

dividends.   Sammons v. Commissioner, 472 F.2d 449, 451 (5th Cir.

     42
      The determination and calculation of earnings and profits
is governed by sec. 316 and the regulations promulgated
thereunder.
                              - 45 -

1972), affg. in part and revg. in part on another ground T.C.

Memo. 1971-145.

     “Corporate expenditures constitute constructive dividends

only if 1) the expenditures do not give rise to a deduction on

behalf of the corporation, and 2) the expenditures create

‘economic gain, benefit, or income to the owner-taxpayer.’”      P.R.

Farms, Inc. v. Commissioner, 820 F.2d 1084, 1088 (9th Cir. 1987)

(quoting Meridian Wood Prods. Co. v. United States, 725 F.2d

1183, 1191 (9th Cir. 1984)), affg. T.C. Memo. 1984-549.   “The

crucial concept in a finding that there is a constructive

dividend is that the corporation has conferred a benefit on the

shareholder in order to distribute available earnings and profits

without expectation of repayment.”43   Truesdell v. Commissioner,

supra at 1295 (citing Noble v. Commissioner, supra at 443).      A

“constructive dividend” is “simply a corporate disbursement that

is a dividend in the contemplation of law though not called such

     43
               “To constitute a distribution taxable as
          a dividend, the benefit received by the
          shareholder need not be considered as a
          dividend either by the corporation or its
          shareholders, declared by the board of
          directors, nor other formalities of a
          dividend declaration need be observed, if on
          all the evidence there is a distribution of
          available earnings or profits under a claim
          of right or without any expectation of
          repayment.” * * *

Noble v. Commissioner, 368 F.2d 439, 443 (9th Cir. 1966), affg.
T.C. Memo. 1965-84 (quoting Clark v. Commissioner, 266 F.2d 698,
711 (9th Cir. 1959)).
                              - 46 -

by the corporation making the disbursement.”     United States v.

Mews, 923 F.2d 67, 68 (7th Cir. 1991).    Furthermore, to be a

constructive dividend to a shareholder, the corporation need not

pay it directly to the shareholder.    Id.

     It is clear that when a corporation confers an economic

benefit upon a shareholder without expectation of reimbursement,

that economic benefit becomes a constructive dividend.     Loftin &

Woodard, Inc. v. United States, 577 F.2d 1206, 1214 (5th Cir.

1978); Thorpe v. Commissioner, T.C. Memo. 1998-115.     For example,

the amount of taxes paid by a corporation on behalf of and for

the benefit of a shareholder was held to be a constructive

dividend.   Inland Asphalt Co. v. Commissioner, 756 F.2d 1425 (9th

Cir. 1985), affg. T.C. Memo. 1982-463.    Corporate payment of a

shareholder’s personal expenses constituted a constructive

dividend.   Dobbe v. Commissioner, 61 Fed. Appx. 348 (9th Cir.

2003), affg. T.C. Memo. 2000-330.   Payments by a corporation for

painting and repairs made to a shareholder’s family residence and

travel expenses incurred for personal purposes were deemed to be

constructive dividends.   Grossman v. Commissioner, 182 F.3d 275

(4th Cir. 1999), affg. T.C. Memo. 1996-452; Noble v.

Commissioner, 368 F.2d 439 (9th Cir. 1966).    And use of a

corporate-owned luxury automobile for personal purposes

constituted a constructive dividend.     Mohan Roy, M.D., Inc. v.

Commissioner, T.C. Memo. 1997-562, affd. 182 F.3d 927 (9th Cir.

1999).
                                       - 47 -

      “In determining whether or not the expenditure related to

the business of the corporation, we must ascertain whether the

payment or expenditure has independent and substantial importance

to the paying corporation.”            Gow v. Commissioner, T.C. Memo.

2000-93 (citing T.J. Enters., Inc. v. Commissioner, 101 T.C. 581

(1993)), affd. 19 Fed. Appx. 90 (4th Cir. 2001).                    “An expenditure

generally does not have independent and substantial importance to

the distributing corporation if it is not deductible under

section 162.”         Id. (citing P.R. Farms, Inc. v. Commissioner,

supra.)

      Respondent determined that numerous transactions constituted

constructive dividends to the Bensons.               For ease of discussion,

we shall separately detail each item and then describe the

economic benefit the Bensons received from those items.

      1.      ERG Transfers to NPI

      Transfers made by ERG to NPI and the amounts reported for

the years 1988 through 1994 are listed as follows:
    Year       ERG Transfer    Amount Reported      Amt. Reported on       Reporting
                  to NPI           by NPI          Shareholder Return     Shareholder

                1
    1988         $180,000             –-                  --                  n/a
    1989          483,098          $248,097             $165,481         The Bensons
    1990            –-              193,508              129,070         The Bensons
    1991            –-            1,764,049              757,025         The Bensons
    1992            –-              907,443              365,754         The Bensons
    1993        3,600,000           220,000              146,667         The Bensons
                                                         24,444          Eric Benson
    1994            160,063         160,063               80,032         The Bensons
                                                         26,677          Eric Benson
                                                         26,677          Brad Benson
                                                          26,677         Mark Benson
      Total     4,423,161         3,493,160            1,748,504
       1
         Petitioners offered no evidence as to this transfer.   Furthermore, Burton
could not recall the purpose of the transfer.
                               - 48 -

     As found above, in 1989 ERG transferred $483,098 to NPI with

respect to the MOA.   Although there was conflicting testimony

concerning what was contemplated by the MOA,44 petitioners

offered no evidence of what specific services, if any, were

performed and/or what equipment, if any, was purchased.   Mr.

Bradac, Burton’s accountant and return preparer, testified that

Burton informed him that no equipment was purchased, and he

instead booked the payment as a security deposit.

     Generally, money was transferred from ERG to NPI ostensibly

for two reasons.    First, in accordance with the exclusive license

agreement between ERG and NPI, 10 percent of ERG’s profits flowed

to NPI in the form of royalties.45   Second, to achieve Burton’s

goal of having ERG show a paper profit of approximately $75,000

per year, the difference between the purported royalty payments

and ERG’s actual annual profit (less approximately $75,000) was

transferred as payment to NPI for purported engineering services

performed by NPI.




     44
      Warren Timothy, a former employee of Hercules, testified
that the MOA was a purchase contract, and it did not contemplate
reengineering. Similarly, William Morton, also a former employee
of Hercules, testified that the MOA was an equipment purchase
contract. However, Bryan Leyda, an ERG employee, testified that
the schedule attached to the MOA was his “personal best estimate”
for time and engineering to design the assembly, the
modifications, and the installation, and any debugging processes.
     45
      The payments were labeled “royalties” on the basis of
information that Burton provided. Bradac did not see a copy of
the royalty agreement until after he prepared the returns.
                              - 49 -

     The realization of the “plan” is demonstrated in a

stipulated exhibit.   For example, in 1992 ERG had $2,704,096 in

total sales and allocated $275,867 in royalties to NPI.46

Similarly, in 1993 ERG had total sales of $2,440,139 and

allocated $244,023 in royalties to NPI.47   ERG reported a profit

in 1989, 1990, and 1993 of $77,930, $79,576, and $76,941,

respectively.

     Because many of ERG’s payments to NPI were made after the

purported royalties and engineering services were supposedly

earned, there had to be a plan or basis upon which the funds were

attributed to the tax years at issue.48   At trial, Mr. Bradac


     46
      NPI’s original 1992 return reported royalty income of
$907,443.
     47
      NPI’s original 1993 return reported royalty income as
$220,000.
     48
      Jill Toibin, C.P.A., prepared the Bensons’ 1992 Form 1040.
On or about Oct. 3, 1996, Toibin wrote a memorandum to her file
which states in pertinent part:

     I asked Burt if all disbursements from ERG were
     ordinary and necessary business expenses of the
     corporation and he confirmed in the positive. He
     indicated that the corporation has a royalty agreement
     with New Process Industries (a related corporation).
     In addition, New Process provides services to ERG
     through the action of the employee owner (himself) that
     are not covered by the rent agreement, so that
     engineering services are paid to compensate the
     corporation for these services.

     At trial, Toibin testified that the classification of
engineering services was on the basis of Burton’s representations
that he provided “know-how, show-how, something of value to NPI”.
                              - 50 -

explained the “plan”:   “And not having exact numbers to work

with, I suggested that we allocate the numbers based upon the

income of the corporation.   When we get down to the end, we’ll

take whatever difference there is and put it into the middle

years.”   The theory of allocating ERG payments for tax years

prior to payment was further refined in Jill Toibin’s letter to

the California Franchise Tax Board:

     The corporation [NPI] receives royalties and performs
     engineering services for a related entity * * * [ERG].
     The corporation is a cash basis taxpayer. However, the
     corporation was required to report as current income
     any amounts constructively received, even though such
     amounts were not actually paid in the current year.
     * * *

During trial, Bradac was asked and answered as follows:

     Q:   Okay. Now was there a discussion at some point
     between you and Admiral Benson of a desire to flow
     profits from ERG to NPI?

     A:    I mean I don’t think of it in those terms, but
     yes, I guess there would be discussion which entailed
     that.

           *      *      *      *      *      *      *

     Q:   Did you specifically recall, do you recall having
     conversations with Admiral Benson about trying to keep
     the profits of ERG down?

     A:    Yes.

           *      *      *      *      *      *      *

     Q:   Did you have an understanding from Admiral Benson
     that more of the profits of ERG could be passed, or
     flowed to New Process through increasing deductions on
     ERG’s returns?
                                - 51 -

     A:   I vaguely recall having some discussions like
     increasing the rents, and along those lines, yes.

     Q:   And in those discussions, do you recall discussing
     performing services as another way that ERG’s profits
     might flow to NPI?

     A:    Probably.

     Q:   And if those profits flowed from ERG to NPI, then
     would ERG appear less profitable?

     A:    Yes.

     Q:    At least on paper?

     A:    Yes.

     Q:   Do you recall a discussion or discussions with
     Admiral Benson in which Admiral Benson expressed a
     desire to keep the profits of ERG for any given year,
     to a level of about $75,000 – excuse me, did I say
     profits? I meant taxable income.

     A:    We have [sic] a conversation along those lines.

Similarly, on or about April 13, 1993, Burton sent Bradac a

memorandum which states in pertinent part:

     ERG   1) ERG had an estimated profit of $757,000 for yr-
           end 1992.

           2) Assume ERG pay [sic] royalties to NPI of $750K
           for this period.

           3) Then ERG has minimal to no tax for Fed & state
           in 92.

     NPI   1) NPI has a est. profit of $750K from ERG plus
           $68K self made profit equals $818K for 1992.

           2) Assume $818K flows to BOB somehow royalty,
           profit, salary, this yet to be determined.

           3) Then NPI has no Fed tax but has CA State
           of 2 1/2% of profit * * *
                                - 52 -

Burton testified that this memorandum was “a tax planning

document”.   Similarly, on or about March 7, 1996, Burton sent a

memorandum to Bradac stating:    “Considering that we desire to

keep ERG at a profit of about $75K, we would then pull about

$260K out of ERG and allocate it to NPI.”    (Emphasis added.)

     Petitioners produced purported “invoices” for the royalties

paid only with respect to 1993.    The invoices are printed on

NPI’s letterhead, addressed to ERG, and show an amount “due”.

Each document is stamped “RECEIVED” by ERG on a specific date and

bears a “paid” stamp showing an amount, date, and check number.

However, these invoices were not created contemporaneously with

payment and/or the receipt of services, but they were prepared in

response to a meeting Burton had with a revenue agent.

     Burton testified that the “engineering services” for which

ERG compensated NPI were consulting design services that he

performed to make the Hercules contract “work”.    He stated:    “The

engineering services I’m referring to was the understanding

between ERG and NPI in light of the agreement that ERG had with

NPI to do the design services, to change the D-5 process, and

scale up to the delivery rate that the customer wanted.”    He

stated that the payments were for his “engineering know-how”.

However, there was no written agreement between ERG and NPI

concerning the provision of engineering services.
                                 - 53 -

     The record also includes purported invoices for engineering

and design services for only 1993.        The documents state in

pertinent part:

     Engineering and Design Services for Hercules Aerospace,
     as Prime Contractor to the Department of Defense
     authorization to ERG for the investment in the
     Facilitization and Plant Equipment required to obtain
     the contract delivery rate requirements under Hercules
     Classified Contract No. 2257-003136 as line item 1 and
     under Hercules Classified Contract No. 2295-03020 as
     line item 2, for the Fleet Ballistic Missile Program
     “Special” D-5 tooling requirements.

The documents are written on NPI’s letterhead, addressed to ERG,

and bear the last day of each month in 1993 as the date.

Additionally, the documents are stamped “RECEIVED” on a certain

date by “ERG, Inc.” and are also stamped “paid” showing an

amount, date, and check number.     Burton admitted, however, that

these invoices were created shortly before an audit meeting with

a revenue agent.

     Burton testified that he kept track of the hours he spent

performing the purported design and engineering services on his

desk calendar.49     In answering a question concerning how much NPI

charged ERG for his alleged services, he testified:        “I’d be

guessing, 200, 300 dollars an hour, something like that.”          Burton

was asked and answered as follows:

     Q:   And how would you make that calculation, if you
     didn’t keep specific hours on your desk calendar?


     49
          The desk calendar was not proffered as evidence.
                               - 54 -


     A:   You know I really don’t know. They seem like very
     round numbers. They could be just what we in the
     business call engineering estimates.

However, Burton presented no evidence detailing precisely what

services he provided, the number of hours he spent performing

those services, and whether the compensation charged was ordinary

and reasonable in the industry.   Clearly, Burton controlled both

sides of the “table” with respect to ERG and NPI.   Transactions

between related corporations are inherently suspect.    Tulia

Feedlot, Inc. v. United States, 513 F.2d 800, 805 (5th Cir. 1975)

(“Transactions between related taxpayers or between a close

corporation and its principals * * * must be subject to close

scrutiny.” (citing United States v. Ragen, 314 U.S. 513 (1942)));

Ludwig Baumann & Co. v. Commissioner, T.C. Memo. 1961-271

(“common ownership factor requires a close scrutiny to determine

the substance of the transaction and whether it reasonably would

have been made between parties dealing at arm’s length.”), affd.

312 F.2d 557 (2d Cir. 1963).

     Furthermore, we infer from the evidence that the exclusive

licensing agreement was merely a tax planning tool, completely

lacking in economic substance.    Although taxpayers are entitled

to structure their transactions in such a way to achieve the most

advantageous tax ramifications, nonetheless, those transactions

must be real and have economic substance.    Gregory v. Helvering,

293 U.S. at 469.   For example, the exclusive licensing agreement
                              - 55 -

was entered into in 1990 but had retroactive application to 1987,

the year during which Burton took sole control of ERG.    The

amounts that ERG transferred to NPI were not regular.    As the

arbitrators found, the pattern of payment demonstrates that

Burton was merely funneling ERG’s profits to NPI.   There is no

evidence of a business purpose why ERG would “sell” its valuable

patent rights to NPI and simultaneously license them back.

Furthermore, there is no evidence whether ERG received the

consideration contemplated by the agreement for “selling” those

rights.   The agreement states that ERG is entitled to, inter

alia, 50 percent of the moneys NPI receives from licensing the

patent rights.   ERG ostensibly was “licensing” those patent

rights under the agreement and paying NPI hundreds of thousands

of dollars for such rights.   However, the record shows only the

unidirectional flow of money from ERG to NPI.

     ERG transferred millions of dollars to NPI for payment of

supposed “engineering services”.   However, there is no evidence

of what services Burton performed on behalf of NPI other than his

testimony that he provided ERG with engineering “know how”.      No

third party testified as to what Burton specifically did.    There

is no evidence of how much time he devoted to this endeavor and

whether the amounts charged were reasonable and customary.      In

fact, we infer from the evidence that in conjunction with the

exclusive licensing agreement, the label “engineering services”
                              - 56 -

was created to achieve Burton’s goal of having ERG show a

consistent paper profit of approximately $75,000.50   For example,

ERG’s records show that in 1991 ERG incurred $1,539,463 for

“engineering services” provided by NPI.   Assuming, as Burton

testified, that NPI charged ERG $300 per hour, Burton would have

had to spend 5,131.5 hours or 213.8 twenty-four hour periods

performing so-called engineering services.

     On brief, petitioners argue that the percentage of ownership

determined in the arbitration decisions affects the issue of what

amount, if any, constitutes taxable income to the Bensons.

Petitioners direct the Court’s attention to the arbitrators’

finding that Burton owned one-third of NPI’s stock during the

years at issue.   Thus, petitioners conclude, if one-third of the

distributive share rights in NPI is considered, the Bensons

overpaid their income tax liability.   We disagree.

     The fact that Burton did not actually own 100 percent of NPI

during the years at issue does not affect our holding that those

ERG funds transferred to NPI constituted constructive dividends

to Burton.   The arbitrators found and the parties agree that

during the years at issue, Burton maintained sole operating




     50
      On brief, petitioners argue: “The allocations of income
to NPI for the engineering services that Burton performed for ERG
respecting the Hercules contract were legitimate business
accounting decisions.” (Emphasis added.)
                                 - 57 -

control of ERG and NPI.51     The record clearly demonstrates that

ERG funds transferred to NPI were used for Burton’s family’s

economic benefit and otherwise lacked a business purpose.

     Furthermore, petitioners argue:      “Respondent has not

presented compelling evidence that Burton appropriated NPI’s bank

accounts to his own benefit.”     Again, we disagree.   The record

demonstrates, and indeed as the arbitrators also found, that

Burton transferred ERG money to NPI and then used this money for

the sole and exclusive benefit of himself and his family.

Glendon received no benefit from his determined ownership rights

in NPI or ERG until after the final arbitration decision.       As he

testified, after June 1987 neither he nor Aker had any

involvement with ERG.     That issue was at the very heart of the

brothers’ dispute during the arbitration proceedings.

     As we discuss infra, the Bensons received a substantial

economic benefit from the ERG funds transferred to NPI.

Accordingly, we find and hold52 that the ERG transfers to NPI




     51
          Petitioners asked us to find as fact that:

     All of the funds at issue that were transferred from
     ERG to NPI were deposited in an NPI bank account * * *
     over which Burton exercised sole authority and control
     as president of NPI responsible to its shareholders.
     [Emphasis added.]
     52
      Our use of the term “find and hold” in this opinion means
that we have determined that a preponderance of evidence supports
our conclusion.
                               - 58 -

constituted constructive dividends to Burton in the year of

transfer.

     2.   ERG-Recreation Fund Account

     Respondent submitted copies of canceled checks and bank

statements for the ERG-Recreation fund account.    Petitioners

conceded that many of the ERG-Recreation fund account items

constituted constructive dividends to Burton.   See appendix, par.

7.   Melody Carter, ERG’s administrative assistant, testified that

this account was funded with moneys that ERG received “from

recycling cans, recycling cardboard, refunds”, etc.    She stated:

“I’ll apply for the refund; the refund will go into that fund.”

She also testified that this account was used to “purchase

baseball tickets, to purchase Christmas parties, company picnic,

weight room equipment, things of that nature.”53

     Respondent demonstrated that Burton was the sole signatory

for this account and withdrew funds from this account.    In

addition to the canceled checks proffered by respondent and

Burton’s concessions, the Court notes that the Bensons failed to

provide evidence that any specific amounts withdrawn were used

for ERG’s business purposes.   In fact, the checks at issue

provide a contrary inference that the ERG-Recreation fund was



     53
      Burton testified that at least one ERG Christmas party was
not paid from this account but was instead charged to a corporate
credit card. See discussion infra. There is no indication that
funds from this account were used to pay this bill.
                              - 59 -

used for personal expenses.   For example, in 1993, check No. 31

is made payable to ERG Retirement Trust for $8,000; similarly, in

1994 Burton issued two checks for expenses relating to his

sailboat, Risktaker, a check to Berkeley Yamaha, and checks to

various individuals.   In the face of the above facts and

concessions, the Bensons failed to substantiate any of the

expenses for which checks were written from this account and

otherwise failed to demonstrate a business purpose for any of the

expenditures.   Accordingly, we find and hold that, in addition to

the amounts conceded, Burton received and failed to report

constructive dividends in 1993 and 1994 of $8,000 and $2,698,

respectively.

     3.   Payment for 143 Alice Lane

     The parties do not dispute that in 1990 ERG paid $336,500

for the real property described as 143 Alice Lane and held that

property in the name “ERG Retirement Trust”.   Petitioners did not

object to respondent’s requested finding of fact that the

purchase of 143 Alice Lane gave the Bensons “a large,

uninterrupted piece of land behind and abutting their personal

residence.”

     The Bensons’ only argument is that they did not receive a

personal benefit until 1997, a year not before the Court, when

the ERG Retirement Trust deeded the property to the Bensons in

their individual capacities for no consideration.   We disagree.
                               - 60 -

The facts indicate that the property was purchased to enhance the

Bensons’ personal residence.   The fact that it was finally deeded

to the Bensons merely confirms this.

     Clearly, the Bensons received a personal and economic

benefit when ERG purchased 143 Alice Lane.     They had the

exclusive use of real property, and eventually the title, for

which they paid no consideration.   We find and hold that ERG’s

payment in 1990 for 143 Alice Lane was a constructive dividend to

Burton.   We also find and hold, under the same reasoning, that

ERG’s payment of property taxes, $3,879 in 1993 and $8,196 in

1994, also constituted constructive dividends to the Bensons.

     4.   ERG Check to Burton (Ref. Carroll)

     According to a 1989 petition for confirmation of an

arbitration award, Burton owed Mr. Carroll $96,748.98, plus

interest thereon.   In 1989, ERG issued a check payable to Burton

for $96,748.98, on which is written “for Michael B. Carroll”.

With these funds, Burton purchased a cashier’s check in the

amount of $97,467.21 made payable to Mr. Carroll.     The Bensons

offered no evidence or explanation concerning this check other

than stating that ERG was also named as a defendant in that suit.

However, the fee arbitration award names only Burton as a

defendant.   Indeed, we infer from the recitation of the facts

that the representation involved a personal and noncorporate

matter between the brothers.   The petition for confirmation of
                                - 61 -

arbitration award and entry of judgment states:    “Carroll

provided * * * advice and services as an advocate for Benson.”

In fact, ownership and control of ERG and NPI was the issue for

which Mr. Carroll provided legal services.

     The payment by a corporation of personal expenses of a

shareholder constitutes a constructive dividend.       See Inland

Asphalt Co. v. Commissioner, 756 F.2d 1425 (9th Cir. 1985); Noble

v. Commissioner, 368 F.2d 439 (9th Cir. 1966).     Accordingly, we

find and hold that Burton received a constructive dividend in

1989 of $96,748.98.

     5.   Automobile Expenses

     ERG claimed the following amounts as deductions for

automobile and truck expenses for the years as stated:

           Tax Year              Amount of Deduction

             1989                     $10,624
             1990                      23,676
             1993                      28,308
             1994                      14,723

The parties stipulated that the $15,000 and the $13,500 that ERG

paid in 1990 and 1993, respectively, to purchase vehicles for

Eric and Mark were constructive dividend income to Burton.      See

appendix, par. 4.     Respondent argues that the balance constitutes

constructive dividend income to Burton.

     Petitioners failed to substantiate any of the expenses

claimed and offered no evidence detailing the percentage that the

automobiles and trucks were used for business purposes.      See
                                - 62 -

Mohan Roy, M.D., Inc. v. Commissioner, T.C. Memo. 1997-562.

Indeed, Burton admitted that possibly some of the automobile

expenses were spent on his family’s cars.    The Bensons have

failed to meet their burden of proving error in respondent’s

determination with respect to the amounts still in issue.54     We

hold that, in addition to the amounts conceded, Burton had

constructive dividend income in 1989, 1990, 1993, and 1994 of

$10,624, $8,676, $14,808, and $14,723, respectively.

     6.   Charitable Contributions

     Because respondent has conceded that ERG’s payments of

$6,000, $6,000, $6,000, and $13,500 in 1989, 1990, 1993, and 1994

to Moraga Valley Presbyterian Church (MVPC) are not constructive

dividends, the Bensons are not entitled to deduct these amounts

on their personal returns.    See sec. 170(a)(1); sec. 1.170A-1(a),

Income Tax Regs.   Additionally, respondent conceded that a $2,000

ERG check to Camp Timberwolf in 1994 was not a constructive

dividend to the Bensons.    Thus, the Bensons are not entitled to

deduct this donation.55    See sec. 170(a)(1); sec. 1.170A-1(a),


     54
      We do not find that respondent has affirmatively proven
that the amounts in issue are constructive dividends.
     55
      There appears to be a scrivener’s error in respondent’s
opening brief. Respondent argues: “Finally, with respect to the
1994 check for $2,000 paid to Camp Timberwolf * * * respondent
has conceded that this amount was not a constructive dividend to
* * * [the Bensons]. Therefore, ERG’s charitable contribution to
Camp Timberwolf should be allowed as an itemized deduction on the
Bensons’ 1994 return.” Given respondent’s first argument that to
                                                   (continued...)
                               - 63 -

Income Tax Regs.    Petitioners appear to concede the deductibility

issue as they advance no argument.

     The only remaining matter of contention is whether an ERG

check issued on December 31, 1992, for $50,000 made payable to

the Bank of America constituted a constructive dividend to the

Bensons.    Burton used these funds to purchase a $50,000 cashier’s

check from the Bank of America made payable to MVPC.    The check

lists Burton as its purchaser.    The Bensons, and not ERG, claimed

a $50,000 deduction on their 1993 return.    Burton testified that

the donation was from him and not ERG.    At trial, Burton

explained that MVPC “put on both the non-negotiable receipt, they

put B.O. Benson and on the face of the [cashier’s] check they put

B.O. Benson.    The reason, Your Honor, I put it on, I wanted to

ensure they knew where it came from.”    Accordingly, we find and

hold that the Bensons received a $50,000 constructive dividend in

1993 and hold that they are entitled to a charitable deduction

for the amount of the donation.    See sec. 170(a)(1); sec. 1.170A-

1(a), Income Tax Regs.

     7.    Excess Rent Paid by ERG Re: Stanford Plant

     Throughout the years 1988 to 1994, ERG occupied the Stanford

plant and paid rent to NPI for its use.    The unbundling agreement


     55
      (...continued)
the extent that amounts paid by ERG are not constructive
dividends to the Bensons they should not also receive the benefit
of the deduction, we presume that respondent inadvertently
omitted the word “not” between “should” and “be”.
                                 - 64 -

contemplated that the parties would enter into a lease on the

Stanford plant for 8 years for “$5,000 (or $5,500 per month)”.      A

commercial lease for this property was prepared but never

executed.     According to this unexecuted document, for a period of

8 years commencing March 1988, ERG was to pay NPI $5,000 per

month for the use of the Stanford plant.

     For 1988 and 1989, ERG paid NPI $5,159 per month for the use

of the Stanford plant.     This monthly amount paid remained

unchanged until August 15, 1990, when ERG paid NPI $26,159 that

month.     For the last 4 months of 1990 the monthly amounts paid

were $8,159, $8,159, $14,159, and $8,159, respectively.     In 1993

and 1994, ERG paid NPI $9,380 and $10,787 per month,

respectively.

     Respondent determined that part of the money, $40,067,

$46,560, and $63,444, ERG paid to NPI as rent for the Stanford

plant in 1990, 1993, and 1994, respectively, constituted

constructive dividends to the Bensons.56    Thus, it appears that

respondent is arguing that the amount of rent paid in excess of

$5,500 per month constitutes constructive dividends.

     The maximum monthly lease amount listed in the unbundling

agreement apparently reflected the product of an arm’s-length




     56
          See supra p. 5, table, note 2.
                                 - 65 -

negotiation between the two warring brothers.57     Under these

circumstances, this is the best indication of the intent of the

parties and the value of the use of the property at that time.

Helba v. Commissioner, 87 T.C. 983 (1986), affd. without

published opinion 860 F.2d 1075 (3d Cir. 1988); see Zirker v.

Commissioner, 87 T.C. 970 (1986).     Furthermore, the “excess rent”

ERG paid pooled money in NPI, which as we later discuss, was used

for the Benson family’s economic benefit.     Accordingly, we find

and hold that Burton had constructive dividend income of $40,067,

$46,560, and $63,444 in 1990, 1993, and 1994, respectively.

     8.     ERG Payments to NPI for Rent on Lowell Plant

     In the unbundling agreement the brothers agreed to enter

into an 8-year lease with respect to the Lowell plant, which was

to provide that Glendon would pay NPI $2,000 per month.       In 1988,

a confirming commercial lease was prepared but not executed.

This lease agreement was for a term of 8 years to commence in

March 1988 and provided for a rental payment by “Acker [sic]

Industries, Inc.” of $2,000 per month.

     During the years at issue, neither Glendon nor Aker paid

rent to NPI for use of the Lowell plant.58     Instead, ERG paid


     57
      Respondent requested the Court to find that the unbundling
agreement was “the result of intense arm’s-length bargaining”.
Petitioners failed to object to this requested finding.
     58
          Glendon explained why he failed to pay rent:

                                                         (continued...)
                               - 66 -

rent to NPI on behalf of Glendon/Aker.   Burton testified that

during the arbitration proceedings, it was ERG’s responsibility

to pay Aker’s rent obligation since it was still, at least until

a final resolution was achieved, ERG’s research and development

division.

     The arbitrators in their final decision found that “the rent

that should be paid by GMB [Glendon]/Aker to NPI is $2,000 per

month from July 1, 1987 to December 31, 1994 and $2,500 per

month” thereafter.   And in fact, Glendon did pay such rent via a

credit to the amount the arbitrators decided Burton owed him.

     Respondent argues that ERG had no duty to pay NPI $31,850,

$29,400, $29,400, $31,020, and $41,736 in 1988, 1989, 1990, 1993,

and 1994, respectively, for Aker’s use of the Lowell plant and

that those payments constituted constructive dividends to the

Bensons.59   We agree with respondent that ERG had no contractual


     58
      (...continued)
     I knew that the performance on the [unbundling]
     agreement required payment of rent. * * * [But it] also
     required my brother to advance money to satisfy the
     terms of that agreement. I was not going to pay rent
     until my brother satisfied his monetary agreement, or
     commitments.
     59
      Respondent determined these amounts in the notices of
deficiency. However, in a stipulated exhibit, the parties agreed
that ERG paid NPI $31,850, $26,950, $31,850, $33,840, and $38,296
during the years at issue, respectively, as rent for the Lowell
plant. But see supra p. 25, table, note 1. From the evidence
and argument presented, we cannot determine why there is a
discrepancy between the amounts that respondent determined and
the amounts the parties stipulated. Thus, we assume the parties
                                                   (continued...)
                              - 67 -

obligation to pay Aker’s rent obligations.   Indeed, it was, as

the arbitrators concluded, Aker’s responsibility to pay NPI for

the use of the Lowell plant, which Glendon ultimately paid by

virtue of the final arbitration decision.    This, of course, is in

accord with what the brothers agreed in the unbundling agreement.

Given that these funds were transferred to NPI, which the Bensons

used for their personal benefit, see infra, we find and hold that

the Bensons received constructive dividends in the amounts of the

excess rents that ERG paid.

     9.   Director’s Fees

     During the years at issue, ERG paid moneys to Esther,

Elizabeth, Mark, Brad, and Eric as purported director’s fees.

Additionally, in 1994, Burton altered the date on a $12,000 check

previously issued to his mother and negotiated it shortly after

her death.   Burton testified that this check also represented

director’s fees paid to his mother.    Respondent argues that all

these payments represent constructive dividends to Burton.   We

agree with respondent.

     At trial, Burton generally testified that his family members

were directors of ERG, that ERG held meetings from time to time,

and that the purported directors performed services for ERG.

However, he did not testify what services the purported directors



     59
      (...continued)
will resolve the difference in their Rule 155 computation.
                               - 68 -

performed, and there is no evidence when and how often board

meetings were held.   No minutes of these alleged board meetings

were proffered as evidence.   Furthermore, ERG did not issue Forms

1099, and generally, none of the purported directors reported the

income on their individual returns.60

     The “Transfer of income within the family presumably

benefits both transferor and transferee.”    P.R. Farms, Inc. v.

Commissioner, 820 F.2d at 1089-1089 (citing Helvering v.

Clifford, 309 U.S. 331, 335 (1940)).    In P.R. Farms, Inc. v.

Commissioner, supra, the majority shareholder of a corporate

taxpayer structured his business affairs to, inter alia, shuttle

money to his children.61   The court found the business

arrangement gratuitous and held that the corporation could not

deduct the transfers as ordinary and necessary business expenses,

and the amounts transferred were constructive dividends to the

shareholder.   Id. at 1088.   A similar result is appropriate here.

     There is no evidence what services the purported directors

performed on behalf of ERG, when the meetings were held, and


     60
      However, Eric did report the fees received in 1994 on his
1994 return.
     61
      In P.R. Farms, Inc. v. Commissioner, 820 F.2d 1084 (9th
Cir. 1987), affg. T.C. Memo. 1984-549, the taxpayer owned and
operated fruit orchards (orchards company). The 91-percent
shareholder, president, and director of the orchards company
incorporated a fruit packing corporation (packing company) owned
by the shareholder’s four children. The packing company was
formed to assume responsibility for packing the orchards
company’s fruit in exchange for fees.
                              - 69 -

whether the amounts paid to the purported directors were

reasonable and customary in the industry.    This appears to be

just another instance where Burton channeled funds from ERG for

personal reasons.   Accordingly, we find and hold that Burton had

constructive dividend income of $6,000, $23,000, $42,000, and

$49,000 in 1989, 1990, 1993, and 1994, respectively.

     10.   Townsend & Townsend Check

     The parties stipulated that the law firm Townsend & Townsend

issued ERG a check for $15,000 dated January 14, 1994, which

Burton negotiated in favor of an insurance company.    The funds

were credited to an insurance policy against which Burton had

previously taken loans.   Additionally, the parties stipulated

that during the years at issue, Elizabeth was the primary

beneficiary of the insurance policy.   The beneficiary was not

changed to ERG until sometime in 1996.    At trial, Burton

testified that when the insurance policy was purchased, it was a

mistake to designate his wife as the primary beneficiary; he

thought the policy was a “key man” policy owned by ERG.      Burton

testified that the loan proceeds originally taken against the

policy were used to meet ERG’s payroll.

     There is no evidence, save Burton’s self-serving testimony,

that the funds were used for the benefit of ERG.    The record,

instead, demonstrates that two loans were taken against the

insurance policy in 1975 and 1984 which totaled approximately
                              - 70 -

$15,000.   Indeed, the policy was not for the benefit of ERG but

for the Bensons.   If Burton had died after repayment, Elizabeth

would have received $15,000 more as a death benefit than if the

loans had not been repaid.   Accordingly, we find and hold that

the $15,000 was a constructive dividend.

     11.   Travel Expenses

     On brief, respondent concedes that the Bensons did not have

constructive dividend income with respect to items of expense

Burton substantiated.   Respondent concedes the following items on

the basis of Burton’s explanation at trial:    Karim Cycling

$16.24, Surf Berkeley $56.40, and Claremont Resort $2,504.30.

The balance is still at issue.

     Burton testified that a $9.23 expense was “Probably * * * a

tank of gas that went into a rental car.”    (Emphasis added.)

Some of the charges were incurred in Corvallis, Oregon, where

Burton’s son was attending college.62    Finally, expenses were

incurred by Pastor Nelson with respect to the performance of

memorial services on behalf of Esther.    Burton testified that

these expenses were allocated to ERG because his mother was a

director of ERG.   After respondent presented evidence supporting

his contention that these items constituted constructive

dividends, with the exception of Burton’s self-serving testimony,


     62
      Burton testified that these expenses were incurred on a
visit to a Hewlett Packard laser and jet ink printer division.
He did not explain what that visit had to do with ERG’s business.
                                - 71 -

petitioners fail to demonstrate a business purpose for any of

these expenditures and otherwise fail to substantiate any of the

items.     Furthermore, expenses for Esther’s memorial services are

clearly personal and noncorporate expenses.    Accordingly, we find

and hold that Burton had constructive dividend income of

$3,889.63

     12.    Legal Expenses

     In 1994, ERG paid legal expenses of $4,660.19.    Respondent

determined that $4,159 constituted a constructive dividend to

Burton.64    The stipulated invoices provide some explanation of

the nature of the charges incurred.

     Although we generally agree with respondent, the face of the

invoices grant the Bensons some relief.    For example, $126 in




     63
      Respondent appears to have double-counted a charge of
$223.82. In his opening brief, respondent lists the amount still
at issue as $6,690. Apparently, this amount is the aggregate of
those items listed on the ERG travel expense report dated Feb. 9,
1994, $616.47, the expense report dated Oct. 4, 1994, $833.06,
and the amounts the parties stipulated totaling $5,241.24.
However, the amount $223.82 concerning a charge at a hotel in
Corvallis, Oregon, is listed twice. Thus, an amount equal to
$223.82 should be backed out of respondent’s determination.
Thus, we calculate Burton’s constructive dividend as follows:
$6,690 less $2,576.94 of substantiated expenses less $223.82.
     64
      We are unable to resolve the apparent discrepancy between
the amount listed in the notice of deficiency and the amount
shown on the documentary evidence. Similarly, respondent asked
us to find as fact that in 1994 ERG paid legal bills of $4,159.
Without an explanation to the contrary, we assume that respondent
has conceded the difference.
                                  - 72 -

legal fees65 was incurred concerning unemployment issues.

Presumably, these were not personal expenses.     However, for the

majority of the charges detailed, it is either impossible to

determine the purpose of the charges or those charges do not

appear to be deductible expenses of ERG.     For example, there are

charges concerning a property line dispute and loan agreement and

“MVPC documents”.     These could be either personal or business

expenses since both ERG and the Bensons donated money to MVPC for

which charitable deductions were claimed.     Additionally, there

are charges relating to probating Esther’s estate, which would

not appear to be ERG’s deductible expense.     Petitioners have

failed to meet their burden of proof as to these items except for

$126.     Accordingly, we hold that Burton has constructive dividend

income of $4,033.66

     13.     Employee Relations Expenses

     Respondent determined that the Bensons received certain

amounts paid by ERG designated as business relations expenses.

On brief, respondent’s only argument is that the Bensons failed

to overcome the presumption of correctness in the notice of

deficiency as to this issue.      The amount of income determined by

respondent is $4,027, but the invoices in evidence total

$3,035.16.     See supra p. 30.   The Bensons failed to overcome the


     65
          That is $210 per hour multiplied by .6 of an hour.
     66
          That is $4,159 less $126.
                                    - 73 -

presumption of correctness with respect to $3,035.16.             We hold

that $3,035 was a constructive dividend.

Use of Funds From NPI

        The Bensons used proceeds from the above-listed transfers

for their personal benefit.        For example, from 1993 through 1995,

Burton caused NPI to expend more than $4.6 million for his

family’s personal benefit.67        These funds were used for, inter

alia, the Bensons’ personal State and Federal income tax

liabilities, personal investments, and transfers to their three

sons.        There is no indication in the record that the Bensons

intended to repay any part of these expenditures and/or transfers


        67
             NPI made the following transfers on behalf of the Bensons:

Transfer Year                      Description                  Amount

   1993                        California Franchise
                                 Tax Board                    $129,480.00
   1993                        IRS                             378,000.00
   1994                        California Franchise
                                 Tax Board                      28,745.00
   1994                        IRS                             135,869.00
   1994                        Checks payable
                                 to Burton                     200,000.00
   1994                        Wire transfer re secured
                                 promissory note             1,000,000.00
   1995                        IRS                              23,331.00
   1995                        Checks payable to
                                 Burton and Elizabeth          400,000.00
   1995                        Burton’s Jack White & Co.
                                 investment account          1,000,000.00
   1995                        Bensons’ USAA Mutual
                                 Fund                        1,000,000.00
   1995                        Bensons’ Insight Capital
                                 Research & Management, Inc.
                                 account                         5,441.55
   1995                        Bensons’ Insight Capital
                                 Research & Management, Inc.
                                 account                         4,860.81
   1995                        Checks payable to Eric, Brad,
                                 and Mark                      300,000.00
 Total                                                       4,605,727.36
                               - 74 -

to NPI.    See Noble v. Commissioner, 368 F.2d at 443; Truesdell v.

Commissioner, 89 T.C. 1280 (1987).      Nor is there any indication

that any of the transfers served NPI’s business purpose.

Additionally, as detailed above, ERG made significant payments to

third parties, family members, and the Bensons themselves.     ERG

paid the Benson family’s personal expenses and purchased real

property for their sole use and enjoyment.

     We disagree with the Bensons that a finding of constructive

dividends necessitates a declaration that NPI is a sham entity.

We do not find that NPI was a sham; however, we do find that

there is competent evidence that transfers by ERG to NPI for

purported royalties and engineering services during the years at

issue were made by Burton for his personal benefit and lacked a

business purpose.    Indeed, the record discloses that NPI was a

receptacle to which ERG transferred and pooled its operational

profits.    The exclusive licensing agreement and the payment of

engineering services were the articulated justification for these

payments.    As the testimony and evidence demonstrates, there was

a “plan” to keep ERG profits static, shuttling amounts in excess

thereof to NPI, clothed as business payments.     The profit level

of ERG was not a function of economic realities but instead of

tax planning and tinkering.

     The record demonstrates that Burton controlled both sides of

the equation; there were no arm’s-length transactions between the
                               - 75 -

two entities.   There is no evidence upon which we can find that

the transfers of funds by ERG to NPI served any business purpose.

The Bensons substantially benefited economically from those

transfers through NPI’s disbursement of millions of dollars for

the Benson family’s personal use and enjoyment.    Accordingly, we

find the Bensons enjoyed considerable economic benefits from the

ERG transfers and expenditures.

Nonconstructive Dividend Issues

     1.   Franklin Dividends

     The Bensons conceded that they had additional, unreported

dividend income from their Franklin account #1 for all the years

at issue except 1994.    In 1994, $1,072 was credited as dividends

to this account.   The stipulated evidence demonstrates that the

account was held in the Bensons’ name, although the account bore

the Social Security number of Eric.     All the funds deposited into

this account are attributable to the Bensons.    Despite the fact

that Eric reported the amount credited on his 1994 return, the

dividends are clearly attributable to the Bensons and should have

been reported by them.   Thus, we find and hold that the Bensons

had additional dividend income in 1994 of $1,072.

     2.   Forgiveness of Debt Income

     On its returns, ERG’s “loans to stockholders/officers” were

reduced from $88,291 in 1987 to $0 in 1988.    Respondent argues

that the forgiveness of the debt was income to the Bensons in
                                 - 76 -

1994, or, alternatively, in 1988.      We agree and sustain

respondent’s determination that the Bensons’ debt was forgiven in

1994.     “Income from discharge of indebtedness" is included within

the broad definition of income.      See sec. 61(a)(12).   “The

underlying rationale for such inclusion is that to the extent a

taxpayer is released from indebtedness, he or she realizes an

accession to income due to the freeing of assets previously

offset by the liability.”      Jelle v. Commissioner, 116 T.C. 63, 67

(2001) (citing United States v. Kirby Lumber Co., 284 U.S. 1, 3

(1931)).      In July 1994, Bradac stated to Burton that without an

explanation such unpaid loans constituted income in the year the

indebtedness was discharged.      ERG filed its 1988 tax return on

August 1, 1994.      Burton’s indebtedness was discharged in 1994

when it was eliminated from ERG’s return.      It was at that

“‘moment it * * * [became] clear that a debt will never have to

be paid, such debt must be viewed as having been discharged.’”

Rinehart v. Commissioner, T.C. Memo. 2002-71 (quoting Cozzi v.

Commissioner, 88 T.C. 435, 445 (1987)).      Accordingly, we find and

hold that Burton had cancellation of indebtedness income of

$88,291 in 1994.

        3.   Partner Expenses--Baden Spiel Haus Partnership

        Burton was a 25-percent partner in the Baden Spiel Haus

partnership, which owned and operated a ski cabin in California.

Respondent determined that the Bensons were not entitled to
                               - 77 -

deductions for partner expenses claimed on their returns.     The

Bensons conceded the issue for the years 1989, 1990, and 1993,

but not for 1994.    The Bensons failed to substantiate any item of

expense.    Accordingly, we sustain respondent’s determination as

to 1994.

     4.    Rental Income/Loss--Residential Rental Expenses:

     Respondent determined that the Bensons were not entitled to

unsubstantiated residential rental expenses of $23,599, $22,951,

$28,621, $23,737, and $23,599 for 1988, 1989, 1990, 1993, and

1994, respectively.    The deductions were claimed by NPI and

passed through to its shareholders.     The Bensons did not provide

the Court with evidence to substantiate the deductions claimed.

Accordingly, we sustain respondent’s determination on this issue.

     5.    Passive Loss Limitation

     Respondent determined that rental losses reported on Eric’s,

Brad’s, and Mark’s returns are subject to the passive loss

limitations contained in section 469.    Petitioners offer no

evidence with which we can find that they fall within the

auspices of any of the exceptions articulated in the

regulations.68   See Kessler v. Commissioner, T.C. Memo. 2003-185;

sec. 1.469-1T(e)(3)(ii)(A) through (F), Temporary Income Tax

Regs., 53 Fed. Reg. 5702 (Feb. 25, 1988).     Without a finding that


     68
      On brief, petitioners state: “Petitioners do not dispute
respondent’s argument on the applicable Subchapter S rules at
page 136-38 of his brief.”
                              - 78 -

petitioners fall within one of those enunciated exceptions,

“material participation” is irrelevant.   See sec. 469(c)(1);

Tarakci v. Commissioner, T.C. Memo. 2000-358; Welch v.

Commissioner, T.C. Memo. 1998-310 (“If * * * [taxpayer]

establishes that the activity was not a rental activity, he then

must establish that he materially participated in the activity to

avoid the proscription of section 469.").   Accordingly, we

sustain respondent’s determination on this issue.

     6.   NPI Distributions

     On its 1994 return, NPI reported total property

distributions other than dividends of $1,017,373.   Eric’s,

Brad’s, and Mark’s shares thereof were $169,562 each.    In the

notice of deficiency, respondent determined that Eric had

substantiated a basis in his NPI stock of $105,224 and that he

had distributions in excess of basis of $64,338.    In the notices

of deficiency for Brad and Mark, respondent determined that they

had substantiated bases in their NPI stock of $76,926 each and,

thus, had distributions in excess of basis of $92,636.

     The parties indicate on brief that the issue concerning what

amounts are properly reportable on Eric’s, Brad’s, and Mark’s

returns can be resolved by the parties under their Rule 155

computation.
                               - 79 -

Fraud Penalty

     In his determinations, respondent asserted fraud penalties.

Although the record discloses what could be construed as “badges

of fraud,” see Bradford v. Commissioner, 796 F.2d 303, 307 (9th

Cir. 1986), affg. T.C. Memo. 1984-601, we are not convinced that

respondent has carried his heavy burden of proving fraud by clear

and convincing evidence, Gow v. Commissioner, T.C. Memo. 2000-93

(“even where there is a strong suspicion of an intent to evade

taxes, we are hesitant to impose the section 6663(a) penalty

unless we are convinced that the Commissioner satisfied his

burden of proof”).   The record contains evidence that the

inaccuracies and the inconsistencies in petitioners’ returns may

have been a result of extraordinary circumstances, albeit many

times at the hands of Burton himself.   For example, petitioners’

long-time accountant and return preparer died just prior to the

years at issue.   A new accountant/return preparer was engaged

years later and inherited a poorly administered accounting

system.   There were few records from which the financial history

of the entities could be reconstructed.   Apparently, a

significant amount of work was performed to get the books and

records of the entities in a position from which returns could be

filed.    Some of the returns were filed out of order, and amended

returns were filed as additional information was discovered.
                              - 80 -

     Clearly, ERG transferred millions of dollars to NPI.     In

reviewing and reconstructing the books and records of the

entities, the accountants inquired as to these transfers.     Burton

and the accountants labeled these transfers as payments of

royalties and for engineering services.    The royalties were paid

on the basis of an exclusive licensing agreement suggested by

Miller, the mediator of the brothers’ dispute.   The balances were

designated “engineering services” by Burton and his accountants.

     When asked at trial who came up with the idea of how to

allocate income between NPI and ERG, Bradac testified “Probably

through my suggestion in the early years we were trying to base

it on the income of ERG and we started with a number, somewhere

an average of fifty to seventy-five thousand dollars of profits

for the corporation.”   That number was based upon Bradac’s

suggestion because “the tax rates for a corporation * * *

[become] rather prohibitive after 75,000, and also looking at

perhaps the balance sheets and estimating the growth of the

company over those years.”   Bradac admitted at trial that “any

plan developed by * * * [Burton], was developed with my

consultation.”   For example, Bradac knew that the $483,098 that

ERG transferred to NPI was not for equipment purchased and,

instead, he claimed a royalty deduction in preparing the ERG

returns for 1989 of $252,679 explaining:   “I believe it was an

unfortunate tag, meaning the royalty name”.   He stated:    “And I
                               - 81 -

was focused on royalties as a possible deduction from ERG to * *

* NPI and we put the amount in there when it probably should have

been better labeled services * * * so we deducted the amount as

royalties when perhaps a better label even then would have been

engineering services.”    According to Bradac’s testimony, there

was no real formula to allocate royalties to the years at issue.

The Court asked and Bradac answered as follows:

          Q: How were the specific amounts arrived at for
     the individual years?

          A: We would–-we initially, one based it on the
     profits of ERG. And when I say that, we anticipated
     that ERG would still be profitable during the period.
     So we estimated their profits in the range of fifty to
     seventy-five thousand dollars. And calculated the
     royalties that were necessary to bring the income down
     to that level.

Additionally, Bradac testified that he suggested the concept of

constructive receipt as a basis to allocate payments to tax years

prior to receipt.   Bradac, Toibin, and Burton discussed the

characterization of other ERG payments to NPI as “engineering

services”.   Finally, Bradac testified that Burton did not order

him to make any particular entry that appeared on the returns and

that he made discretionary decisions with respect to classifying

income and expense.

     Given this record, we are unable to sustain respondent’s

determination of fraud.
                                  - 82 -

Accuracy-Related Penalties

      With respect to the Bensons,69 respondent determined that to

the extent we do not find fraud, we should impose accuracy-

related penalties.70      Additionally, respondent determined

accuracy-related penalties for Eric, Brad, and Mark for 1994.

Respondent based his determinations on negligence or disregard of

the tax rules and regulations and/or a substantial understatement

of income tax.      Respondent’s determinations are presumed correct,

and the burden lies with petitioners to demonstrate that

respondent’s penalty determinations were in error.71       Rule

142(a).

      Section 6662(a) imposes a 20-percent penalty on the portion

of an underpayment of tax attributable to, inter alia, negligence

and/or a substantial understatement of income tax.       Sec. 6662(a)

and (b).      “Underpayment” is defined as the amount by which any

tax imposed exceeds the excess of the sum of the amount shown by

the taxpayer on his return plus the amounts not so shown




      69
      Respondent also determined, as an alternate to the fraud
penalty which he conceded shall not apply to Eric, an accuracy-
related penalty for Eric’s 1993 tax year. See docket No. 585-98.
However, on brief, respondent explains that the penalty is
affected by our holding on the issue of constructive dividends.
      70
      In fact, respondent’s alternative position for 1989, 1990,
1993, and 1994 is based upon sec. 6662(a).
      71
           Sec. 7491(c) does not apply in this case.   See supra note
41.
                                - 83 -

previously assessed (or collected without assessment) over the

amount of rebates made.   Sec. 6664(a).

     “Negligence” is defined as “any failure to make a reasonable

attempt to comply with the provisions of this title” and

“disregard” means “any careless, reckless, or intentional

disregard.”   Sec. 6662(c).   Similarly, caselaw defines negligence

as a lack of due care or “‘the failure to do what a reasonable

and ordinarily prudent person would do under the circumstances.’”

Freytag v. Commissioner, 89 T.C. 849, 887 (1987) (quoting

Marcello v. Commissioner, 380 F.2d 499, 506 (5th Cir. 1967),

affg. on this issue 43 T.C. 168 (1964) and T.C. Memo. 1964-299)),

affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S. 868 (1991).

Pursuant to the regulations, “‘Negligence’ also includes any

failure by the taxpayer to keep adequate books and records or to

substantiate items properly.”    Sec. 1.6662-3(b)(1), Income Tax

Regs.

     Section 6664(c) provides an exception to the penalty imposed

under section 6662(a).    “No penalty shall be imposed under this

part with respect to any portion of an underpayment if it is

shown that there was a reasonable cause for such portion and that

the taxpayer acted in good faith with respect to such portion.”

Sec. 6664(c)(1).   The determination of whether the taxpayer acted

with reasonable cause and in good faith is made on a case-by-case
                                - 84 -

basis, contemplating all the relevant facts and circumstances.

Sec. 1.6664-4(b)(1), Income Tax Regs.

     “Reasonable cause requires that the taxpayer exercise

ordinary business care and prudence”.    Bitker v. Commissioner,

T.C. Memo. 2003-209 (citing United States v. Boyle, 469 U.S. 241

(1985)).   With respect to the tax treatment of an item, the good

faith reliance on the advice of a competent and independent

professional may constitute “reasonable cause”.    Id.; sec.

1.6664-4(b), Income Tax Regs.    However, whether a taxpayer

reasonably relies on the advice of a professional depends upon

the facts and circumstances of the case and the applicable law.

Sec. 1.6664-4(c)(1)(i), Income Tax Regs.    “[T]he ultimate

responsibility for a correct return lies with the taxpayer who

must furnish the necessary information to his agent who prepared

his return.”   Pessin v. Commissioner, 59 T.C. 473, 489 (1972);

sec. 1.6664-4(c)(1)(i), Income Tax Regs.    The taxpayer “has the

burden of establishing that he at least supplied the correct

information to his accountant * * * and that the incorrect

returns were a result of the accountant’s mistakes.”    Pessin v.

Commissioner, supra at 489.

     In this case, the understatement and underpayment of tax is

a direct result of the misapplication and mislabeling of

transactions in derogation of the tax laws.    Furthermore,

Burton’s failure to keep accurate and complete corporate books
                                - 85 -

significantly contributed to his failure to accurately and

completely report income and file returns.72

       The record is replete with indications that Burton did not

supply complete and/or correct information to his return

preparers.    He cannot hide behind the shield of ignorance or

reliance.    Indeed, both Bradac and Toibin testified repeatedly

that they relied in large part on Burton’s representations and

characterizations.     For example, Bradac testified that with

respect to the automobile and truck deductions, he relied

completely on Burton’s representations that the correct

allocation between personal and business use was made.

Additionally, Bradac testified that he had not seen a copy of the

royalty agreement before he commenced preparation of ERG’s and

NPI’s returns.    We sustain respondent’s determination of

negligence penalties in this case against the Bensons.

       Likewise, petitioners argue on brief that “Burton testified

he was responsible for getting his son’s returns completed and

filed for 1993 and 1994, and * * * accuracy related penalties

should not inure to the sons for what the father undertook to

do.”    We disagree.   “[T]he taxpayer must bear the consequences of

any negligent errors committed by its agent.”     Ellwest Stereo

Theater v. Commissioner, T.C. Memo. 1995-610 (citing Logan Lumber


       72
      On brief, petitioners argue: “there is no question that
Burton neglected his responsibilities to enlist new accounting
help and to keep up with required tax return filings.”
                               - 86 -

Co. v. Commissioner, 365 F.2d 846, 854 (5th Cir. 1966), affg.

T.C. Memo. 1964-126).   Thus, we sustain respondent’s

determinations of accuracy-related penalties as to Eric, Brad,

and Mark.

Additions to Tax--Failure To File Timely Return

     Pursuant to section 6651(a)(1), respondent determined that

the Bensons are liable for additions to tax for 1989 and 1990 and

that Eric is liable for additions to tax for 1993.73     An addition

to tax is imposed under section 6651 for the failure to file a

return within the period prescribed, unless the taxpayer shows

that such failure was due to reasonable cause and not due to

willful neglect.   Sec. 6651(a)(1).     The amount of the addition is

5 percent of the amount required to be shown as tax for each

month that the delinquency persists, up to a maximum of 25

percent.    Id.

     The delinquency is due to reasonable cause if the taxpayer

exercised ordinary business care and prudence but was

nevertheless unable to perform his tax obligations in a timely

manner.    Brewery, Inc. v. United States, 33 F.3d 589, 592 (6th

Cir. 1994); Housden v. Commissioner, T.C. Memo. 1992-91.



     73
      According to the notice of deficiency, Eric’s delinquency
addition to tax is a result of an invalid extension. Since he
did not properly estimate his tax liabilities on his extension
application and since he failed to show a reasonable attempt to
secure the information necessary to make the estimate, his
extension was considered invalid.
                                - 87 -

However, “The delinquency is due to willful neglect if it

resulted from a conscious decision or from reckless

indifference.”     Ellwest Stereo Theater v. Commissioner, supra

(citing United States v. Boyle, supra at 245).

     The Bensons offered no evidence or excuse for their failure

to file timely returns, and we conclude that they have not shown

that their failure to file returns for the years at issue was due

to reasonable cause and not due to willful neglect.    Accordingly,

we sustain respondent’s determinations.

     Furthermore, petitioners argue on brief that since Burton

testified that he was responsible for filing his son’s returns,

the additions to tax “should not inure to the sons for what the

father undertook to do.”    Petitioners cite no authority upon

which we can look to relieve Eric from his duty to file his tax

return timely.   They rely solely upon Burton’s testimony that he

undertook the responsibility to file his children’s returns.

     Where the duty to file the return is imposed on the
     guardian charged with the care of the taxpayer's
     property, and not on the taxpayer, the inability of the
     taxpayer is not controlling, and the applicability of
     additions to tax depends on whether or not there was a
     lack of good cause and due care on the part of the
     guardian.

Bassett v. Commissioner, 67 F.3d 29, 32 (2d Cir. 1995), affg. 100

T.C. 650 (1993).    We are not convinced that the failure to file

was attributable to reasonable cause and not to willful neglect.
                             - 88 -

Thus, we sustain respondent’s imposition of delinquency additions

to tax as to Eric’s 1993 tax year.



                                          Decisions will be entered

                                     under Rule 155.
                                 - 89 -

                                Appendix
                       Concessions of the Parties


     1.   Respondent concedes that payments of $6,000 made in

1989, 1990, and 1993, and $13,500 in 1994, by Energy Research &

Generation, Inc. (ERG), to Moraga Valley Presbyterian Church

(MVPC) are not constructive dividends to Burton Benson

(Burton).74

     2.   Respondent concedes that the following payments that ERG

made for the years listed are not constructive dividends to

Burton:

                Year         Check No.      Amount

                1988           19378       $10,000
                1988           18617        10,000
                1989           20021        33,328
                1990           21166         2,610

Respondent concedes that Burton O. and Elizabeth C. Benson (the

Bensons) are not liable for constructive dividends with respect

to the category “other payments” that ERG made of $5,700 for

1990.

     3.   Respondent concedes that a payment that ERG made in 1993

for medical expense of $4,000 is not a constructive dividend to

Burton.



     74
      In the text of respondent’s opening brief, he states the
amount conceded as $13,500. However, he also states the amount
as $15,500. We assume from the parties concessions and the
record that respondent conceded $13,500 paid to MVPC and $2,000
to Camp Timberlake.
                              - 90 -

     4.   Burton concedes that he had constructive dividend income

with respect to payments that ERG made for automobile expenses in

the following amounts:

                   Year                Amount

                   1990             $15,000
                   1993              13,500

     5.   Burton concedes that he had constructive dividend income

with respect to payments that ERG made for life insurance for the

years and in the amounts listed:

                   Year                Amount

                   1988                $2,425
                   1989                 2,404
                   1990                 2,480
                   1994                 4,781

     Respondent concedes the adjustment of $2,646 for 1993.

     6.   Burton concedes that he had constructive dividend income

with respect to payments that ERG made in 1993 and 1994 for Eric

Benson’s (Eric) education of $2,599 and $9,166, respectively.

     7.   Burton concedes that he had constructive dividend income

with respect to funds withdrawn from the ERG-Recreation fund bank

account(s) for the years and in the amounts listed:

                   Year                Amount

                   1988                $3,000
                   1990                   686
                   1993                18,556

The amount conceded for 1993 includes $9,000 from cashing check

No. 27 dated March 8, 1993, payable to ERG.     It also includes
                                  - 91 -

check No. 30 drawn on the ERG-Recreation fund account payable to

Mark Benson (Mark) for $9,000.      However, the balance for 1993,

$8,000, remains at issue as well as the entire amount for 1994.

     8.    Respondent concedes that a payment made from the ERG-

Ford Retirement Fund in 1990 of $26,000 is not income to the

Bensons.    Respondent also concedes that the Bensons are not

liable for the 10-percent penalty pursuant to section 72 of

$2,600 for 1990.

     9.    The Bensons concede that they had additional royalty

income from Form 1099 sources in the years and amounts listed:

                    Year                   Amount

                    1988                    $883
                    1989                     709
                    1993                     570
                    1994                     586

     10.    The Bensons concede that they had additional dividend

income from Franklin Money Fund accounts for the years, for the

accounts, and in the amounts listed:

     Account No.           1988     1989            1990     1993

     11102309431      $204.36     $192.66      $229.39     $360.04
     11100025476        -0-          -0-        461.69      627.07

     11.    The Bensons are not entitled to the dependency

exemptions claimed for Esther Benson (Esther) for 1988, 1989, and

1990.

     12.    The Bensons are not entitled to itemized deductions for

mortgage interest in excess of the amounts allowed by respondent
                                 - 92 -

in the notices of deficiency for tax years 1988, 1989, 1990, and

1993.

     13.      The Bensons are not entitled to deductions for partner

expenses with respect to the Baden Spiel Haus partnership for the

years and in the amounts listed:

                      Year                Amount

                      1989                $1,281
                      1990                 1,182
                      1993                 1,473

        14.   For 1993, Eric had additional:   (1) Capital gain income

of $1,957; (2) dividend income of $565; and (3) interest income

of $121.

        15.   Respondent concedes that Eric and Elizabeth Benson

(Elizabeth) are not liable for civil fraud penalties for the

years at issue.

        16.   For 1994, Brad Benson (Brad) had additional:   (1)

Capital gain income of $2,444; (2) dividend income of $2,779; and

(3) interest income of $65.

        17.   For 1994, Mark had additional:   (1) Capital gain income

of $2,542; (2) dividend income of $11,674; (3) income from ERG of

$5,000; and (4) self-employment income with respect to the

amounts received from ERG.

        18.   For 1994, Eric had additional:   (1) Capital gain income

of $2,443; (2) dividend income of $2,822; (3) interest income of

$112; (3) gross wage income of $232; and (4) self-employment
                              - 93 -

income with respect to the amounts received from ERG and reported

on his 1994 return as “other income”.

     19.   Respondent concedes that the Bensons did not have

constructive dividend income in 1994 with respect to payments

that ERG made for travel expense for $536.

     20.   Respondent concedes his alternative position that the

fair market value of rent on the Stanford plant was as determined

by an expert appraiser whose report respondent submitted to the

Court.

     21.   Respondent concedes ERG’s computer purchase in the

amount of $3,847 did not constitute a constructive dividend to

the Bensons in 1993.

     22.   Respondent concedes that ERG’s payment of $692 for

health insurance coverage for Esther did not constitute a

constructive dividend to the Bensons in 1994.

     23.   Respondent concedes that if the Court determines that

the Bensons received constructive dividends of $96,749 from ERG’s

payment of legal expenses, the Bensons are entitled to deduct

legal expenses (subject to the limitations in section 67) of

$77,973 for 1989.

     24.   For the years 1988, 1989, 1990, 1993, and 1994 to the

extent that the Court determines constructive dividends, these

amounts are taxed as dividends to the Bensons.
                              - 94 -

     25.   The parties agree that if respondent prevails on the

constructive dividend issue, then the income reported by the

other shareholders of New Process Industries, Inc., will have to

be accordingly adjusted.
