                  T.C. Memo. 1999-282



                UNITED STATES TAX COURT



   LAW OFFICES--RICHARD ASHARE, P.C., Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 18439-97.                    Filed August 24, 1999.


     P is a corporate law firm, and A is its sole
shareholder and only professional employee. P has
represented a class of plaintiffs from 1974 to date and
was awarded $12,567,623 in legal fees when the case was
settled in 1989. P received those fees from 1989
through 1992 and is not entitled to further fees for
significant ongoing services which it must perform on
that case. P's workload in and after 1990 was minimal,
except for the ongoing services. P paid A $10,492,500
of "compensation" from 1989 through 1992 and, for each
year but one, reported no taxable income. For 1990 P
reported taxable income of $3,775,699; $2,487,547 was
retained for P's future operations, and $1,282,998 was
retained to pay P's 1990 Federal income tax liability.
P paid A $1,750,000 of "compensation" during 1993 and
reported a $1,857,933 loss that it carried back to 1990
to claim a refund of $581,812. P borrowed $916,756
from A and sold most of its assets to have the funds to
pay A the $1,750,000. Exclusive of $1,373,913 of
Federal income tax refunds received or accrued by P on
                               - 2 -


     its carryback of losses from 1991, 1992, and 1993, P's
     deficit in retained earnings on Dec. 31, 1993, was
     $1,463,768.
          Held: R did not conduct a second examination of
     P's books of account in violation of sec. 7605(b),
     I.R.C.
          Held, further, sec. 162(a)(1), I.R.C., allows P to
     deduct $1,750,000 in 1993 as reasonable compensation
     paid to A.



     Gordon S. Gold, David J. Lieberman, and Barry R. Bess,1 for

petitioner.

     Trevor T. Wetherington and Robert D. Heitmeyer, for

respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     LARO, Judge:   Petitioner petitioned the Court to redetermine

an income tax deficiency of $546,634 for 1990.   The deficiency

stems from respondent's determination that petitioner may not

deduct $1,750,000 paid to its shareholder/employee in 1993

reportedly as compensation.   Petitioner reported a net operating

loss (NOL) for 1993 that it carried back to 1990.

     We must decide the following issues:




     1
       At the start of trial, the Court allowed Mr. Bess to
withdraw as counsel because he was going to be a witness for
petitioner.
                                - 3 -


     1.   Whether respondent violated the prohibition of section

7605(b) against a second examination of petitioner's books of

account for 1993.   We hold he did not.

     2.   Whether section 162(a) allows petitioner to deduct the

$1,750,000 as compensation.    We hold it does.

     Unless otherwise indicated, section references are to the

Internal Revenue Code in effect for the applicable years.     Rule

references are to the Tax Court Rules of Practice and Procedure.

Dollar amounts are rounded to the nearest dollar.

                           FINDINGS OF FACT

     Some of the facts have been stipulated.      The stipulation of

facts and the exhibits submitted therewith are incorporated

herein by this reference.    Petitioner is a corporate law firm

that specializes in State and municipal employee pension benefits

and the litigation thereof.    It uses the cash method for Federal

income tax purposes and an accrual method for book purposes.      Its

principal place of business was in Detroit, Michigan, when its

petition was filed.

     Richard Ashare, an attorney, incorporated petitioner in 1974

with a capital contribution of $1,000.    Mr. Ashare is

petitioner's sole shareholder and one of its two employees.

Petitioner's other employee is Mr. Ashare's secretary, Kathleen

Moore Baker (Ms. Moore).    Petitioner has three directors:   Mr.

Ashare, his wife, Marlene, and his longtime tax adviser, Barry
                                 - 4 -


Bess.   Petitioner has two officers:      Mr. Ashare (president and

treasurer) and Mrs. Ashare (secretary).       Mr. Bess is petitioner's

(and Mr. Ashare's) principal tax adviser; among other things, Mr.

Bess advised Mr. Ashare on petitioner's incorporation in 1974.

     Mr. Ashare has focused almost exclusively on one case (the

Gentile case) during his employment by petitioner.       In that case,

Mr. Ashare, on behalf of petitioner, represented a class of 9,000

to 10,000 persons known as the Policeman and Fireman Retirement

System of the City of Detroit.    The class retained petitioner on

a contingent fee basis to sue the city of Detroit (the city) for

a correct computation of employee pension benefits.

     In 1989, following prolonged litigation, the city agreed to

pay the class $70 million to settle the Gentile case.       The court

overseeing the litigation awarded petitioner $12,567,623 of the

settlement proceeds as legal fees.       Petitioner received these

fees from 1989 through 1992.   Petitioner reportedly paid

compensation of $10,492,500 to Mr. Ashare during the same years.

Except for its work on the Gentile case, petitioner's workload in

and after 1990 was and is minimal.       Petitioner generally began to

wind down its business after it settled the Gentile case, and its

only case as of December 31, 1993, was the Gentile case.

     Petitioner reported on its 1993 Form 1120, U.S. Corporation

Income Tax Return, that it paid Mr. Ashare $1,750,000 in

compensation.   Mr. Ashare lent petitioner $916,756, and
                                 - 5 -


petitioner liquidated most of its assets so that it would have

the funds to pay Mr. Ashare the $1,750,000.     Petitioner reported

a $1,857,933 taxable loss for 1993, which, on February 14, 1994,

it carried back to 1990 to receive a $581,812 refund of taxes

paid for 1990.   Petitioner's reported loss resulted in a reported

deficit of $89,855 in retained earnings on December 31, 1993,

which translates into a deficit of $1,463,768 in retained

earnings exclusive of the tax refunds of $733,006, $59,095, and

$581,812 described infra and supra.      Petitioner's reported

balance sheet at the beginning and end of 1993 was as follows:

                                                    1/1/93 12/31/93

Assets:
  Cash                                              $146,130   $35,197
  Mortgage receivable                                 11,000    11,000
  Loan receivable                                      5,000      -0-
  Prepaid expense                                      3,200     3,200
  Refundable income tax                               69,095   582,812
  Investments--marketable securities                 569,173     9,048
  Depreciable property (net of depreciation)         197,164   187,113
    Total assets                                   1,000,762   828,370

Liabilities:
  Payroll taxes withheld                              2,871     469
  Accrued pension contribution                       40,002     -0-
  Loans from shareholders                             8,800 916,756
    Total liabilities                                51,673 917,225

Shareholder's equity:
  Common stock                                         1,000   1,000
  Retained earnings (deficit)                        948,089 (89,855)
    Total shareholder's equity (deficit)             949,089 (88,855)

   Total liabilities & S/H's equity (deficit) 1,000,762 828,370
                                - 6 -


     Mr. Ashare, in his capacity as petitioner's employee, has

served as trustee of the Gentile case settlement fund from 1989

to date.   Following the settlement, petitioner has had to perform

a "tremendous amount of work" administering the fund; e.g., it

has had to identify and locate each Gentile case plaintiff,

ascertain actuarially each plaintiff's pension benefit with the

assistance of few or no records maintained by the city on its

employees, and distribute to each plaintiff his or her

ascertained benefit. Both Mr. Ashare and Ms. Moore, on behalf of

petitioner, have devoted and continue to devote significant time

and effort to the fund's administration, and petitioner continues

to employ Ms. Moore full time at a salary of $45,000.    Petitioner

continues to lease the office space let to it since its

incorporation.   Except for the $12,567,623 award, petitioner is

not entitled to any further compensation for the postsettlement

services performed on the Gentile case.   As of September 13,

1996, petitioner still had to locate and ascertain the benefits

of approximately 900 plaintiffs.   As of March 17, 1999,

petitioner still had to locate and ascertain the benefits of

approximately 500 plaintiffs.

     Petitioner's items of income and expense as reported on its

1989 through 1993 Forms 1120 are as follows:
                                           - 7 -


                            1989         1990          1991       1992          1993
Income:
  Legal fees
    Gentile case         $2,030,341   $5,774,602    $100,000   $4,662,680         -0-
    Other cases1            309,380        8,156      20,725          -0-      $30,525
    Total                 2,339,721    5,782,758     120,725    4,662,680      30,525
  Dividends                   9,993       23,966     149,875      202,378      30,746
  Interest                  140,267      108,551      11,571       18,635       8,641
  Business prop. sales          164           75        -0-          -0-         -0-
  Client costs reimb.          -0-          -0-         -0-        26,474        -0-
  Mediation fees              3,000        2,250        -0-          -0-         -0-

 Total income            2,493,145    5,917,600      282,171   4,910,167       69,912

Deductions:
  Officer compensation   2,151,666    1,690,834    $2,000,000 $4,650,000    $1,750,000
  Secretary's compens.     107,932      145,920       102,090    108,580        66,040
  Rents                     23,140       13,820        12,780     12,780        12,780
  Taxes                     21,036      104,800       119,995     30,196        11,898
  Interest                    -0-          -0-            215       -0-           -0-
  Depreciation               5,437        2,974         4,135      8,535         7,816
  Officer pension plans     88,900       56,089        97,106    101,990        27,678
  Employee benefits         13,262       13,037        12,227     13,639        14,528
  Client/contract service     -0-        20,889          -0-       6,000         4,500
  Seminars & publications    3,364        2,988         1,844      2,500         2,124
  Insurance                  7,199        7,979        10,050      9,435         9,906
  Office                     6,478       17,151           427      3,730         4,156
  Postage                    1,830        1,158         1,686      1,176         2,188
  Professional fees          8,661       14,797        36,372     12,881        22,033
  Entertainment             32,450       26,021        19,556     16,976         6,624
  Telephone                  4,950        3,320         4,201      4,599         3,078
  Vehicles                  11,419       12,356        10,387      8,643         7,364
  Tuition                    5,250        5,677         5,000       -0-           -0-
  Reimbursements              -0-          -0-           -0-        -0-       (36,262)
  NOL carryover from 1988     170        2,091           -0-        -0-           -0-
Special deduction             -0-          -0-           -0-      92,315        11,454
  Total deductions       2,493,144    2,141,901     2,438,071  5,083,975     1,927,905
  Taxable income (loss)       -0-     3,775,699    (2,155,900)  (173,808)   (1,857,933)

 Total Tax                    -0-     1,283,738         -0-         -0-          -0-
  1
    Most (if not all) of these fees for 1989 are attributable to a cause of action alleged
in the Gentile case but treated by petitioner as unrelated to the Gentile case.


      In 1992, petitioner carried the 1991 loss back to 1990 and

      received a refund of $733,006 (and a corresponding abatement of

      an estimated tax penalty).         In 1993, petitioner carried the 1992

      loss back to 1990 and received a refund of $59,095 (and a

      corresponding abatement of the estimated tax penalty).
                                     - 8 -


       Respondent audited petitioner's 1990 through 1992 taxable

years.      In connection therewith, petitioner agreed with

respondent in December 1993 that some of the compensation paid to

Mr. Ashare during the related years was constructive dividends;

petitioner has never formally declared or paid a dividend.                The

amounts recharacterized to dividends are as follows:

Year       Reported compensation Agreed compensation   Constructive dividends

1989             $2,151,666        $2,151,666                  -0-
1990              1,690,834         1,563,447               $126,553
1991              2,000,000         1,947,045                 52,958
1992              4,650,000         4,602,596                 47,404

Following the audit, petitioner carried its 1993 loss back to

1990.

       During the relevant years, petitioner's board did not

convene as a board in person.          Every December, the board would

transact its business for that year through one or more telephone

conversations between Messrs. Bess and Ashare.              Board action was

reflected in written resolutions signed by all three board

members who, contemporaneously therewith, consented under State

law for the board to act without an actual meeting.               Board action

included setting each employee's compensation for that year in

accordance with petitioner's unwritten compensation policy.

       In accordance with petitioner's compensation policy, Mr.

Bess telephones petitioner's accountant2 every December, and the


       2
           Petitioner's accountant during the relevant years was
                                                       (continued...)
                              - 9 -


accountant "recommends" to Mr. Bess the total amount of

compensation that petitioner should pay its employees.    Mr. Bess

then telephones Mr. Ashare to relay the accountant's

recommendation to him, and Mr. Ashare sets the specific amounts

of compensation that petitioner will pay to him and Ms. Moore.

Petitioner's plan of compensation for Mr. Ashare is to pay him

annually all legal fees that petitioner receives during the year,

less an amount equal to the sum of its corporate expenses

(exclusive of Mr. Ashare's compensation) plus any funds retained

for petitioner's future operations.   Petitioner's plan of

compensation, as applied, has allowed it through 1993 to report

no profits subject to Federal income tax, except for its first 7

years of operation and for 1990.   From petitioner's incorporation

through 1995, petitioner reported the following profit (loss),

compensation paid to Mr. Ashare, and contributions to Mr.

Ashare's pension fund:

         Year                  Compensation      Pension
         Ended       Profit        Paid        Contribution
         9/30/74    $10,500      $48,500          $7,000
         9/30/75     14,999      100,000          10,000
         9/30/76     10,715       63,263           7,143
         9/30/77     14,940       87,500           9,960
         9/30/78     12,563       87,500           8,375
         9/30/79     13,616       75,000           9,077
         9/30/80     13,014       70,000           8,696
         9/30/81       -0-        55,417           7,261


     2
      (...continued)
Herbert Lazarus of Lazarus, Rice & Lopatin, C.P.A.'s, P.C.
Mr. Lazarus has since died.
                                 - 10 -


           9/30/82       -0-         17,500         3,699
           9/30/83       -0-         20,417         3,900
           9/30/84       -0-        100,000       107,881
           9/30/85       -0-        130,000       113,082
           9/30/86       -0-         96,250       105,444
           9/30/87       -0-        157,445       102,047
          12/31/87       -0-         23,333        20,068
          12/31/88       -0-        921,334        63,178
          12/31/89       -0-      2,151,666        88,901
          12/31/90 3,775,699      1,690,834        56,089
          12/31/91 (2,155,900)    2,000,000        97,106
          12/31/92   (173,808)    4,650,000       101,990
          12/31/93 (1,857,933)    1,750,000        27,678
                       1                             1
          12/31/94                  -0-
                       1                             1
          12/31/95                   -0-
     1
         Undisclosed by the record.

     Petitioner's board resolved on December 31, 1990, that

petitioner would retain $2,487,547 of its 1990 profit for "the

reasonably anticipated needs of the business for the forthcoming

years";3 petitioner used another $1,282,998 to pay its 1990

Federal income tax liability.     The board also resolved on that

date that petitioner would pay $1,690,834 in compensation to Mr.

Ashare during 1990 "in consideration of the efforts expended by

Richard Ashare on behalf of the Corporation for the calendar year

ending December 31, 1990".

     The board resolved on December 31, 1993, that petitioner

would pay $1,750,000 in compensation to Mr. Ashare "in

consideration of the efforts expended by Richard Ashare on behalf

of the Corporation for both the calendar year ending December 31,


     3
       The record does not identify the "reasonably anticipated
needs" for which petitioner retained some of the 1990 earnings.
                               - 11 -


1993 and for prior years' efforts yet uncompensated".      One day

before, Mr. Ashare had received and deposited petitioner's check

in the amount of $1,061,971.   The board also resolved on December

31, 1993, that petitioner's officers are "authorized, empowered

and directed, for and on behalf of the Corporation, to execute a

Promissory Note in favor of the sole Shareholder in the principal

amount of Eight Hundred Sixteen Thousand Seven Hundred Fifty-Six

and no/100 ($816,756.00) Dollars".      Petitioner issued the

referenced note to Mr. Ashare on the same day.      The board also

resolved on December 31, 1993, that $100,000 of the $916,756 that

Mr. Ashare lent petitioner during the year "shall be duly

reflected" on petitioner's books as a contribution to capital.

Petitioner's December 31, 1993, balance sheet does not reflect

any of the lent amount as a capital contribution, and Mr. Bess

does not understand Mr. Ashare to have transferred the $100,000

to petitioner as a capital contribution.

     Respondent began auditing petitioner's 1993 taxable year in

or about December 1994, and the case was assigned to a revenue

agent who had not been involved in the audit of petitioner's 1990

through 1992 taxable years.    The agent examined petitioner's 1993

tax return and requested and received correspondence from

petitioner's representative, David Lieberman.      The agent had no

direct contact with either Mr. Ashare or any of petitioner's

other officers or employees.
                               - 12 -


     On August 10, 1995, the agent prepared a report that stated

that petitioner was liable for alternative minimum tax (AMT); the

agent limited the scope of his report to AMT because the

application thereof generated the maximum amount of taxes that

could be recovered for 1993.   On the same day, respondent

forwarded the agent's report to Mr. Bess as part of a 30-day

letter.   Petitioner had notified respondent that Mr. Lieberman

and his coworker, Mr. Bess, both served as its representatives

for purposes of the 1993 audit.    On January 29, 1996, the agent,

after learning months before that he had incorrectly applied AMT

to petitioner's 1993 taxable year, prepared a second report that

stated that petitioner was not entitled to deduct any of Mr.

Ashare's "compensation".   On the same day, the respondent mailed

that report to Mr. Bess as part of a second 30-day letter.

     Between the dates of the 30-day letters, the agent was

considering Mr. Ashare's personal income tax liability.    In

connection therewith, the agent requested petitioner's board

minutes from Mr. Lieberman, who also represented Mr. Ashare.    Mr.

Lieberman delivered to the revenue agent petitioner's board

resolutions for 1993, which included the resolution mentioned

above as to the promissory note.   The agent prepared his second

report on petitioner's 1993 taxable year on the basis of

information that he received from petitioner on or before August

10, 1995.
                               - 13 -


                               OPINION

     We must decide whether any or all of the $1,750,000 paid to

Mr. Ashare in 1993 was reasonable compensation under section

162(a)(1).   Petitioner argues it was, asserting that it paid Mr.

Ashare the disputed amount to compensate him for past and present

services.    Petitioner asserts that it had a formula under which

Mr. Ashare would be paid all legal fees received by petitioner

and that the $12,242,500 paid to Mr. Ashare over the 5-year

period from 1989 to 1993 was less than the $12,567,623 received

on the Gentile case.    Respondent argues that the disputed amount

is nondeductible because it was neither reasonable in amount nor

paid to Mr. Ashare to compensate him for past or present

services.

     Before deciding this issue, we pause to discuss a claim by

petitioner that respondent violated its rights under section

7605(b) by conducting a second examination of its books of

account for 1993.    Petitioner contends that the revenue agent

performed a second examination when he asked Mr. Lieberman for

petitioner's minutes.    Petitioner asserts that respondent needed

petitioner's 1993 board resolutions to determine that petitioner

had paid Mr. Ashare unreasonable compensation during that year.

We understand petitioner to conclude that respondent, because of

the purported second examination, is precluded from asserting in
                              - 14 -


this proceeding that Mr. Ashare's 1993 compensation is

nondeductible.4

     We disagree with petitioner that respondent is precluded by

section 7605(b) from asserting that it may not deduct the

compensation it paid Mr. Ashare in 1993.   Section 7605(b)

generally limits the Commissioner to "one inspection of a

taxpayer's books of account * * * for each taxable year".

Congress enacted this section intending "to guarantee that

taxpayers whose accounts had been closed * * * [will] not be

subject to 'unnecessary' harassment by being required frequently

to present their 'books of account' to the income tax agency".

Hinchcliff v. Clarke, 371 F.2d 697, 700 (6th Cir. 1967).

Congress did not intend for section 7605(b) to be a severe

restriction on the Commissioner's powers in monitoring and

enforcing the Code.   See United States v. Powell, 379 U.S. 48,




     4
       Petitioner, taking language from Reineman v. United
States, 301 F.2d 267 (7th Cir. 1962), argues that the Court "must
* * * set aside the deficiency assessment set forth in * * * [the
revenue agent's second report]" because of a violation of the
sec. 7605(b) prohibition against a second examination. That
language is inapplicable to a proceeding originating in this
Court. When a proceeding originates in a District Court, as was
the case in Reineman, the Commissioner has already assessed the
deficiency that is the subject of the proceeding. When a
proceeding originates in this Court, the Commissioner usually has
not assessed a deficiency. Absent certain exceptions, none of
which are applicable here, the filing of a petition in this Court
bars the Commissioner from assessing a deficiency until after the
decision entered by this Court becomes final. See sec. 6213(a).
                               - 15 -


54-56 (1964); see also Crosby v. Commissioner, T.C. Memo.

1970-286.

     We are unable to conclude under the facts herein that

respondent violated the second examination prohibition of section

7605(b).    The record simply does not persuade us that respondent

performed more than one inspection of petitioner's books of

account.    Whereas petitioner argues that a second inspection

occurred mainly because the revenue agent, on behalf of the

Commissioner, prepared two reports, we do not agree.    That the

Commissioner may issue two or more reports on a single taxable

year of a taxpayer does not necessarily mean that the

Commissioner performed more than one examination of the

taxpayer's books of account.    See United States v. Balanced Fin.

Mgt., Inc., 769 F.2d 1440, 1446 (10th Cir. 1985) ("'the standard

is whether the examination or investigation sought by the IRS is

unnecessarily duplicative of some prior examination'" (quoting

United States v. Davey, 543 F.2d 996, 1000 (2d Cir. 1976)); see

also Brodhead v. Commissioner, T.C. Memo. 1979-113.     The

applicability of section 7605(b), as relevant herein, turns as a

threshold matter upon a finding of unnecessary multiple

examinations of a taxpayer's books of account and does not rest

upon a finding that a revenue agent may have prepared multiple

reports on his or her examination of the underlying year.     See

Feldman v. Commissioner, T.C. Memo. 1985-132; see also Hall v.
                              - 16 -


Commissioner, 406 F.2d 706, 710 (5th Cir. 1969) (the term "books

of account" as used in section 7605(b) is limited to the

taxpayer's books and records), affg. 50 T.C. 186 (1968); Geurkink

v. United States, 354 F.2d 629, 631 (7th Cir. 1965) (same);

Estate of Adams v. Commissioner, T.C. Memo. 1967-221 (same), and

the cases cited therein.

     Nor does the record support petitioner's proposed finding

that the Commissioner needed its 1993 board resolutions to learn

that Mr. Ashare had made a large loan to petitioner during 1993,

or, more importantly, to determine that petitioner could not

deduct the amount of compensation reportedly paid to Mr. Ashare

during that year.   Before commencing his examination of

petitioner's 1993 taxable year, respondent had petitioner's 1993

corporate income tax return, which stated explicitly that:    (1)

Petitioner was deducting $1,750,000 in compensation paid to its

sole shareholder, Mr. Ashare, (2) the $1,750,000 deduction was

generating a $1,857,933 taxable loss for 1993, (3) petitioner

owed Mr. Ashare $916,756 on December 31, 1993, and that he had

lent at least $907,956 of that amount to petitioner during 1993,

(4) petitioner had a reported retained earnings deficit of

$89,855 at December 31, 1993, and (5) petitioner had liquidated

most of its assets in 1993.   Respondent also was privy to the

fact that petitioner had used almost all of its 1993 reported

loss to claim a $581,812 refund for taxes paid for 1990 and that,
                                - 17 -


after the 1993 taxable year, petitioner would no longer be

allowed to recover those taxes by virtue of a carryback.    Section

7605(b) is not violated in a case such as this, where the

Commissioner simply applies the facts, figures, and other data

within his lawful possession with an eye towards a legitimate

governmental purpose of determining the correct tax liability of

a taxpayer under examination.    See Jackson v. Commissioner, T.C.

Memo. 1982-556; see also Pleasanton Gravel Co. v. Commissioner,

64 T.C. 510, 528 (1975), affd. per curiam 578 F.2d 827 (9th Cir.

1978).

     We also find it meaningful that the revenue agent was

contemporaneously considering issues as to the personal income

tax liability of Mr. Ashare, who was petitioner's officer,

director, sole shareholder, and key employee.   That the

Commissioner may glean from the books of an individual third

party such as Mr. Ashare information that is relevant to the tax

liability of his or her controlled entity does not necessarily

mean that the Commissioner performs an improper second

examination of the entity under section 7605(b).   See Geurkink v.

United States, supra at 631 ("We emphasize that sec. 7605(b)

relates to a second examination of books of account of a taxpayer

and does not apply to an examination of books of account of a

third person.").   In some settings, the Commissioner's

examination of the books of a corporation's officer, shareholder,
                              - 18 -


or employee may actually be an examination of the corporation's

books because of the inextricable identity between them or

because examination of the individual's books serves as a

subterfuge for examining the corporation's books; e.g., where the

separate accounts are all maintained in the same volume.    Compare

Reineman v. United States, 301 F.2d 267 (7th Cir. 1962), and

Application of Leonardo, 208 F. Supp. 124 (N.D. Cal. 1962), with

Hall v. Commissioner, 50 T.C. at 201-202, and United States

Holding Co. v. Commissioner, 44 T.C. 323, 327-328 (1965).    The

record at hand, however, lacks the requisite evidentiary

foundation to persuade us that any examination of Mr. Ashare's

books of account was a subterfuge for examining petitioner's

books.   The record merely suggests that the revenue agent simply

did what he purported to do; namely, gather information on the

potential personal income tax liability of Mr. Ashare, a taxpayer

who, although related to petitioner, is separate and distinct

from it.   See United States Holding Co. v. Commissioner, supra.

     We turn to the primary issue; namely, whether section 162(a)

allows petitioner to deduct the $1,750,000 paid to Mr. Ashare as

compensation.   A payment of compensation is deductible under that

section if it is reasonable in amount and for services actually

rendered to the payor in or before the year of payment.    See sec.

162(a)(1); Lucas v. Ox Fibre Brush Co., 281 U.S. 115, 119 (1930);

Alpha Med., Inc. v. Commissioner, 172 F.3d 942, 945 (6th Cir.
                                 - 19 -


1999), revg. T.C. Memo. 1997-464; sec. 1.162-7(a), Income Tax

Regs.; see also Pulsar Components Intl., Inc. v. Commissioner,

T.C. Memo 1996-129; Mad Auto Wrecking, Inc. v. Commissioner, T.C.

Memo 1995-153.   Petitioner must prove that it may deduct

compensation in an amount greater than that determined by

respondent.   See Rule 142(a).    Careful scrutiny of the facts is

appropriate in a case such as this where the payor is controlled

by the payee/employee.   See Pulsar Components Intl., Inc. v.

Commissioner, supra; Mad Auto Wrecking, Inc. v. Commissioner,

supra.

     We have no doubt that the $1,750,000 paid to Mr. Ashare

meets the first test for deductibility; i.e., it is reasonable in

amount as to the compensation that a personal service corporation

such as petitioner could pay its key employee in a year for his

services.   Mr. Ashare's qualifications for his position with

petitioner justify high compensation, as does the fact that he is

vital and indispensable in petitioner's operation and success.

Petitioner's business also is complex and highly specialized, and

it demands a person of Mr. Ashare's expertise.    See Alpha Med.,

Inc. v. Commissioner, supra at 945; Mayson Manufacturing Co. v.

Commissioner, 178 F.2d 115, 119 (6th Cir. 1949), revg. and

remanding a Memorandum Opinion of this Court dated Nov. 16, 1948;

see also Pulsar Components Intl., Inc. v. Commissioner, supra;

Mad Auto Wrecking, Inc. v. Commissioner, supra.
                              - 20 -


     The mere fact that the $1,750,000 is reasonable in amount

does not necessarily mean that it is deductible in full.    A

deduction for compensation is not allowed to the extent that the

compensation is paid for something other than services rendered

by the payee/employee primarily in or before the year of payment.

See sec. 162(a)(1); Whitcomb v. Commissioner, 733 F.2d 191, 193

(1st Cir. 1984), affg. 81 T.C. 505 (1983); Bonaire Dev. Co. v.

Commissioner, 679 F.2d 159 (9th Cir. 1982), affg. 76 T.C. 789

(1981); 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); see also Tool Producers, Inc. v.

Commissioner, T.C. Memo. 1995-407, affd. without unpublished

opinion 97 F.3d 1452 (6th Cir. 1996).    This brings us to our

second inquiry:   Did petitioner pay Mr. Ashare the disputed

amount primarily for services provided in or before 1993?    On the

basis of our review of the record, we conclude it did.    According

to petitioner, the $1,750,000 is deductible in full mainly

because the $12,242,500 paid to Mr. Ashare from 1989 through 1993

is less than the $12,567,623 received on the Gentile case.

Respondent replies that petitioner is incorrect as to the

mechanics of its compensation formula.    Messrs. Ashare and Bess

testified that Mr. Ashare's compensation was set at the legal

fees received by petitioner during the year, less corporate
                              - 21 -


expenses, and respondent applies that testimony to conclude that

Mr. Ashare was overcompensated in each of the years relevant

herein and entitled to no compensation for 1993.   Respondent

notes that 1993 was the last year from which petitioner could

carry back an NOL to 1990 to recover the Federal income taxes

paid for that year, see sec. 172(b)(1) (a carryback of an NOL

such as the one at hand is limited to the prior 3 years), and

argues that the main reason for the $1,750,000 payment was to

recover those taxes.   Respondent notes that petitioner had a

significant deficit in retained earnings on December 31, 1993.

     We agree with petitioner that it may deduct the $1,750,000

because it paid the amount to Mr. Ashare to compensate him for

work on the Gentile case.   Up until the time that the Gentile

case was settled in 1989, Mr. Ashare, on behalf of petitioner,

had performed significant services on that case to entitle the

class to receive the $70 million settlement payment.   Afterwards,

petitioner, and hence, Mr. Ashare, was obligated to perform

significant services in administering the proper disposition of

that $70 million payment.   But for Mr. Ashare, petitioner never

would have received the $12,567,623 of legal fees in the first

place.   But for Mr. Ashare, petitioner would never be able to

dispose of the settlement funds properly.   Given the necessity

and indispensability of Mr. Ashare's services on the Gentile

case, we do not believe it unreasonable to conclude, as we do,
                                - 22 -


that petitioner paid Mr. Ashare the $1,750,000 to compensate him

for services connected to that case.

     Respondent focuses on petitioner's longstanding compensation

formula and observes that the amount of Mr. Ashare's compensation

does not follow from an application of that formula.   Respondent

concludes that petitioner paid the $1,750,000 to Mr. Ashare

without the requisite intent to compensate him for his services.

We do not agree.   Although it is true, as respondent observes,

that petitioner did not correctly apply its longstanding formula

to ascertain Mr. Ashare's compensation for 1993, petitioner's

management obviously decided that Mr. Ashare was entitled to be

paid a greater amount during that year.   It does not matter that

petitioner's revenues during that year were less than the

$1,750,000 payment, or that the $1,750,000 payment produced a

deficit in retained earnings.    The dispositive fact of this case

is that petitioner's board, through an exercise of unwritten

corporate policy, set Mr. Ashare's compensation for 1993 at

$1,750,000.

     The facts of this case indicate that the board truly

believed that Mr. Ashare's services were worth paying him

$1,750,000 in 1993.   Mr. Bess testified adamantly that the board

considered the value of petitioner's past and present services

when it set Mr. Ashare's compensation for each year, and we find

in the record that the board knew how to limit Mr. Ashare's
                              - 23 -


compensation to the value of his uncompensated services as of the

end of each year.   The board, for example, considered the value

of Mr. Ashare's uncompensated services as of December 31, 1990,

and resolved specifically that Mr. Ashare's compensation for that

year was limited to services performed during that year.

Petitioner definitely had the opportunity, the means, and a

strong tax incentive to inflate Mr. Ashare's compensation for

that year.   It did not, which indicates to us that the board was

set on establishing Mr. Ashare's compensation at its fair value.

     In this regard, the board resolved that Mr. Ashare was

entitled to receive compensation of $1,750,000 during 1993 for

his past and present services.   The board, through the exercise

of its sound business judgment, resolved that Mr. Ashare was

entitled to that amount of compensation, and we decline to second

guess the board's wisdom.   The board knew that 1993 was the last

year from which petitioner could use an NOL to recover all of the

taxes which it paid for 1990 and that paying petitioner the

$1,750,000 would allow it to recover all those taxes.   The board

also knew that petitioner had a continuing obligation to provide

significant services on the Gentile case for many years after

1993, that petitioner's revenues in post-1992 years would

practically be nonexistent, and that petitioner would not have

any resources to pay Mr. Ashare future compensation.
                              - 24 -


     We also believe it critical that petitioner had the funds to

pay Mr. Ashare the $1,750,000.   Petitioner did not pay Mr. Ashare

the $1,750,000 by way of a debt instrument such as a promissory

note.   Petitioner used funds which it was able to raise through a

liquidation of assets, most of which were obtained on account of

the efforts of Mr. Ashare, and through one or more loans.   The

fact that Mr. Ashare is the one who lent the funds to petitioner

is of no consequence.   It is a legitimate managerial function to

ascertain the amount of employee compensation that will be paid

in a year, and, absent abuse, which is not present here, we

decline to second-guess management's decision on the amount and

timing of that compensation or on the manner in which management

goes about obtaining the underlying funds.

     We hold that petitioner may deduct the $1,750,000 payment to

Mr. Ashare as reasonable compensation.   In so holding, we have

considered all arguments made by the parties and, to the extent

not discussed above, find them to be without merit.

     To reflect the foregoing,

                                         Decision will be entered

                                    under Rule 155.
