                       T.C. Memo. 2002-104



                     UNITED STATES TAX COURT



         SAM AND ANNA ZHADANOV, ET AL.,1 Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 14021-95, 24646-95,    Filed April 25, 2002.
                 24647-95.


     Sam and Anna Zhadanov, pro sese.

     Shawna Early, Alan S. Kline, Theodore R. Leighton,

Timothy V. Mulvey, and Michelle Or, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     MARVEL, Judge: In separate notices of deficiency, respondent

determined the following income tax deficiencies, penalties, and



     1
      The following cases are consolidated herewith: Vortex
Products Corp., docket No. 24646-95; and Sam Zhadanov, docket No.
24647-95.
                                    - 2 -

additions to tax with respect to petitioners’ Federal income

taxes:

Vortex Products Corp. (Vortex), docket No. 24646-95

                                    Addition to Tax   Penalty
FYE Sept. 30      Deficiency        Sec. 6651(f)2     Sec. 6663
1991              $ 28,813                            $21,610
1992                85,831                             64,373
1993                77,968            $58,476

Sam and Anna Zhadanov (the Zhadanovs), docket No. 14021-95

                               Penalty
Year         Deficiency        Sec. 6663
1990         $35,031           $26,273
1991          61,862            46,397
1992          77,522            58,142

           Anna Zhadanov

                               Penalty
Year         Deficiency        Sec. 6663
1993         $60,272           $45,204

Sam Zhadanov, docket No. 24647-95

                               Penalty
Year         Deficiency        Sec. 6663
1993         $43,048           $32,286

Alternatively, respondent also determined that Vortex was liable

for the addition to tax under section 6651(a) if we conclude that

Vortex is not liable for the penalty under section 6651(f) for

its FYE 1993 and that the Zhadanovs were liable for accuracy-

related penalties under section 6662(a) if we conclude that they




       2
      Unless otherwise indicated, all section references are to
the Internal Revenue Code for the years in issue, and all Rule
references are to the Tax Court Rules of Practice and Procedure.
                               - 3 -

are not liable for the section 6663 penalties determined in the

notices of deficiency.

     In an Amendment to Answer filed October 5, 1999, respondent

asserted an increased deficiency of $127,070 and an increased

section 6663 penalty of $95,302 against Vortex for FYE 1993.

     These cases were consolidated for trial, briefing, and

opinion pursuant to Rule 141(a) because they present common

issues of fact and law.   Hereinafter, we refer to the

consolidated cases as this case.

     After the parties’ concessions,3 the remaining issues for

decision are:

     (1) Whether Vortex is liable for the fraud penalty under

section 6663, or alternatively, for the accuracy-related penalty

under section 6662(a) for FYEs 1991 and 1992;

     (2) whether Vortex is liable for the addition to tax for

fraudulent failure to file a tax return under section 6651(f), or




     3
      Petitioner Vortex Products Corp. (Vortex) conceded its
deficiencies at trial. Mr. Zhadanov admitted that he did not pay
tax on his Social Security benefits for 1993. On its FYE 1993
tax return and petition, Vortex claimed that it was entitled to a
deduction for property forfeited by Mr. Zhadanov pursuant to his
plea agreement in United States v. Zhadanov, No. 93-240, 1995
U.S. Dist. Lexis 5707 (E.D. Pa. Apr. 25, 1995). Petitioners did
not present any evidence or make any further argument regarding
this claim. Accordingly, we treat this claim as abandoned and do
not address it herein. See Bradley v. Commissioner, 100 T.C.
367, 370 (1993); Rybak v. Commissioner, 91 T.C. 524, 566 n.19
(1988).
                              - 4 -

alternatively, for the delinquency addition to tax under section

6651(a) for FYE 1993;

     (3) whether respondent is barred by section 6501(a) from

assessing a deficiency against Vortex for FYE 1991;

     (4) whether the Zhadanovs received constructive dividends

from Vortex in 1990, 1991, 1992, and 1993 in the amounts

determined by respondent or in any amounts;

     (5) whether Mr. Zhadanov was required to include a portion

of his 1993 Social Security benefits in his income for 1993;

     (6) whether the Zhadanovs are liable for the fraud penalty

under section 6663, or alternatively, for the accuracy-related

penalty under section 6662(a), for any of the years at issue;

     (7) whether respondent is barred by section 6501(a) from

assessing a deficiency against the Zhadanovs for 1990 and 1991;4

     (8) whether the additions to tax for fraud proposed against

Mr. Zhadanov violate the Double Jeopardy Clause of the United

States Constitution; and

     (9) whether Mrs. Zhadanov is entitled to relief from joint

and several liability under section 6015 for 1990, 1991, and

1992.5


     4
      The Zhadanovs claimed that Form 872, Consent to Extend Time
to Assess Tax, extending the period of limitations to Dec. 31,
1995, for taxable year 1991, is invalid as it was obtained under
duress.
     5
      Petitioners also argue that Mrs. Zhadanov is entitled to
                                                   (continued...)
                                 - 5 -

                        FINDINGS OF FACT

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

The stipulation of facts is incorporated in this opinion by this

reference.

     A.   Background

     The Zhadanovs were married in 1957 and remained married

throughout the years at issue.    The Zhadanovs were born in Kiev,

Ukraine, and immigrated to the United States in 1973.    Before

they emigrated, both Mr. and Mrs. Zhadanov earned a degree in

mechanical engineering in the former Soviet Union.   The

Zhadanovs’ legal residence was in Brooklyn, New York, when they

filed their petitions in this case.

     Mr. Zhadanov was president and sole shareholder of Vortex

Products Corp. (Vortex) during the years at issue.   Vortex had

its principal place of business in Brooklyn, New York, when it

filed its petition in this case.

     In 1981, Vortex was incorporated in New Jersey to engineer,

develop, and manufacture plastic products.   Since its

incorporation, Vortex has derived its income from the manufacture

and sale of various brush products, safety syringe holders, and

custom-molded products for which Mr. Zhadanov held patents.    For


     5
      (...continued)
relief from joint and several liability for any income tax
deficiency for 1993 under sec. 6015. However, Mrs. Zhadanov
filed a separate Federal income tax return for 1993, and,
therefore, sec. 6015 does not apply to 1993.
                               - 6 -

all relevant years, Vortex used the cash method of accounting and

a FYE September 30.

     Mrs. Zhadanov worked as a senior engineer for a Russian

consulting firm before moving to the United States.    After the

Zhadanovs immigrated, Mrs. Zhadanov first worked as a draftsman

and then she became a design engineer in 1974.   In 1985, Mrs.

Zhadanov began working for Vortex as its bookkeeper.    She also

calculated Vortex manufacturing costs for various products,

including plastic vials.   Throughout the years at issue, Mrs.

Zhadanov was listed on corporate documents as a Vortex corporate

officer.

     Mrs. Zhadanov prepared all financial documents for Vortex,

sometimes with the assistance of Anthony Abbate, C.P.A.    She also

supplied Mr. Abbate with all documents used to prepare Vortex’s

tax returns.   Mrs. Zhadanov regularly reviewed the documents

prepared by Mr. Abbate and periodically called him with

questions.

     In 1986, the Zhadanovs and their son Eli Zhadanov formed a

partnership “100 Prospect Associates” through which they

purchased property located at 108 Prospect Street (the Prospect

Street property).   Vortex moved its operations to the Prospect

Street property that same year.   Vortex paid monthly rent of

$8,000 directly to Mr. Zhadanov, who deposited the checks into

the Zhadanovs’ personal checking account.   In turn, the Zhadanovs
                                - 7 -

paid the Prospect Street property mortgage and taxes from their

personal checking account.   The Zhadanovs also paid numerous

Vortex expenses for facility upgrades out of their personal

checking account during the years at issue.

     In 1990, the Zhadanovs sold their house in Metuchan, New

Jersey, and used the net proceeds of $180,000 to pay off the

balance of the mortgage on the Prospect Street property.

     B.    Plastic Vial Manufacturing

     In 1990, Mr. Zhadanov was approached by Henry Belkin and

Leonard Edelson to create custom molds to manufacture plastic

vials.    Belkin and Edelson were in the business of purchasing and

selling vials for crack cocaine, but they represented to Mr.

Zhadanov that the plastic vials were for perfume oil samples.

     Belkin and Edelson used Tri-State General, a front company,

to conduct business with Vortex.   Vortex and Tri-State General

signed an agreement to begin production of the plastic vials in

November 1990.   Belkin and Edelson wanted to pay cash for the

plastic vials and molds and told Mr. Zhadanov that they did not

want Vortex to deposit the cash in the bank.   Although Mr.

Zhadanov initially insisted that Vortex be paid by check, when

production began, Belkin and Edelson paid Vortex using a

combination of checks and cash.

     Vortex conducted business directly with Tri-State until May

1991 when Mr. Zhadanov learned that the Government had seized a
                                - 8 -

shipment of vials, allegedly because the vials were being used by

drug dealers to hold crack cocaine.     Vortex ceased production of

the plastic vials for a few weeks thereafter but then resumed

vial production in July 1991.   From that date, Belkin and Edelson

paid Vortex for the plastic vials solely in cash.

     In an attempt to insulate Vortex from Belkin and Edelson’s

drug activities, Sam Zhadanov entered into a leasing agreement

with Alex Srebrianski, a Vortex employee, in July 1991.    The

agreement provided that Mr. Srebrianski’s company, U.S. Trading,

would lease Vortex’s machinery and premises for $8,000 per month

for the purpose of manufacturing plastic vials.    In reality,

Vortex continued its production of the plastic vials.    Mr.

Zhadanov remained in control of the manufacturing operations at

Vortex and deducted the expenses associated with the manufacture

of the plastic vials on Vortex’s tax returns for the years at

issue.

     Alex Srebrianski delivered the vials, collected the cash

payments from Belkin and Edelson, and turned the cash over to Mr.

Zhadanov at the Vortex factory.   At the Zhadanovs’ direction,

Alex deposited a portion of the cash receipts into U.S. Trading’s

checking account.   He then wrote checks to Vortex from U.S.

Trading’s checking account and included the notation “lease” on

each check.
                               - 9 -

     C.    Cash Hoard

     Checks that Vortex received from Tri-State General and U.S.

Trading were deposited into the corporate checking account and

recorded in the Vortex general ledger.    However, cash received

from Belkin and Edelson and Srebrianski was not deposited into

the corporate checking account or recorded in the Vortex general

ledger.   Instead, Mrs. Zhadanov recorded the cash in a cash

receipts journal and later into a cash disbursement journal.      The

cash receipts journal recorded cash received by Vortex in

connection with the plastic vial production totaling $728,346.

The cash disbursement journal recorded expenses and income

generated by the plastic vial production.    With two exceptions,

the entries in the cash receipts journal and the summary of cash

income in the cash disbursement journal correspond exactly.

     Mrs. Zhadanov put the cash from the sale of plastic vials in

shoe boxes she kept in a safe located at the Zhadanovs’

residence.   Each shoe box had a tally slip on which Mrs. Zhadanov

kept a running total of the balance to indicate whether money was

added or removed from the shoe box.    Sometimes, cash from one

shoe box was combined with another shoe box in an effort to save

space in the safe.

     Vortex did not report the cash receipts on its income tax

returns, financial statements, general ledger, or a 1992

application for a $400,000 loan to buy equipment.
                             - 10 -

     On occasion, Mr. Zhadanov used cash to pay Vortex expenses,

including raw materials and employee salaries.

     D.   Swiss Bank Account and Trips to Europe

     The Zhadanovs made several trips to Russia and Europe during

the years at issue.

     In April 1992, the Zhadanovs traveled to Switzerland and

opened an account in the names of Sam, Anna, and Eli Zhadanov at

the Union Bank of Switzerland (UBS) in Zurich.6

     In July 1992, the Zhadanovs traveled to Switzerland.    From

Switzerland, they traveled to Kiev to investigate potential

materials to use in manufacturing a new medical x-ray screening

device.

     On the July 1992 trip to Switzerland the Zhadanovs deposited

several marked U.S. Postal Money Orders (the money orders)

totaling $12,000 into the UBS account and withdrew a

corresponding amount of cash, which they used, at least in part,

to pay travel and related expenses.7   The money orders originated


     6
      Over the course of the next year, the Zhadanovs deposited
$300,000 into the Union Bank of Switzerland (UBS) account. The
Zhadanovs did not disclose the UBS account on their 1992 or 1993
income tax returns. The Zhadanovs claimed that the funds in the
UBS account were given to them by Russian businessmen interested
in bringing money into Europe to invest. Mr. Zhadanov did not
know the names of the Russian businessmen but claimed that his
son Eli had developed the contacts through his video rental
business at the U.S. embassy in Moscow.
     7
      Mr. Zhadanov testified that the unspent portion of the
$12,000 was brought back to the United States. Mr. Zhadanov also
                                                   (continued...)
                              - 11 -

from a Government informer who used them to pay Belkin for an

order of plastic vials.   Belkin, in turn, used them to pay

Vortex.   After tracing the deposit, the U.S. Postal Service

turned over the negotiated money orders to an agent of the

Criminal Investigation Division, Internal Revenue Service.

     In September 1992, the Zhadanovs made another trip to

Switzerland, in part to explore the potential for expanding

Vortex’s manufacturing business to Europe.   Prior to departing on

this trip, Mr. Zhadanov had exchanged correspondence with Jack

Reiss, a commercial broker, regarding suitable commercial space

for a new manufacturing facility.   During the trip, Mr. Reiss

showed Mr. Zhadanov potential warehouse space for product

assembly, and following the meeting, Mr. Reiss sent Mr. Zhadanov

a letter detailing the procedures for marketing, distribution,

and sales in Europe.   The Zhadanovs also traveled from

Switzerland to Milan and Bergamo in Italy during September 1992

to meet with potential Vortex clients.

     E.    Criminal Investigation of Vortex and Sam Zhadanov

     In May 1993, after an investigation by various Federal and

State law enforcement agencies, Mr. Zhadanov was arrested on

charges stemming from his relationship with Belkin and Edelson

and his manufacture and sale of alleged crack vial paraphernalia,


     7
      (...continued)
testified that whenever he used money from the safe for business
expenses, he returned unspent portions to the safe.
                                - 12 -

(i.e., plastic vials).     Incident to the arrest, law enforcement

agents searched the Vortex facility and the Zhadanovs’ apartment

where they seized $827,981 in cash from the safe.

     Mr. Zhadanov pleaded guilty in March 1994 to charges of

conspiracy to aid and abet the distribution of crack cocaine and

money laundering.     Pursuant to his plea agreement, Mr. Zhadanov

agreed to forfeit the $827,981 in cash seized from the safe, his

properties, Vortex’s assets, funds in his personal bank accounts,

and Vortex funds traceable to the UBS account in Switzerland.

Mr. Zhadanov also agreed to cooperate with the Internal Revenue

Service by filing accurate personal and corporate Federal income

tax returns for relevant years.     In return, Mr. Zhadanov received

a reduced sentence of 5 years in prison at his sentencing hearing

in August 1994.8

     F.      Notices of Deficiency and Reconstruction of Income

     Vortex filed timely corporate tax returns for FYEs 1991 and

1992.     Vortex received an extension to file its FYE 1993 return


     8
      In the criminal proceedings against Mr. Zhadanov in the
United States District Court for the Eastern District of
Pennsylvania, Mrs. Zhadanov, Eli Zhadanov, and Mr. Zhadanov’s
mother, Maria Zhadanov, filed a claim to recover a portion of the
seized funds in which they alleged they owned in the aggregate,
$200,000 of the $827,981 seized from the Zhadanovs’ safe and
subject to forfeiture. During the forfeiture hearing, Mrs.
Zhadanov introduced into evidence the Vortex cash receipts
journal in an attempt to explain the source of cash in the safe.
The journal had not been seized with the Vortex corporate records
during the May 1993 search of the Vortex factory and the
Zhadanovs’ residence. The District Court denied the claims of
Mrs. Zhadanov, Eli, and Maria Zhadanov.
                                - 13 -

until June 15, 1994, but did not file its FYE 1993 return until

October 1995.

     On August 23, 1995, respondent issued a notice of deficiency

to Vortex for its FYEs 1991, 1992, and 1993.    Although

respondent’s agents performed net worth analyses and source and

application of funds analyses on Vortex and the Zhadanovs in an

effort to reconstruct their income for the years at issue, those

analyses proved inconclusive.    Consequently, respondent

determined in the notice of deficiency issued to Vortex that

Vortex had unreported vial income for those years equal to the

cash receipts shown in Vortex’s cash receipts journal ($728,346)

and that Vortex was liable for fraud penalties under section 6663

for FYEs 1991 and 1992 and for the addition to tax for

fraudulently failing to file its return for FYE 1993.9      The

Zhadanovs filed timely joint Federal income tax returns for 1990,

1991, and 1992, and filed timely married filing separate returns

for 1993.   The Zhadanovs subsequently signed Form 872, Consent To

Extend The Statute Of Limitations On Assessment And Collection Of

Their Individual Tax, extending the period of limitations for

1991 to December 31, 1995.




     9
      Respondent does not dispute that the cash receipts journal
accurately reflects the cash income Vortex received from the
plastic vial sales. The Zhadanovs admit that the cash received
from the plastic vial sales was deposited in the safe and not
included as income on Vortex’s tax returns.
                              - 14 -

     In notices of deficiency dated May 23, 1995, respondent

determined that Vortex’s unreported income10 for the FYEs 1990

through 1993 was taxable to the Zhadanovs personally as

constructive dividends.   Respondent also determined that Mr.

Zhadanov must include a portion of his Social Security benefit

for 1993 in income and that the Zhadanovs were liable for the

fraud penalty under section 6663 or, alternatively, for the

accuracy-related penalty under section 6662 for each of the

taxable years at issue.

                              OPINION

I.   The Statute of Limitations Issues

     Petitioners contend that the period of limitations on

assessment has expired with respect to the Zhadanovs for 1990 and

1991 and with respect to Vortex for FYE 1991.   The Zhadanovs

timely filed their 1990 tax return on April 15, 1991, and filed

their 1991 tax return on April 15, 1992.   Respondent mailed the

notice of deficiency for those years on May 23, 1995.     Vortex

timely filed its tax return for FYE 1991 on December 16, 1991,

and the notice of deficiency for that year was issued on May 23,

1995.

     Generally, the Commissioner must assess an income tax

deficiency for a specified year within 3 years from the date the


     10
      Respondent determined the Zhadanovs received $117,829 for
1990; $203,813 for 1991; $249,318 for 1992; and $157,386 for 1993
from Vortex (totaling $728,346 for the years at issue).
                                - 15 -

taxpayer’s return for that year was filed.     Sec. 6501(a).

However, in cases where a party files a false or fraudulent

return with the intent to evade tax, the tax may be assessed at

any time.    Sec. 6501(c)(1).   Respondent argues that Vortex and

the Zhadanovs fraudulently understated their income for all the

years at issue and that, therefore, the exception under section

6501(c)(1) to the general 3-year limitations rule of section

6501(a) applies.11

     Respondent bears the burden of proving that an exception to

the general 3-year limitation period set forth in section 6501(a)

applies.    Rule 142(b); Harlan v. Commissioner, 116 T.C. 31, 39

(2001).    In order to rely upon the fraud exception under section

6501(c)(1), respondent must prove the same elements as he must

prove to impose an addition to tax for fraud under prior section

6653(b).    Mobley v. Commissioner, T.C. Memo. 1993-60, affd.

without published opinion 33 F.3d 1382 (11th Cir. 1994).       The

elements that must be proved to support the imposition of the

fraud addition to tax under prior section 6653(b) are essentially

the same elements that must be proved to impose the fraud penalty




     11
      Respondent also argues that the 6-year period of
limitations provided in sec. 6501(e) applies to petitioners if we
conclude that sec. 6501(c)(1) is not applicable. Sec. 6501(e)
provides that tax may be assessed at any time within 6 years
after a return is filed that omits from gross income an amount
exceeding 25 percent of the amount of gross income stated in the
return.
                                 - 16 -

under section 6663(b).12   See, e.g., Rhone-Poulenc Surfactants &

Specialties, L.P. v. Commissioner, 114 T.C. 533, 548 (2000),

appeal dismissed and remanded 249 F.3d 175 (3d Cir. 2001).

Because our resolution of the limitations issues depends, at

least initially, upon our resolution of the fraud issues in this

case, we examine first whether, on this record, respondent has

proven that Vortex and/or the Zhadanovs engaged in fraudulent

conduct under section 6663(b).

II.   Fraud Penalty In General

      In order for the Commissioner to prove that a taxpayer is

liable for a fraud penalty under section 6663(b) or its

predecessor, the Commissioner must prove by clear and convincing

evidence that (1) an underpayment of tax exists, and (2) some

part of the underpayment is due to fraud.    Sec. 7454(a); Rule

142(b); DiLeo v. Commissioner, 96 T.C. 858, 873 (1991), affd. 959

F.2d 16 (2d Cir. 1992).    The Commissioner may not rely on a

taxpayer’s failure to carry its burden of proof on the underlying

deficiency as proof that the taxpayer underpaid his tax.     DiLeo

v. Commissioner, supra.

      Fraud is established by showing that the taxpayer intended

“to evade tax believed to be owing by conduct intended to


      12
      Sec. 6663(a) was added to the Code by sec. 7721(a) of the
Omnibus Budget Reconciliation Act of 1989 (OBRA 1989), Pub. L.
101-239, 103 Stat. 2395-2398. Prior to the passage of OBRA 1989,
the fraud penalty (or addition to tax, as it was then known) was
contained in former sec. 6653(b).
                                - 17 -

conceal, mislead, or otherwise prevent the collection of such

tax.”    Recklitis v. Commissioner, 91 T.C. 874, 909 (1988).    Fraud

“does not include negligence, carelessness, misunderstanding or

unintentional understatement of income.”     United States v.

Pechenik, 236 F.2d 844, 846 (3d Cir. 1956).     Although respondent

bears the burden of proving by clear and convincing evidence that

a taxpayer has filed a fraudulent return with the intent to evade

tax, respondent need not prove the precise amount of the

underpayment resulting from fraud; he must only prove that some

portion of the underpayment of tax for each year is due to fraud.

Niedringhaus v. Commissioner, 99 T.C. 202, 210 (1992).

        The existence of fraud is a question of fact to be resolved

upon consideration of the entire record.     DiLeo v. Commissioner,

supra at 874.    Fraud is never presumed and must be established by

independent evidence of fraudulent intent.     Edelson v.

Commissioner, 829 F.2d 828, 833 (9th Cir. 1987), affg. T.C. Memo.

1986-223.     Fraud may be shown by circumstantial evidence because

direct evidence of the taxpayer’s fraudulent intent is seldom

available.     Gajewski v. Commissioner, 67 T.C. 181, 199 (1976),

affd. without published opinion 578 F.2d 1383 (8th Cir. 1978).

The taxpayer’s entire course of conduct may establish the

requisite fraudulent intent.     Stone v. Commissioner, 56 T.C. 213,

223-224 (1971).     However, fraud is not proven when a court is

left with only a suspicion of fraud, and even a strong suspicion
                              - 18 -

is not sufficient to establish a taxpayer’s liability for the

fraud penalty.   Olinger v. Commissioner, 234 F.2d 823 (5th Cir.

1956), affg. in part and revg. in part on another ground T.C.

Memo. 1955-9; Davis v. Commissioner, 184 F.2d 86, 87 (10th Cir.

1950); Green v. Commissioner, 66 T.C. 538, 550 (1976); Axelrod v.

Commissioner, T.C. Memo. 1982-92, affd. 711 F.2d 1062 (9th Cir.

1983).

     Courts have relied upon a number of indicia or badges of

fraud in deciding whether an underpayment of tax is due to fraud.

E.g., Bradford v. Commissioner, 796 F.2d 303, 307-308 (9th Cir.

1986), affg. T.C. Memo. 1984-601; Clayton v. Commissioner, 102

T.C. 632, 647 (1994); Petzoldt v. Commissioner, 92 T.C. 661, 700

(1989).   Although no single badge is necessarily sufficient to

establish fraud, the existence of several badges of fraud

constitutes persuasive circumstantial evidence of fraud.

Petzoldt v. Commissioner, supra.

     Respondent contends that the following badges of fraud are

present in this case: (1) Understatement of income; (2) failure

to file tax returns; (3) implausible or inconsistent explanations

of behavior; (4) concealment of assets; (5) failure to cooperate

with tax authorities; (6) engaging in illegal activity; (7)

attempting to conceal illegal activity; and (8) extensive
                                 - 19 -

dealings in cash.      We consider these badges as appropriate in

deciding whether Vortex and the Zhadanovs are liable for the

fraud penalty for any of the years at issue.

III.   Vortex Issues

     A. The Fraud Penalty Against Vortex for FYEs 1991
and 1992

            1.   The Underpayment Requirement

       Respondent asserts Vortex fraudulently underreported its

income for FYEs 1991 and 1992, and fraudulently failed to file a

tax return for FYE 1993.      Vortex concedes that it did not include

cash receipts from vial sales in gross income for FYEs 1991,

1992, and 1993, but disputes that its omission of income for FYEs

1991 and 1992, and its failure to timely file its Federal income

tax return for FYE 1993 were fraudulent.

            2.   The Underpayment Due to Fraud Requirement

       Respondent determined petitioners were liable for additions

to tax and penalties for FYEs 1991 and 1992 under section 6663,

which provides: “If any part of any underpayment of tax required

to be shown on a return is due to fraud, there shall be added to

the tax an amount equal to 75 percent of the portion of the

underpayment which is attributable to fraud.”

       In deciding whether a corporation has acted fraudulently, we

examine the actions of the corporation’s officers.      DiLeo v.

Commissioner, supra at 874; Kahrahb Rest., Inc. v. Commissioner,

T.C. Memo. 1992-263 (“A corporation can act only through
                               - 20 -

individuals who are its officers or employees”).    The fraud of a

sole or dominant shareholder may be attributed to the

corporation.    E.J. Benes & Co. v. Commissioner, 42 T.C. 358, 383

(1964), affd. 355 F.2d 929 (6th Cir. 1966).    In this case, we

must consider the actions of Mr. Zhadanov, Vortex’s president and

sole shareholder, in deciding whether some portion of Vortex’s

underpayments of tax for FYEs 1991 and 1992 was due to fraud.

     The record in this case is replete with evidence supporting

respondent’s determination that Vortex’s underpayments of tax

were due to fraud.    Among the evidence of fraud in the record are

the following:

     (1) Repeated Understatements of Income.    Vortex conceded it

failed to report income received from the manufacture and sale of

plastic vials for FYEs 1991 and 1992.    That failure resulted in

underpayments of tax in excess of $28,000 and $85,000,

respectively.    This failure to report substantial amounts of

income over successive years is persuasive evidence of fraudulent

intent.   Kurnick v. Commissioner, 232 F.2d 678 (6th Cir. 1956),

affg. T.C. Memo. 1955-31.

     (2) Implausible or Inconsistent Explanations of Behavior.

Vortex, through Mr. Zhadanov, gave inconsistent and implausible

explanations for not depositing the unreported income from vial

sales in the bank.    First, Mr. Zhadanov claimed that he did not

deposit cash into the Vortex checking account because he did not
                             - 21 -

know how to make such deposits.   We find this explanation

implausible given Mr. Zhadanov’s level of education and

entrepreneurial efforts at Vortex.    In addition to his position

as president of Vortex, Sam Zhadanov held numerous U.S. patents

and a degree in mechanical engineering.   We do not find his

testimony regarding his inability to perform such ministerial

tasks as depositing cash in a bank account to be credible.

     Second, Mr. Zhadanov testified that he did not deposit cash

into the Vortex checking account because Belkin and Edelson did

not want to be revealed as the source of such cash.   Mr. Zhadanov

testified that he did not question the request because he

believed Belkin and Edelson had a legitimate business, as they

sold the plastic vials openly in their stores.   Whatever Mr.

Zhadanov’s belief might have been when Vortex first agreed to

manufacture plastic vials for Belkin and Edelson, the evidence

reflects that, no later than July 1991, Mr. Zhadanov became aware

of the intended use of the plastic vials, but he did not

terminate his business dealings with Belkin and Edelson.

Instead, Mr. Zhadanov attempted to hide Vortex’s involvement in

the manufacturing process by arranging for a front company to

“rent” Vortex’s operation.

     (3) Concealment of Assets.   Vortex concedes that it did not

deposit the cash income derived from the manufacture and sale of

the plastic vials in its corporate bank account or report the
                                - 22 -

income for Federal income tax purposes.      Although Mr. Zhadanov

testified that, as a Russian, he did not trust banks and was

unaccustomed to keeping his money in banks, we are convinced that

Mr. Zhadanov intended to conceal the cash by keeping it in his

safe.    Mr. Zhadanov’s intent to conceal the cash is further

demonstrated by his concealment of the cash from his accountant.

See Duffey v. Commissioner, 91 T.C. 81 (1988); Langworthy v.

Commissioner, T.C. Memo. 1998-218 (taxpayer’s failure to be

forthcoming with his return preparer was evidence of fraud).

        (4) Engaging in Illegal Activity.   Vortex was engaged in the

illegal manufacture and sale of plastic vials used in the

distribution of crack cocaine during the years at issue.      As we

have previously stated, it is reasonable for us to assume that,

when income is derived from illegal activity, a taxpayer’s

failure to report the income is intended to mislead and frustrate

a potential criminal prosecution and is an indication of a

taxpayer’s intent to evade his taxes.       Reed v. Commissioner, T.C.

Memo. 1997-388, affd. per curiam without published opinion 155

F.3d 560 (4th Cir. 1998); Baker v. Commissioner, T.C. Memo. 1991-

340, affd. without published opinion 9 F.3d 1550 (9th Cir. 1993).

        (5) Attempting To Conceal Illegal Activity.   When Mr.

Zhadanov became aware that the plastic vials were being used in

the distribution of crack cocaine, he attempted to distance

Vortex from Belkin and Edelson.    He entered into a sham lease of
                              - 23 -

the Vortex factory with Alex Srebrianski and U.S. Trading and

used the ostensible leasing transaction to launder a portion of

the cash generated by the plastic vial sales.   A taxpayer’s

attempt to conceal its illegal activity, particularly when the

attempt contributes to the understatement of a taxpayer’s income,

is an indication of fraud.   Spies v. United States, 317 U.S. 492,

499 (1943).

     (6) Extensive Dealings in Cash.   Vortex amassed a

considerable cash hoard and used some of the cash to pay some of

Vortex’s expenses, including the cost of raw materials and Alex

Srebrianski’s salary.

     Based on the above, we hold that Vortex’s underpayment of

tax resulting from its failure to report proceeds from the sale

of plastic vials on its Federal income tax returns for FYEs 1991

and 1992 was attributable to fraud and that therefore Vortex is

liable for the fraud penalty under section 6663 for each of those

years.

     B.   The Fraudulent Failure To File Penalty Against
          Vortex for FYE 1993

     Respondent determined that Vortex was liable for the

addition to tax pursuant to section 6651(f)13 for fraudulently


     13
      Sec. 6651(a) imposes an addition to tax for late filing
equal to 5 percent of the amount required to be shown on the
return if a taxpayer files within 1 month of the date prescribed.
That section further imposes an additional 5-percent addition to
tax for each additional month or fraction thereof that the return
                                                   (continued...)
                              - 24 -

failing to file a timely income tax return for FYE 1993.   Vortex

filed its Federal income tax return for FYE 1993 in October 1995,

after respondent issued to Vortex the notice of deficiency dated

August 23, 1995.

     We examine the same badges of fraud we used when considering

the imposition of the fraud penalty under section 6663(a) to

decide whether Vortex is liable for the addition to tax for

fraudulently failing to file a timely tax return under section

6651(f).   Clayton v. Commissioner, 102 T.C. 632, 653 (1994).    Our

analysis, however, necessarily must focus on the taxpayer’s

decision not to file its return when due for it is only if that

decision was made with the intent to evade tax that the addition

to tax under section 6651(f) may properly be imposed.   Respondent

bears the burden of proving by clear and convincing evidence that

an underpayment exists and that the taxpayer intended to conceal,

mislead, or otherwise prevent the collection of taxes by not

filing his return when due.   Parks v. Commissioner, 94 T.C. 654,

660-661 (1990).




     13
      (...continued)
is not filed, not to exceed 25 percent in the aggregate. If any
failure to file a return is fraudulent, sec. 6651(f) increases
the additions to tax imposed under sec. 6651(a) to 15 percent of
the net amount of tax due for each month that the return is not
filed, up to a maximum of 75 percent.
                              - 25 -

     As discussed, supra, Vortex’s corporate tax return for the

year at issue was due June 15, 1994.14    Vortex concedes it did

not file a tax return for FYE 1993 until after it received the

notice of deficiency in August 1995.     Vortex maintains that its

failure to file its FYE 1993 return by the extended due date was

not due to any attempt on its part to evade its taxes but rather

was due to other circumstances stemming from the investigation,

arrest, trial, and imprisonment of Mr. Zhadanov.    Mr. Zhadanov

was arrested in May 1993.   Incident to the arrest, law

enforcement agents searched the Vortex facility and the

Zhadanovs’ apartment and seized, among other things, many of

Vortex’s books and records.   In January 1994, Mr. Zhadanov

pleaded guilty, and from 1994 to 1999 Mr. Zhadanov was

incarcerated.

     By June 15, 1994, the deadline for filing Vortex’s FYE 1993

return, Mr. Zhadanov had already pleaded guilty pursuant to a

plea agreement that required him, among other things, to file

accurate Federal income tax returns on behalf of Vortex and for

himself.   The terms of the plea agreement provided an extremely

strong incentive to file accurate tax returns because the failure




     14
      Corporate fiscal year income tax returns are required to
be filed on the fifteenth day of the third month following the
close of the corporation’s fiscal year. Sec. 6072(b). Vortex’s
income tax return for FYE 1993 was originally due on Dec. 15,
1993, but the filing deadline was extended to June 15, 1994.
                              - 26 -

to do so could result in a violation of the plea agreement and a

harsher sentence for Mr. Zhadanov.

     Our review of the record leaves us unconvinced that Vortex

fraudulently failed to file its FYE 1993 return.   The record

leaves us instead with the impression that Vortex’s failure to

file its return was due to other circumstances such as the

seizure of necessary records, and the arrest and imprisonment of

Vortex’s sole shareholder/president.   Because respondent has the

burden of proving that Vortex fraudulently failed to file its

return by clear and convincing evidence, the unconvincing nature

of the record is fatal to respondent’s claim.   Accordingly, we do

not sustain respondent’s determination of the section 6651(f)

penalty for FYE 1993.

     C.   The Delinquency Penalty Against Vortex for FYE 1993

     Alternatively, respondent determined that Vortex was liable

for the addition to tax pursuant to section 6651(a) should we

find that Vortex’s failure to file was not due to fraud.   Vortex

bears the burden of proof on this issue.15   Rule 142(a); Lee v.

Commissioner, 227 F.2d 181, 184 (5th Cir. 1955), affg. a

Memorandum Opinion of this Court; BJR Corp. v. Commissioner, 67

T.C. 111, 131 (1976).



     15
      The burden of proof provisions of sec. 7491 do not apply
here because the examination in this case began before July 22,
1998. See Internal Revenue Service Restructuring & Reform Act of
1998, Pub. L. 105-206, sec. 3001, 112 Stat. 726.
                                - 27 -

     Section 6651(a) authorizes the Commissioner to impose an

addition to tax whenever a taxpayer fails to file a required

return when due (determined with regard to any extension of the

filing deadline) unless the taxpayer shows that such failure was

due to reasonable cause and was not due to willful neglect.

In this case, the parties agree that Vortex did not file its

income tax return for its FYE 1993 by the extended filing

deadline.   Consequently, in order to avoid liability for the

section 6651(a) addition to tax, Vortex must show that its

failure to timely file was due to reasonable cause and not due to

willful neglect.     AJF Transp. Consultants, Inc., v. Commissioner,

T.C. Memo. 1999-16, affd. 85 AFTR 2d 1909, 2000-1 USTC par. 50473

(2d Cir. 2000).    The term “reasonable cause” is defined as the

exercise of ordinary business care and prudence.    Sec. 301.6651-

1(c)(1), Proced. & Admin. Regs.    The term “willful neglect” is

defined as a “conscious, intentional failure or reckless

indifference.”     United States v. Boyle, 469 U.S. 241, 246 (1985).

At trial, Mrs. Zhadanov recited the difficulties she faced in

dealing with the Zhadanovs’ and Vortex’s legal and tax issues

while her husband was in jail.    She testified that she hired tax

lawyers who did nothing but “calculate numbers, numbers,

numbers,” then withdrew their representation.    She testified

about the money problems she and her husband encountered as a

result of the forfeiture and the efforts that she and other
                                - 28 -

members of her family took to recover a portion of the forfeited

funds.     However, Mrs. Zhadanov did not adequately explain why she

was unable to prepare, or arrange for the preparation of,

Vortex’s return in the time between Mr. Zhadanov’s guilty plea

and Vortex’s filing deadline.       In addition, Vortex did not make

any additional arguments regarding this issue.       We conclude that

Vortex has failed to prove that it exercised ordinary business

care and prudence or that its failure to file was not due to

conscious, intentional, or reckless indifference.       Accordingly,

we hold Vortex liable for the addition to tax under section

6651(a) with respect to FYE 1993.

      D.    The Limitations Issue

         Because we have found that Vortex fraudulently

underreported its income and underpaid its income tax for its FYE

1991, we hold that respondent is not barred by section 6501(a)

from assessing a deficiency with respect to Vortex for its FYE

1991.

IV.   The Zhadanov Issues

      A.    Respondent’s Adjustments to Income

      Respondent has determined that the Zhadanovs had unreported

constructive dividend income during each of the years at issue

attributable to the unreported cash from vial sales that the

Zhadanovs kept in their safe.       In addition, respondent has

determined that Mr. Zhadanov failed to include in income Social
                              - 29 -

Security benefits he received during 1993.    The Zhadanovs

vigorously disagree that they had constructive dividend income in

any of the years at issue.   The Zhadanovs bear the burden of

proving, by a preponderance of the evidence, that they did not

receive the income alleged by respondent.    Rule 142(a).

          1.   Constructive Dividends

     Respondent asserts that the Zhadanovs diverted Vortex income

totaling $728,346 and retained it for their personal use.     The

Zhadanovs claim that the cash was not diverted but remained

Vortex’s asset despite its physical location in the Zhadanovs’

safe, and that, therefore, they did not underreport their income

or underpay their income tax liabilities for the years at issue.

     A constructive dividend arises when a corporation confers an

economic benefit upon a shareholder without expectation of

repayment and the corporation on the date of the deemed

distribution had current or accumulated earnings and profits.16

Crosby v. United States, 496 F.2d 1384, 1388 (5th Cir. 1974);

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

Constructive dividends are includable in a taxpayer’s gross

income under section 61(a)(7).

     As a general rule, “a taxpayer need not treat as income

moneys which he did not receive under a claim of right, which


     16
      Petitioners conceded that Vortex had sufficient earnings
and profits for the years at issue to support a constructive
dividend of the amounts at issue.
                                - 30 -

were not his to keep, and which he was required to transmit to

someone else as a mere conduit.”     Diamond v. Commissioner, 56

T.C. 530, 541 (1971), affd. 492 F.2d 286 (7th Cir. 1974).     The

receipt of money by a taxpayer acting in an agency or fiduciary

capacity ordinarily is not a taxable event to that taxpayer.

Heminway v. Commissioner, 44 T.C. 96, 101 (1965).     The mere fact

that funds pass through an owner-taxpayer’s hands is not

determinative of a constructive dividend.     Ashby v. Commissioner,

50 T.C. 409 (1968); Marks v. Commissioner, T.C. Memo. 1963-304.

     A greater potential for constructive dividends, however,

exists in closely held corporations where dealings between

stockholders and the corporation are commonly characterized by

informality.   Bittker & Eustice, Federal Income Taxation of

Corporations and Shareholders, par. 8.05, at 8-39 (7th ed. 2000).

“Where a shareholder uses corporate property for his personal

benefit, not proximately related to corporate business, the

shareholder must include the value of the benefit in income as

constructive dividends to the extent of the corporation’s

earnings and profits.”     AJF Transp. Consultants, Inc. v.

Commissioner, T.C. Memo. 1999-16, affd. 85 AFTR 2d 1909, 2000-1

USTC par. 50473 (2d Cir. 2000); see also DiZenzo v. Commissioner,

348 F.2d 122, 125 (2d Cir. 1965), revg. in part and remanding

T.C. Memo. 1964-121;     Truesdell v. Commissioner, supra; Falsetti

v. Commissioner, 85 T.C. 332, 335-336 (1985); Nicholls, North,
                              - 31 -

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

Manufacturing Co. v. Commissioner, 37 T.C. 650, 663 (1962).      The

courts have often used a two-level inquiry to decide whether a

taxpayer received constructive dividend income.   The first level

of inquiry requires an examination of whether the corporation

conferred an economic benefit on the shareholder without

expectation of repayment.   United States v. Smith, 418 F.2d 589

(5th Cir. 1969).   The second level requires an examination of

whether the benefit primarily advanced the shareholder’s personal

interest as opposed to the business of the corporation.    Ireland

v. United States, 621 F.2d 731 (5th Cir. 1980); Sammons v.

Commissioner, 472 F.2d 449 (5th Cir. 1972), affg. on this point

T.C. Memo. 1971-145; United States v. Gotcher, 401 F.2d 118 (5th

Cir. 1968).

     Respondent argues that the Zhadanovs received constructive

dividends equal to the unreported vial income kept in their safe

because their unfettered control over the funds in the safe

conferred an economic benefit upon them, and the benefit was

primarily personal.   Respondent relies upon the fact that Mr.

Zhadanov, as president and sole shareholder of Vortex, had ample

opportunity to spend the cash by virtue of its location in his

personal safe.
                               - 32 -

     Although the Zhadanovs do not dispute that they had physical

control over the cash, they vigorously contest that they

appropriated the cash to their own use.    They emphasize that they

never spent any of the unreported corporate cash for personal

purposes, as evidenced by the fact that the entire disputed

amount was still in the safe on the date the cash was seized and

Mr. Zhadanov was arrested in 1993.17

     Although control over an asset can be evidence of an

economic benefit, control of an asset by a shareholder-officer

does not necessarily result in a benefit that is taxable to the

shareholder.    For example, a constructive dividend does not

result when, despite “extremely informal” dealings, a sole

shareholder’s intent in transferring funds from the corporation

to his personal checking account “was to use such funds for

corporate purposes as an agent of the corporation.”    Nasser v.

United States, 257 F. Supp. 443, 449 (N.D. Cal. 1966); see also

Loftin & Woodard, Inc. v. United States, 577 F.2d 1206, 1215 (5th

Cir. 1978).    Likewise, we have held that a sole shareholder’s

physical control over unreported corporate cash does not result

in constructive dividends where the shareholder evidences an

intention to hold and use those funds for corporate purposes.


     17
      We note that $827,981 was seized from the safe in May
1993, but respondent has taken the position in this case that the
total unreported vial income for all the years at issue was only
$728,346. Implicit in respondent’s position is that $99,635 of
the cash seized from the safe was not unreported vial income.
                              - 33 -

Bard v. Commissioner, T.C. Memo. 1990-431; Alisa v. Commissioner,

T.C. Memo. 1976-255.

     A careful review of the record in this case reveals a dearth

of credible evidence supporting respondent’s position that the

unreported Vortex cash was diverted by the Zhadanovs for their

personal use and economic benefit.     The preponderance of credible

evidence in the record supports the Zhadanovs’ position that they

held the unreported cash for corporate use.    At trial, the

Zhadanovs relied upon a cash receipts journal that, for

unexplained reasons, was not seized by the Government when it

executed search warrants in May 1993, and a cash disbursements

journal that recorded Vortex’s vial income and related

expenditures, which was seized during the May 1993 search.     Both

documents record Vortex’s cash vial income and show it as a

corporate asset.   Respondent apparently concluded that the cash

receipts journal was credible as he relied on it in determining

the amount of Vortex’s unreported income from cash vial sales for

each of the years at issue.

     The facts clearly establish that the entire amount

respondent determined was unreported constructive dividend income

was seized by Government agents in May 1993.    Respondent’s only

credible evidence in support of his determination that the

diverted corporate cash was a constructive dividend to the

Zhadanovs is that the Zhadanovs had physical control over the
                                - 34 -

cash.     We are not convinced that such control, without some

evidence that the Zhadanovs intended to appropriate the cash for

personal use or actually used it for personal purposes, is enough

to counter the evidence in the record supporting the Zhadanovs’

argument that they held the cash on behalf of Vortex.

     Obviously, the Zhadanovs did not use any of the diverted

cash for personal purposes because all of the diverted cash at

issue in this case was in the safe when it was seized by the

Government agents.     The record contains no evidence that the

Zhadanovs lived a lavish lifestyle inconsistent with their

reported income.     In fact, although respondent used indirect

methods to reconstruct the Zhadanovs’ income before he issued the

notices of deficiency in this case, respondent did not rely on

those analyses, opting instead to treat the seized cash, to the

extent recorded in the cash receipts journal, as the unreported

income.     Although there is evidence in the record that the

Zhadanovs used cash from time to time to pay expenses, the

expenses in question appear to have been Vortex’s expenses, not

personal expenses of the Zhadanovs.

        Respondent attempts to bolster his argument by pointing to

evidence that the Zhadanovs opened a Swiss bank account into

which they deposited $300,000 over the course of a year and that

the Zhadanovs cashed $12,000 of money orders given in payment of

plastic vials and used a portion of the funds to pay travel
                              - 35 -

expenses while in Europe.   In our view, this evidence falls short

of establishing that the Zhadanovs used the diverted corporate

cash for personal purposes for several reasons.   First, although

respondent implies and even argues that the $300,000 deposited in

the Swiss bank account represented unreported vial income,

respondent did not “gross up” the alleged unreported income (as

determined in the notice of deficiency) to include the $300,000.

If respondent’s position that the $300,000 consisted of

unreported vial income were correct, respondent certainly would

have grossed up his calculation of the diverted income from vial

sales to include the $300,000.   Respondent did not do so.

Second, although the record establishes that the Zhadanovs cashed

$12,000 of money orders directly traceable to Vortex’s plastic

vial sales, the Zhadanovs did so on one of their 1992 trips to

Europe during which they explored extending Vortex’s

manufacturing operations and product lines overseas.   The

business purpose of the Zhadanovs’ trips is established not only

by their testimony but by credible third party evidence

confirming the business nature of the trips.   The Zhadanovs’ use

of part or all of the $12,000 during one of the business trips is

not convincing evidence of any intent to appropriate Vortex funds

for personal purposes.

     The Zhadanovs sometimes held business meetings in their

home, and they used the safe in their home for corporate
                                - 36 -

purposes.    The Zhadanovs kept corporate records and cash in the

safe because they believed the safe was more secure than the

storage facilities at Vortex.    While it is certainly true that

keeping corporate cash in a shareholder’s personal safe creates

an ambiguous ownership trail, it is not convincing evidence of

fraud that Mr. Zhadanov would do so, particularly where he used

both the corporate office and his residence for business

purposes.

     For the reasons discussed, we conclude that the Zhadanovs

did not derive an economic benefit from the unreported Vortex

cash and that they did not keep the cash in their safe primarily

for their personal benefit.   We hold, therefore, that the

Zhadanovs did not have constructive dividend income during the

years at issue as determined by respondent.

            2.   Social Security Benefits to Sam Zhadanov

     Respondent alleges that Mr. Zhadanov received $6,811 in

Social Security benefits for 1993, which he did not include in

his gross income as required by section 86.    Section 86(a)(1)

provides that, except as provided in section 86(a)(2), a

taxpayer’s gross income includes the lesser of one half of any

Social Security benefits received by the taxpayer during the

taxable year or one-half of the amount determined under section

86(b)(1).
                               - 37 -

     Mr. Zhadanov’s 1993 return actually showed the Social

Security benefits he received during 1993 (line 21(a)), but the

return does not contain a completed entry on the relevant income

line (line 21(b)).   Mr. Zhadanov admitted at trial that he

received the Social Security benefits in question and that he did

not pay tax on those benefits for 1993, but he did not present

any additional evidence or make any further argument regarding

respondent’s adjustment.   We conclude, therefore, that Mr.

Zhadanov has conceded this issue (assuming that the issue is not

computational in nature), Bradley v. Commissioner, 100 T.C. 367,

370 (1993); Rybak v. Commissioner, 91 T.C. 524, 566 n.19 (1988),

and sustain respondent’s adjustment accordingly.18

     B.   Fraud Penalty Determined Against the Zhadanovs

     Respondent determined that the Zhadanovs were jointly liable

for a fraud penalty under section 6663 for 1990, 1991 and 1992,

and that Mr. Zhadanov and Mrs. Zhadanov were each liable for a

fraud penalty for 1993.    Respondent bears the burden of proving

by clear and convincing evidence that an underpayment exists and

that the underpayment is attributable to fraud.   Sec. 7454(a);

Rule 142(b).



     18
      We note, however, that Mr. Zhadanov’s 1993 return showed a
negative adjusted gross income figure and no taxable income.
Even after Mr. Zhadanov’s deemed concession is taken into
account, it does not appear that Mr. Zhadanov will have any
underpayment of tax for 1993, but we leave that analysis to the
Rule 155 calculation.
                              - 38 -

     By reason of our holding with respect to the constructive

dividend issue, we conclude that the Zhadanovs did not underpay

their tax for 1990, 1991 and 1992, and that neither Mr. Zhadanov

nor Mrs. Zhadanov had any constructive dividend income in 1993.

Moreover, although Mr. Zhadanov must include half of his 1993

Social Security payments in income for 1993, it does not appear

that Mr. Zhadanov will have an underpayment for 1993 even after

the adjustment is made.   We conclude, therefore, that respondent

has failed to prove that the Zhadanovs underpaid their tax

liability for any of the years at issue.   Consequently, we hold

that the Zhadanovs are not liable for the fraud penalty for any

of the years at issue.

     C.   Other Issues

     Because of our holding regarding the constructive dividend

issue, we do not address, and need not decide, the other issues

raised by the parties, including the Zhadanovs’ assertion

regarding the statute of limitations for 1990 and 1991, Mr.

Zhadanov’s double jeopardy argument, and Mrs. Zhadanov’s claim to

relief under section 6015.
                        - 39 -



To reflect the foregoing,



                                  Decision will be entered

                             for petitioners in docket No.

                             14021-95.

                                  Decisions will be entered

                             under Rule 155 in docket Nos.

                             24646-95 and 24647-95.
