                         T.C. Memo. 1999-409



                       UNITED STATES TAX COURT



            COMPACT EQUIPMENT COMPANY, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent

    BERNARD J. ATKINSON AND CAROL S. ATKINSON, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 10040-97, 10041-97.      Filed December 16, 1999.



     James P. Kleier, for petitioners.

     Paul J. Krug, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     VASQUEZ, Judge:    In these consolidated cases, respondent

determined the following deficiencies in and additions to
                                       - 2 -

petitioners’1 Federal income taxes:


                      Taxable Period                    Additions to Tax
  Petitioners             Ending        Deficiency   Sec. 6653(b) Sec. 6661

 Compact                03/31/85          $23,783      $11,892*       $5,946
 Equipment Co.          03/31/86          247,334      123,667*       61,834
                        05/31/86           33,609       16,805*        8,402

 Bernard and            12/31/85          209,313      104,657*       52,328
 Carol Atkinson         12/31/86          124,851       93,638*       31,213

                  *   Plus 50 percent of interest due on portion of
                      underpayment of tax attributable to fraud.


     Unless otherwise noted, all section references are to the

Internal Revenue Code in effect for the years in issue, and all

Rule references are to the Tax Court Rules of Practice and

Procedure.

     After concessions, the issues for decision are:              (1) Whether

Compact Equipment Co. (petitioner) underpaid its taxes by

deducting various payments (made on behalf of its president) as

compensation expenses; (2) if petitioner underpaid its taxes,

whether the 3-year statute of limitations under section 6501(a)

bars respondent from assessing and collecting the underpayment of

tax; (3) whether petitioner is liable for fraud additions to tax

under section 6653(b); (4) whether Bernard and Carol Atkinson

(Atkinsons) are liable for fraud additions to tax under section

6653(b); and (5) whether petitioners are liable for an addition

to tax for substantial understatement of tax pursuant to


     1
        References to petitioners are to Compact Equipment Co.,
Bernard Atkinson, and Carol Atkinson.
                                - 3 -

section 6661.


                         FINDINGS OF FACT

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

The stipulation of facts and the attached exhibits are

incorporated herein by this reference.    At the time they filed

their petitions, petitioner’s principal place of business was in

Irwindale, California, and the Atkinsons resided in Carnelian

Bay, California.

Bernard Atkinson’s Professional Experience in the Automotive
Industry

     From 1950 to 1959, after graduating from high school,

Bernard Atkinson (Atkinson) was employed at an automobile

dealership and a finance company specializing in automobile

loans.   During that time, Atkinson supplemented his practical

knowledge of the automobile industry by studying automobile

mechanics and dealership management at the General Motors

Institute in Flint, Michigan.

     From 1959 to 1968, Atkinson worked in General Motor’s

Pontiac Motor Division as a warranty clerk.    In 1968, he

continued working in the automotive field by taking a position

with Trafco Corp. (Trafco) in Brown, Michigan.    Trafco

manufactured recreational vehicles.     In 1973, Compact Equipment

Co., a subsidiary of Trafco located in Southern California, hired
                                 - 4 -

Atkinson as its general manager.2    By 1975, due to severe

financial losses, Trafco began closing many of its operations and

liquidating its subsidiaries.     Seeing an opportunity for

financial independence and success, Atkinson purchased Compact

Equipment Co.’s assets, incorporated petitioner as BJ Atkinson

Co., and contributed the assets to petitioner.3    Shortly

thereafter, petitioner, which was owned 100 percent by Atkinson,

was renamed Compact Equipment Co.    Petitioner, however, conducts

its business under the name “Family Wagon”.

Petitioner’s Business Activities

     Like Trafco, petitioner manufactures recreational vehicles,

a process commonly known as van conversions.     Petitioner obtains

raw chassis and vans and, through customization, turns them into

recreational vehicles.4    Atkinson, as president and sole

shareholder, guided petitioner with skill and adeptness in a very

competitive industry.     By the mid 1980's, petitioner achieved

considerable success, generating significant revenues and

profits.   During that time, petitioner was the number one van



     2
        Compact Equipment Co., Trafco’s subsidiary, is a distinct
company unrelated to petitioner.
     3
        Because the “Compact Equipment Company” name was still
being used by Trafco’s subsidiary at the time Atkinson formed
petitioner, Atkinson did not initially name petitioner “Compact
Equipment Company”.
     4
        Raw chassis and vans are simple, operational vehicles
lacking any amenities such as sophisticated stereo systems, small
kitchens, sofas, etc.
                                - 5 -

conversion company on the West Coast; nationwide, it ranked

seventh or eighth.   Petitioner’s success was largely due to

Atkinson’s keen administrative, sales, and marketing techniques.

The Construction of the Carnelian Bay Residence

     On November 7, 1983, the Atkinsons purchased a residential

property in Carnelian Bay, California, for $550,000 (Carnelian

Bay property).   Carnelian Bay is located on the north shore of

Lake Tahoe, approximately 5 miles from Tahoe City.   The Atkinsons

purchased the Carnelian Bay property with the intent to live and

retire there.    Because the Atkinsons planned to build a new home

on the Carnelian Bay property (Carnelian Bay residence), the

Atkinsons did not immediately relocate to Carnelian Bay.

     In 1984, petitioners hired James Woodle (Woodle) to

supervise construction of the Carnelian Bay residence and

improvements to the Carnelian Bay property.    Construction began

in 1985 and lasted 16 months.   In July of 1986, the Atkinsons

moved into their new 4,000-square-foot-home.

     Woodle’s duties included ordering construction materials and

recruiting construction workers necessary for the completion of

the Carnelian Bay residence.    Woodle paid for small expenditures

on construction materials from a checking account established by

Atkinson with a local bank.    Most of the larger expenditures on

construction materials and the wages of the construction workers

(construction expenses) were paid directly by petitioner.
                               - 6 -

Petitioner’s Payment of the Construction Expenses

     Petitioner’s accounts payable clerk (the clerk) processed

all invoices forwarded to petitioner.   Normally, the clerk would

match the invoices to corresponding purchase orders and then

prepare checks for the appropriate vendors.   If purchase orders

did not exist for certain invoices, the clerk forwarded the

invoices to petitioner’s general manager for approval.   After

approval, the clerk prepared the checks.

     In 1985, petitioner began receiving invoices from various

vendors for lumber and for electrical and plumbing fixtures used

in the construction of the Carnelian Bay residence (construction

invoices).   The construction invoices did not have matching

purchase orders.   As instructed by Atkinson, however, the clerk

forwarded the construction invoices to Atkinson instead of the

general manager.   After Atkinson reviewed the construction

invoices and authorized payment, the clerk prepared the checks

for the vendors.   After the clerk prepared the checks for all

invoices (including the construction invoices), the general

manager reviewed the purchase orders (if any), invoices, and

checks and approved the transactions by signing the checks.

After issuing and mailing the checks to the vendors, the general

manager or the clerk returned the construction invoices to

Atkinson with copies of the checks, a procedure inconsistent with

the company’s normal bookkeeping process and record retention
                                - 7 -

policy.

     Because petitioner paid the wages of the construction

workers, their names were added to petitioner’s payroll list

pursuant to Atkinson’s instructions.    As directed by Atkinson,

Woodle required the workers to fill out weekly timecards with the

number of hours worked.    Woodle then forwarded the names of the

workers, with the corresponding number of hours worked, to the

clerk or petitioner’s controller (the controller).    Because

Woodle was also on petitioner’s payroll, Woodle also informed the

clerk or the controller of the number of hours he worked for that

particular week.   A professional payroll processing firm,

thereafter, prepared the payroll checks for the general manager’s

or Atkinson’s signature.   After the general manager or Atkinson

signed the payroll checks, the clerk mailed the payroll checks to

a post office box in Lake Tahoe for Woodle to distribute.

Atkinson’s Discussions With Petitioner’s Accountants

     Petitioner hired an accounting firm to prepare its Federal

corporate income tax returns (corporate tax returns) for the

taxable periods ending March 31, 1985, March 31, 1986, and May

31, 1986.   A certified public accountant at the accounting firm,

David Dunkin (Dunkin), had primary responsibility for preparing,

reviewing, and submitting the corporate tax returns to

petitioner.   Dunkin also prepared the Atkinsons’ 1985 and 1986

Federal individual income tax returns (individual tax returns).
                               - 8 -

     Between November 1984 and January 1985, Dunkin and Edward

Fryer from the accounting firm (accountants) met with Atkinson to

provide tax advice with regard to petitioner’s taxable year

ending March 31, 1985, and growing profitability.   At that

meeting, Atkinson informed the accountants that during

petitioner’s board of directors meeting on April 4, 1983, the

board of directors established Atkinson’s compensation package

for petitioner’s taxable year ending March 31, 1984, and

subsequent taxable years.5   In response, the accountants

explained to Atkinson that petitioner’s compensation deductions

for Atkinson’s salary and bonuses had to be justified and

memorialized.   The accountants advised Atkinson that to

demonstrate reasonable compensation for tax purposes, petitioner

should establish a formula based on the profitability of the

company to determine Atkinson’s salary and bonuses.   The

accountants also suggested to Atkinson that petitioner maintain

minutes for its board of directors meetings.

     Following the accountants’ advice, petitioner established a

formula to determine Atkinson’s compensation and created and

maintained minutes for petitioner’s board of directors meetings.

The minutes for the board of directors meetings for March 30,



     5
        Petitioner’s board of directors consisted of the
Atkinsons and a third party. On June 29, 1984, the board of
directors was reduced to two directors consisting of only the
Atkinsons.
                                - 9 -

1985 and 1986, which relate to petitioner’s taxable years ending

March 31, 1985 and 1986, respectively, show that petitioner’s

board of directors provided Atkinson with a salary and bonuses.

The minutes do not provide any other form of compensation for

Atkinson.    Petitioner’s board of directors never authorized any

additional compensation for Atkinson in the form of payments by

petitioner for the construction expenses.

Petitioner’s Treatment of the Construction Expenses on Its Books
and Corporate Tax Returns

     To prepare each of petitioner’s corporate tax returns,

Dunkin’s staff visited petitioner’s place of business, retrieved

all pertinent information from its books and records, and

identified questions and issues that needed further addressing.

Dunkin’s staff, however, did not inspect, review, or audit

petitioner’s books.    Dunkin then met with Atkinson and the

controller to inform them of his preliminary findings and to seek

answers to the questions and issues raised by his staff and

himself.    Based on the answers and information provided by

Atkinson and petitioner’s employees, Dunkin’s staff prepared

petitioner’s corporate tax return.      After Dunkin reviewed the

corporate tax return, he sent it to Atkinson for his approval and

signature.

     The total cost of the construction of the Carnelian Bay

residence and the improvements to the Carnelian Bay property

amounted to more than $1 million.    Of that amount, petitioner
                                   - 10 -

paid the following construction expenses during the taxable

periods at issue:


          Taxable Periods                  Construction Expenses
              Ending                        Paid by Petitioner

                3/31/85                           $25,362
                3/31/86                           495,498*
                5/31/86                           103,941

           *   Petitioner paid for other construction expenses.
               Because Atkinson reimbursed petitioner for those
               other construction expenses, those amounts are
               not included in the $495,498.


On its books, petitioner listed the construction expenses as

corporate expenses.      Because the construction expenses were

listed on petitioner’s books as corporate expenses, Dunkin’s

staff deducted the construction expenses on petitioner’s

corporate tax returns.      The deductions claimed for the

construction expenses were classified mostly as cost of goods

sold.   The construction expenses were not classified as

compensation on petitioner’s books or corporate tax returns.

     On its corporate tax returns, petitioner reported the

following compensation deductions for Atkinson’s services and

dividends declared to Atkinson for the taxable periods at issue:


     Taxable Period           Atkinson’s             Dividends
         Ending              Compensation            Declared

         3/31/85                $558,000               $4,980
         3/31/86                 532,975                4,980
         5/31/86                  35,530                 -0-
                              - 11 -

     The Atkinsons’ individual tax return for the 1985 calendar

year includes two Forms W-2 for Atkinson.   The Forms W-2 reflect

$559,441 in compensation earned from petitioner.   For the 1986

calendar year, the Atkinsons’ individual tax return contains one

Form W-2 for Atkinson from petitioner in the amount of

$561,506.38.   The Forms W-2 from petitioner do not reflect as

compensation any of the construction expenses.

Petitioner’s $69,000 Payment for Lumber

     In early 1986, during the preparation of petitioner’s

corporate tax return for the taxable year ending March 31, 1986,

Dunkin’s staff questioned the propriety of deducting a $69,000

payment to the Tahoe Lumber Co. for lumber.6   During a subsequent

meeting with Atkinson, Dunkin discussed the $69,000 payment with

Atkinson.   Atkinson dismissed Dunkin’s concerns and instructed

Dunkin to treat the $69,000 payment as a deduction on

petitioner’s corporate tax return.

     Around the time that Dunkin questioned the $69,000

deduction, Atkinson began negotiating with Victor Ameye, the

chief executive officer of Neoax Corp., for the sale of

Atkinson’s 100-percent interest in petitioner to Neoax Corp.

During the negotiations, Ameye addressed the $69,000 payment.

Ameye expressed concern about the use of corporate funds for the


     6
        The parties stipulate that the payment for the lumber
amounted to “approximately $70,000". The record indicates that
the payment was closer to $69,000.
                              - 12 -

construction of the Carnelian Bay residence.   Atkinson alleviated

Ameye’s concerns by stating that the issue had already been

brought to his attention and that he intended to pay back the

$69,000 to petitioner.   Atkinson failed to tell Ameye that

petitioner incurred and paid many other expenses related to the

construction of the Carnelian Bay residence.

     A few days later, Atkinson and Dunkin again addressed the

$69,000 deduction.   Atkinson instructed Dunkin not to deduct the

$69,000 payment on petitioner’s corporate tax return.   With

Atkinson’s approval, Dunkin also established a $69,000 accounts

receivable from Atkinson on petitioner’s books.    Atkinson was to

pay back the loan out of his next bonus.   Atkinson failed to

inform Dunkin of the other expenditures incurred by petitioner in

the construction of the Carnelian Bay residence.   On March 23,

1986, Atkinson paid petitioner $69,051 with regard to the loan.

On May 28, 1986, Neoax Corp. purchased Atkinson’s 100-percent

interest in petitioner for $3.5 million plus a contingent amount

based on petitioner’s earnings over the subsequent 3 years.

The Internal Revenue Service’s (IRS) Investigation of
Petitioners’ Corporate and Individual Tax Returns

     On May 11, 1988, an IRS special agent and an IRS revenue

agent interviewed Atkinson regarding allegations that he had

underreported his income on his 1985 and 1986 individual tax

returns and that petitioner had improperly deducted the

construction expenses on its corporate tax returns for the
                                - 13 -

taxable periods at issue.   In response to the agents’ questions,

Atkinson stated that petitioner had not deducted any of the

construction expenses on its corporate tax returns.

     Atkinson, however, stated that if petitioner paid his

personal expenses, he would repay petitioner when petitioner

billed him for those amounts.    Atkinson explained that he

recollected one instance when petitioner paid $75,000 for lumber

to be used in the construction of the Carnelian Bay residence

which he subsequently repaid.    Atkinson failed to disclose to the

agents that petitioner paid various other construction expenses

for which he did not reimburse petitioner.    The IRS subsequently

served Atkinson with a summons seeking the construction invoices,

but they were never delivered to the IRS.

     On September 12, 1991, a Federal grand jury charged Atkinson

with violating section 7201 with regard to Atkinson’s 1985 and

1986 individual tax returns and section 7206(1) with regard to

petitioner’s corporate tax returns for the taxable periods at

issue.   Atkinson subsequently was convicted.   On December 20,

1991, a Federal district court judge ordered Atkinson to serve 1

year and 1 day in prison, to pay a $500,000 fine, and to pay the

taxes owed with regard to the Atkinsons’ 1985 and 1986 individual

tax returns.

     In separate notices of deficiency dated March 14, 1997,

respondent determined that petitioner fraudulently deducted the
                              - 14 -

construction expenses on its corporate tax returns and that the

Atkinsons fraudulently failed to include the construction

expenses as income on their individual tax returns.7   Respondent

also determined that petitioner fraudulently deducted numerous

charges incurred on its credit cards and that the Atkinsons

fraudulently failed to include the credit card charges8 in

income.9

     Additionally, in the notices of deficiency, respondent

imposed additions to tax pursuant to sections 6653(b) and 6661 on

petitioners.   As to petitioner, we review respondent’s

determinations of deficiencies and additions to tax.   As to the

Atkinsons, they concede that they committed fraud in failing to

report the construction expenses as income on their individual


     7
        In addition to the construction expenses already
discussed, respondent initially classified certain additional
amounts as construction expenses. Respondent determined that
petitioner fraudulently deducted those amounts and that the
Atkinsons fraudulently failed to include those amounts in income.
The parties are in agreement with regard to the tax consequences
of those amounts, and we do not further discuss those additional
amounts in this opinion.
     8
        The tax treatment of a portion of the credit card charges
is subject to a stipulation by the parties. Our discussion of
the credit card charges is with regard to amounts not subject to
the stipulation.
     9
        Because the Atkinsons filed their individual tax returns
based on a calendar year and petitioner filed its corporate tax
returns on a fiscal yearend (other than the short return year),
the amounts listed on the Atkinsons’ notice of deficiency with
regard to the construction expenses and credit card charges
differ from the amounts listed on petitioner’s notice of
deficiency.
                                  - 15 -

tax returns and that they are liable for the fraud additions to

tax with respect to the construction expenses.      The Atkinsons

also concede that they failed to report the credit card charges

as income.       Still before us, however, is the issue of whether the

fraud additions to tax with regard to the credit card charges

should be sustained and whether the Atkinsons are liable for the

addition to tax pursuant to section 6661.


                                  OPINION

I.     Corporate Fraud

        Generally, pursuant to section 6501(a), the Commissioner

must assess taxes owed and due on a tax return within 3 years

after the return is filed.      Section 6501(c)(1), however, provides

that if a taxpayer fraudulently files a return, the 3-year

statute of limitations under section 6501(a) will not bar the

Commissioner from assessing and collecting the taxes owed and

due.        Additionally, if any part of an underpayment of tax is due

to fraud, the Commissioner may impose fraud additions to tax

under section 6653(b)(1) and (2).10

       In order to prove fraud, the Commissioner must show by clear

and convincing evidence that the taxpayer underpaid its tax and


       10
        Sec. 6653(b)(1) provides for an addition to tax in the
amount of 50 percent of the underpayment if any part of the
underpayment is due to fraud. Sec. 6653(b)(2) provides for an
addition to tax in the amount of 50 percent of the interest
payable under sec. 6601 with respect to the portion of the
underpayment which is attributable to fraud.
                               - 16 -

that some portion of the underpayment is due to fraud.    See sec.

7454(a); Rule 142(b); Laurins v. Commissioner, 889 F.2d 910, 913

(9th Cir. 1989), affg. Norman v. Commissioner, T.C. Memo. 1987-

265; Edelson v. Commissioner, 829 F.2d 828, 832 (9th Cir. 1987),

affg. T.C. Memo. 1986-223; Petzholdt v. Commissioner, 92 T.C.

661, 698-699 (1989); Mitchell v. Commissioner, T.C. Memo. 1994-

242.    If the Commissioner proves an underpayment and that some

portion of the underpayment is due to fraud, the bar of the 3-

year statute of limitations is lifted with respect to all items

on the return, and the Commissioner’s deficiency determinations

enjoy the usual presumption of correctness, placing the burden on

the taxpayer to prove an error.    See Welch v. Helvering, 290 U.S.

111 (1933); Jackson v. Commissioner, 380 F.2d 661, 664 (6th Cir.

1967), affg. T.C. Memo. 1964-330; Colestock v. Commissioner, 102

T.C. 380, 385 (1994); Willits v. Commissioner, 36 B.T.A. 294, 300

(1937); Bencivenga v. Commissioner, T.C. Memo. 1989-239.

       Further, the addition to tax under section 6653(b)(1) will

apply to the entire underpayment ultimately determined, even

though only part of the underpayment is due to fraud.    See Stone

v. Commissioner, 56 T.C. 213, 220-221 (1971); Otsuki v.

Commissioner, 53 T.C. 96, 105 (1969); Kelley v. Commissioner,

T.C. Memo. 1991-324, affd. without published opinion 988 F.2d

1218 (11th Cir. 1993); Cleveland v. Commissioner, T.C. Memo.

1983-299.    The addition to tax under section 6653(b)(2), however,
                                - 17 -

will apply only to the portion of the underpayment which is

attributable to fraud.

     A.    Construction Expenses

            1.   Underpayment

     Respondent must prove by clear and convincing evidence that

petitioner underpaid its taxes during each of the taxable periods

at issue.    See sec. 7454(a); Rule 142(b).   Respondent contends

that the construction expenses paid by petitioner on behalf of

Atkinson constitute nondeductible constructive dividends and that

petitioner underpaid its taxes when it deducted the constructive

dividends.    Petitioner argues that although petitioner improperly

classified the construction expenses as cost of goods sold on its

tax returns, the construction expenses actually constitute

reasonable compensation for services rendered by Atkinson and

therefore are deductible by petitioner.

     Section 162(a)(1) permits a taxpayer to deduct "a reasonable

allowance for salaries or other compensation for personal

services actually rendered" as an ordinary and necessary business

expense.    See King's Ct. Mobile Home Park, Inc. v. Commissioner,

98 T.C. 511, 514 (1992); Paula Constr. Co. v. Commissioner, 58

T.C. 1055, 1058 (1972), affd. without published opinion 474 F.2d

1345 (5th Cir. 1973); sec. 1.162-7(a), Income Tax Regs.     The

taxpayer, however, can deduct payments for personal services only

if the payments are intended as compensation.     See King's Ct.
                              - 18 -

Mobile Home Park, Inc. v. Commissioner, supra at 514; Paula

Constr. Co. v. Commissioner, supra at 1058.

     It is a question of fact whether payments are made with an

intent to compensate for services performed.   See Whitcomb v.

Commissioner, 733 F.2d 191, 194 (1st Cir. 1984), affg. 81 T.C.

505 (1983); Paula Constr. Co. v. Commissioner, supra at 1058-

1059.   The relevant time for determining the requisite intent is

when the purported compensation payment is made, not, for

example, years later when an amended return is filed after the

start of an IRS audit.   See King's Ct. Mobile Home Park, Inc. v.

Commissioner, supra at 514; Paula Constr. Co. v. Commissioner,

supra at 1059-1060; Joyce v. Commissioner, 42 T.C. 628, 636

(1964); Drager v. Commissioner, T.C. Memo. 1987-483.

     In the instant case, the board of directors established

Atkinson’s salary and bonuses during its yearly meetings.    The

board of directors, however, did not designate the construction

expenses as compensation for Atkinson’s services.   The amounts of

the construction expenses were not reported on Atkinson’s Forms

W-2 from petitioner.   On its books and corporate tax returns,

petitioner accounted for the construction expenses as cost of

goods sold instead of compensation.    Further, when questioned by

Dunkin and Ameye about the $69,000 payment for part of the

construction expenses, Atkinson did not claim that these amounts

constituted compensation for services rendered by Atkinson.
                                 - 19 -

Instead, Dunkin, under Atkinson’s authority, established an

accounts receivable due from Atkinson for the $69,000 payment.

The evidence in the record shows that petitioner did not intend

for the construction expenses to be compensation for services

rendered; thus, we find that the construction expenses constitute

nondeductible constructive dividends and that petitioner

underpaid its taxes.

            2.    Fraudulent Intent

     Along with proving an underpayment, the Commissioner must

show that the taxpayer intended to evade taxes known to be owing

by conduct intended to conceal, mislead, or otherwise prevent the

collection of taxes.     See Powell v. Granquist, 252 F.2d 56, 60-61

(9th Cir. 1958); Rowlee v. Commissioner, 80 T.C. 1111, 1123

(1983).   A corporation has no intent separate from those who

control it.      See King’s Ct. Mobile Home Park v. Commissioner,

supra at 516.     The existence of fraudulent intent by a

corporation, therefore, is determined by the acts of its

officers.    See id.

     Fraud is not to be presumed.     See Toussaint v. Commissioner,

743 F.2d 309, 312 (5th Cir. 1984), affg. T.C. Memo. 1984-25;

Rowlee v. Commissioner, supra at 1123.     The existence of fraud is

a factual question to be determined from all the facts and

circumstances contained in the record.     See id.   Since direct

proof of intent is rarely available, fraud may be proved by
                              - 20 -

circumstantial evidence and reasonable inferences drawn from the

facts.   See Spies v. United States, 317 U.S. 492, 499 (1943);

Bradford v. Commissioner, 796 F.2d 303, 307 (9th Cir. 1986),

affg. T.C. Memo. 1984-601.

     Over the years, courts have developed a nonexclusive list of

factors that demonstrate fraudulent intent.   These badges of

fraud include:   (1) Understatement of income, (2) inadequate

records, (3) failure to file tax returns, (4) implausible or

inconsistent explanations of behavior, (5) concealment of income

or assets, (6) failure to cooperate with tax authorities, (7)

presence of illegal activities, (8) an intent to mislead which

may be inferred from a pattern of conduct, (9) lack of

credibility of the taxpayer’s testimony, (10) filing false

documents, and (11) dealing in cash.   See Spies v. United States,

supra at 499; Douge v. Commissioner, 899 F.2d 164, 168 (2d Cir.

1990), affg. an order of this Court; Laurins v. Commissioner, 889

F.2d at 913; Bradford v. Commissioner, supra at 307-308;

Recklitis v. Commissioner, 91 T.C. 874, 910 (1988).   Although no

single factor is necessarily sufficient to establish fraud, the

combination of a number of factors constitutes persuasive

evidence.   See Solomon v. Commissioner, 732 F.2d 1459, 1461 (6th

Cir. 1984), affg. per curiam T.C. Memo. 1982-603.   A taxpayer’s

intelligence, education, and tax expertise are also relevant for

purposes of determining fraudulent intent.    See Stephenson v.
                             - 21 -

Commissioner, 79 T.C. 995, 1006 (1982), affd. 748 F.2d 331 (6th

Cir. 1984); Iley v. Commissioner, 19 T.C. 631, 635 (1952).     We

evaluate this latter standard in relation to the

corporation’s officers.

     As petitioner’s president, sole shareholder, and one of two

board directors, Atkinson’s actions provide evidence with regard

to whether petitioner committed fraud.   The Atkinsons purchased

the Carnelian Bay property intending to build their home there.

Atkinson directed that corporate funds be used to pay for the

construction of the Carnelian Bay residence.   He instructed

petitioner’s employees to classify the payments on petitioner’s

books as corporate expenses related to its operations.   Atkinson

also instructed his employees to return all construction invoices

to him, a procedure inconsistent with petitioner’s normal record-

keeping practice.

     Because petitioner maintained inadequate records, Dunkin

classified the construction expenses as cost of goods sold on

petitioner’s corporate tax returns.   When Dunkin questioned the

propriety of deducting a $69,000 payment for lumber, Atkinson

quickly dismissed Dunkin’s objections.   Only after Ameye

expressed concerns about the $69,000 payment during negotiations

for the sale of Atkinson’s 100-percent interest in petitioner did

Atkinson instruct Dunkin to forgo the $69,000 deduction.

Atkinson, however, continued to conceal from Dunkin and Ameye
                              - 22 -

that various other payments for the construction expenses had

been listed on petitioner’s books and corporate tax returns as

corporate expenses.   Atkinson’s dealings with petitioner’s

employees, Dunkin, and Ameye demonstrate an intent to mislead.

     In addition, Atkinson lied to the IRS agents.   When the IRS

agents questioned Atkinson about whether petitioner had

improperly deducted the construction expenses, Atkinson stated

that the construction expenses had not been deducted on

petitioner’s corporate tax returns.    Further, Atkinson attempted

to mislead the IRS agents by stating that petitioner had only

paid for part of the construction expenses (the $69,000 payment

for lumber) for which he had repaid petitioner.   Also, after

requested, Atkinson failed to provide the IRS with the

construction invoices.

     In summary, the evidence shows that Atkinson understated

petitioner’s taxable income, concealed records and maintained

inadequate records, failed to cooperate with tax authorities, and

undertook a pattern of conduct with the intent to mislead Dunkin,

Ameye, and the IRS.   Furthermore, Atkinson is a sophisticated

businessman who managed petitioner very successfully, attracting

regional and national recognition.

     Petitioner argues that Atkinson was not aware that treating

the construction expenses as cost of goods sold on petitioner’s

corporate tax return, instead of declaring corporate dividends,
                              - 23 -

would result in a lower tax liability.   Petitioner, therefore,

argues that Atkinson did not have the intent to evade

petitioner’s taxes.   Between November 1984 and January 1985 and

before the preparation of petitioner’s corporate tax return for

the taxable year ending March 31, 1985, Atkinson attended a

meeting with petitioner’s accountants.   At that meeting, the

accountants advised Atkinson that petitioner’s compensation

expenses for Atkinson’s services had to be justified for the

expenses to be deductible for Federal tax purposes.   Petitioner’s

corporate tax returns reported significant amounts for Atkinson’s

compensation, and petitioner declared only minimal dividends to

Atkinson.   These facts show that petitioner paid most of its

earnings to Atkinson in the form of compensation instead of

dividends to minimize its corporate tax liability.    Based on the

evidence, we conclude that Atkinson was aware that petitioner

could not deduct dividends declared on its corporate tax returns.

     Petitioner also argues that even if we find that Atkinson

intended to evade petitioner’s Federal income taxes, the U.S.

Court of Appeals for the Ninth Circuit, to which this case is

appealable, requires that the Commissioner prove that “there is

no doubt, beyond a frivolous one, regarding the substantive tax

treatment of the item at issue”.   Petitioner cites United States

v. Dahlstrom, 713 F.2d 1423, 1427 (9th Cir. 1983), for the

proposition that if the tax law is unsettled, a taxpayer lacks
                                 - 24 -

the intent to violate the tax law.        Petitioner argues that there

is an uncertainty as to whether the payments for the construction

expenses should be treated as compensation for services rendered

or nondeductible constructive dividends.       We disagree.

Decisional authority clearly provides that a taxpayer may deduct

only amounts intended as compensation for services rendered to

the taxpayer.    See King’s Ct. Mobile Home Park, Inc. v.

Commissioner, 98 T.C. at 514; Paula Constr. Co. v. Commissioner,

58 T.C. at 1058.

     We, therefore, conclude that respondent has established that

petitioner underpaid its taxes with respect to the construction

expenses and did so with the intent to evade tax.       Because

petitioner underpaid its taxes with an intent to evade those

taxes, we hold that the 3-year statute of limitations under

section 6501(a) does not bar respondent from assessing taxes owed

and due.    Further, respondent may impose fraud additions to tax

under section 6653(b)(1) and (2) with regard to the underpayment

associated with the deductions of the construction expenses.

     B.    Credit Card Charges

            1.   Presumption of Correctness

     Because the presumption of correctness attached to

respondent’s deficiency determinations, petitioner bears the

burden of proving that the credit card charges do not constitute

nondeductible constructive dividends.       Petitioner has failed to
                                - 25 -

meet its burden.    Accordingly, respondent’s deficiency

determinations with regard to the credit card charges are

sustained.

            2.   Fraud Additions to Tax Pursuant to Section
                 6653(b)(1) and (2)

      Pursuant to section 6653(b)(2), respondent may impose a

fraud addition to tax on the portion of the underpayment

attributable to fraud.    In this case, respondent provided no

evidence that petitioner committed fraud by deducting the credit

card charges.    The addition to tax under section 6653(b)(2),

therefore, may be imposed on only the underpayment attributable

to the deductions of the construction expenses.     Pursuant to

section 6653(b)(1), however, the fraud addition to tax applies to

the entire underpayment ultimately determined even if respondent

manages to prove that only part of the underpayment is due to

fraud.     Hence, the fraud addition to tax under section 6653(b)(1)

is also applicable to the underpayment resulting from the

deductions of the credit card charges.

II.   The Atkinsons’ Fraud

      A.   1985 Calendar Year

      The Atkinsons concede that they committed fraud by not

including the construction expenses in income.    Respondent,

however, has failed to provide clear and convincing evidence that

the Atkinsons committed fraud by not including the credit card

charges in income.    As explained above with regard to
                               - 26 -

petitioner’s deductions of the credit card charges, the Atkinsons

are liable for the fraud addition to tax under section 6653(b)(1)

on the underpayment associated with the failure to include in

income the credit card charges.   The Atkinsons are liable for the

fraud addition to tax under section 6653(b)(2) only on the

underpayment attributable to the fraudulent failure to include in

income the construction expenses.

     B.   1986 Calendar Year

     In 1986, Congress amended section 6653(b), effective for tax

returns with a due date after December 31, 1986.   See Tax Reform

Act of 1986, Pub. L. 99-514, sec. 1503, 100 Stat. 2085, 2742.

Congress consolidated the fraud additions to tax, formerly under

section 6653(b)(1) and (2), into section 6653(b)(1).   Through

amended section 6653(b)(1), Congress provided that only the

portion of the underpayment attributable to fraud would be

subject to the fraud additions to tax:

     SEC. 6653(b) Fraud.--

          (1) In General.--If any part of any underpayment (as
     defined in subsection(c)) of tax required to be shown on a
     return is due to fraud, there shall be added to the tax an
     amount equal to the sum of–-

                (A) 75 percent of the portion of the underpayment
           which is attributable to fraud, and

                 (B) an amount equal to 50 percent of the interest
           payable under section 6601 with respect to such portion
           * * *

     Under amended section 6653(b)(2), however, once the
                               - 27 -

Commissioner proves that any portion of the underpayment is

attributable to fraud, the entire underpayment is treated as

attributable to fraud, except with respect to any portion which

the taxpayer establishes is not attributable to fraud.

       In the instant case, the Atkinsons concede that they

fraudulently failed to include in income the construction

expenses.    Therefore, pursuant to amended section 6653(b)(2), the

underpayment associated with the failure to include in income the

construction expenses and the credit card charges is treated as

attributable to fraud unless the Atkinsons prove otherwise.      The

Atkinsons have failed to prove that the failure to include in

income the credit card charges is not attributable to fraud.

Hence, the fraud additions to tax determined by respondent under

amended section 6653(b)(1)(A) and (B) are sustained.

III.    Substantial Understatement of Tax

       The final issue for decision is whether petitioners are

liable for the addition to tax under section 6661.     For

assessments made after October 21, 1986, section 6661(a) provides

for an addition to tax equal to 25 percent of the amount of any

underpayment attributable to a substantial understatement of tax.

See Omnibus Budget Reconciliation Act of 1986, Pub. L. 99-509,

sec. 8002(a), 100 Stat. 1874, 1951.     An understatement is

substantial if it exceeds the greater of $5,000 ($10,000 in the

case of a corporation) or 10 percent of the tax required to be
                              - 28 -

shown on the return.   See sec. 6661(b).   The amount of the

understatement may be reduced under section 6661(b)(2)(B) for

amounts adequately disclosed or supported by substantial

authority.   Neither exception under section 6661(b)(2)(B) applies

because no amounts were adequately disclosed or supported by

substantial authority.

     Because the parties have made various concessions, they will

have to determine whether petitioners substantially understated

their income taxes when making the Rule 155 computations.      For

this purpose, the parties will take into account the parties’

concessions and our disallowance of petitioner’s deductions for

the construction expenses and the credit card charges.

     In reaching our holdings herein, we have considered all

arguments made by petitioners, and to the extent not mentioned

above, we find them to be irrelevant or without merit.

     To reflect the foregoing,

                                           Decisions will be entered

                                    under Rule 155.
