                      T.C. Memo. 2001-3



                UNITED STATES TAX COURT



        NORMAN E. DUQUETTE, INC., Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 1933-98.              Filed January 8, 2001.



     D, a consultant, carried on his consulting
business as an employee of P, a "C corporation". D and
his wife were the sole shareholders and directors of P.
R disallowed various deductions claimed by P during its
1994 fiscal year and also determined that P was subject
to the sec. 6662, I.R.C., accuracy-related penalty. P
alleged that R’s notice of deficiency was invalid.
     1. Held: The notice of deficiency is valid.
     2. Held, further, R’s disallowance of various
deductions is sustained in substantial part.
     3. Held, further, R’s penalty against P for the
taxable year is sustained, in part, under sec. 6662,
I.R.C.



Norman E. Duquette (an officer), for petitioner.

Alan R. Peregoy, for respondent.
                                - 2 -


                         MEMORANDUM OPINION

     HALPERN, Judge:    By notice of deficiency dated November 20,

1997 (the notice), respondent determined a deficiency in

petitioner’s Federal income tax for its taxable year ended

September 30, 1994 (the 1994 tax year), in the amount of $63,232

and an accuracy-related penalty in the amount of $12,646.

     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the year in issue, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.

     The parties have resolved certain issues, and issues

remaining for decision are (1) the validity of the notice,

(2) petitioner’s entitlement to certain deductions for rent,

depreciation, business meals, travel, supplies, and legal fees,

and (3) the accuracy-related penalty.

     Some facts have been stipulated and are so found.    The

stipulation of facts, with accompanying exhibits, is incorporated

herein by this reference.   We need find few facts in addition to

those stipulated and will not, therefore, separately set forth

our findings of fact.   We will make additional findings of fact

as we proceed.   Petitioner bears the burden of proof.   See

Rule 142(a).
                               - 3 -

                             Background

     Petitioner is a Maryland corporation, organized on

November 8, 1991.   At the time of the petition, petitioner’s

mailing address was in Rockville, Maryland.    During the period

relevant to this case, petitioner was owned equally by Norman E.

and Aline J. Duquette (together, the Duquettes; individually,

Norman and Aline, respectively).

     From 1968 until 1986, Norman was employed as an auditor by

the Defense Contract Audit Agency (DCAA).   In 1986, he left the

employ of DCAA, and he opened a consulting business (the

consulting business), offering advice to Government contractors

in connection with their dealings with DCAA.    Initially, Norman

carried on the consulting business as a sole proprietorship.

Norman’s activities as a proprietor were subject to examination

by respondent in May 1991.   That examination led to a criminal

investigation of Norman for tax crimes committed in connection

with the sole proprietorship (the criminal investigation).    The

criminal investigation was resolved by Norman’s pleading guilty

to two counts of filing a false income tax return, for 1989 and

1990, in violation of section 7206(1).    As a result of his guilty

pleas, Norman paid a fine, but he did not serve a prison

sentence.

     In November 1991, Norman organized petitioner to carry on

the consulting business.   Norman testified that petitioner was
                               - 4 -

organized in order to encourage him to keep better records, so as

to avoid further difficulties with respondent.   Petitioner

carried on the same business, with the same clients, as had

Norman (as a proprietor).   During the 1994 tax year, Norman and

Aline were the only directors and officers of petitioner.

Petitioner’s Federal income tax return for the 1994 tax year (the

1994 tax return) shows gross receipts of $309,630.35 and taxable

income of $1,178.30.   On the 1994 tax return, petitioner claimed

no deduction for salaries and wages but did claim a deduction for

compensation of officers in the amount of $112,000, which amount

was reported by the Duquettes, $100,000 by Norman and $12,000 by

Aline, on the joint return of income that they made for 1994.

Norman was employed by petitioner to provide consulting services

to customers.   Although Norman testified that petitioner employed

part-time consultants, petitioner has failed to identify those

individuals, and the 1994 tax return does not show any salary or

wage paid to any such part-time consultants.   We conclude,

therefore, that, at least during the 1994 tax year, petitioner’s

sole business activity was offering Norman as a consultant.

     The Duquettes were married in Rockville, Maryland, on

February 4, 1988, and they were divorced in Florida in June 1996.

They lived in Montgomery County, Maryland, until December 1991,

when they moved to Dallas, Texas.   In Dallas, they made their

home in a condominium apartment located at 3510 Turtle Creek
                                  - 5 -

Blvd. (the Dallas apartment or the apartment).    The Dallas

apartment was their home from December 1991 until April 18, 1994.

In April 1994, the Duquettes relocated to Naples, Florida.

Aline made her home there, and Norman visited her there until

September 1994, after which, in substantial part because of

marital difficulties, he did not return to Florida.

      In May 1993, Norman began work for a Washington, D.C., law

firm (the law firm) as an accounting consultant.    The law firm

treated Norman as an employee, issuing him a Form W-2, Wage and

Tax Statement, for both 1993 and 1994.    Those Forms W-2 show

compensation of $52,060 and $155,372.50 for 1993 and 1994,

respectively.    During the 1994 tax year, Norman worked in

Washington, D.C., on approximately 177 days.    On those days,

Norman resided in an apartment in Bethesda, Maryland (the

Bethesda apartment).

                             Discussion

I.   Validity of Notice

      A.   Assignments of Error

      In the petition, petitioner assigns the following errors to

respondent’s determination of a deficiency:

        (a) The Commissioner issued an invalid notice of
      deficiency as the notice is not based on an actual
      deficiency determination. Further, the notice is
      invalid because the IRS did not examine the
      petitioner’s tax return for the tax year ended
      September 30, 1994.
                                - 6 -

       (b) The notice of deficiency is arbitrary and
     erroneous, and is not based on any ligaments of fact.
     Moreover, the notice of deficiency amounts to a naked
     assessment without foundation whatsoever.

     B.   Facts

     Documents in evidence establish the following:   On

October 27, 1997, Pat Grimes, a Revenue Agent employed by

respondent, commenced an examination (the examination) of the

1994 tax return.   On that date, Revenue Agent Grimes sent to

petitioner two letters and a request for documents.   The first

letter informs petitioner that the 1994 tax return has been

assigned to Revenue Agent Grimes for examination.   It also states

that she needs additional information to verify certain items on

that return.   The request for documents (document request)

contains a specific and comprehensive list of documents,

including documents substantiating the following items with

respect to the 1994 tax year:

     1.   Year end wages accrued but not paid to shareholder
     2.   Supplies
     3.   Professional Services
     4.   Rent expense
     5.   Automobile expenses and depreciation
          Travel expenses:
          a. Meal expenses
          b. Hotel expenses
          c. Airplane tickets

The second letter informs petitioner that the limitation period

for the assessing of additional tax for the 1994 tax year will

expire soon, encloses a Form 872, Consent to Extend the Time to

Assess Tax (Form 872), and requests that petitioner sign and
                               - 7 -

return the Form 872.   In pertinent part, the Form 872 states:

“The amount of any Federal Income tax due on any return(s) made

by or for the above taxpayer(s) for the period ended

September 30, 1994, may be assessed any time before December 31,

1998.”   Petitioner did not return the Form 872 or respond to the

document request.   Instead, petitioner attempted to negotiate

restrictions to be incorporated into the Form 872.    Revenue Agent

Grimes and her supervisors refused to restrict the Form 872 and,

on November 20, 1997, no Form 872 having been received by

respondent, the notice was issued.     By letter dated December 8,

1997, Stephen P. Taylor, Chief, Exam Branch V (apparently, a

supervisor of Revenue Agent Grimes), explained respondent’s

failure to restrict the Form 872:    “Conditions required under the

Internal Revenue Manual were not met.    We do not restrict

statutes or the scope of an examination prior to initiating the

examination.”

     Other documents in evidence establish the following:     On

October 27, 1997 (the date the examination commenced), Revenue

Agent Grimes was examining petitioner’s income tax returns for

the 2 taxable years preceding 1994 (the preceding years’

examination).   She completed the preceding years’ examination on

November 6, 1997.   On that date, petitioner was sent a copy of

the resulting report (the report).     The report shows adjustments

with respect to the following items:
                                 - 8 -

     Accrued wages to related party
     Rents
     Auto/truck expense
     Depreciation
     Supplies–office
     Legal & professional fees
     Meals & entertainment
     Hotel expenses

     In negotiating with respect to the Form 872, petitioner

attempted to have the Form 872 restricted so that petitioner

would consent to waive the time to assess tax only with respect

to tax attributable to items similar to those giving rise to

adjustments in the report.   As stated, respondent’s agents would

not agree to such restriction.

     The notice is addressed to petitioner, references the 1994

tax year, determines the deficiency in income tax and penalty

described above, and, with additional explanations, sets forth

the following adjustments to income giving rise to such

deficiency:

     a.   Interest income
     b.   Compensation of officers
     c.   Rents
     d.   Depreciation
     e.   Other deductions

The category “Other Deductions” (other deductions) is

particularized as follows:

     Business meals
     Travel
     Supplies
     Professional fees
                                 - 9 -

     C.   Discussion

            1.   Validity of Notice

     Petitioner claims that the notice is invalid because

respondent failed to determine a deficiency in petitioner’s

income tax or examine its return.

     Section 6212(a) authorizes the Secretary to send a notice of

deficiency in respect of certain taxes, including the income tax.

We have jurisdiction to redetermine deficiencies determined by

the Secretary.    See sec. 6214(a).   A valid notice of deficiency

has been described as the “ticket to the Tax Court”.     E.g.,

Baron v. Commissioner, 71 T.C. 1028, 1034 (1979).     Petitioner

directs us to Scar v. Commissioner, 814 F.2d 1363 (9th Cir,

1987), revg. 81 T.C. 855 (1983).      In Scar, the Court of Appeals

for the Ninth Circuit considered a notice of deficiency that, on

its face, revealed that no determination of a deficiency had been

made with respect to the taxpayers in question for the year in

question.    See id. at 1370.   The Court of Appeals held that such

a notice was invalid and the petition contesting such notice

should have been dismissed in the taxpayers’ favor for lack of

jurisdiction.    See id.   Commenting on Scar, we have held:     “Where

the notice of deficiency does not reveal on its face that the

Commissioner failed to make a determination, a presumption arises

that there was a deficiency determination.”      Campbell v.

Commissioner, 90 T.C. 110, 113 (1988).
                               - 10 -

     We have examined the notice and, on its face, it does not

reveal that respondent failed to make a determination:      It is

addressed to petitioner, references the 1994 tax year, states

both that respondent has determined a deficiency in petitioner’s

tax for that year and the amount of that deficiency, and sets

forth the adjustments (and explanations of those adjustments)

giving rise to such determination.      Petitioner has failed to

rebut the resulting presumption that respondent did determine a

deficiency in petitioner’s income tax for the 1994 tax year.

Indeed, the presumption is borne out by evidence in the record.

The adjustments in the notice are similar to the adjustments

resulting from the preceding years’ examination.      No doubt,

Revenue Agent Grimes, being responsible for examination of all

3 years, determined that petitioner was subject to adjustments

for the 1994 tax year similar to those for the preceding 2 years.

The particularity of the document request, to which petitioner

made no response, and the content of the correspondence from

Norman, negotiating on behalf of petitioner with respect to the

Form 872, make clear that, prior to the date of the notice,

Revenue Agent Grimes had examined petitioner’s return for the

1994 tax year and determined that, barring a satisfactory

explanation from petitioner of the items in question, similar

adjustments were called for.   Prior to the notice, respondent

(acting through his agent) had determined a deficiency in
                                - 11 -

petitioner’s tax for the 1994 tax year.    Petitioner has failed to

show the invalidity of the notice.

          2.   Claim of Arbitrariness

     Petitioner claims that the notice is arbitrary and

erroneous, and amounts to nothing more than a naked assessment,

without foundation.     We assume that petitioner wishes to invoke

the rule of Helvering v. Taylor, 293 U.S. 507 (1935).     The

rule of Helvering v. Taylor, may be simply put:     A court is given

sufficient cause to set aside respondent’s determination of a

deficiency if it is shown to the court that such determination

was arbitrarily made.    See id.   We need engage in no extended

discussion of that rule.    The record adequately demonstrates that

respondent’s determination of a deficiency was based on the

similarity of the 1994 tax return to petitioner’s returns for the

preceding 2 years (for which respondent found cause for

adjustments) and petitioner’s failure to comply with the document

request and consent to an extension of time to assess tax.

Simply put, respondent did not act arbitrarily, but with cause.1


     1
        On brief, petitioner argues that respondent acted
arbitrarily in not agreeing to a restricted Form 872, requiring
petitioner to consent to waive the time to assess tax only with
respect to tax attributable to items similar to those giving rise
to adjustments for the preceding 2 years. Respondent’s
explanation is that it is against policy to agree to restricted
consents until an examination is completed. While we do not find
that policy arbitrary (quite to the contrary), we fail to see how
here, at least, respondent’s refusal to agree to a restricted
consent makes respondent’s determination of a deficiency
                                                   (continued...)
                                     - 12 -

Respondent did not make a naked assessment.          The rule of

Helvering v. Taylor is not properly invoked in this case.

II.   Rental Expenses

      A.     Introduction

      On the 1994 tax return, petitioner deducted $32,244.12 for

rents paid (the deduction for rents).          By the notice, respondent

disallowed the deduction for rents, explaining that petitioner

had failed to establish that the amount deducted constituted an

ordinary and necessary business expense, was expended, or was

expended for the purpose designated.          The parties have stipulated

that the deduction for rents represents three separate amounts,

as follows:

          $7,540   –   Rent for space in the Dallas apartment
          13,994   –   Bethesda apartment expenses
          10,710   –   Florida expenses
          32,244   -   Total

      B.     Dallas Apartment

              1.       Facts

      As stated, the Duquettes made their home in the Dallas

apartment from December 1991 until April 1994.          On February 8,

1992, the board of directors of petitioner (sometimes, the board)

resolved that petitioner’s offices be transferred from Maryland


      1
      (...continued)
arbitrary and erroneous. The adjustments in the notice appear to
reflect in substantial part the scope of the examination of the
1994 tax year communicated by Revenue Agent Grimes to petitioner
and forming the basis of Norman’s request for a restricted
consent.
                                - 13 -

to Texas and petitioner’s address be the address of the Dallas

apartment, effective January 1, 1992.     The board also resolved:

     The rental expense for the Corporation offices in
     Dallas, Texas shall not exceed $1,500.00 per month.
     The actual rental shall be the association maintenance
     fees charged by the Claridge Association to the
     residents of 3510 Turtle Creek Blvd. All additional
     charges including the acquisition of the unit, property
     taxes, insurance, and telephone expense shall be borne
     personally by Norman E. Duquette and shall not be
     charged to the Corporation.

Norman prepared a document headed “COMPUTATION OF FAIR RENTAL[,]

OFFICE AT 3510 TURTLE CREEK BLVD.[,] DALLAS, TEXAS” (the

computation document).     Among the entries on the computation

document is the following:

     1.   Square Footage Proration
           a. Business Use                   625 square feet
           b. Total Square Footage         2,500 square feet
           c. Percentage Business             25 percent

The computation document also has entries entitled “Annual

Expenses”, “Prorated Expenses”, “Unique Business Expenses”, and

“Total Business Expenses”.     The amount shown as “Total Business

Expenses” is $12,919.29.     The computation document states:   “The

corporation will pay the association fees of $11,477.16 as fair

rental for the office in home.     This is less than the $12,919.29

calculated * * * [as “Total Business Expenses”].”

     The parties have stipulated that the $7,540 deducted by

petitioner as rent for space in the Dallas apartment (the Dallas

apartment amount) represents condominium fees with respect to the
                                - 14 -

Dallas apartment of approximately $1,000 a month from September

1993 until April 1994.

          2.   Section 162(a)(3)

     In pertinent part, section 162(a)(3) provides:

          There shall be allowed as a deduction     [in
     computing taxable income] all the ordinary     and
     necessary expenses paid or incurred during     the taxable
     year in carrying on any trade or business,     including-–

               *   *      *      *    *    *    *

            (3) rentals or other payments required to be
          made as a condition to the continued use or
          possession, for purposes of the trade or business,
          of property to which the taxpayer has not taken or
          is not taking title or in which he has no equity.

          3.   Arguments of The Parties

     Petitioner argues:     “The rental of minimum office space at a

reasonable cost in a major revenue producing location is clearly

an ordinary and necessary expense.”

     Respondent argues:

     [T]he evidence shows that * * * [petitioner’s] payment
     of Norman Duquette’s condominium fees for the Texas
     home was merely the payment of the Duquette’s personal
     living expenses. * * * [petitioner’s] payment of such
     condominium fees is a constructive dividend to Norman
     Duquette. It was not an ordinary and necessary
     business expense for * * * [petitioner] to pay the
     condominium fees for the Duquette’s home. Therefore,
     the expense must be disallowed.

          4.   Discussion

     In Greenspon v. Commissioner, 23 T.C. 138 (1954), we dealt

with a corporation taking deductions for expenditures on the home

of its dominant stockholder and chief executive officer.      We
                                - 15 -

said:     “In such circumstances, the proof should be very clear and

very certain that the expenses charged to the corporation were

legitimate business expenses of the corporation.     Otherwise, the

opportunity for abuse would be great.”     Id. at 151.     In Place v.

Commissioner, 17 T.C. 199 (1951), affd. per curiam 199 F.2d 373

(6th Cir. 1952), we dealt with a taxpayer claiming a deduction

for rentals paid his wife for the use of her property in a

manufacturing concern owned and operated by him.     The

Commissioner argued that the rentals were excessive.       We stated:

              The basic question is not whether these sums
        claimed as a rental deduction were reasonable in amount
        but rather whether they were in fact rent instead of
        something else paid under the guise of rent. The
        inquiry is whether the petitioner was in fact and at
        law “required” to pay these sums as rent. See * * *
        [predecessor of sec. 162(a)(3)]. When there is a close
        relationship between lessor and lessee and in addition
        there is no arm’s length dealing between them, an
        inquiry into what constitutes reasonable rental is
        necessary to determine whether the sum paid is in
        excess of what the lessee would have been required to
        pay had he dealt at arm’s length with a stranger.
        * * *

Id. at 203.

        In 1994, there was a close relationship between the

Duquettes and petitioner.     The Duquettes were the sole owners of

petitioner, which was, in effect, Norman’s one-man corporation.

That close relationship gives us reason to question whether their

dealings were at arm’s length, and petitioner has failed to show
                             - 16 -

any reason why they would (or did) deal at arm’s length.2

Further, petitioner has failed to prove that the Dallas apartment

amount was a reasonable rental for the use that petitioner

obtained of the apartment.

     In short, petitioner has failed to substantiate its claim

that 25 percent of the apartment was for business use.   There is

no plan of the apartment in evidence showing any dedication of a

portion of the apartment to business use, nor did petitioner

testify as to such dedication.   Moreover, the apartment was the

Duquettes’ home, and petitioner has failed to show that the

apartment was any larger than the Duquettes needed for domestic

purposes or that they were in any way discommoded on account of

Norman’s carrying out petitioner’s business on the premises.

Norman testified that a considerable amount of his work for

petitioner is done by telephone and fax, and that, in the

apartment, as in other places, he did research and wrote reports.



     2
        Congress has expressed skepticism that lease transactions
between employers and employees are negotiated at arm’s length:
Sec. 280A(c)(6) provides that no home office deduction is
allowable to an employee who leases a portion of his home to his
employer. The reports of the tax writing committees that
preceded the addition of sec. 280A(c)(6) to the Code state the
doubt of such committees that lease transactions between an
employer and employee are generally negotiated at arm’s length.
See H. Rept. 99-426 (1985), 1986-3 C.B. (Vol. 2) 1, 133–134; S.
Rept. 99-313 (1986), 1986-3 C.B. (Vol. 3) 1, 83. Both of those
reports accompanied H.R. 3838, 99th Cong., 1st Sess. (1985) (H.R.
3838). H.R. 3838 was enacted as the Tax Reform Act of 1986 (TRA
86), Pub. L. 99-514, 100 Stat. 2404. Sec. 280A(c)(6) constituted
sec. 143(b) of TRA 86.
                               - 17 -

There is no evidence that petitioner had to maintain an extensive

library or extensive files for Norman to do his work, or that

Norman required a dedicated area in which actually to write his

reports.    There is no substantiation of Norman’s claim:   “The

Dallas office was used about 10 days a month to deal with

clients”.   Petitioner has failed to convince us that any use of

the apartment by Norman to further petitioner’s business was more

than incidental to the Duquette’s use of the apartment as a home.

Assuming such incidental use, petitioner has failed to show that

there was even a market from which to determine what a reasonable

rental would be for such incidental use.

     Petitioner has failed to prove that it was required to pay

the Dallas apartment rental amount as a condition to the

continued use or possession of a portion of the apartment.

Consistent with the lack of evidence that petitioner’s use of the

apartment was anything more than incidental to the Duquettes’ use

of the apartment as their home is the conclusion that, if the

Dallas apartment amount was paid to or for the benefit of the

Duquettes, such payment was not made for business purposes but to

distribute to them, as owners of the corporation, profits or

funds unnecessary for business operations.    Petitioner has failed

to prove that such payment was an ordinary and necessary expense

paid or incurred during the 1994 tax year in carrying on

petitioner’s trade or business.
                                 - 18 -

          5.     Conclusion

     We shall sustain respondent’s determination of a deficiency

to the extent it is based on a disallowance of a deduction for

the Dallas apartment rental amount.

     C.   Florida Expenses

           1.    Facts

     The parties have stipulated that, in April 1994, the

Duquettes relocated to Naples, Florida.      A property settlement

agreement entered into by them in connection with their divorce

recites that they “lived and cohabited as Husband and Wife until

on or about April 1994".      The Duquettes were married during all

of calendar year 1994, and they filed a joint Federal income tax

return for that year (the joint return).      The joint return is

signed by Norman and is dated March 13, 1995.      Attached to the

joint return is a form reporting the sale of the Dallas

apartment.     That form recites that, on July 25, 1994, Aline had

purchased a replacement residence and that Norman “will do so

within the two year period [permitted for tax free replacement of

a principal residence]”.      From April 1994, until September 30,

1994 (the last day of the 1994 tax year), Norman’s presence in

Florida was sporadic.    He testified:    “When I went down there in

May and June, I helped her [Aline] look for places.”      Apparently,

Aline was staying in temporary lodgings.      Norman testified that

he spent time with Aline in such temporary lodging.      He testified
                                 - 19 -

that, as of September 1994, primarily because of marital

difficulties, he had no reason to return to Florida.

     Petitioner claimed a deduction for rent in the amount of

$10,710 on account of the reimbursement of Norman for expenses

incurred from April 22, 1994, through September 30, 1994, as

follows (the Florida expenses):

      $8,732.50     rent for April-September and application fee
          97.12     phone
         150.00     home inspection
         513.40     utilities
       1,202.50     furniture storage
    3
      10,695.52        Total

          2.      Arguments of the Parties

     Petitioner argues that the Florida expenses relate to the

relocation of its corporate office from the Dallas apartment to

Florida in April 1994 and the continued use of a home in Florida

as a corporate office for the balance of the 1994 tax year.     In

support of that argument, petitioner states:     There were many

large Government contractors within a 200-mile radius of Naples,

Florida; its Texas client base was diminishing; and it was able

to secure a large client (Honeywell Corp.) shortly after the

Duquettes arrived in Florida.     Petitioner points to a resolution

of the board deciding to relocate the corporate headquarters from

Texas to Florida.     Respondent asks us to find that the relocation



     3
        The sum of the stipulated individual items is $10,695.52.
There is no explanation of the $14.48 difference between this
number and the stipulated total expenses of $10,710.
                              - 20 -

to Florida was tied in with the Duquettes’ separation, she to

Florida, he to Washington.   Based upon that proposed finding

respondent argues that the relocation and living expenses

associated with that relocation were personal expenses of the

Duquettes, the reimbursement of which constituted a nondeductible

constructive dividend.

          3.   Discussion

     We agree with respondent.   Petitioner is not clear on the

grounds for his deduction of the Florida expenses.   To the extent

that petitioner claims a deduction for the Florida expenses under

section 162(a)(3), as rentals, petitioner has failed to

substantiate the business use of any rental property.    We deny

such a deduction for reasons similar to those we set forth with

respect to the Dallas apartment amount.   To the extent that

petitioner otherwise claims a business purpose for the

reimbursement of the Florida expenses, we find that such

reimbursement was made principally to serve the personal needs of

the Duquettes, in connection with the breakup of their marriage,

and only incidentally for any purpose associated with petitioner.

       Petitioner has failed to prove that the reimbursement of

the Florida expense was an ordinary and necessary expense paid or

incurred during the 1994 tax year in carrying on petitioner’s

trade or business.
                               - 21 -

           4.   Conclusion

     We shall sustain respondent’s determination of a deficiency

to the extent based on a disallowance of a deduction for

reimbursement of the Florida expenses.

     D.   The Bethesda Apartment Expenses

           1.   Facts

     At the meeting of the board on February 8, 1992, in addition

to resolving that petitioner’s offices be transferred to Texas,

the board resolved:

     The corporation will maintain a Corporate apartment in
     Maryland to serve as a Resident Agent address as
     required by Maryland law. The corporate apartment will
     also be used by employees of the Corporation when
     traveling to the Washington area on Corporation
     business.

     On the 1994 tax return, petitioner claimed a deduction with

respect to the Bethesda apartment as follows (the Bethesda

apartment expenses):

       $9,540   monthly rent of $795 paid to owner
          805   maid service
        1,300   cable TV
           15   parking fee
           43   Pepco
           19   newspaper
        1,294   telephone
          897   answering service
           80   misc. credit card charge
     4
       13,993      Total



     4
        Here again there is no explanation of the discrepancy (in
this case, $1) between the sum of the individual items and the
stipulated total of $13,994. Presumably, the $1 was lost in
rounding one or more of the items to the nearest dollar.
                              - 22 -

          2.   Sections 162(a)(2) and 274(d)(1)

     In pertinent part, section 162(a)(2) provides:

     There shall be allowed as a deduction [in computing
     taxable income] all the ordinary and necessary expenses
     paid or incurred during the taxable year in carrying on
     any trade or business, including--

               *   *      *    *    *     *    *

          (2) traveling expenses (including amounts expended
          for meals and lodging other than amounts which are
          lavish or extravagant under the circumstances)
          while away from home in the pursuit of a trade or
          business * * *

       Section 274(d)(1) provides that no deduction shall be

allowed pursuant to the provisions of section 162 for traveling

expenses, including meals and lodging, unless the taxpayer

substantiates “by adequate records or by sufficient

evidence corroborating the taxpayer’s own statement” the specific

time, place, and amount of the claimed expenditures, as well as

the business purpose of the expense.    Section 274(d)(1) is

applicable to corporate as well as individual taxpayers.    See

Group Admin. Premium Serv., Inc. v. Commissioner, T.C. Memo.

1996-451; Rosenthal Chiropractic Offices, Inc. v. Commissioner,

T.C. Memo. 1993-331.

          3.   Arguments of the Parties

     Petitioner argues:   “In FY 94 [the 1994 tax year], the

apartment was used for business for approximately 177 days.”
                               - 23 -

“This is an ordinary and necessary expense clearly deductible

under IRC sections 161 and 162.”5

     Respondent argues that the Bethesda apartment was Norman’s

tax home for the 1994 tax year and, therefore, when he was there,

he was not "away from home", so as to allow a deduction pursuant

to section 162(a)(2).   Respondent argues that the Bethesda

apartment expenses were personal living expenses provided by

petitioner to Norman and, therefore, additional nondeductible

constructive dividends.

          4.    Discussion

     A corporation may deduct its costs for the travel of its

employees on the business of the corporation.   See, e.g., Avon

Mills v. Commissioner, 7 B.T.A. 143, 146 (1927).    Among the

conditions that must be satisfied before a deduction for

traveling expenses may be taken under section 162(a)(2) is that

the expense is incurred in pursuit of business.    See Commissioner

v. Flowers, 326 U.S. 465, 470 (1946) (interpreting section

23(a)(1)(A) of the 1939 Code, the precursor to section

162(a)(2)).    In Flowers, the taxpayer, an employee of a railroad,

resided in Jackson, Mississippi.    His principal post of business

was in Mobile, Alabama, and he attempted to deduct as traveling


     5
        Sec. 161 provides: “In computing taxable income under
section 63, there shall be allowed as deductions the items
specified in this part, subject to the exceptions provided in
part IX (sec. 261 and following, relating to items not
deductible).”
                                   - 24 -

expenses the costs he incurred in making trips from Jackson to

Mobile and his expenditures for meals and hotel rooms while in

Mobile.   See id. at 468-469.      With respect to the pursuit-of-

business condition, in the context of the facts before it in

Flowers, the Supreme Court said:

     This means that there must be a direct connection
     between the expenditure and the carrying on of the
     trade or business of the taxpayer or his employer.
     Moreover, such an expenditure must be necessary or
     appropriate to the development and pursuit of the
     business or trade.

Id. at 470.   The Supreme Court dismissed almost summarily any

claim that the expenses in question had been incurred in pursuit

of the business of the corporation.         See id. at 473.   The Court

found that the expenses were no different in kind than the

commuting expenses incurred by employees residing in proximity to

their post of duty.    See id.     Such local commuting expenses the

Court characterized as “living and personal expenses lacking the

necessary direct relation to the prosecution of the [employer’s]

business.”    Id.   The Court found that the taxpayer’s added costs

of a long-distance commute "were as unnecessary and inappropriate

to the development of the railroad’s business”.         Id.   The

railroad, the Court stated, did not require the taxpayer to

travel on business from Jackson to Mobile or to maintain living

quarters in both cities:    “It simply asked him to be at his

principal post in Mobile as business demanded and as his personal

convenience was served”.     Id.    The Court concluded:
                              - 25 -

          Travel expenses in pursuit of business within the
     meaning of * * * [sec. 162(a)(2)] could arise only when
     the railroad’s business forced the taxpayer to travel
     and to live temporarily at some place other than
     Mobile, thereby advancing the interests of the
     railroad. Business trips are to be identified in
     relation to business demands and the traveler’s
     business headquarters. The exigencies of business
     rather than the personal conveniences and necessities
     of the traveler must be the motivating factors. * * *

Id. at 474.

     We must determine whether the exigencies of petitioner’s

business rather than the personal conveniences and necessities of

Norman motivated his travel to the Washington, D.C., area, in

order to determine whether any or all of the Bethesda apartment

expenses are traveling expenses deductible by petitioner.   There

is no doubt that petitioner had business in the Washington area.

That business included providing Norman’s services to the law

firm, which treated Norman as an employee.   Taking together

Norman’s testimony, the fact that the income from the law firm

varied from year to year, and our belief that petitioner reported

that income on its own return, we are prepared to give petitioner

the benefit of the doubt, and we find that Norman was not an

employee of the law firm (but that petitioner did business with

the law firm, selling its consulting services provided by Norman,

petitioner’s employee).   To determine whether the exigencies of

petitioner’s business brought Norman to Washington, we must

determine whether Washington was Norman’s principal post of duty.
                              - 26 -

We find that it was not, at least through April 18, 1994; it was,

at least through April 18, 1994, a minor post of duty.

     We have considered a list of petitioner’s customers, and the

receipts that each generated, for the 1994 tax year and the

preceding and following years.   Those customers are located all

over the country, and, even though the law firm provided over

one-half of petitioner’s receipts for the 1994 tax year, that was

not true for either the preceding or following year.   We give

credit to Norman’s testimony that, in 1991, when the Duquettes

moved to Dallas, major business opportunities for petitioner

existed there.   We also give credit to his testimony that, by

April 18, 1994, when the Duquettes sold the Dallas apartment,

petitioner’s Texas business was in decline.   We, therefore, find

that Norman’s principal post of duty was in Dallas, Texas, during

the 1994 tax year, until April 18, 1994, when the Duquettes moved

from Dallas.   Petitioner has failed to prove that, from April 18,

1994, until the end of the 1994 tax year, Norman’s major post of

duty was other than in the Washington, D.C., area.

     Petitioner has convinced us that rental of the Bethesda

apartment was an economical alternative to the cost of hotels,

when Norman traveled to Washington on petitioner’s business.

Petitioner has also substantiated the fact of the Bethesda

apartment expenses by adequate records, principally canceled

checks.   We are satisfied as to the business purpose associated
                               - 27 -

with the rental of the Bethesda apartment by the action of the

board, authorizing the rental of a corporate apartment, and the

use of the Bethesda apartment by Norman on the 177 days during

the 1994 tax year that he worked in Washington.    Therefore, we

find that petitioner incurred, and has adequately substantiated,

traveling expenses on account of the travel of Norman to

Washington, in an amount equal to that portion of the Bethesda

apartment expenses incurred on or before April 18, 1994.

            5.   Conclusion

       We shall sustain respondent’s determination of a deficiency

to the extent based on a disallowance of a deduction for the

Bethesda apartment expenses only to the extent of such expenses

incurred after April 18, 1994.

III.    Travel Expenses

       On the 1994 tax return, under the heading “Other

Deductions”, petitioner deducted $45,937.83 for “Travel”.

Respondent disallowed all "other deductions" on the grounds “that

it has not been established that any amount claimed constitutes

an ordinary and necessary business expense, was expended or was

expended for the purpose designated.”

       We may dispose of this item without much discussion.   The

parties have stipulated to a “meal analysis” and a “travel

analysis” prepared by petitioner, which analyses (the analyses)

contain details of the travel expenses (travel expenses) claimed
                                - 28 -

by petitioner).   The parties also have stipulated that many of

the travel expenses were reimbursed by payment from petitioner’s

customers directly to Norman.    Respondent argues:   “[Petitioner]

is not entitled to a deduction for the travel expenses because

they were all reimbursed.”   Petitioner agrees that travel

expenses were reimbursed to Norman, but claims that all such

reimbursements were included in petitioner’s gross income.

Petitioner points to a stipulated exhibit, a copy of a cash

receipts journal for petitioner prepared by Norman, which,

petitioner claims, supports its claim that all such reimbursement

were included in gross income.    Petitioner has not, however, tied

the entries in the cash receipts journal to the line one amount,

$309,630.25, “Gross receipts or sales”, on the 1994 return.

Nevertheless, we find that all reimbursements were included in

gross income.   We think that such finding is a fair inference

from the substantial amount of gross receipts or sales reported

on the 1994 tax return, the cash receipts journal, and is

implicit in Norman’s testimony that petitioner reported all

reimbursements.   Respondent offered no proof to rebut that

inference.

     Respondent also argues that petitioner has failed to

substantiate the business purpose of the travel expenses, as

required by section 274(d)(1).    See sec. 1.274-5T(c)(2)(ii)(B),

Temporary Income Tax Regs., 50 Fed. Reg. 46018 (Nov. 6, 1985).
                              - 29 -

     The travel expenses set forth in the analyses are supported

by other stipulated exhibits, including canceled checks, copies

of credit card statements, and a daily diary kept by Norman,

which corroborates the list of miscellaneous expenses for

parking, tolls, taxis, gasoline, tips, etc., set forth in one of

the analyses.   We find that those exhibits, plus the parties’

stipulation and Norman’s testimony (not disputed by respondent)

that virtually all of the travel expenses associated with visits

to business clients that are listed on the analyses were

reimbursed by such clients, constitute adequate substantiation of

the amounts, time and place, and business purpose of such

expenses as required by section 274(d) and the regulations.

Travel expenses incurred in connection with the trips to Florida,

which we have found to be personal trips, and all travel expenses

incurred by Norman in the Washington, D.C., area after April 18,

1994 (not shown to be other than commuting expenses), are not

included within that finding on the ground that such expenses do

not constitute expenses associated with business travel while

away from home as required by section 162(a)(2).

     Based upon the foregoing criteria, we find that petitioner

incurred deductible travel expenses for the 1994 tax year in the

amount of $30,958.
                               - 30 -

IV.   Business Meals

      A.   Introduction

      On the 1994 tax return, under the heading other deductions,

petitioner deducted $16,070.60 for “Business Meals” (business

meals).    On brief, petitioner concedes a portion of the

adjustment for business meals, arguing for a deduction of

$14,777, divided as follows:

            Per diems - Aline Duquette        $6,440
            Per diems - Norman Duquette       10,010
            Business meals with clients        1,711
            Board of directors meetings          310
                               Total          18,471

            Deductible business meals (80 percent)6 $14,777

      We may also dispose of this item without much discussion.

Respondent argues lack of substantiation, failure to report

reimbursements, and duplication of certain expenses.    Petitioner

supports the deduction with the analyses and other stipulated

documents.    For the same reason as set forth supra, in

section III, we find that all reimbursements were included in

gross income.

      B.   Per Diems – Aline Duquette

      We allow no deduction with respect to the $6,440 claimed as

business meals for “Per diems – Aline Duquette”.    Petitioner

argues that it paid Aline per diem of $35 a day for 184 days


      6
        With exceptions not here pertinent, sec. 274(n)(1)
provides that any deduction for food or beverages shall not
exceed 80 percent of such expense.
                                - 31 -

($6,440), while she was “in a travel status”, related to her

relocation to Florida.   Petitioner’s policy was to pay a per diem

amount for meals rather than reimbursing an employee’s actual

meal expenses, if the employee so elected.    As set forth supra in

section II.D.2, section 162(a)(2) permits a deduction for

traveling expenses (including amounts expended for meals) while

away from home in the pursuit of business.    Aline’s duties for

petitioner are vaguely described at best.    Her marriage to Norman

was in trouble in April 1994, and, we believe, she moved to

Florida for personal reasons.    Petitioner has failed to prove

that the expenses incident to her relocation to Florida were

incurred in pursuit of its business, rather than pursuant to

Aline’s relocation to Florida for personal reasons.    On that

basis, we allow no deduction.

     C.   Per Diems – Norman Duquette

     We allow a deduction of $3,409 with respect to the $10,010

claimed as business meals for “Per diems – Norman Duquette”.

Petitioner claims that it paid Norman per diem of $35 a day for

286 days ($10,010), while he was “in a travel status”.    We

believe that, to a limited extent, such per diem payments were

legitimate traveling expenses (for meals) incurred by petitioner

with respect to travel by Norman while away from home in pursuit

of the business of petitioner.    During the 1994 tax year, through

April 18, 1994, Norman’s principal post of duty was in Dallas,
                               - 32 -

Texas.   See supra sec. II.D.4.   During that period, Norman was in

a travel status with respect to petitioner when he traveled away

from Dallas in pursuit of petitioner’s business.    The analyses

show per diem payments to Norman for various dates (e.g., “11/3 –

11/5; 11/29 – 12/17) through April 18, 1994.    We accept that

Norman was traveling on behalf of petitioner, away from Dallas,

on all dates through April 18, 1994, for which per diem payments

are shown (all as reflected in the analyses and supporting

documents).7   Per diem payments for such travel are deductible by

petitioner.    After April 18, 1994, Dallas no longer was Norman’s

principal post of duty, see section III.D.4., and Norman has

failed to prove that his principal post of duty was other than

Washington, D.C., where he worked for 177 days during the 1994

tax year.   See id.   The analyses show per diem payments to Norman

for every day from April 19, 1994, through the end of the 1994

tax year (the remainder of the year).    Petitioner has failed to

prove that Norman was in a travel status on every day during the

remainder of the year.    Nevertheless, the analyses and certain

supporting documents allow us to determine that petitioner was

outside of the Washington, D.C., area on petitioner’s business on


     7
        Petitioner’s payment of per diem to Norman and
petitioner’s reimbursement of his miscellaneous travel expenses
is evidenced by copies of canceled checks issued to Norman, which
contain notations that they represent expense reimbursements.
Also, respondent did not object to the amount of the per diem
($35 a day). Therefore, we do not consider the amount to be in
issue.
                               - 33 -

some days during the remainder of the tax year and, on those

days, incurred expenses for meals.

     Based upon the foregoing discussion, we find that, for the

1994 tax year, petitioner incurred deductible traveling expenses

(for meals), under the heading:    Per diems – Norman Duquette, in

the amount of $3,409 (80% x $4,261).

     D.   Business Meals With Clients

     We allow no deduction with respect to the $1,711 claimed as

“Business meals with clients” (client meals).    On brief, in its

discussion of client meals, petitioner merely directs us to the

analyses and other stipulated documents.    We have examined those

exhibits and are unable to identify the charges that constitute

the client meals.    Moreover, with respect to the group of charges

that might contain the charges for client meals, petitioner has

failed to comply with the substantiation requirements of section

1.274-5T(b)(3), Temporary Income Tax Regs., governing

entertainment of clients.    Petitioner has presented no evidence

concerning the specific "business reason" for the meals, the

"nature of business derived or expected to be derived as a result

of the [meals]", or (with few exceptions) the "business

relationship" of the person or persons entertained by

Mr. Duquette.   See sec. 1.274-5T(b)(3)(iv) and (v), Temporary

Income Tax Regs.    We, therefore, deny any deduction for the

charges for client meals.
                               - 34 -

     E.   Board of Director’s Meetings

     We allow no deduction with respect to the $310 claimed for

“Board of Directors Meetings” (board meals).    As stated, during

the 1994 tax year, the Duquettes were petitioner’s only

directors.    On January 1 and February 1, 1994, the Duquettes met,

as directors, to discuss corporate matters (the January 1 meeting

and the February 1 meeting, respectively).    The January 1 meeting

took place at a restaurant called “The Mansion at Turtle Creek”,

and the February 1 meeting took place at a restaurant called "The

Riviera”.    The charge for dinner at the first restaurant was $162

and the charge for dinner at the second restaurant was $148.

Petitioner claimed a deduction for both dinners ($310).    The

minutes of the January 1 meeting show that the sole substantive

purpose of that meeting was to approve payment for the Duquettes’

prior trips to Naples, Florida, and the decision "to relocate the

corporation to Naples".    The minutes of the February 1 meeting

show that the purpose of that meeting was to hear Mr. Duquette’s

report of petitioner’s earnings as of December 31, 1993, and to

approve Mr. Duquette’s consultation with an attorney "regarding

some tax issues".    (See the discussion of those attorney’s fees,

infra.)     There is no evidence that these matters actually

required significant discussion or, in light of Norman’s absolute

control of all aspects of petitioner’s business, any action other

than the preparation and signing of the minutes by Norman as
                               - 35 -

petitioner’s secretary.   Petitioner has failed to show any

business necessity for it to spend anything (much less $310) for

two meals for two persons so that the Duquettes, who were

married, lived together, and, as petitioner would have it, worked

together, could discuss the affairs of Norman’s one-man

corporation.   See Moss v. Commissioner, 758 F.2d 211, 213 (7th

Cir. 1985), affg. 80 T.C. 1073 (1983); see also Dugan v.

Commissioner, T.C. Memo. 1998-373.

V.   Automobile Depreciation

      On the 1994 tax return, petitioner deducted depreciation of

$2,550, which it explained as being with respect to an automobile

placed in service on June 17, 1992, costing $15,884, used

100 percent for business, and driven 12,000 miles on business

during the 1994 tax year (the automobile).   Respondent disallowed

that deduction, explaining that petitioner had failed to

establish the cost of the automobile, that it was depreciable,

and that it was used in a trade or business.

      On brief, petitioner claims:

      The company car was driven 12,000 business miles in
      FY94 which included a househunting trip from Dallas to
      Naples [Florida] in December 1993, a one way trip to
      Florida in April 1994 incident to the relocation, and a
      trip from Dallas to Phoenix in January 1994 for
      consulting. * * * These three trips account for 6,100
      of the 12,000 business miles in FY 94. The balance of
      the business miles (5,900) is an average of 113 miles
      per week for travel to business meetings, post office,
      banks, and other incidental business activity.
                               - 36 -

     The parties have stipulated a copy of a purchase agreement

for a 1992 Honda, dated June 13, 1992, at a price of $17,184

(“Unpaid balance * * * $15,884")8, and showing co-purchasers:

petitioner and Norman.

     Section 167(a)(1) allows a depreciation deduction with

respect to property used in a trade or business.    Section

274(d)(4) requires substantiation of various items with respect

to any deduction for property such as the automobile.

     We have already concluded that petitioner failed to prove

that the expenses incident to Aline’s relocation to Florida were

incurred in pursuit of its business.    See supra sec. IV.b.   We

assume that the mileage described by petitioner for house hunting

in, and relocation to, Florida were incident to Aline’s

relocation there.   Any mileage associated with such relocation is

not business mileage.    In addition there is no evidence to

support petitioner’s statement that 5,900 miles were attributable

to incidental business activity.    Petitioner points to an exhibit

headed “Car Mileage”, which Norman testified was an annual

analysis of business usage of petitioner-owned automobiles made

at the end of each of petitioner’s taxable years.    For the 1994

tax year, the entries merely indicate that the automobile was




     8
        Petitioner has furnished no explanation for its use of
$15,884, rather than the $17,184 purchase price, as the
depreciable cost basis for the automobile.
                               - 37 -

driven 12,905 total miles without any breakout of business miles

that would justify a depreciation deduction for that year.

       Only the business purpose of the trip to Phoenix is

adequately substantiated by (1) a copy of the expense report

submitted to the law firm, (2) the travel expense analysis

prepared by Norman, which lists the cost of that trip as one of

Norman’s travel expenses for the audit year, and (3) the parties’

stipulation that all travel expenses that pertain to clients of

the law firm were reimbursed in full by that firm (which we

assume that petitioner included in gross income).    The expense

report submitted by Norman to the law firm states that the round

trip covered 2,160 miles, which is 16.7 percent of the total

mileage (12,905 miles) for the 1994 tax year.

       Because we find that the percentage of business use of the

auto during the audit year was less than 50 percent, depreciation

for the year is limited to straight line over a 5-year period, as

opposed to declining balance over a 3-year period as shown on the

Form 4562, Depreciation and Amortization, attached to the 1994

return.    See secs. 280F(b)(1), 168(g)(2)(A) and (3)(D).

Depreciation is deductible only to the extent of business use.

D’Angelo Associates, Inc. v. Commissioner, 70 T.C. 121, 138

(1978); L&L Marine Serv. Inc. v. Commissioner, T.C. Memo. 1987-

428.    Therefore, the correct automobile depreciation deduction
                                 - 38 -

for the audit year is $531 determined as follows:        16.7% x

$15,884 (the original cost of the auto) x 20%.

VI.   Supplies

      On the 1994 tax return, under the heading “Other

Deductions”, petitioner deducted $8,900.50 for “Supplies”

(supplies).      Of that amount, $2,765 remains in dispute.9   The

remaining amount claimed for supplies is as follows:

           (1)    Safe deposit box                 $30
           (2)    Registry of motor vehicles       498
           (3)    Condo application fee            100
           (4)    Furniture storage                730
           (5)    Office decorations               300
           (6)    FOIA request                     488
           (7)    Entertainment                    247
           (8)    Auto insurance                   149
           (9)    Life insurance                    90
          (10)    Medical bills                    133
                                   Total         2,765

      Items (1)-(4) represent costs associated with Aline’s

relocation from Dallas to Florida.        We find that petitioner’s

payment of those costs, like its payment of other costs

associated with Aline’s relocation, was not in connection with

petitioner’s business.

      Item (5), office decorations, also represents a personal

benefit to the Duquettes, based upon our finding, supra sec. II.B




      9
        A portion of this difference is attributable to
petitioner’s concession prior to trial, that many of the
reimbursements for so-called supplies charged to American Express
by Norman related to nondeductible personal items.
                              - 39 -

and C., that neither the Dallas apartment nor the Florida

residence qualified as business premises of petitioner’s.

     Petitioner’s description of item (6), its request under the

Freedom of Information Act (FOIA) "for tax information", does not

reveal whether the request related to respondent’s examination of

petitioner, of Norman, or to the criminal proceeding instituted

against Norman (discussed infra).    As a result, petitioner has

not shown that that expense provided any business benefit to

petitioner.

     Petitioner states that item (7), entertainment, represents

the cost of five "shows" at the Kennedy Center in Washington,

D.C.:   Three attended by Norman and "a part-time consultant to

the petitioner" and two attended by Norman and employees of "a

major client".

     Entertainment expenses are deductible to the extent that

they are (1) "directly related to" the "active conduct of the

taxpayer’s trade or business" or    (2) "associated with" the

active conduct of such trade or business, and the entertainment

directly preceded or followed "a substantial and bona fide

business discussion".   Sec. 274(a)(1)(A).   In this case, the

entertainment was not "directly related entertainment" as defined

in section 1.274-2(c), Income Tax Regs.    See sec. 1.274-

2(c)(7)(ii)(a), Income Tax Regs.    Also, it does not qualify as

"associated" entertainment because petitioner has failed to offer
                              - 40 -

any evidence as to the existence or nature of any bona fide

business discussion either before or after the entertainment.

See sec. 1.274-2(d)(3), Income Tax Regs., sec. 1.274-5T(b)(3)(iv)

and (b)(4), Temporary Income Tax Regs., 50 Fed. Reg. 46015

(Nov. 6, 1985).   Therefore, the entertainment expense is

nondeductible.

     Item (8), the cost of insurance for the automobile, was

incurred on May 28, 1994, more than 4 months after the Dallas-

Phoenix round trip, the only demonstrated business use of the

auto during the audit year.   Because there is no evidence that

the $297 payment of automobile insurance was attributable to

other than periods of personal use of the auto during the 1994

tax year, we find that no portion of this payment constitutes a

deductible expense under section 162(a).

     Petitioner argues that item (9), a premium for life

insurance on Norman’s life, was purchased pursuant to a company

plan or policy adopted on February 6, 1992, by Norman acting in

his capacity as petitioner’s president (the plan).   The plan

provided for "[l]ife insurance offered through American Express

on the life of * * * [Norman]", and was limited to life insurance

"covering accidents while traveling".   There is no evidence as to

the amount of the insurance in question.   Apparently, the

proceeds of the policy were payable to petitioner:   “The proceeds

from the policy will be used to effect an orderly business
                                - 41 -

transition in the event Mr. Duquette is no longer available to

lead the company.”   Those are just words; they fail to establish

any corporate need for insurance should Norman’s death deprive

his one-man corporation of his services.    Cf. Whipple Chrysler-

Plymouth v. Commissioner, T.C. Memo. 1972-55.

     The plan also provided a self-insured medical benefit

consisting of "[p]ayment of Medical Expenses up to a maximum of

$2,000 per year, per employee."    That language is the basis for

item (10), the $133 deduction for "medical bills".    We find that,

even though it covered only the two shareholder employees, the

Duquettes, the plan qualified as a medical benefit plan under

section 105(b), see section 1.105-5(a), Income Tax Regs., and

that petitioner is entitled to deduct any medical expense

payments made under the plan.     Seidel v. Commissioner, T.C. Memo.

1971-238; see sec. 1.162-10(a), Income Tax Regs.    Norman’s

American Express bills covering the 1994 tax year (all of which

were paid by petitioner) show a $25 dentist bill and a $108

charge for prescription drugs.    However, the January 16, 1994,

American Express statement shows both a charge and a credit for

the $108, and Norman’s payment was reduced by the amount of such

credit.   We, therefore, find that petitioner is entitled only to

a $25 deduction for medical expense reimbursements under the

plan.
                                 - 42 -

VII.   Legal Fees

       On the 1994 tax return, under the heading other deductions,

petitioner deducted $57,862.03 for “Professional Fees”.

Remaining in dispute is the amount of $33,842 paid by petitioner

to a law firm in Washington, D.C. (the legal fees), for

representation of Norman in connection with the criminal

investigation.      Petitioner argues that payment of the legal fees

is deductible as an ordinary and necessary expense of

petitioner’s incurred in its business because an unfavorable

result to the criminal investigation “would have destroyed

petitioner’s ability to remain in business by depriving the

Petitioner of its key employee.”     Respondent argues that

petitioner’s payment of Norman’s legal fees was a constructive

dividend to Norman.

       The issue presented herein is identical to that recently

considered by this Court in Hood v. Commissioner, 115 T.C. 172

(2000).    Hood concerned the deductibility of legal fees paid by a

corporation on behalf of its sole shareholder and key,

indispensable employee in connection with his indictment for

criminal tax evasion relating to his operation of the same

business prior to incorporation.     In Hood, we held that the

corporation’s payment of legal fees constituted a nondeductible

constructive dividend on the ground that the shareholder-

employee, not the corporation, primarily benefited from such
                               - 43 -

payment.    We found that, in Hood, the shareholder "had the

wherewithal to pay the legal fees associated with his criminal

defense."   We found that "while the incarceration of Mr. Hood

might have caused * * * [the corporation] to cease operations,

petitioners have not shown that * * * [the corporations’s]

failure to pay the legal fees would have led to Mr. Hood’s

incarceration."    Id. at 181-182.

     There is no evidence in this case to contradict that Norman,

like Mr. Hood, was financially capable of paying the legal fees

associated with his criminal defense.    In both cases, the benefit

to the shareholder ("free legal representation for which * * *

[the shareholder] would otherwise have to pay to avoid

incarceration and/or a felony conviction") outweighed any benefit

to the corporation making the payment.    Id. at 181.

     We, therefore, find that petitioner’s payment of the legal

fees was primarily for Norman’s, not petitioner’s, benefit and,

therefore, is nondeductible by petitioner.

VIII.   Accuracy-Related Penalty

     Respondent determined a 20-percent accuracy-related penalty

under section 6662(a) and (b)(1) on account of negligence or
                              - 44 -

intentional disregard of rules or regulations.10   Petitioner

assigns error to respondent’s determination.

     In the case of an underpayment of tax required to be shown

on a return, section 6662(a) and (b)(1) imposes a penalty in the

amount of 20 percent of the portion of the underpayment that is

attributable to negligence or intentional disregard of the rules

or regulations (hereafter, simply, negligence).    Negligence has

been defined as lack of due care or failure to do what a

reasonable and prudent person would do under like circumstances.

E.g., Hofstetter v. Commissioner, 98 T.C. 695, 704 (1992).

Negligence includes any failure by the taxpayer to keep adequate

books and records or to substantiate items properly.    See sec.

1.6662-3(b)(1), Income Tax Regs.   Section 6664(c)(1) provides

that the accuracy-related penalty shall not be imposed with

respect to any portion of an underpayment if it is shown that the

taxpayer acted in good faith and that there was reasonable cause

for the underpayment.   The determination of whether a taxpayer

acted in good faith and with reasonable cause is made on a case-

by-case basis, taking into account all pertinent facts and



     10
        In his notice of deficiency, respondent also seeks to
impose the penalty on the ground that there was a substantial
understatement of tax under sec. 6662(b)(2). On brief, however,
respondent has not pursued that argument. We, therefore,
consider him to have abandoned it. See Bernstein v.
Commissioner, 22 T.C. 1146, 1152 (1954), affd. 230 F.2d 603 (2d
Cir. 1956); Lime Cola Co. v. Commissioner, 22 T.C. 593, 606
(1954); Roberts v. Commissioner, T.C. Memo. 1996-225.
                              - 45 -

circumstances.   "Circumstances that may indicate reasonable cause

and good faith include an honest misunderstanding of * * * law

that is reasonable in light of all of the facts and

circumstances, including the experience, knowledge, and education

of the taxpayer."   Sec. 1.6664-4(b)(1), Income Tax Regs.

Petitioner bears the burden of proving facts showing good faith

and reasonable cause.   See Rule 142(a).

     Petitioner defends against respondent’s determination of a

penalty for negligence by claiming:    “Petitioner has maintained

comprehensive records and had a reasonable basis for all aspects

of the tax return.”   Petitioner concedes that Norman has passed

the examination to be a certified public accountant.   Respondent

argues that "[petitioner] intentionally disregarded rules

prohibiting deductions for personal items and deducted items for

which it had been reimbursed."   Respondent also argues that

petitioner failed to keep adequate records under sections 6001

and 274(d).

     To the extent we have sustained respondent’s adjustments, we

have done so principally because petitioner has failed to show

that its deductions represented expenses incurred in carrying on

petitioner’s business, rather than expenses incurred to benefit

the Duquettes, personally.   With respect to such deductions, it

appears to us that Norman believed that, if he produced corporate

resolutions and policies authorizing such expenses, no further
                              - 46 -

consideration was necessary as to whether the expense really

benefited petitioner.   Respondent’s adjustments raise few

questions of law.   They raise questions of fact; indeed, of

judgment.   Norman exercised poor judgment.   He had been a

Government auditor, and he had passed his C.P.A. exams.

Undoubtedly, he understood that he wore more than one hat with

respect to his corporation, as shareholder, director, and

employee, and that an expenditure to benefit a shareholder

directly is not a deductible corporate expense.    There is ample

evidence that Norman abused his dual status, exploiting his

director and employee roles in order to shortchange the tax

collector; for example, by deducting dinners at expensive

restaurants to discuss with his wife matters over which he had

complete control or deducting as corporate relocation expenses

personal costs incident to his divorce and his wife’s relocation

to Florida.   See also supra note 8, in which we report Norman’s

concession that he billed petitioner for personal expenditures.

Also, contrary to petitioner’s claim, it did not keep adequate

and full records.   Except as stated in the next paragraph,

petitioner has failed to convince us that it did not act

negligently with respect to any of the adjustments it here

contests.

     Petitioner has not argued that the negligence penalty should

not be sustained for adjustments that petitioner conceded.     We
                             - 47 -

sustain the negligence penalty for the whole of petitioner’s

underpayment in tax other than that portion of the underpayment

arising from respondent’s disallowance of the legal fees, since

petitioner’s reporting position regarding the deductibility of

legal fees was consistent with our holding in Jack’s Maintenance

Contractor’s, Inc. v. Commissioner, T.C. Memo. 1981-349, revd.

per curiam 703 F.2d 154 (5th Cir. 1983), which we overruled in

Hood v. Commissioner, 115 T.C. 172 (2000).

     To reflect the foregoing,


                                        Decision will be entered

                                   under Rule 155.
