                       T.C. Memo. 1999-268



                     UNITED STATES TAX COURT



UNITED PARCEL SERVICE OF AMERICA, INC. ON BEHALF OF ITSELF AND
          ITS CONSOLIDATED SUBSIDIARIES, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 15993-95.            Filed August 9, 1999.



     Joel V. Williamson, J. Allen Dougherty, Maurice M. Agresta,

Joseph R. Goeke, Kim Marie Boylan, Roger J. Jones, William A.

Schmalzl, Daniel Dumezich, Thomas L. Kittle-Kamp, Clisson S.

Rexford, Scott M. Stewart, Thomas C. Durham, Gayle L. Elsner,

Michelle J. Kim, Richard T. Morrison, Mary Ellen Kiruit, and

Wayne S. Kaplan, for petitioner.

     Theodore J. Kletnick, Suzanne Corbin, Curt M. Rubin, William

S. Garofalo, Maria T. Stabile, Elizabeth A. Maresca, Halvor Adams

III, Stephen C. Best, Paul S. Manning, Anthony J. Kim, and Ron J.

Mizrachi, for respondent.
                                     - 2 -




               MEMORANDUM FINDINGS OF FACT AND OPINION


     RUWE, Judge:        Respondent determined deficiencies in

petitioner's Federal income taxes and additions to tax as

follows:

                                       Additions to Tax
     Year   Deficiency    Sec. 6653(a)(1) Sec. 6653(a)(2)   Sec. 6661

     1983   $2,330,687        --                --               --
     1984   64,870,674     $3,243,534     50% of the        $11,280,731
                                          interest due
                                          on $45,122,925

Respondent also determined that petitioner is liable for

increased interest pursuant to section 6621(c)1 on the portion of

the 1984 deficiency attributable to respondent's determination

that excess value charges are includable in petitioner's income.

     After concessions,2 the issues for decision are:

     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
     2
      Respondent concedes that $8,855,121 of income earned on
funds invested by Overseas Partners, Ltd. (OPL), is not income to
petitioner pursuant to sec. 482. Respondent determined that if
petitioner must include excess value charges in gross income,
petitioner is entitled to a corresponding deduction of
$32,543,889 for shippers' claims.

     Respondent concedes that $325,740 of the $1.2 million paid
Liberty Mutual Insurance Group (Liberty Mutual) for claims
adjustment services is deductible. Respondent further concedes
the deductibility of $50,000 paid by petitioner to Liberty Mutual
for the retained layer of liability for losses above $250,000.
These concessions reduce the amount of the deduction at issue
                                                   (continued...)
                               - 3 -


     (1)   Whether amounts collected by petitioner as "excess

value charges" (EVC's)3 from its customers must be included in

gross income in 1984 pursuant to section 61.   We hold that EVC's

must be included in petitioner's income.4

     (2)   Whether petitioner is entitled to deductions under

section 162 for any amounts paid to National Union Fire Insurance

Co. of Pittsburgh, Pennsylvania (NUF).   We hold that petitioner

is not entitled to those deductions.

     (3)   Whether respondent properly disallowed petitioner's

deduction of $11,151,675 paid to Liberty Mutual Insurance Group

(Liberty Mutual) as California workers' compensation premiums.

We hold that the deduction is allowable.

     (4)   Whether petitioner is liable for an addition to tax

pursuant to section 6653(a)(1) and (2) for negligence or



     2
      (...continued)
with respect to the Liberty Mutual policy to $11,151,675.

     In the notice of deficiency, respondent disallowed sec. 38
investment tax credits of $1.6 million and $19,006,175 reported
by petitioner in 1983 and 1984, respectively. On Sept. 15, 1997,
the parties filed a Joint Motion to Sever, requesting that the
Court sever the investment tax credit issue. On Sept. 15, 1997,
the motion to sever the sec. 38 investment tax credit was
granted. The parties subsequently engaged in mediation and
settled this issue.
     3
      Throughout the opinion, "EVC" represents "excess value
charge" and "EVC's" represents "excess value charges".
     4
      As a result of our holding, we need not consider
respondent's alternative arguments under secs. 482 and 845(a).
                                     - 4 -


intentional disregard of rules or regulations for the tax year

1984.      We hold that it is.

      (5)    Whether petitioner is liable for an addition to tax

under section 6661 for a substantial understatement of tax for

1984.      We hold that it is.

      (6)    Whether petitioner is liable for increased interest on

substantial underpayments attributable to tax-motivated

transactions under section 6621 for 1984.       We hold that it is.

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

The stipulations of facts are incorporated herein by this

reference.      At the time the petition was filed, petitioner was a

Delaware corporation with its principal office in Atlanta,

Georgia.

                            FINDINGS OF FACT

I.   General

      A.     United Parcel Service

      Petitioner is the largest motor carrier in the United States

with a principal business consisting of the pickup and delivery

of small packages and parcels.        During 1983 and 1984, petitioner

conducted its business through wholly owned subsidiaries in the

United States, Canada, and West Germany.       Petitioner, United

Parcel Service of America, Inc. (UPS), had several wholly owned

subsidiaries, including United Parcel Service, Inc.--New York

(UPS-New York), United Parcel Service, Inc.--Ohio (UPS-Ohio), and
                               - 5 -


United Parcel Service General Services Co. (UPS-General

Services).   UPS-General Services provides management services to

affiliates of UPS.   UPS-New York provides ground delivery

services in the eastern region of the United States.   UPS-Ohio

provides ground delivery services in the central and western

region of the United States.   Within the United States,

petitioner generally provided statewide intrastate service5 and

interstate service between all points in the States and the

District of Columbia.6   Another subsidiary, UPS-Air, provided air

delivery service for packages traveling partially by air.

     Petitioner had 62 operating districts in the United States.

Each district had an operational and administrative staff and a

manager who was responsible for all district operations.     The

district manager reported to 1 of 11 regional managers, who, in

turn, reported to the corporate headquarters.

     Generally, each package picked up by a UPS driver is

delivered to a package operating center.   At each center,

packages are unloaded from package cars and loaded onto trailers,

which haul the packages either directly to another center for

delivery or to a UPS sorting hub.   At the hub, packages are




     5
      Petitioner did not provide intrastate service within Texas.
     6
      There were limited exceptions pertaining to Texas, Hawaii,
and Alaska in which petitioner did not provide full services.
                                 - 6 -


sorted by destination, loaded back onto trailers, and hauled to

the appropriate center, where they are loaded onto package cars

for delivery.    Packages traveling by air are sorted at an air hub

and transported to the center for delivery.

     B.     Shipping Rates and Tariffs

     As a domestic motor common carrier, petitioner was regulated

by the Interstate Commerce Commission (ICC).    Petitioner's

intrastate service was regulated by State transportation agencies

and public utility commissions.    As an air carrier, petitioner

was regulated by the Civil Aeronautics Board.

     The ICC issued Certificates of Public Convenience and

Necessity as evidence of the carrier's authority to engage in

transportation as a common carrier by motor vehicle.    UPS-New

York and UPS-Ohio each filed tariffs7 and tariff supplements with

the ICC.8    The ICC tariffs and tariff supplements contained

provisions which governed the rates and services offered by

petitioner to its shippers.    The tariffs filed with the ICC by



     7
      A tariff is a "public document setting forth services of
common carrier being offered, rates and charges with respect to
services and governing rules, regulations and practices relating
to those services." Black's Law Dictionary 1457 (6th ed. 1990).
     8
      Generally, a motor common carrier must publish and file
with the ICC tariffs containing the rates for transportation it
may provide. See Trucking Industry Regulatory Reform Act of
1994, 49 U.S.C. sec. 10762(a)(1) (1994); see also Fabulous Fur
Corp. v. United Parcel Serv., 664 F. Supp. 694, 695 (E.D.N.Y.
1987).
                                 - 7 -


UPS-New York and UPS-Ohio which were in effect during the years

in issue contained, among other things, provisions relating to

the scope of operations, damaged and unclaimed property, methods

of determining rates, and filing of claims.      With respect to the

scope of operations, the tariffs for both UPS-New York and UPS-

Ohio provide:     "Rates and provisions named in this tariff, or as

amended, are limited in their application to the extent of the

operating rights set forth below."       The provisions of the tariffs

governed the rates and services offered by petitioner to its

shippers.

     The ICC tariffs filed by UPS-Ohio and UPS-New York were

similarly filed with the State transportation commissions of most

of the States.9    Individual State filings were required in the


     9
      The tariffs filed by UPS-Ohio were filed with the State
transportation commissions of Alabama, Arkansas, Colorado,
Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky,
Louisiana, Michigan, Minnesota, Mississippi, Missouri, Montana,
New Mexico, North Carolina, North Dakota, Ohio, Oregon, South
Carolina, South Dakota, Tennessee, Utah, and Washington.

     The tariffs filed by UPS-New York were similarly filed with
the State transportation commissions of Connecticut, Maryland,
Massachusetts, New Hampshire, New York, Pennsylvania, Rhode
Island, Vermont, and West Virginia.

     In 1983 and 1984, the States of Arizona, Delaware, Florida,
Maine, New Jersey, and Wisconsin did not regulate intrastate
motor common carriers. In Wyoming, no regulatory filing was
required.   In Texas, intrastate service was limited to the
Dallas-Fort Worth, Houston, and San Antonio metropolitan areas.
In Hawaii, an intraisland service was commenced between all
islands of the State. Petitioner did not operate in Alaska
                                                   (continued...)
                                - 8 -


States of California, Hawaii, Nebraska, Oklahoma, and Virginia.

Whenever UPS-Ohio or UPS-New York made a change to its tariff, a

tariff supplement was filed with the ICC.

           1.    Pre-1984

                 a.   Excess Value Charges

     Petitioner refers to its customers as shippers.      Petitioner

charged its shippers a fee for the shipment of each package based

on the weight of the package, the distance that the package would

travel, the value of the package, and various accessorial

services offered by petitioner.     Petitioner's rates were governed

by the tariffs, which it submitted to the ICC and the various

States.   The tariffs10 submitted to the ICC provided, among other

things, for rates in cents per package and per pound as follows:

     ITEM 1000

           *      *         *   *       *      *      *

     The rate for delivery of packages, released to value
     not exceeding $100 per package, shall be 116.0¢ per
     package plus the following rates per pound or fraction
     thereof:




     9
      (...continued)
outside the regulatory-free zones.
     10
      The provisions of the tariffs were similar except that the
tariff provided by UPS-Ohio further included "item 1040", which
does not affect our decision, and we will not reproduce it in the
opinion.
                               - 9 -


                Zone                   Rate

                2....................8.9¢
                3...................11.8¢
                4...................15.4¢
                5...................19.5¢
                6...................25.3¢
                7...................31.5¢
                8...................38.5¢

The rates published in item 1000 applied to all the packages

shipped by petitioner.

     Petitioner provided its shippers with a rate card that

enabled shippers to determine what petitioner would charge for a

particular shipment.   The distance a package was to travel

determined the number of zones from the point of origin that the

package would cross.   A package shipped to zone 2, for example,

would travel approximately 150 miles.     A package shipped to zone

3 would travel up to 300 miles.   Zone 8 was the furthest zone and

distance a package would travel within the United States.     Zones

2 through 8 were represented as column headings at the top of the

rate card.

     Weight categories also determined how much petitioner

charged shippers for transporting a particular package.    The rate

card listed weights down the left side of the table in 1-pound

increments from 1 pound to 50 pounds.     By cross-referencing the

zone and the weight, a shipper could determine the exact shipping

charge for a particular package whose released value did not

exceed $100.   There was an additional charge under the tariff
                             - 10 -


when a shipper declared the value of the package to be in excess

of $100.

     Under the tariff, shippers could also elect to purchase

accessorial services that had additional charges.   Accessorial

services included, among other things, collection on delivery

(COD) and acknowledgment of delivery (AOD).

     With respect to damaged and unclaimed property, the tariffs

provided the following:

                 DAMAGED AND UNCLAIMED PROPERTY

     Whenever property is damaged by the carrier in the
     course of transportation, the carrier will tender the
     damaged property to the shipper and offer to pay for
     the damage, not to exceed the actual or declared value
     of the property, whichever is the lower. If the
     shipper so elects, the carrier will pay the full actual
     or declared value of the property, whichever is lower,
     and title of the property shall thereupon pass to the
     carrier.

Thus, petitioner was obligated to shippers under the tariffs to

pay up to the actual or declared value for loss or damages caused

by petitioner during the course of transporting the package.

Petitioner applied for and received from the ICC an order

generally allowing petitioner and its shippers to agree in

writing that petitioner's liability would be limited to a

released value not exceeding $100 per package.    With respect to

the released rate and EVC, the tariff provided as follows:

     To determine rates in this tariff:
                             - 11 -


          1.   Refer to governing rate basis tariff to
               determine appropriate zone for use in
               determining the poundage rate.

          2.   Refer to Item 1000 or 1040 herein.

     Released value of shipment:

          The rates published in Item 1000 or 1040 are
          applicable only when the value of the property
          declared in writing by the shipper or agreed upon
          in writing as the released value thereof is as
          follows:

               Released to a value      Apply the rates as
               not exceeding $100       published in Item
               per package or           1000 or 1040.
               article not enclosed
               in a package

               Released to a value      Apply the rates as
               exceeding $100 per       published in Item
               package or article       1000 or 1040 as
               not enclosed in a        base rates, plus a
               package                  value charge of 25
                                        cents for each $100
                                        or fraction thereof
                                        of value in excess
                                        of the valuation in
                                        which the base rate
                                        applies.

     Under the provisions of the tariff, petitioner received from

its shippers 25 cents for each additional $100 of declared value

of a package shipped, and petitioner referred to the additional

amount as an "excess value charge" (EVC).   If a shipper paid the

EVC of 25 cents per $100 of value, part or all of the declared

value of the package would be paid to the shipper in the event

that the package was damaged, lost, or destroyed.   In the event

that a shipper did not declare the value of the package to be in
                                 - 12 -


excess of $100, petitioner was liable to the shipper for the

value of the package up to $100.

     In June 1983, petitioner filed supplements to its ICC

tariffs amending the provision related to the method of

determining rates for shippers under the original tariff.     The

supplements provided an additional clause with respect to the

method of determining rates:

     Unless otherwise directed by the shipper, the carrier
     may remit excess valuation charges to an insurance
     company as a premium for excess valuation cargo
     insurance for the shipper's account and on its behalf.
     If the carrier does so, claims for loss of or damage to
     the shipper's property will be filed with and settled
     by the carrier on behalf of the insurance company. In
     the event that the insurance company fails to pay any
     claim for loss of or damage to the shipper's property
     under the terms of its policy, the carrier will remain
     liable for loss or damage within the limits declared
     and paid for.[11]

Although the supplements were filed June 1983 and became

effective July 1983, petitioner did not remit EVC's to an

insurance company before 1984.

     The declared value in excess of $100 is indicated on

petitioner's package pickup record.12     The package pickup record


     11
          Identical changes were made to petitioner's State tariffs.
     12
          Petitioner's pickup record states:

     Unless a greater value is declared in writing on this
     receipt, the shipper hereby declares and agrees that
     the released value of each package or article not
     enclosed in a package covered by this receipt is $100,
                                                   (continued...)
                               - 13 -


was used to enter billing information into petitioner's billing

system.   Billing information for regular customers and shippers

who shipped parcels from petitioner's customer counters was

entered into petitioner's computer system regularly by each

district, and petitioner billed its regular customers weekly.

The bills sent to petitioner's regular shippers reflected all

amounts to be collected from those shippers.    Included, and

itemized separately, on those bills were the EVC's and other

miscellaneous charges.   All amounts collected from shippers by

petitioner, including amounts for EVC's, were deposited into

petitioner's bank accounts.

     For the taxable year ended December 31, 1983, EVC's billed

and/or collected from shippers were included in petitioner's

reported income for tax, financial accounting, ICC, State

regulatory, and Securities and Exchange Commission (SEC)

reporting purposes.

                b.    Claims

     Shippers' claims were governed by the tariffs submitted by

petitioner to the ICC and the various States.    Petitioner's


     12
      (...continued)
     which is a reasonable value under the circumstances
     surrounding the transportation. The entry of a C.O.D.
     amount is not a declaration of value. In addition, the
     maximum value for an air service package is $5,000 and
     the maximum carrier liability is $5,000. Claims not
     made to carrier within 9 months of shipment date are
     waived. * * *
                              - 14 -


tariff 201-C effective January 31, 1983, included provision 510

relating to filing of claims, which provided:

     All claims for loss or damage to property transported
     or accepted for transportation in interstate or
     intrastate commerce must be in writing and must include
     reference to the pickup record number and date or
     copies of other documents sufficient to identify the
     shipment involved; must assert liability of the carrier
     for alleged loss or damage; must make claim for payment
     of a specified or determinable amount of money; and
     must be accompanied with a copy of the original invoice
     or, if no invoice was issued, other proof, certified to
     in writing, as to the value of the property or extent
     of the damage. * * *

Under tariff provision 510, a shipper was required to assert that

petitioner was liable for the alleged loss or damages.   Tariff

201-C also contained provision 520 limiting the time for filing

claims.   Provision 520 provided:

     As a condition precedent to recovery, claims must be
     filed in writing with the carrier within nine months
     after delivery of the property or, in case of failure
     to make delivery, then within nine months after a
     reasonable time for delivery has elapsed; and suits
     shall be instituted against the carrier only within two
     years and one day from the day when notice in writing
     is given by the carrier to the claimant that the
     carrier has disallowed the claim or any part or parts
     thereof specified in the notice. Where claims are not
     filed or suits are not instituted thereon in accordance
     with the foregoing provisions, the carrier hereunder
     shall not be liable, and such claims will not be paid.

Under provision 525, petitioner was required to promptly

investigate "each claim filed against [petitioner]".   With

respect to disposition of claims, tariff 201-C provides:

"Carrier after receiving a written claim for loss or damage to
                               - 15 -


property transported will pay, decline, or make a firm compromise

settlement offer in writing to the claimant within 120 days after

receipt of the claim by the carrier".   UPS-New York and UPS-Ohio,

through their respective district offices, processed all claims

for loss or damage to parcels, including any excess value portion

of a claim.   When a shipper was in need of a verification of the

status of a shipment, the shipper initiated an inquiry, by either

telephone or mail, which was referred to the delivery information

department of the district from which the shipment was made.

     Tracing requests were initiated as a result of shippers'

inquiries.    After the tracing request was completed, it was

transmitted to the destination district via computer.    If the

record showed that the package was delivered and signed for, the

clerk made a copy of the delivery record.   If the tracing

procedure was unsuccessful, petitioner assigned a loss damage

investigation number to identify the shipper claim.

     Petitioner remitted amounts for claims processed by UPS-New

York and UPS-Ohio from petitioner's central bank account.

Generally, a single check was issued to a shipper if the shipper

had declared excess value and a claim for loss or damage was

paid.   Before 1984, petitioner reported claims paid in excess of

$100 as an expense for tax, financial accounting, ICC, State

regulatory, and SEC reporting purposes.
                              - 16 -


     Petitioner made efforts to reduce claims, including excess

value claims.   Petitioner advised its drivers to pay extra

attention to declared value packages.   Petitioner also incurred

added handling costs in connection with excess value packages.

     In Metro New York, Long Island, New Jersey, and Metro

Chicago, petitioner took special precautions to avoid loss or

damage to high-value packages.   For instance, in New York, with

respect to jewelry and similar items, petitioner's driver would

segregate them in his load, and upon arrival at petitioner's

facility, a designated clerical person would meet the driver and

take the packages containing the jewelry or other items.     Under

certain circumstances, the packages would be specially bagged and

tagged.   Thereafter, the appropriate contact person at the next

destination of the package would be informed of the position of

the package on the trailer.   When the trailer reached its

destination, a person would be present to retrieve the bag.

     Petitioner instituted and used special parcel handling

procedures, which involved segregating and protecting high-value

parcels in other districts as well.    Petitioner referred to the

special handling procedure as "controlled parcel handling".13



     13
      This procedure was not used in the Metro New York, Long
Island, New Jersey, and Metro Chicago districts. Controlled
parcel handling procedures that were stricter than the controls
set forth in the loss prevention manual were applied in Metro New
York, Long Island, New Jersey, and Metro Chicago.
                                   - 17 -


Petitioner maintained a "Loss Prevention" manual that contained

written standards and procedures on prevention of loss associated

with the shipment of packages.       Controlled parcel handling was

addressed in a specific section of the loss prevention manual.

As part of the controlled handling procedures, petitioner

performed audits in its hub, transportation, and delivery

operations to ensure security of high-value packages.       Petitioner

considered these procedures to be expensive and time consuming.

                c.   Negotiations To Change Petitioner's Method of
                     Handling Excess Value Charges

     Mr. Kenneth Johnson was the head of petitioner's insurance

department.   After various discussions with Mr. Walter

Danielewski, petitioner's chief financial officer (CFO),

regarding the manner in which petitioner collected EVC's, Mr.

Johnson contacted the brokerage firm of Frank B. Hall (Hall).

                      (1)   Hall

     Hall was one of the largest insurance brokerage firms in the

world.   Mr. Johnson had first worked with representatives at Hall

in 1981.   At that time, Mr. George Corde, an experienced vice

president of Hall, worked with Mr. Johnson in connection with

insurance for petitioner's aircraft and other matters.        Mr.

Thomas Garrity was a Hall vice president who worked for Mr.

Corde.
                               - 18 -


     In 1982, Mr. Johnson met with representatives of Hall to

discuss petitioner's EVC's.    At their first meeting regarding

petitioner's EVC's, Mr. Corde advised Mr. Johnson of potential

alternatives that might be available to petitioner, including the

possibility of petitioner's forming its own insurance subsidiary.

Thereafter, Mr. Corde and Mr. Garrity attended meetings relating

to the planning, structuring, and implementation of petitioner's

subsidiary and petitioner's excess value activity.

     In September 1982, at the request of petitioner, Hall

prepared a document titled "United Parcel Service--A Preliminary

Analysis of an Insurance Subsidiary" (preliminary analysis).      The

preliminary analysis indicated that Hall understood that

petitioner currently was liable to its shippers for the value of

any parcels lost or damaged up to $100.    The preliminary analysis

indicated that Hall understood that those parcels with values in

excess of $100 could be declared by the shipper, and the shipper

could secure protection at a cost of 25 cents per $100 of value

in excess of the first $100.    Hall further understood that while

the protection provided by the EVC was not considered to be

insurance, insurance could be provided by a UPS-owned insurance

company.   The preliminary analysis then proceeded to make the

following assumptions and conclusions:

     We have been advised that the revenues generated by
     this "declared value" protection for the 1981 year
     approximated $67,000,000 and that the loss in excess of
                                - 19 -


     $100 per claim approximated $20,000,000. In Exhibits
     II-1A and II-2A we have attempted to set forth the
     implications of this coverage to * * * [petitioner] on
     a net after tax basis. In this Exhibit we have made
     the following assumptions:

          1.   Revenues are in equal amounts payable at mid
          points of quarters;

          2.      Expenses as percent of gross premium = 0%;

          3.      Loss ratio = .299;

          4.      Duration (in years) to ultimate value of losses =
          2;

          5.      Annual payout pattern - 70%, 30%;

          6.   Plan reimburses gross paid losses for each month
          at the end of the following month;

          7.   Applicable Federal Income Tax rate as percentage =
          46%; and,

          8.   Effective rate of interest per annum as percent =
          12%.

     Based upon these assumptions review of Exhibits II-1A
     and II-2A disclose that the contribution of this
     program to * * * [petitioner's] after tax earnings is
     $31,001,618 at the end of the second subsequent year
     when all losses are closed.

     On February 24, 1983, a meeting was held at Hall's offices

in Briarcliff Manor, New York, to discuss petitioner's excess

value activity.    In attendance at this meeting were:   Messrs.

Danielewski, Johnson, Pat Edmunds, Jerry Stein, and Jack

McGuinness representing petitioner; Mr. Allen Dougherty, as

petitioner's attorney; and Messrs. Corde, Garrity, and Roger Wade

representing Hall.    Mr. Corde prepared a memorandum dated March
                             - 20 -


1, 1983, that summarized the purpose and content of the February

24 meeting at Briarcliff Manor.   The memorandum states:

     The purpose of this meeting was to consider Frank B.
     Hall's proposal presented to * * * [petitioner] last
     September 1982 which dealt with the feasibility of
     creating a subsidiary insurance company. The subject
     reviewed in the report dealt with declared value
     insurance and the utilization of an insurance
     subsidiary to handle customer risk of loss on property
     in transit.

     The topics discussed in our Thursday meeting focused
     strictly on the declared value program and the
     viability of converting this into an insured plan that
     would produce, in the final analysis, an improved
     economic result for * * * [petitioner]. The report
     submitted by Hall dealt with the organization of a
     United Parcel insurance subsidiary company. This new
     insurance entity would assume reinsurance from a
     licensed admitted US carrier who would underwrite the
     declared value program.

     During the February 24 meeting, petitioner's tax counsel,

Mr. Dougherty, expressed concern with the specifics of the Hall

proposal, and he believed that the proposal would not be viewed

favorably by the Internal Revenue Service (IRS).   Mr. Dougherty

suggested an alternative whereby petitioner would form an

insurance company in Bermuda to be owned by petitioner's

employees and, in this manner, such a company would be classified

as a noncontrolled foreign corporation.   Mr. Dougherty believed

that the Bermuda insurance company could accept reinsurance of a

licensed U.S. underwriter directly and not have U.S. tax

obligations on profits until risk funds were repatriated.
                                    - 21 -


     After all the alternatives were discussed, it was agreed

that petitioner would pursue the alternative to create an

insurance subsidiary to act as a reinsurer.          Further, the

insurance subsidiary would be owned by petitioner, and

ultimately, petitioner might adopt a long-range strategy of

transferring ownership in such a company to petitioner's

shareholders.   Finally, it was agreed that Mr. Danielewski and

other members of the UPS team would submit a proposal to senior

management based on the following financial projections, as

stated in Mr. Corde's March 1, 1983, memorandum:

                              UPS CURRENT POSITION
     A:
          Projected 1983 Declared Value Revenue      $69,900,000
          Estimated 1983 Losses                      $21,400,000

          Pretax Profit                              $48,500,000

          Net After Tax Profit                       $26,190,000

     B-Alternative Program:

          1.    Insured Declared Value Program (U.S. Front)

                Estimated Annual Premium             $69,900,000
                *Estimated Expenses (6.5)             $4,485,000

                Net Underwriting Income              $65,415,000

          2.    UPS Insurance Subsidiary

                Foreign Reinsurance Premium Income   $65,415,000
                Ceding Commission - 2-1/2%            $1,747,500

                Net Premium Income                   $63,667,500
                Expected Losses                      $21,400,000

                Underwriting Profit                  $42,267,500

          C:    Projected Benefit to * * *
                  [Petitioner]                       $16,077,500
                                  - 22 -


               *       Front Fee             2.0
                       Premium Tax           3.5%
                       Federal Excise Tax    1.0%
                                             6.5%

The $16,077,500 projected benefit to petitioner is the amount of

Federal income tax petitioner would have otherwise paid and is

based on the assumption that the underwriting profit, which was

referred to as the "UPS Insurance Subsidiary" in Bermuda, would

not be subject to Federal income tax.

                       (2)   AIG/NUF

     American International Group, Inc. (AIG), was a holding

company and the parent of over 500 subsidiary operating insurance

and subsidiary companies.      AIG Risk Management, Inc. (AIGRM), was

a subsidiary of AIG.     Mr. Joseph Smetana served as president and

CEO of AIGRM and senior vice president of NUF.       NUF was a wholly

owned subsidiary of AIG and operated as a domestic insurance

company.

     On behalf of Hall, through a letter dated April 27, 1983,

Mr. Corde contacted Mr. Smetana.       In the letter, Mr. Corde

apprised Mr. Smetana of petitioner's plan regarding the EVC's.

Mr. Corde indicated in the letter that petitioner's plan

contemplated that the shippers' property handled by petitioner

would be insured under a master "Shippers Interest Policy".

Further, the letter indicated that the contract of insurance

would be issued to petitioner and would cover the property of the

owners, shippers, consignees, or other interested parties.        With
                             - 23 -


respect to the anticipated risk or exposure to AIG, the letter

stated:

     The Shippers Interest Program is to be 100% reinsured
     to Union International/Hamilton, Bermuda. Union will
     then retrocede this risk to other insurers. This,
     therefore, would leave the shippers interest issuing
     carrier in a "fronting" capacity with essentially no
     risk or exposure to loss under the program.

Finally, the letter requested that AIG submit a proposal on

petitioner's Shippers Interest Program setting forth:

     a.   The fronting/administration fee it would require as the
          issuing carrier.

     b.   Estimated premium taxes applicable under this program.

     c.   Its acceptance of Union International as the program
          reinsurer.

     d.   Acceptance and confirmation of * * * [petitioner] as
          the authorized program administrator with total claim
          settlement authority.

     e.   The specific documentation required to be given to
          shippers electing coverage under this program.

     On April 27, 1983, Mr. Corde sent a letter to Mr. Robert

Sargent of Travelers Insurance Co. (Travelers) discussing

petitioner's excess value program and requested that Travelers

submit a proposal for the excess value program.   On May 20, 1983,

Mr. Sargent sent a letter to Mr. Corde outlining an alternative

for petitioner.

     In a letter dated May 7, 1983, to Mr. Corde, Mr. Smetana

presented AIGRM's proposal for an excess value program.   In the

letter, AIGRM proposed that it would issue a single master
                               - 24 -


insurance contract that would cover the interests of petitioner's

shippers.   The proposal indicated that the documentation of

coverage under such a contract would be identified through a

"Service Instruction Agreement" and the declared value entry on

the bill of lading.   AIGRM's proposal was based upon insurance

coverage for values in excess of $100, at a premium charge of 25

cents per $100 of insured value in excess of $100.   Among other

things, AIGRM proposed that:   (a) Premiums be remitted by

petitioner to NUF on a monthly basis less any losses paid and

loss expense incurred; (b) petitioner administer all claims under

the policy on behalf of NUF; and (c) petitioner be responsible

for bad debts or uncollectible items since NUF had no control

over the payment of premiums by shippers.   Hall found the AIGRM

proposal to be more reflective of petitioner's requirements than

the Traveler's proposal and submitted the AIGRM proposal as its

recommendation for review by petitioner's management.

     NUF prepared a "binder of insurance" under which it

described the insured as "United Parcel Service of America, Inc.

on behalf of its customers, shippers, consignees or other

interested parties, as Their Interest may Appear."   The binder

described the insurance as "Shippers Interest".   The rate or

premium under the binder was set at 25 cents per $100 of declared

value, and the insurance would become effective as of August 8,

1983.
                              - 25 -


     However, on August 8, 1983, Mr. Corde sent a telex to Mr.

Smetana which stated:

     [PETITIONER] HAS POSTPONED FINALIZATION OF SHIPPERS
     INTEREST PROGRAM PENDING THEIR REVIEW AND EVALUATION OF
     NEW TAX LEGISLATION CURRENTLY ON THE FLOOR OF THE HOUSE
     OF REPRESENTATIVES WHICH WE UNDERSTAND CAME [sic] OF
     COMMITTEE END OF LAST WEEK. WILL KEEP YOU COMPLETELY
     APPRISED OF THE DEVELOPMENTS AS THEY OCCUR.

     Petitioner and AIG continued to work together in planning

petitioner's Shippers Interest Program.   On October 25, 1983, Mr.

Corde of Hall sent Mr. Smetana of AIG a letter which, among other

things, proposed that changes be made to the wording of

petitioner's service explanation.

     Petitioner's service explanation is a document regularly

provided by petitioner to its customers as part of a kit

containing other documents, upon commencement of the

relationship, upon request by customers, and upon other

occasions.   Service explanations were generally available to

petitioner's walkup customers upon request.
                             - 26 -


     As of November 1983,14 petitioner's service explanation

stated:

     Unless a greater value is declared in writing on the
     pickup record, the shipper declares the released value
     of each package or article not enclosed in a package,
     to be $100. For each $100 or fraction thereof of value
     per package or article not enclosed in a package, in
     excess of $100, an additional charge, as stated on the
     current rate chart, applies. Except if otherwise
     directed by the shipper, the carrier will remit excess
     valuation charges to National Union Fire Insurance
     Company of Pittsburgh, PA as a premium for excess
     valuation cargo insurance for the shipper's account and
     on its behalf. When the carrier does so, claims for
     loss of or damage to the shipper's property will be
     filed with and settled by the carrier on behalf of the
     insurance company. In the event that the insurance
     company fails to pay any claim for loss of or damage to
     the shipper's property under the terms of its policy,
     the carrier will remain liable for loss or damage
     within the limits declared and paid for. Shippers
     Interest Policy IMB9310977 is available for inspection
     at the office of the carrier. Claims not made within
     nine months after receipt by the carrier of the
     merchandise shall be deemed waived.

     In December 1983, petitioner circulated to its shippers an

edition of its quarterly newsletter entitled "Roundups".   Within

the December Roundups, petitioner informed its shippers that


     14
      This service explanation was used throughout 1984.
Petitioner's service explanations, as revised in 1986 and 1988,
contained similar wording. These revisions both stated that
petitioner remained liable for loss or damage. However, the 1986
and 1988 revised service explanations state that petitioner "may"
remit EVC's to NUF as opposed to the "will remit" language in the
above excerpt. We note that the "may remit" language of the 1986
and 1988 revisions is the same language used in petitioner's
tariff. We also note that the "will remit" language in the
November 1983 service explanation could not have been effective
in 1983 since the NUF contract itself does not purport to apply
before January 1984.
                              - 27 -


petitioner intended to make permanent the practice of allowing

its drivers to leave packages at certain specified locations

without a signature.   With respect to the delivery of packages

without the normal signature, petitioner stated the following in

its newsletter:

     [Petitioner] also will continue to assume liability for
     lost and damaged packages up to $100, or the declared
     value. It might seem that leaving packages even in
     safe places risks theft, weather damage, denial of
     delivery or other types of losses. Actually, claims
     for lost and damaged packages declined in Indiana and
     Iowa where we've had the most experience with the
     program.

     On December 28, 1983, representatives of AIG and NUF signed

an insurance policy, entitled "Shippers Insurance"15 and numbered

IMB 9310977, on behalf of NUF which listed the name and address

of the insured as follows:

     NAME AND ADDRESS OF INSURED

     Shippers, Consignees, Customers or other interested
     parties, as their interest may appear with regard to
     parcels shipped via United Parcel Service of America,
     Inc. and/or its subsidiaries as now or hereafter
     constituted (herein after referred to as UPS)
     643 West 43rd Street
     New York, New York

The address listed under the name and address of the insured

served as petitioner's world headquarters.   The contract was for

a term from January 1, 1984, until canceled.   NUF issued the


     15
      For reasons explained in our opinion, we will refer to the
agreement between petitioner and NUF as the Shippers Interest
contract.
                               - 28 -


contract in the State of New York with the understanding that it

was pursuant to the free trade zone legislation, article 63 of

the New York Insurance Law.

     Clause 2 of the Shippers Interest contract states:

     [Petitioner] will provide space on its "Pick-Up Record"
     which will be labeled "Declared value if in excess of
     $100.00". A declared value indicated by the Named
     Insured in the space provided shall evidence the
     existence and the amount of this insurance subject to
     limits of liability provided herein. This insurance
     shall not apply unless a declared value is indicated by
     the Named Insured in the space provided in * * *
     [petitioner's] "Pick-up Record".

     Clause 6 of the Shippers Interest contract generally

provided that NUF was not liable for the first $100 of the value

of the property, and in no event did NUF's liability exceed the

declared value for surface shipments and a maximum of $25,000 per

package for air shipments.    The cancellation provision of the

contract stated:

     This policy may be cancelled [sic] by the Named Insured
     or * * * [petitioner] on behalf of the Named Insured by
     mailing to the Company written notice stating when
     thereafter such cancellation shall be effective. This
     Policy may be cancelled [sic] by the Company by mailing
     to the Named Insured or * * * [petitioner] at the
     address shown in this Policy or last known address
     notice stating when not less than thirty (30) days
     thereafter such cancellation shall be effective. * * *

Under this provision, petitioner had the power to cancel the

Shippers Interest contract.

     Clause 20 of the Shippers Interest contract addressed other

insurance and stated:
                               - 29 -


          If there is any other insurance covering the
     property insured hereunder, or * * * [petitioner's]
     liability, if any, whether prior, subsequent to, or
     simultaneous with this policy, which in the absence of
     this insurance would cover the loss, damage or
     liability hereby covered, then this Company shall not
     be liable hereunder for more than the excess over and
     above such other insurance. This clause, however,
     shall not apply to insurance effected by a Named
     Insured, and the existence of such insurance, or
     payment of a loss thereunder, shall not constitute a
     defense of any claim otherwise payable under this
     Policy, nor shall such insurance be called on to
     contribute to any loss payable hereunder.

Under clause 20, NUF was not liable in the event that

petitioner's liability for loss or damage to a shipper's package

was covered by another insurance policy unless the other policy

was "effected" by a shipper.

                     (3)   Affiliated FM Insurance
                           Policy

     Petitioner maintained an insurance policy with Affiliated FM

Insurance Co. (AFM policy).    The AFM policy was issued on

December 27, 1982, and provided coverage from October 1, 1982 to

1985.   The AFM policy insured petitioner's property and liability

for, among other things, petitioner's interest in the "real and

personal property of others, including parcels held for delivery

and in transit for which petitioner may be liable or for which

the * * * [petitioner] may assume liability or agree to insure

prior to loss affected thereby."    The AFM policy contained a $100

million liability limitation with sublimits.    The AFM policy had

a $10 million limit "on Personal Property while in the course of
                             - 30 -


transportation as respects loss or damage arising out of any one

occurrence" and a deductible clause that excluded the first

$25,000 of claims arising out of any one occurrence from

coverage.

     On December 28, 1983, an endorsement was added to the AFM

policy, which became effective January 1, 1984.   The endorsement

stated:

     Permission is hereby granted to insure the deductible
     amount (25,000.00) applicable to coverage 1B. Personal
     Property while in the course of transportation. If
     such property is also insured under policy #IMB-9310977
     issued by the National Union Fire Insurance Company of
     Pittsburgh, PA, and any renewals, or rewrites thereof,
     it is agreed that any such insurance shall be ignored
     in determining the amount of loss to which such
     deductible amount applies. It is also agreed that
     thirty (30) days advance notice of cancellation shall
     be given to National Union Fire Insurance Company of
     Pittsburgh, PA. Any claims presented that exceeds
     $25,000.00 National Union agrees to abide with our
     settlement of such claims.

     Petitioner paid annual installment premiums of $356,945 for

coverage of all petitioner's real and personal property,

including parcels held for delivery and in transit.   The annual

premium was based on property values and stated rates.   The AFM

policy provided a calculation for the annual premium which

operated to apportion $86,820 of the total annual installment

premium to property value related to parcels in transit.16


     16
      The $86,820 premium attributable to parcels was computed
by multiplying the average daily value of parcels of $354,369,000
                                                   (continued...)
                                 - 31 -


                       (4)   UPSINCO, Ltd./OPL

     On June 9, 1983, pursuant to petitioner's plan, Hall,

through Parker & Co.-Interocean, Ltd. (Parker & Co.),17 prepared

a summary of a proposal to organize an insurance subsidiary

domiciled in Bermuda under the name UPSINCO, Ltd. (UPSINCO).    By

a memorandum dated June 13, 1983, Mr. Corde provided to Mr.

Johnson copies of the forms filed with the Registrar of Companies

in Bermuda relating to the incorporation of UPSINCO.

     On June 23, 1983, a meeting was held which the following

persons attended:     Messrs. Danielewski, Johnson, and Jerome Stein

representing petitioner; Messrs. Garrity, Corde, and John Iacono

representing Hall; Messrs. Robin Spencer Arscott and Geoffrey

Hunt of Hall-Bermuda; and Messrs. Chet Butterfield and John

Ellison of the Bermuda law firm of Conyers, Dill & Pearman.

Among other things, the purpose of the meeting was to discuss

various aspects of the Shippers Interest program including the

contract form, documentation/ certification, service instruction

agreement, monthly bordereaux,18 and premium/loss reports.


     16
      (...continued)
times the rate of .0245 percent. The average daily value equaled
the average parcel value of $80 times the annual total parcels of
1,616,809,741 divided by 365.
     17
          Parker & Co. is a wholly owned subsidiary of Hall.
     18
      Petitioner's bordereau is a statement which summarizes, by
State, the units of excess value purchased by shippers and the
                                                   (continued...)
                              - 32 -


     UPSINCO was incorporated in Bermuda as a wholly owned

subsidiary of petitioner on June 28, 1983.    UPSINCO was

registered as an exempted company pursuant to the provisions of

section 13 of the Companies Act of 1970, under the laws of

Bermuda.   On June 28, 1983, the first meeting of the provisional

board of directors of UPSINCO was held.   The provisional

directors of UPSINCO were listed as Messrs. John A. Ellison,

director, C.F.A. Cooper, and N.B. Dill, Jr.    UPSINCO was

incorporated with initial capital of $1.2 million and had 12

million shares of capital stock.   Initial ownership of the stock

of UPSINCO was as follows:

            Name                    No. of Shares
     United Parcel Service
       of America, Inc.                1,199,994
     Walter E. Danielewski                     1
     Kenneth L. Johnson                        1
     Jerome D. Stein                           1
     John Ellison                              1
     H.C. Butterfield                          1
     R.S.L. Pearman                            1

     On July 14, 1983, the shareholders of UPSINCO held their

first general meeting in which they elected a board of directors.

The elected board of directors consisted of five people.     Three

of the five directors elected, Messrs. Danielewski, Johnson, and

Stein, were also employees of petitioner.    The remaining two

elected directors, Messrs. Ellison and Butterfield, were


     18
      (...continued)
claims in excess of $100 paid to petitioner's shippers.
                               - 33 -


representatives of the Bermuda law firm of Conyers, Dill &

Pearman.   The minutes of the first meeting indicate that Messrs.

Danielewski and Johnson were, respectively, elected to the

positions of president and vice president of UPSINCO.   The

minutes further indicate that Mr. Stein was appointed as

secretary and treasurer and that Mr. Danielewski was appointed as

assistant treasurer.19   Thus, the majority of UPSINCO's board of

directors and officers were all employees of petitioner.

     During the July 14, 1983, meeting, the board of directors of

UPSINCO appointed Parker & Co. as manager of the company and

passed bylaws which it then submitted to the shareholders for

confirmation.20   Also on July 14, 1983, the shareholders of

UPSINCO confirmed and adopted the bylaws and approved all actions

taken by UPSINCO's provisional directors on June 28, 1983, and

its directors on July 14, 1983.   On August 1, 1983, UPSINCO was

certified as an insurer in Bermuda by the Minister of Finance.

     By resolution dated October 31, 1983, the executive

committee of the board of directors of petitioner authorized a

capital contribution in the amount of $41,017,575 in cash to

UPSINCO.   In addition, the executive committee of the board of


     19
      The minutes also indicate that Mr. A.L. Vincent Ingham was
appointed assistant secretary.
     20
      As of Jan. 1, 1985, subject to the directions and
instructions of OPL, the administrative functions of OPL were
provided by Parker & Co., a Bermuda corporation.
                              - 34 -


directors of petitioner resolved to take all actions necessary to

effect a change of the name UPSINCO to Overseas Partners, Ltd.

(OPL).

     By resolution on November 3, 1983, the board members of

UPSINCO increased the authorized share capital of the company by

$15,687,030, from $1.2 million to $16,887,030, through the

creation of an additional 156,870,300 shares of capital stock at

10 cents par value.   The members of UPSINCO further resolved that

the sum of $25,330,545 be accepted as contributed surplus,

resulting in an increase of $41,017,575 in UPSINCO's capital to

$42,217,575.

     On November 14, 1983, petitioner made a capital contribution

of cash in the amount of $41,017,575 to UPSINCO.    On November 17

and 18, 1983, petitioner's board of directors declared a dividend

of 1 share of OPL (then known as UPSINCO) capital stock on each

outstanding share of petitioner's stock (excluding petitioner's

shares held in treasury) payable on December 31, 1983, to

shareholders of record on November 18, 1983.

     On November 23, 1983, the board members of UPSINCO resolved

that the name of the company be changed to OPL.    By resolution

dated November 25, 1983, petitioner's board of directors changed

the name of UPSINCO to OPL.

     On December 28, 1983, NUF and OPL entered into a Facultative

Reinsurance Agreement (agreement) under which NUF agreed to cede
                              - 35 -


its liability under the Shippers Interest contract to OPL as

reinsurer.   Under the terms of the agreement, NUF was required to

remit to OPL 100 percent of the gross amounts received from

petitioner under the Shippers Interest contract less:   (a) A

commission to NUF of 1.18 percent of the gross premiums not to

exceed $1 million; (b) an allowance of 3.1 percent of the gross

premiums written to cover NUF's premium tax and board and bureau

charges; and (c) 1 percent of the gross premiums for the purpose

of paying Federal excise taxes.   In addition, under article IX of

the agreement, NUF held as security an amount equal to the first

2 months of gross premiums written less commission, taxes, board

and bureau charges, losses paid, loss expenses paid, and Federal

excise taxes, if any.

     The agreement became effective on January 1, 1984, and

remained in effect until canceled or terminated.   The termination

provision of the agreement stated:

     Neither the Company nor Reinsurer may terminate this
     Agreement while the Policy listed in Article I Item B
     is in force; however, if the Policy listed in Article I
     Item B[21] is in fact terminated then in that event and
     that event only this Agreement shall be terminated
     simultaneously therewith. * * *

Under this provision, neither NUF nor OPL could cancel the

agreement while the Shippers Interest contract remained in force.


     21
      Article I Item B lists only the Shippers Interest contract
between petitioner and NUF.
                               - 36 -


     On December 31, 1983, petitioner made a distribution, which

it treated as a taxable dividend to its shareholders, of 1 share

of OPL stock for each share of petitioner's stock then

outstanding.    Petitioner distributed 164,477,491 shares of OPL

stock with a net asset value of 25 cents per share.    The total

dividend was $41,119,372.75.    The fair market value of the OPL

capital stock received by each of petitioner's shareholders was

considered by petitioner to be ordinary income to each of

petitioner's shareholders.

     In 1983, petitioner was owned by its active employees and

former employees, as well as the families, estates, and trusts of

former employees.    In 1983, there were approximately 14,000

shareholders.    On December 31, 1983, as of the moment of

distribution of the OPL stock, the shareholders of OPL were

essentially the same as petitioner's shareholders.    The only

difference between the shareholders of OPL and petitioner's

shareholders was that petitioner's shareholders did not receive

the same proportionate interest in OPL that they owned in

petitioner because petitioner itself was a shareholder of OPL.

     On December 31, 1984, there were 14,811 shareholders in OPL

holding an aggregate of 164,358,562 shares of common stock, not

including the 4,511,738 treasury shares of OPL owned by

petitioner.    The total shares in OPL equaled 168,870,300.   On

December 31, 1984, there were 16,297 shareholders in petitioner
                                 - 37 -


holding an aggregate of 163,182,028 shares of common stock.    The

4,511,738 shares of OPL owned by petitioner represented 2.67

percent of the 168,870,300 shares in OPL on December 31, 1984.

     During the years in issue, restrictions applied in the event

an OPL shareholder wanted to sell shares of OPL.    No outstanding

shares of OPL capital stock were transferable, except by gift or

inheritance, unless the shares were first offered for sale to

petitioner at the lower of the net book value of the OPL stock or

at the price and terms at which the OPL stock was offered to the

proposed transferee.    OPL shareholders were required to notify

petitioner's treasurer of the number of shares proposed to be

sold, the proposed price per share, the name and address of the

proposed transferee, and the terms of the proposed sale and

provide a statement of the proposed transferee that the

information contained in the notice was true and correct.    OPL

shareholders had the right to pledge OPL stock but were not

allowed to transfer the stock upon foreclosure without

petitioner's having first been offered the option to purchase the

stock.

          2.   1984 and Years Following

                a.     General

     For the taxable year ending December 31, 1984, excess value

amounts billed to regular shippers and collected from other

shippers were not included in petitioner's reported taxable
                               - 38 -


income.   Petitioner did not include excess value amounts billed

to regular shippers in its filings with the SEC and the ICC for

the year ended December 31, 1984.   Otherwise, petitioner's

activities with respect to the excess value activity basically

remained the same as in prior years.    Petitioner continued to

bill customers for shipping charges on the basis of information

recorded by shippers on the package pickup records.    The bills

reflected all amounts to be collected from shippers, including

EVC's.    All amounts collected, including EVC's, from the shippers

were deposited in petitioner's bank accounts.    Petitioner

continued to process all claims for loss or damage to parcels,

including any excess value portions of the claims.    If a claim

for loss or damage was paid, petitioner continued to remit the

amount for the claim by check to the shipper.

     Petitioner did not apply for, and did not hold, an insurance

license of any type.   During 1984, petitioner's employees who

processed shippers' claims were not licensed as claims adjusters

in the States in which they processed claims.    NUF did not

participate in the resolution of specific claims in 1984,

challenge the amounts of specific loss claims paid by petitioner,

or challenge the amounts of loss and damage claims that

petitioner subtracted from the amounts that it remitted to NUF

during 1984 in connection with NUF contract IMB 9310977.
                               - 39 -


                 b.   Accounting

     For the taxable years ended December 31, 1983 and 1984, UPS-

New York and UPS-Ohio were required to file annual reports with

the ICC and were required to follow the rules of accounting and

use the accounts established by the ICC in connection with ICC

accounting and reporting requirements.    Petitioner was also

required to follow Generally Accepted Accounting Principles.     For

financial accounting and managerial reporting purposes,

petitioner used a system of accounts that was generally the same

as the ICC system of account numbers.    However, petitioner's

expense accounts are much more detailed than ICC expense accounts

used for ICC accounting purposes.

     With respect to a shipment made by a regular customer, there

was no change in the method in which journal entries were made in

1983 and 1984.   Petitioner generally debited accounts receivable

and credited an intercompany account.    When petitioner received

the EVC amounts from its shippers, the amounts were deposited in

petitioner's bank accounts.   Petitioner paid shippers' claims out

of corporate bank accounts.

     Petitioner did make changes to its internal accounting

worksheets at its district level in 1984.    The worksheets

detailed the EVC's differently in 1984 than in 1983.    However,

petitioner's accounting journal entries were the same in 1984 as

they were in 1983 at the district level.
                                 - 40 -


                 c.   Transactions Between Petitioner and NUF

     Beginning in January 1984, petitioner transferred excess

value amounts billed to its regular shippers and collected from

other shippers, net of claims paid in excess of $100, to NUF on a

monthly basis.   Petitioner did not receive reimbursement or

compensation from NUF for generating, billing, and collecting

EVC's or for processing the excess value claims.

     In 1984, petitioner began preparing a "bordereau" statement

which summarizes, by State, the units of excess value purchased

by shippers and the claims in excess of $100 paid to petitioner's

shippers.   The bordereau statement reflects total amounts

transferred by petitioner to NUF during 1984 as follows:

Month            Gross Premium       Claims Paid     Net Premium

Jan.             $6,441,266.73        $67,764.74    $6,373,501.99
Feb.              8,872,879.29        493,372.97     8,379,506.32
Mar.              8,204,394.80      1,152,402.35     7,051,992.45
Apr.              7,543,896.37      1,537,670.65     6,006,225.72
May               7,564,372.78      1,945,900.71     5,618,472.07
June              9,287,618.30      2,086,223.87     7,201,394.43
July              6,999,418.50      1,970,519.97     5,028,898.53
Aug.              9,998,146.19      2,367,289.23     7,630,856.96
Sept.             8,034,914.33      2,098,262.38     5,936,651.95
Oct.              8,522,263.90      2,887,865.46     5,634,398.44
Nov.             10,600,501.16      2,922,216.00     7,678,285.16
Dec.              7,725,117.32      2,554,523.60     5,170,593.72

  Total          99,794,789.67     22,084,011.93    77,710,777.74

The category "Net Premium" represents EVC's billed to

petitioner's regular customers and collected from other shippers

from each of the States and the District of Columbia, less claims
                                - 41 -


over $100 remitted to petitioner's shippers during the month.

Generally, around the middle of the month following billing to

regular shippers or collection from walk-in shippers, the net

amounts were remitted by wire transfers from petitioner's account

to an NUF account.     No interest on excess value amounts that had

been collected before the excess value amounts were transferred

to NUF was paid to NUF.    During 1984, if a shipper did not pay a

bill that included declared excess value amounts, petitioner did

not reduce the amount transferred to NUF.    If collection

activities occurred, petitioner attempted to collect the entire

amount due from the shipper, including any EVC's included in the

bill.     Petitioner did not reduce the amount transferred to NUF by

any amount uncollected or any cost it incurred in collecting

delinquent EVC's.

                  d.   Transactions Between NUF and OPL

     Beginning in January 1984, after receiving the amounts

remitted to NUF by petitioner, NUF prepared a bordereau and

remitted the net amounts shown on NUF's bordereau to OPL by wire

transfer.     The following table summarizes the amounts and dates

of transfers made by NUF to OPL relating to excess value amounts

during 1984:22




     22
      The amounts shown in the table were rounded, resulting in
minor discrepancies of a few dollars.
                                         - 42 -


                           Under-      Taxes                    Interest on
                 Net1     writing     Boards &        Funds        Funds      Net Payment
 Month        Premiums    Expenses    Bureaus2      Withheld3    Withheld       to OPL4
 Jan.        $6,373,502     $76,007   $264,092     $6,033,403       -0-           -0-
 Feb.         8,379,506     104,700    363,788      7,911,018       $45,453       $45,453
 Mar.         7,051,992      96,812    336,380        -0-           113,879     6,732,679
 Apr.         6,006,226      89,018    309,300        -0-           142,349     5,750,256
 May          5,618,472      89,260    310,139        -0-           113,879     5,332,953
 June         7,201,394     109,594    380,792        -0-           113,879     6,824,888
 July         5,028,899      82,593    286,976        -0-           146,416     4,805,745
 Aug.         7,630,857     117,978    409,924        -0-           109,812     7,212,767
 Sept.        5,936,652      94,812    329,431        -0-           142,349     5,654,758
 Oct.         5,634,399     100,563    349,413        -0-           113,879     5,298,302
 Nov.         7,678,285      38,663    434,621        -0-           113,879     7,318,880
 Dec.         5,170,594     -0-        316,730        -0-           126,081     4,979,945
 Total       77,710,778   1,000,000   4,091,586    13,944,421     1,281,855    59,956,626

         1
        This column was arrived at by netting gross income and losses paid.
         2
        This column contains the total amounts included on the bordereau for
taxes, board and bureau charges, and Federal excise taxes.
      3
        In 1984, the net amounts to be remitted by NUF to OPL for January and
February were withheld in escrow by NUF.
      4
        The "Net Payment to OPL" is calculated by reducing the net premiums
shown in column one by expenses, taxes, board and bureau charges, and funds
withheld and by increasing that amount by interest on funds withheld.

NUF paid Hall $250,000 from the $1 million it received from

petitioner as fees.            OPL ultimately recorded the funds received

in its general ledger.

         C.      FFIC/PIP

         Fireman's Fund Insurance Co. (FFIC), through a policy sold

by Parcel Insurance Plan, Inc. (PIP), since 1966, offered excess

value protection for shipments sent via petitioner, the U.S.

Postal Service, and other carriers.                 Most of FFIC/PIP's business

came from petitioner's shippers.                  PIP tried to solicit business

from petitioner's shippers who spent at least $1,000 annually for
                                - 43 -


EVC's.     Generally, PIP charged 50 percent of the rate charged for

the excess value coverage offered by petitioner to its shippers.

This amounted to a price of $0.125 per $100 of coverage.

      PIP declined to provide coverage to certain high-risk

shippers and also declined to provide coverage on certain types

of packages.    However, PIP's marketing materials indicate that

shippers in industries with serious theft problems could still

participate, but they were charged more than $0.125 per $100 of

coverage.    If such a shipper were accepted by PIP, PIP would

charge between $0.15 and $0.175 per $100 of coverage.

      FFIC was responsible for payment of losses and reimbursed

PIP weekly for loss claims paid.    For the years 1983 and 1984,

PIP's profit margins equaled 36 percent and 34 percent,

respectively.    PIP paid approximately 64 percent and 66 percent

for 1983 and 1984, respectively, of the amounts collected to FFIC

for the parcel protection.    For 1983, FFIC's gross profit margin

equaled 27 percent of the premium written.23

II.   Liberty Mutual Insurance Policy

      A.    Insurance Policy Between Petitioner and Liberty Mutual

      Liberty Mutual is a group of mutual insurance companies.

Liberty Mutual are multiline property and casualty insurers based

in Boston, Massachusetts, which operate in all 50 States and the


      23
      The "profit margin" is equal to premiums minus claims paid
minus commissions.
                                - 44 -


District of Columbia, Canada, and the U.S. Virgin Islands.

Liberty Mutual Fire Insurance Co. (Liberty Mutual Fire) is a

member of Liberty Mutual.

     Liberty Mutual wrote workers' compensation insurance in all

States except those that were "monopolistic".     In the eight

"monopolistic" States, only one State-affiliated company was

permitted to write workers' compensation policies.     In 1984,

workers' compensation policies accounted for 39.3 percent of

Liberty Mutual Fire's net premiums.      In 1984, Liberty Mutual Fire

wrote workers' compensation policies in California.     California

law prohibited insurance policies for California workers'

compensation risks from also insuring workers' compensation risks

for other States.   Thus, a California workers' compensation

policy was always a "stand-alone" policy.

     The initial premium for a workers' compensation policy in

California was determined by a statutory formula which took

account of the estimated payroll for each job classification.

However, an employer's loss experience could also affect the

premium if the employer received an "experience modification"

from the State of California.    Generally, California law permits

the payment of dividends by a mutual insurance company but

prohibits any individual or insurance company from promising the

future payment of dividends under an unexpired workers'

compensation policy or misrepresenting the conditions for
                               - 45 -


dividend payment.    See Cal. Code Regs. tit. 10, sec. 2504 (1999).

     From 1979 through 1983, petitioner self-insured its workers'

compensation risks in California.    R.L. Kautz, a company

unrelated to petitioner or Liberty Mutual, administered this

program.    Liberty Mutual wrote the workers' compensation

insurance for petitioner in all other States that were not

monopolistic during this period.

     Any employer in California seeking to be self-insured for

workers' compensation must submit an application to the State and

obtain State approval.    Any employer seeking to change from a

self-insured to an insured program for workers' compensation must

also submit an application to California and obtain State

approval.

     On October 3, 1983, Mr. Eugene Schoenleber of petitioner's

insurance department requested that Mr. Al Sharlun submit a

proposal for taking over the administration of petitioner's

California workers' compensation program from R.L. Kautz.    Mr.

Sharlun worked in Liberty Mutual's national sales department,

which handles large national accounts.    Subsequently, petitioner

and Liberty Mutual agreed that Liberty Mutual would write an

insurance policy for petitioner's 1984 California workers'

compensation liability.

     On December 15, 1983, the State of California sent a letter

to petitioner reflecting its understanding that it was the
                               - 46 -


intention of petitioner to withdraw from workers' compensation

self-insurance status in California.      On December 28, 1983,

petitioner sent a letter to the State of California confirming

that Liberty Mutual Fire was taking over the management of all

open and closed self-insurance claims from 1979 through 1983.

     The State of California granted petitioner's application to

terminate its self-insurance plan.      As of January 1, 1984,

petitioner and Liberty Mutual entered into an insurance policy

with respect to petitioner's 1984 California workers'

compensation liability.    Petitioner was listed as the insured.

The policy was issued by Liberty Mutual Fire and was a

permissible workers' compensation policy in the State of

California.   As part of the agreement, Liberty Mutual Fire was

required to investigate and adjust all claims made under the

policy.   The policy provides coverage for compensation and other

benefits required of petitioner by the workers' compensation laws

of California and provides coverage for all sums which petitioner

is legally obligated to pay as damages because of bodily injury

or accident or disease, including death arising out of the course

of employment.

      Under the Participating Provision Endorsement of the

insurance policy, petitioner was designated a member of Liberty

Mutual, with a right to participate in the distribution of

dividends.    Dividends were determined by the board of directors
                               - 47 -


of Liberty Mutual.   This endorsement provided that the policy was

nonassessable.    As a nonassessable policyholder, petitioner could

not be assessed for Liberty Mutual's losses and expenses in

excess of the premiums paid for the 1984 California workers'

compensation policy.    The Participating Provision Endorsement

also reiterated the statutory provision in California which made

it unlawful for Liberty Mutual to promise the future payment of

dividends before the expiration of the 1984 policy period, and

the endorsement noted that dividends are payable only as

determined by the board of directors of Liberty Mutual following

the expiration.

     The policy also contained a Redetermination Agreement

Endorsement which provided that an initial apportionment of

dividends may be made from a surplus accumulated from the

California workers' compensation insurance following termination

of the policy.    Further, the policy provided that if a subsequent

dividend is greater than the dividend previously paid to

petitioner, Liberty Mutual shall pay to petitioner the additional

dividend shown to be due.    However, if the subsequent dividend is

less than the dividend previously paid to petitioner, petitioner

shall refund the amount by which the previous dividend exceeds

the current dividend.

     The audited premium for the policy is based upon actual

payroll amounts during the policy period for various job
                              - 48 -


classifications, multiplied by a standard rate set by the State

for each classification, and further multiplied by an experience

modification factor.   The estimated modified annual premium is

the amount initially paid to Liberty Mutual Fire, which is

determined based upon estimates of payroll amounts for the year.

After the end of the year, the audited modified premium is

determined based upon the final payroll figures for the year.

     Under the policy, Helmsman Management, a subsidiary within

the Liberty Mutual group, would administer the runoff of the 1979

through 1983 workers' compensation self-insurance plan for

petitioner beginning in 1984 for a flat fee of $250,000.   Liberty

Mutual charged petitioner 12 percent of its workers' compensation

losses, subject to a maximum of $1.2 million, for the cost of

handling the workers' compensation claims.   Liberty Mutual

charged petitioner 1 percent of its audited premium for excise

tax and 1 percent for management fees.   Dividends were to be

declared and paid in accordance with California law and the

determinations of the board of directors of Liberty Mutual.

     In 1984, petitioner made premium payments to Liberty Mutual

in connection with the California workers' compensation policy

and received a dividend payment in 1985.   During 1984, petitioner

also continued to insure its workers' compensation liability for

most other States with Liberty Mutual.   In April 1984, the

estimated premium for petitioner in California was calculated to
                               - 49 -


be $14,241,915.   The $14,241,915 estimated premium was paid to

Liberty Mutual by petitioner in monthly installments in 1984.     By

April 1, 1985, Liberty Mutual completed its audit of the hours

worked by various classes of petitioner's employees in California

and determined the audited premium.     After the audit, the

standard premium for petitioner was increased by $204,496 to

reflect the actual amounts of petitioner's California payroll for

the year 1984.

     In October 1985, Liberty Mutual Fire sent petitioner a

statement showing the first dividend adjustment to the Liberty

Mutual policy.    Every year thereafter through 1994, an annual

dividend statement was sent to petitioner reflecting further

dividend readjustments to the policy.

     B.   Liberty Mutual-OPL Reinsurance Treaty

     Effective January 1, 1984, Liberty Mutual and OPL entered

into a reinsurance treaty for petitioner's 1984 California

workers' compensation liability, which was the subject of the

Liberty Mutual policy.    Pursuant to the agreement, in 1984

Liberty Mutual:    Paid OPL $12,228,077.62 in premiums in monthly

installments; retained a ceding commission of $1.2 million;

withheld and created an escrow of $480,000 to cover OPL's

liability for losses paid by Liberty Mutual; paid a Federal

excise tax of $141,919.15; and retained a management fee of

$141,918.23.
                                 - 50 -


     The agreement, with respect to OPL's reinsurance of Liberty

Mutual includes but is not limited to the following terms:

     1.    OPL reinsured Liberty Mutual's UPS California workers'

compensation exposure for losses not exceeding $250,000 from any

one accident.     Liberty Mutual retained the exposure for losses

exceeding $250,000 from any one accident.     Liberty Mutual also

retained the risk of multiple accidents with losses in excess of

$250,000.

     2.    Liberty Mutual Fire agreed to pay over to OPL an amount

equal to the premiums received on the California workers

compensation policy, less $50,000 for the retained layer of

liability for losses above $250,000, a management fee equal to 1

percent of the premium, 1 percent of the premium for excise tax,

and a ceding commission equal to 12 percent of the losses

incurred.     The ceding commission was capped at $1.2 million.

     3.    Liberty Mutual retained the obligation to investigate

and adjust all claims for the UPS workers' compensation program

in California.

     4.    Liberty Mutual paid a 1 percent excise tax on

reinsurance by a foreign insurer, pursuant to I.R.C. section

4371.

     C.      Amount in Dispute

        On its 1984 Federal income tax return, petitioner deducted

the estimated premium of $14,241,915 it paid to Liberty Mutual
                               - 51 -


for California workers' compensation coverage.    By December 31,

1984, petitioner had incurred workers' compensation losses in

California that had been paid by Liberty Mutual in the amount of

$2,714,500.   Respondent disallowed $11,527,41524 deducted on

petitioner's 1984 return.   After concessions, the amount in

dispute with respect to the Liberty Mutual policy has been

reduced to $11,151,675.25

                               OPINION

I.   Excess Value Charges

     Respondent determined that EVC's in the amount of

$99,794,790 must be included in petitioner's 1984 income pursuant

to section 61.   Section 61(a) provides in part that "gross income

means all income from whatever source derived".   It is

fundamental to our system of taxation that income must be taxed

to the one who earns it.    See Commissioner v. Culbertson, 337


     24
      This amount represents the difference between the total of
$14,241,915 of deductions and the $2,714,500 actually paid out by
Liberty Mutual Fire in 1984 claims.
     25
      Respondent conceded a total of $375,740. See supra note
2. Thus, respondent's initial disallowance of $11,527,415 has
been reduced by $375,740 to $11,151,675. The $375,740 conceded
by respondent is made up of $325,740, representing a 12-percent
claim adjustment expense for losses paid in 1984 plus $50,000 in
premiums paid to Liberty Mutual for risk associated with claims
over $250,000.

     The $325,740 conceded amount was calculated by respondent to
be an allocation of a portion of the total $1.2 million retained
by Liberty Mutual based on the ratio of 1984 claim payments to
total 1984 claims paid between 1984 and 1994.
                              - 52 -


U.S. 733, 739-740 (1949).   The incidents of taxation cannot be

avoided through an anticipatory assignment of income.     See United

States v. Basye, 410 U.S. 441, 447, 449-450 (1973); Lucas v.

Earl, 281 U.S. 111, 114, 115 (1930).    This has been described as

"the first principle of taxation".     Commissioner v. Culbertson,

supra at 739.   The question of who should be taxed depends on

which person or entity in fact controls the earning of the income

rather than who ultimately receives the income.    See Commissioner

v. Sunnen, 333 U.S. 591, 604-606 (1948); Corliss v. Bowers, 281

U.S. 376, 378 (1930); Vercio v. Commissioner, 73 T.C. 1246, 1253

(1980); see also Ronan State Bank v. Commissioner, 62 T.C. 27, 35

(1974); American Sav. Bank v. Commissioner, 56 T.C. 828 (1971);

Nat Harrison Associates, Inc. v. Commissioner, 42 T.C. 601

(1964).   A taxpayer realizes income if he controls the

disposition of that which he could have received himself but

diverts to another as a means of procuring the satisfaction of

his goals.   The receipt of income by the other party under such

circumstances is merely the fruition of the taxpayer's economic

gain.   See Commissioner v. Sunnen, supra at 605-606; Helvering v.

Horst, 311 U.S. 112, 116-117 (1940).

     Respondent does not, and need not, challenge OPL's separate

existence as a valid corporate entity.    The classic assignment of

income cases involve persons and entities whose separate

existence was unquestioned.   See United States v. Basye, supra;
                              - 53 -


Lucas v. Earl, supra; Leavell v. Commissioner, 104 T.C. 140

(1995).   The Supreme Court's articulation of the assignment of

income doctrine requires no challenge to the separate existence

of the persons or entities to which the doctrine applies.     As the

Court stated:

     The entity earning the income--whether a partnership or
     an individual taxpayer--cannot avoid taxation by
     entering into a contractual arrangement whereby that
     income is diverted to some other person or entity.
     Such arrangements, known to the tax law as
     "anticipatory assignments of income," have frequently
     been held ineffective as means of avoiding tax
     liability. * * * [United States v. Basye, supra at
     449-450.]

Therefore, the issue we must decide is whether petitioner, rather

than NUF and OPL, earned the EVC's.

     During the years prior to 1984, petitioner properly reported

revenues from EVC's as income for Federal income tax purposes.

During those years petitioner performed the following EVC

functions and activities:

     1.    Maintained and advertised the shipping activity,

           which provided a customer base for petitioner's

           excess value activity.

     2.    Printed shipping forms with an excess value election.

     3.    Published excess value rates in tariffs.
                               - 54 -


     4.    Incurred liability for damage or loss to packages in

           excess of $100 when the shipper declared such excess

           value and paid an EVC.26

     5.    Billed shippers for EVC's.

     6.    Collected EVC's.

     7.    Deposited EVC's into petitioner's bank accounts.

     8.    Retained interest paid on EVC income held in

           petitioner's accounts.

     9.    Processed excess value claims.

     10.   Investigated excess value claims.

     11.   Traced lost parcels.

     12.   Inspected damaged parcels.

     13.   Paid excess value claims.

     14.   Maintained a "loss prevention" manual and

           personnel to audit and implement it.

     15.   Defended against lawsuits brought by shippers whose

           excess value claims had been denied.

     16.   Incurred all costs associated with the administration

           of its excess value activity.

     17.   Obtained and paid for catastrophic insurance

           to cover its liability for lost or damaged shipments.




     26
      Petitioner accepted liability for damage or loss to
packages up to $100 and made payment for such loss or damages.
                                - 55 -


After January 1, 1984, petitioner continued to perform all these

functions and activities.   This continuity in petitioner's EVC

activity after January 1, 1984, was consistent with a plan

petitioner had formulated during 1983.

     During 1983 petitioner asked AIG to submit a proposal for

restructuring petitioner's excess value program.    AIG's proposal

contemplated that NUF would perform in a "fronting" capacity; a

capacity in which NUF would receive excess value income under the

Shippers Interest contract and reinsure its liability under the

Shippers Interest contract with OPL.     In his letter dated April

27, 1983, Mr. Corde, of Hall, stated that NUF would exist "in a

fronting capacity with essentially no risk or exposure to loss

under the program."    NUF retained an even $1 million in 1984 as a

fronting service fee for agreeing to reinsure the Shippers

Interest contract with OPL.27

     Mr. Smetana of AIG proposed that petitioner would continue

to collect EVC's from shippers, administer and pay all valid

claims, and remit excess value amounts to NUF net of claims.    Mr.

Smetana also proposed that petitioner be responsible for

uncollectible EVC's.   Mr. Smetana reasoned that "since * * *


     27
      A front has been generally described as an arrangement
whereby an insurance company allows another company to use its
name for a fee. See Old Sec. Life Ins. Co. v. Continental Ill.
Natl. Bank & Trust, 740 F.2d 1384, 1387 n.2 (7th Cir. 1984); see
also Northwestern Natl. Ins. Co. v. Marsh & McLennan, Inc., 817
F. Supp. 1424, 1426 (E.D. Wis. 1993).
                               - 56 -


[AIG/NUF] would have no control over the payment of premium by

shippers, * * * [AIG/NUF] would not take on the responsibility

for any bad debt or uncollectables under the program."    These

proposals all became part of petitioner's method of operation on

January 1, 1984.

     Under the Facultative Reinsurance Agreement between NUF and

OPL, article I, item B lists the Shippers Interest contract as

the policy to be reinsured.    Under article XVIII, subparagraph

(A), neither NUF nor OPL could terminate the reinsurance

agreement while the Shippers Interest policy remained in force.

Article XVIII further requires that only in the event that the

Shippers Interest contract is in fact terminated will the

reinsurance agreement between NUF and OPL be terminated

simultaneously therewith.    Either petitioner or the "Named

Insured" could cancel the Shipper's Interest contract under the

terms of that agreement.28

     Beginning in January 1984, petitioner transferred excess

value amounts billed to its regular shippers and collected from

other shippers, net of claims paid in excess of $100, to NUF on a

monthly basis.   Petitioner did not reduce the amounts transferred

to NUF in order to compensate itself for sales and marketing


     28
      We note that it is unrealistic to conceive of a situation
in which a single shipper could cancel the whole Shipper's
Interest contract or that all the unrelated shippers in unison
could cancel the contract.
                              - 57 -


expenses that it incurred regarding the EVC's.   Petitioner did

not charge either NUF or OPL for providing the point of contact

with shippers who declared excess value and paid EVC's.    No

interest on excess value amounts that had been collected before

the excess value amounts were transferred to NUF was paid to NUF.

During 1984, if a shipper did not pay a bill that included excess

value amounts, petitioner attempted to collect the entire amount

due from the shipper, including any EVC's included in the bill.

Petitioner did not reduce the amount transferred to NUF by any

amount uncollected or any cost it incurred in collecting

delinquent EVC's.   Petitioner also adjusted and paid all claims

with respect to lost or damaged shipments.   Petitioner also

defended against shippers' claims that had been denied.

Petitioner did not reduce the amounts it transferred to NUF in

order to compensate itself for performing these activities and

did not otherwise charge NUF or OPL for performing any of these

activities.

     Petitioner also continued to provide other services related

to EVC's.   Petitioner provided "controlled parcel handling"

procedures, which were expensive and time consuming.   Those

procedures included bagging, tagging, and tracking high value

packages that had declared values in excess of $100.   Petitioner

maintained a loss prevention department in which it employed

personnel to audit controlled parcel handling procedures.    Such
                              - 58 -


audits took place at petitioner's hub and delivery center

operations.   Petitioner's special controlled parcel handling

procedure with respect to high-value packages constituted extra

services for shipments whose declared value exceeded $100.

Petitioner did not reduce the amount transferred to NUF in return

for performing the controlled parcel handling procedures and did

not otherwise charge NUF or OPL for performing these activities.

     Before January 1, 1984, petitioner performed all the

functions and activities related to the EVC's and was liable for

the damage or loss of packages up to their declared value.     After

January 1, 1984, petitioner continued to perform all the

functions and activities related to EVC's, including billing for

and receiving EVC's, and remained liable to shippers whose

shipments were damaged or lost while in petitioner's possession.

Petitioner continued to receive shippers' claims for lost or

damaged goods, investigate and adjust such claims, and pay such

claims out of the EVC revenue that it had collected from

shippers.   The difference between petitioner's EVC activity

before and after January 1, 1984, was that after that date it

remitted the excess of EVC revenues over claims paid, i.e., gross

profit, to NUF, which, after subtracting relatively small

fronting fees and expenses, paid the remainder to OPL, which was

essentially owned by petitioner's shareholders.
                               - 59 -


     The only potentially relevant change that occurred on

January 1, 1984, was the introduction of the Shippers Interest

contract between petitioner and NUF and the Facultative

Reinsurance Agreement between NUF and OPL.    Petitioner attempts

to justify this arrangement on the ground that it was based on

bona fide business considerations and that the arrangement had

economic substance.   If on the other hand the arrangement with

NUF and OPL had neither business purpose nor economic substance,

other than tax avoidance, the entire arrangement has all the

earmarks of a classic assignment of income wherein petitioner was

attempting to assign EVC income that had been earned through its

own services and activities to OPL for the benefit of

petitioner's and OPL's common shareholders.

     On brief, petitioner relies on Moline Properties, Inc. v.

Commissioner, 319 U.S. 436 (1943), for the proposition that it

may rearrange, change, and divide business activities among

business entities.    We agree that, normally, a choice to transact

business in corporate form will be recognized for tax purposes as

long as there is a business purpose or the corporation engages in

business activity.    See Northern Ind. Pub. Serv. Co. v.

Commissioner, 105 T.C. 341, 347-348 (1995) (citing Moline

Properties, Inc. v. Commissioner, supra at 438-439), affd. 115

F.3d 506 (7th Cir. 1997).   As previously noted, OPL's separate

corporate existence is not being questioned.   The issue then is
                              - 60 -


whether the restructuring of petitioner's EVC activity in 1984 by

inserting NUF and OPL as part of the EVC transactions had

substance.   If these transactions lack substance, then petitioner

engaged in an anticipatory assignment of income and cannot avoid

taxation "no matter how clever or subtle" the arrangement.

United States v. Basye, 410 U.S. at 450.   While a taxpayer may

structure a transaction to minimize tax liability, that

transaction must have economic substance if it is to be respected

for tax purposes.   See Kirchman v. Commissioner, 862 F.2d 1486

(11th Cir. 1989), affg. Glass v. Commissioner, 87 T.C. 1087

(1986).

     The inquiry into whether transactions have sufficient

substance to be respected for tax purposes turns on both the

objective economic substance of the transactions and the

subjective business motivation behind them.   See Kirchman v.

Commissioner, supra at 1491-1492;29 see also ACM Partnership v.


     29
      In Kirchman v. Commissioner, 862 F.2d 1486, 1492 (11th
Cir. 1989), affg. Glass v. Commissioner, 87 T.C. 1087 (1986), the
court observed:

          Courts have recognized two basic types of sham
     transactions. Shams in fact are transactions that
     never occur. In such shams, taxpayers claim deductions
     for transactions that have been created on paper but
     which never took place. Shams in substance are
     transactions that actually occurred but which lack the
     substance their form represents. * * *

Because all the transactions at issue in this case actually
                                                   (continued...)
                              - 61 -


Commissioner, 157 F.3d 231 (3d Cir. 1998), affg. in part and

revg. in part on another ground T.C. Memo. 1997-115; Lerman v.

Commissioner, 939 F.2d 44, 53-54 (3d Cir. 1991), affg. Fox v.

Commissioner, T.C. Memo. 1988-570; Casebeer v. Commissioner, 909

F.2d 1360, 1363 (9th Cir. 1990), affg. in part and revg. in part

on another ground Larsen v. Commissioner, 89 T.C. 1229 (1987).

The objective and subjective prongs of the inquiry are related

factors both of which form the analysis of whether the

transaction had sufficient substance apart from its tax

consequences.   See ACM Partnership v. Commissioner, supra at 247;

Casebeer v. Commissioner, supra at 1363.

     In making our determination as to whether a transaction has

substance, we will first look to whether the taxpayer had a

business purpose for engaging in the transaction other than tax

avoidance.   See Frank Lyon Co. v. United States, 435 U.S. 561,

583-584 (1978); Kirchman v. Commissioner, supra at 1492; Bail

Bonds by Marvin Nelson, Inc. v. Commissioner, 820 F.2d 1543, 1549

(9th Cir. 1987), affg. T.C. Memo. 1986-23.   The determination of

whether the taxpayer had a legitimate business purpose in

entering into the transaction involves a subjective analysis of




     29
      (...continued)
occurred, we limit our inquiry to the question of whether their
substance corresponds to their form.
                                - 62 -


the taxpayer's intent.   See Kirchman v. Commissioner, supra at

1492.

     Petitioner argues that it had legitimate business purposes

for entering into the arrangement with NUF and OPL, other than

tax avoidance.   Petitioner specifically alleges that during 1983

it was seriously concerned that its continued receipt of the

excess value income was potentially illegal under various State

insurance laws and that it was this concern that motivated it to

rearrange its method of handling its EVC activity.    Therefore,

petitioner argues, the EVC income cannot properly be considered

to belong to petitioner.   Petitioner cites Bank of Coushatta v.

United States, 650 F.2d 75 (5th Cir. 1981), as authority.

     In Bank of Coushatta v. United States, supra, the taxpayer

bank was contesting the imposition of Federal income tax on

credit life insurance commissions, which the bank contended were

actually earned by one of its executives.    See id. at 76.   The

bank had transferred the credit life insurance business to the

executive because the bank believed that it would have been

illegal for it to continue to earn and receive insurance

commissions.   The District Court reasoned that because there was

no showing of any kind that the bank ever received the

commissions as income under section 61, the bank had not "earned"

the income.    See id. at 77.   The Court of Appeals for the Fifth

Circuit affirmed on the basis of the District Court's opinion.
                              - 63 -


However, the Court of Appeals limited its holding to the

situation where the bank's decision to transfer the insurance

business to the executive was motivated by the good faith belief

that it would be illegal for the bank to continue to earn and

receive insurance commission income.   See id. at 76.   Therefore,

petitioner's ability to rely on Bank of Coushatta depends on

whether petitioner's decision to transfer the excess value income

to OPL through NUF was motivated by a good faith concern that it

was illegal for petitioner to continue to receive the excess

value income.   We do not believe that this was petitioner's

purpose.

     Mr. Kenneth Johnson, head of petitioner's insurance

department, testified that in the early 1980's he learned that

the collision damage waivers offered by the Hertz and Avis rental

car companies were being challenged by State insurance regulators

as an illegal insurance business and that this caused him to

become concerned that petitioner's excess value activity could be

viewed by State insurance regulators as engaging in an unlicensed

insurance activity.   No State insurance regulators had ever

questioned the legality of petitioner's EVC activity, and Mr.

Johnson was not aware that any such questions had ever been

raised with other carriers.   Mr. Johnson testified that, because

of his concerns, he had a casual conversation with an
                              - 64 -


acquaintance, Ms. Yudain, who was an insurance broker who told

him that his concerns might have substance.

     Both Mr. Johnson and Mr. Corde testified that they met in

1982 and had some discussion regarding the possibility that

petitioner's EVC activities might run afoul of State insurance

regulations.   After Mr. Johnson met with Mr. Corde in 1982, Mr.

Corde sent Mr. Johnson a report on September 7, 1982, discussing

the feasibility of creating a subsidiary to reinsure declared

value risks.   The report stated:

     It is our understanding that * * * [petitioner]
     currently provides its customers with coverage for any
     parcels lost or damaged up to $100. Those parcels with
     values in excess of $100 can be declared by the shipper
     and protection secured at a cost of $.25 per $100 of
     value. While this protection is not considered to be
     insurance, it could be converted to insurance and that
     insurance could be provided by a * * * [petitioner]
     owned insurance company.

The report contains figures regarding petitioner's EVC revenues,

claims, and gross profits and discusses the potential for

increasing profits.   The report does not discuss problems with

State insurance laws.

     Mr. Johnson's conversation with Mr. Corde in 1982 appears to

be his and petitioner's last inquiry regarding problems with

State insurance regulation.   Neither Mr. Johnson nor petitioner

sought legal advice regarding these alleged concerns.   In

addition, neither Mr. Johnson nor anyone else on petitioner's

staff appears to have made an inquiry as to whether the EVC
                               - 65 -


program, as proposed to be restructured, might violate State

insurance regulations.   No contemporaneously prepared documentary

evidence was presented to indicate that petitioner had such

concerns or to indicate that petitioner analyzed the alleged

problem and considered the steps necessary to deal with its

alleged concerns.30   Mr. Johnson's testimony on cross-examination

is revealing:

          Q.   Your concern about possible state regulation, you
     never discussed this with the [sic] anybody at the ICC, did
     you?

          A.    I did not.   No.

          Q.   And you're not aware of anybody at UPS ever
     discussing it with anybody at the ICC.

          A.    I'm not aware of it.




     30
      During 1983, Mr. Corde of Frank B. Hall inquired about how
other Hall clients handled cargo coverage in connection with
analyzing the proposed UPS declared value program. Mr. Doug
Brown of Hall prepared an internal memorandum to Mr. Corde dated
Mar. 2, 1983, outlining the arrangements of other companies which
were Hall clients. The concluding paragraph of Mr. Brown's
memorandum states:

     In my discussions with Frank B. Hall people and
     underwriters, the opinion with regard to the legality
     of selling shippers interest when in fact neither
     client is a licensed insurance agent was that provided
     the carrier is simply requesting an acceptance or
     declination from the shipper for the insurance does not
     put them in a brokerage or agency position. I find
     this questionable especially since both clients that I
     reviewed are doing very little domestic Shippers
     Interest coverage, consequently, the problem may not
     have arisen.
                          - 66 -


     Q.   You're not aware -- you did not discuss it with
any state regulators.

     A.   No, I didn't.

     Q.   Either insurance or transportation.

     A.   That's correct.

     Q.   And you're not aware of anybody at UPS discussing
it with any state regulators, insurance or transportation.

     A.   No, I'm not.

     Q.    Throughout the entire time that UPS was
considering revising the excess value program, it never
obtained a legal -- a written legal opinion relating to
whether the excess value activity could be construed as
insurance.

     A.   I did not.

     Q.   And you're not aware of UPS doing it.

     A.   No, I'm not.

     Q.   And you never -- UPS never prepared an opinion of
even in-house counsel relating to whether the activity --
its excess value activity could be construed as insurance.

     A.   Not that I'm aware of.

     Q.   Pardon me?   I didn't hear you.

     A.   I said -- I'm sorry -- not that I'm aware of.   I
did not request one.

     Q.   Even after you became concerned and started with
the negotiations, you didn't ask for an opinion, a legal
opinion.

     A.   No.

     Q.   Okay. You indicated yesterday you were concerned
about the Avis and Hertz collision damage waiver cases.

     A.   And liability insurance.
                          - 67 -


     Q.   And liability insurance cases. Did you ever
request a legal opinion as to whether UPS's activity was
similar or distinguishable?

     A.   No.

     Q.   During the negotiations, did you ever request an
opinion regarding whether federal transportation law
preempted state regulation?

     A.   No, I didn't.

     Q.   Okay. At some point in late 1984, UPS decided to
go forward with the transaction. Correct?

     A.   1983.

     Q.   1983.   I'm sorry.

     A.   1983, yes.

     Q.   And it --

     A.   I don't know if it was late in 1983.

     Q.   It's not my intention to quibble about the date.
Sometime in 1983, UPS decided to go forward.

     A.   Yes.

     Q.   And at some point, the structure was fairly known
to you. National Union would be involved, and OPL would be
the reinsurer. Is that correct?

     A.   Yes.

     Q.   At that point in time, did you request a legal
opinion as to whether that satisfactorily alleviated your
concerns about state regulation?

     A.   No.

     Q.   Did UPS?

     A.   Not that I'm aware of.

     Q.   Now, was --
                           - 68 -


          THE COURT:    Mr. Johnson, could you speak up just a
little bit.

            THE WITNESS:   I'm sorry, sir.

            BY MR. KLETNICK:

     Q.   Was one of the aspects of your concern that UPS
employees were selling excess value units in 1983?

      A.  That was one of my -- my concerns were that it was
offered to our customers and they were accepting it in
1983.

       Q.   And who was it offered by?

     A.   It was in -- I guess, in our explanation of
service, and I assume the customer service people were
talking to our customers about it.

     Q.   So they would, in effect, be selling excess value
units, wouldn't they?

       A.   I think it would certainly look like that.   Yes.

       Q.   And so was that part of your concern?

       A.   Yes, it was.

       Q.   And they're not licensed as brokers.

       A.   No, they're not.

       Q.   They're not licensed as agents.

       A.   No, they're not.

     Q.   And then if there's a claim, UPS customer service
personnel would on occasion settle the claim.

       A.   We had a claims department --

       Q.   Right.

       A.   -- yes, in the company that would settle claims.
Yes.
                                - 69 -


          Q.   All right.    And those people weren't licensed in
     various states?

          A.   No.

          Q.   Okay.   So was that part of your concern?

          A.   Yes.

          Q.   Okay. So now after NUF comes into the picture,
     the same UPS employees are still meeting with the
     customers. Correct? The shippers?

          A.   Yes.

          Q.   They're still selling the excess value units.
     Right?

          A.   I wouldn't characterize it as -- well, call it
     selling if you want, but I don't --

          Q.   Well, what would you call it?

          A.   I don't know. I don't know what I would call it.
     I don't really know how they did it is my problem.

          Q.   They were going out and meeting with the
     customers, telling them about UPS's excess value -- the
     excess value charges.

          A.   Yes.    I'm sure they were.

          Q.   So -- and -- but you did not take the next step
     and obtain an opinion as to whether that would be
     permissible under state insurance laws?

          A.   No, I did not.

     With nothing more than the sketchy testimony about vague

concerns by Mr. Johnson, petitioner would have us conclude that

it divested itself of a very profitable $100 million per year

revenue source that was based on a decades-old system for setting

shipping rates that had consistently received approval of the
                              - 70 -


Federal and State Governments.    We do not believe that petitioner

would have restructured a significant portion of its business in

order to avoid a potential State law problem without having

thoroughly analyzed and considered the matter and the

ramifications that any proposed change might have.

     Had petitioner been seriously concerned with State insurance

regulation, a logical question would have been whether

petitioner's EVC activity regarding interstate transportation was

preempted by Federal law.   The liability of an interstate carrier

for damage to a shipment is a matter of Federal law controlled by

Federal statutes and decisions.   See Missouri Pac. R.R. v. Elmore

& Stahl, 377 U.S. 134, 137 (1964); A.T. Clayton & Co. v.

Missouri-Kan.-Tex. R.R., 901 F.2d 833, 834 (10th Cir. 1990) ("The

Carmack Amendment codifies an initial carrier's liability for

goods lost or damaged in shipment.").   Generally, carriers are

liable for loss or damage caused by them to property they

transport.   See id.; see also Shippers Natl. Freight Claim

Council, Inc. v. ICC, 712 F.2d 740, 745 (2d Cir. 1983).

     During the years in issue, pursuant to the Carmack Amendment

to the Interstate Commerce Act,31 a motor common carrier could


     31
      Although the substance of the Carmack Amendment
(originally 49 U.S.C. sec. 20(11) (1906)) was recodified into 49
U.S.C. secs. 11707, 10730, and 10103, these sections were
commonly termed the Carmack Amendment. See Hughes v. United Van
Lines, Inc., 829 F.2d 1407, 1412 n.6 (7th Cir. 1987). Effective
                                                   (continued...)
                             - 71 -


establish rates for the transportation of property under which

the liability of the carrier was limited to a value established


     31
      (...continued)
Jan. 1, 1996, the Carmack Amendment was again recodified at 49
U.S.C. secs. 11706, 14706, and 15906. See Accura Sys., Inc. v.
Watkins Motor Lines, Inc., 98 F.3d 874, 876 n.2 (5th Cir. 1996).

49 U.S.C. sec. 11707 (1994) provides in pertinent part:

          (a)(1) A common carrier providing transportation
     or service subject to the jurisdiction of the
     Interstate Commerce Commission * * * shall issue a
     receipt or bill of lading for property it receives for
     transportation * * *. That carrier or freight
     forwarder and any other common carrier that delivers
     the property and is providing transportation or service
     * * * are liable to the person entitled to recover
     under the receipt or bill of lading. The liability
     imposed under this paragraph is for the actual loss or
     injury to the property caused by [the carrier] * * *

          *      *      *      *        *     *     *

          (c)(4) A common carrier may limit its liability
     for loss or injury of property transported under
     section 10730 of this title.

49 U.S.C. sec. 10730(b)(1) (1994) provides:

     [A] motor common carrier * * * may * * * establish
     rates for the transportation of property (other than
     household goods) under which the liability of the
     carrier * * * for such property is limited to a value
     established by written declaration of the shipper or by
     written agreement between the carrier * * * and shipper
     if that value would be reasonable under the
     circumstances surrounding the transportation.

49 U.S.C. sec. 10103 (1994) provides:

          Except as otherwise provided in this subtitle, the
     remedies provided under this subtitle are in addition
     to remedies existing under another law or at common
     law.
                              - 72 -


by written declaration of the shipper or by written agreement

between the carrier and the shipper if that value would be

reasonable under the circumstances surrounding the

transportation.   See 49 U.S.C. sec. 11707(a)(1) (1994); see also

Fabulous Fur Corp. v. United Parcel Serv., 664 F. Supp. 694, 696

(E.D.N.Y. 1987); Art Masters Associates, Ltd. v. United Parcel

Serv., 567 N.E.2d 226, 227-228 (N.Y. 1990).   A motor common

carrier must publish and file with the ICC tariffs containing the

rates for transportation it may provide.   See 49 U.S.C. sec.

10762(a)(1) (1994); Fabulous Fur Corp. v. United Parcel Serv.,

supra at 696.

     Petitioner offered its interstate shippers "released rates"

authorized by a series of ICC Released Rate Orders (RRO).32

Petitioner filed tariffs and tariff supplements during the years

in issue which determined released value rates authorized by the

ICC by Released Rates Decision MC-978.   Under the "Damaged and

Unclaimed Property" provision 535 of the tariffs, if the package

was damaged by petitioner, petitioner was liable to the shipper

to pay the full actual or declared value of the property,

whichever was lower.   Under the "Method of Determining Rates"

provision of the tariffs, if a shipper did not declare value in

excess of $100, petitioner collected its base rate and its


     32
      Similar orders were issued by each State relating to
intrastate orders.
                                - 73 -


liability was limited to $100.    If a shipper declared value in

excess of $100, petitioner collected its base rate plus an EVC of

25 cents per $100 of additional declared value and its liability

equaled the amount of value declared.     Thus, the EVC was part of

the rate charged by petitioner, and the rates, including the EVC,

were determined under the tariff.    Under both Federal law and the

provisions of the tariff, petitioner was liable for damage to

shippers' packages up to the declared value or $100 if no value

was declared.

     Even if petitioner's excess value activity could be

characterized as some form of "insurance" under the various State

laws, Federal law appears to preempt State law with regard to the

liabilities of interstate carriers.      The Supreme Court addressed

the preemptive scope of the Carmack Amendment, relating to State

regulation of carrier liability, in Adams Express Co. v.

Croninger, 226 U.S. 491 (1913).    There, the Court held:

     Almost every detail of the subject is covered so
     completely that there can be no rational doubt but that
     Congress intended to take possession of the subject and
     supersede all state regulation with reference to it.
     * * * [Id. at 505-506.]

Later, in Moffit v. Bekins Van Lines Co., 6 F.3d 305 (5th Cir.

1993), the Court of Appeals for the Fifth Circuit addressed the

Carmack Amendment and stated:

     a purpose of the Carmack Amendment was to "substitute a
     paramount and national law as to the rights and
     liabilities of interstate carriers subject to the
                              - 74 -


     Amendment." This Court, furthermore, adopted the
     Supreme Court's language in Adams Express Co.:

               That the legislation supersedes all the
          regulations and policies of a particular
          state upon the same subject results from its
          general character. It embraces the subject
          of the liability of the carrier under a bill
          of lading which he must issue, and limits his
          power to exempt himself by rule, regulation,
          or contract.

               To hold that the liability therein
          declared may be increased or diminished by
          local regulation or local views of public
          policy will either make the provision less
          than supreme, or indicate that Congress has
          not shown a purpose to take possession of the
          subject. The first would be unthinkable, and
          the latter would be to revert to the
          uncertainties and diversities of rulings
          which led to the amendment. [Id. at 306-307
          (citing Air Prods. & Chems. v. Illinois Cent.
          Gulf R.R., 721 F.2d 483, 486 (5th Cir. 1983)
          (quoting Adams Express Co. v. Croninger,
          supra at 505-506)).]

     Petitioner has successfully asserted that the Carmack

Amendment preempted State law which might otherwise govern a

shipper's claim for damage to packages.   See Plaid Giraffe, Inc.

v. United Parcel Serv., Inc., No. 94-1002-PFK (D. Kan., Sept. 26,

1994); Art Masters Associates, Ltd. v. United Parcel Serv., supra

at 228-229.   Petitioner similarly defended itself in other

actions by shippers for recovery of lost or damaged shipments.33


     33
      In United Parcel Serv., Inc. v. Smith, 645 N.E.2d 1 (Ind.
Ct. App. 1994), petitioner appealed from an action in which Glenn
Smith, the shipper, filed suit against petitioner regarding an
allegedly lost shipment. Mr. Smith sought to recover $995, the
                                                   (continued...)
                             - 75 -


While we need not specifically decide whether Federal law

preempts State insurance laws with respect to petitioner's excess

value activity, we believe that petitioner was well aware of the

preemption position and had good reason to believe that it


     33
      (...continued)
value of the lost package, from petitioner.   On appeal,
petitioner advanced the position that

          Congress clearly intended the Carmack Amendment to
     preempt all state regulation of claims against common
     carriers for interstate ground shipments, and the
     Supreme Court has specifically so held * * *
     [Appellant's Opening Brief at 14, United Parcel Serv.,
     Inc. v. Smith, supra.]

The Indiana Court of Appeals concluded that "49 U.S.C. § 10101 et
seq., the Interstate Commerce Act, and specifically those
portions known as the Carmack Amendment, preempt all state
regulation of interstate ground shipments." Id. at 3 (fn. ref.
omitted).

     In Simmons v. United Parcel Serv., 924 F. Supp. 65 (W.D.
Tex., 1996), Mr. James W. Simmons filed suit in the State
District Court of Bexar County, Texas against petitioner
regarding two 1994 excess value shipments. Mr. Simmons sought to
recover $49,000 in damages. On motion by Mr. Simmons to remand
to the State Court, petitioner alleged that the Carmack Amendment
completely preempted all State law claims. The court stated:

     Under the "complete pre-emption doctrine," once an area
     of state law has been completely pre-empted, any claim
     purportedly based on that pre-empted state law is
     considered, from its inception, a federal claim, and
     therefore arises under federal law. * * * Both the
     Supreme Court and the Fifth Circuit have held that the
     Carmack Amendment preempts all state law claims against
     a common carrier. * * * [Id. at 67 (citing Adams
     Express Co. v. Croninger, 226 U.S. 491 (1913); Moffit
     v. Bekins Van Lines, Co., 6 F.3d 305 (5th Cir. 1993)).]

The court held that the "complete pre-emption" doctrine applied
and that removal from State court was proper. See id.
                                   - 76 -


applied.34       Nevertheless, petitioner made no attempt to analyze

the issue or obtain legal advice before deciding to restructure

the EVC part of its business.       This leads us to believe that

petitioner's interjection of NUF and OPL into its excess value

activities in 1984 was not done in order to avoid running afoul

of State insurance laws and regulations.35



     34
      Petitioner has not attempted to draw a distinction between
concerns about interstate versus intrastate matters. According
to the testimony of petitioner's former chairman and C.E.O., in
excess of 75 percent of petitioner's volume in 1984 consisted of
interstate shipments and 98 percent of petitioner's volume in
1984 consisted of ground transportation. As previously
indicated, petitioner obtained authorization for its pre-1984 EVC
activities from the required State transportation authorities,
and no State had asserted that petitioner was not in compliance
with State insurance law.
     35
          As stated by Dr. Shapiro in his expert report:

     Assuming the risk of state regulation was real,
     abandoning a profitable business because of this risk
     is equivalent to burning down the barn to get rid of
     the rats. Even if you solved the problem, the price
     was too high.

             *        *      *      *       *     *      *

          Based on my business experience, it is my
     strongly-held opinion that a company would not walk
     away from such a valuable business on a mere suspicion
     that it might be subject to an added risk of
     regulation. Rather, in such a situation, the company
     would first meet with legal counsel to get an opinion
     as to the likelihood and business consequences of such
     regulation. Next, it would analyze the financial
     impact of such regulation and explore how it might be
     able to legally avoid, minimize, or delay the impact of
     any potential regulation. * * * [Fn. ref. omitted.]
                                 - 77 -


     Assuming that petitioner's excess value activity might have

been considered "insurance" subject to regulation under various

State laws, petitioner's "restructured" method of handling EVC's

would also seem to violate State laws.     For example, in some

States the sale or solicitation of insurance without

authorization is a violation of State statutes.     See, e.g., Cal.

Ins. Code sec. 700 (West 1993);36 N.Y. Ins. Law sec. 109(a)


     36
          Cal. Ins. Code sec. 700 (West 1993) provides:

     §700.     Admittance required; penalties; compliance; hearings;
                 issuance of certificate

          (a) A person shall not transact any class of
     insurance business in this state without first being
     admitted for that class. Admission is secured by
     procuring a certificate of authority from the
     commissioner. The certificate shall not be granted
     until the applicant conforms to the requirements of
     this code and of the laws of this state prerequisite to
     its issue.

          (b) The unlawful transaction of insurance business
     in this state in willful violation of the requirement
     for a certificate of authority is a public offense
     punishable by imprisonment in the state prison, or in a
     county jail not exceeding one year, or by fine not
     exceeding one hundred thousand dollars ($100,000), or
     by both, and shall be enjoined by a court of competent
     jurisdiction on petition of the commissioner.

Cal. Ins. Code sec. 35 (West 1993) provides:

     §35.     Transact

          "Transact" as applied to insurance includes any of
     the following:

             (a) Solicitation.
                                                      (continued...)
                                   - 78 -


(McKinney 1985).37       During 1984, petitioner provided its shippers


     36
          (...continued)
              (b) Negotiations preliminary to execution.

             (c) Execution of a contract of insurance.

          (d) Transaction of matters subsequent to execution
     of the contract and arising out of it.
     37
          N.Y. Ins. Law sec. 1102 (McKinney 1985) provides:

     §1102.      Insurer's license required; issuance

          (a) No person, firm, association, corporation or
     joint-stock company shall do an insurance business in
     this state unless authorized by a license in force
     pursuant to the provisions of this chapter, or exempted
     by the provisions of this chapter from such
     requirement. Any person, firm, association,
     corporation or joint-stock company which transacts any
     insurance business in this state while not authorized
     to do so by a license issued and in force pursuant to
     this chapter, or exempted by this chapter from the
     requirement of having such license, shall, in addition
     to any other penalty provided by law, forfeit to the
     people of this state the sum of one thousand dollars
     for the first violation and two thousand five hundred
     dollars for each subsequent violation.

N.Y. Ins. Law sec. 1101(b)(1) (McKinney 1985) provides:

     § 1101. Definitions; doing an insurance business

          (b)(1) Except as provided in paragraph two hereof,
     any of the following acts in this state, effected by
     mail from outside this state or otherwise, by any
     person, firm, association, corporation or joint-stock
     company shall constitute doing an insurance business in
     this state and shall constitute doing business in the
     state within the meaning of section three hundred two
     of the civil practice law and rules:

             *       *       *      *       *     *      *

                                                         (continued...)
                               - 79 -


with the necessary forms upon which the shippers could declare

excess value.   The package pickup record was used by petitioner

to bill shippers for the EVC's sold.    Petitioner received and

deposited EVC income in its corporate accounts.    Thus, assuming

that the Shippers Interest Program was insurance, petitioner sold

or solicited the putative insurance in 1984.    Petitioner also

received, reviewed, defended, and paid claims.    By selling the

Shippers Interest policy, collecting the premiums, and adjusting

claims without the appropriate licenses, petitioner would

seemingly have been in violation of State statutes prohibiting

the sale, collection of premium, and adjustment of claims related

to the NUF insurance policy.   It strains credulity to believe

that petitioner attempted to avoid the requirements of State

statutes by restructuring its excess value activity in a manner

that arguably caused petitioner to remain in violation of State

statutes.38   Had such a restructuring occurred to avoid violating

State law, we believe that a large successful corporation such as




     37
      (...continued)
          (C) collecting any premium, membership fee,
     assessment or other consideration for any policy or
     contract of insurance;
     38
      Indeed, on the question of whether petitioner's EVC
activity constitutes "insurance", petitioner fails to make any
meaningful distinction between the promise to "insure" the first
$100 of value in return for a shipping fee, which petitioner
continued after Jan. 1, 1984, and the excess value activity.
                               - 80 -


petitioner would have thoroughly analyzed the legal and business

ramifications.    That was not done.

     Petitioner also argues that one of its business purposes for

restructuring the EVC activity was to leverage the excess value

profits into the creation of a new reinsurance company, which

over time could become a full-line insurer.    We have no doubt

that transferring the profits from the EVC activity, tax free,

could provide OPL with the capital to become a full-line insurer

of other risks.    But any investment of money into OPL could

accomplish this purpose.    The question here is whether petitioner

earned, and must pay tax on, the funds ultimately transferred to

OPL or whether the EVC profits were earned by NUF and OPL.      The

purpose for which the profits were ultimately used, or intended

to be used, does not answer the question before us.

     Petitioner alleges that another business purpose for

restructuring its EVC activity was to enable it to increase its

rates.    Petitioner argues that by removing the excess value

revenue from its operating ratio computation, it could obtain

larger rate increases than would have otherwise been possible.

Petitioner historically targeted a 90-percent operating ratio on

its ground transportation business.39   Petitioner alleges that


     39
      Petitioner's operating ratio was computed as a ratio of
operating expenses to operating revenue. An operating margin is
the inverse of an operating ratio. Thus, a 90-percent operating
                                                   (continued...)
                              - 81 -


its operating ratios played an important role in obtaining rate

increases.

     We do not believe that petitioner shifted EVC income to OPL

in order to justify raising its rates.   The 90-percent operating

ratio was a standard set by petitioner rather than a Federal or

State regulatory mandate.   The Motor Carrier Act of 1980 (MCA),

Pub. L. 96-296, 94 Stat. 793, provided for a Zone of Rate Freedom

(ZORF) for motor common carriers and freight forwarders.   ZORF

allowed for the filing of rate increases up to 10 percent above

the rate in effect 1 year before the effective date of the

proposed increase or a decrease of as much as 10 percent below

the lesser of the rate in effect on July 1, 1980, or the rate in

effect 1 year before the effective date of the proposed rate.

See MCA sec. 11, 94 Stat. 801.40   Petitioner did not offer any


     39
      (...continued)
ratio is equal to a 10-percent operating margin.
     40
      The pertinent portion of the Motor Carrier Act of 1980,
Pub. L. 96-296, sec. 11, 94 Stat. 801, provided:

     ZONE OF RATE FREEDOM FOR MOTOR CARRIERS OF PROPERTY AND
     FREIGHT FORWARDERS

          Sec. 11. Section 10708 of title 49, United States
     Code, is amended by adding at the end thereof the
     following new subsection:

          (d)(1) Notwithstanding any other provision of this
     title, the Commission may not investigate, suspend,
     revise, or revoke any rate proposed by a motor common
     carrier of property or freight forwarder on the grounds
                                                   (continued...)
                              - 82 -


credible evidence that the various Federal and State regulatory

agencies would have denied a rate increase had it retained the

EVC income.   Petitioner's primary consideration in setting rates

was fairness and competition, according to its former executives.

Indeed, the testimony of petitioner's former executives indicates

that they could have sought greater rate increases under ZORF

than what was requested and that they were not concerned about

maximizing rates.   In November 1984, petitioner sought and

obtained from the ICC and various State regulatory bodies a 5.45-

percent rate increase effective January 1, 1985.   Petitioner's

rate increase of 5.45 percent was 4.55 percent less than the

maximum increase allowed by ZORF.




     40
      (...continued)
     that such rate is unreasonable on the basis that it is
     too high or too low if--,

          (A) the carrier notifies the Commission that it
     wishes to have the rate considered pursuant to this
     subsection; and

          (B) the aggregate of increases and decreases in
     any such rate is not more than 10 percent above the
     rate in effect one year prior to the effective date of
     the proposed rate, nor more than 10 percent below the
     lesser of the rate in effect on July 1, 1980 (or, in
     the case of any rate which a carrier first establishes
     after July 1, 1980, for a service not provided by such
     carrier on such date, such rate on the date such rate
     first becomes effective), or the rate in effect one
     year prior to the effective date of the proposed rate.
                                - 83 -


     Mr. Kent C. Nelson who, during the years in issue, was a

member of petitioner's board of directors and was petitioner's

chief financial officer, testified as follows:

           Q.  Mr. Nelson, I believe you mentioned earlier
     you were familiar with the rate increase in January
     1985?

          A.      Yes.

          Q.   Was that rate increase higher or lower
     because of the spinoff of the [excess value] business?

          A.   It's hard to tell, because the projection
     process projects increased volume, projected labor
     costs, and the revenue that we had from growing
     businesses that are profitable. And it all comes
     together the way it comes together. I don't know if it
     would have had any effect on it at the time. It would
     be conjecture on my part.

          *        *      *      *       *     *      *

          Q.   Assuming that all other factors were equal,
     did the rate increase in 1985 increase or decrease
     because of the transfer of the excess value business.

          A.      I don't think it made any difference.

Like petitioner's other alleged business justifications for

restructuring its EVC activity, there is no contemporaneous

documentation that petitioner investigated or considered the

impact that restructuring its EVC activity would have on its

shipping rates.

     Petitioner also argues that by restructuring the EVC

activity, it enhanced protection of the assets of its core

transportation activity from the risks associated with assuming
                             - 84 -


liability for declared value in excess of $100.   In order to

evaluate this alleged business purpose, we will look to whether

petitioner actually transferred or reduced its liability to

shippers in any meaningful sense.   In other words, did the

rearranged EVC activity have any real economic impact on

petitioner?

     In 1983, petitioner supplemented tariffs filed with the ICC

on behalf of UPS-New York and UPS-Ohio.   Supplement provision

540-A to the tariffs provided that petitioner "may" remit excess

valuation charges to an insurance company as a premium for excess

valuation cargo insurance on the shipper's behalf.   However,

supplement provision 540-A also stated that in the event that the

insurance company failed to pay any claim for loss or damage to

the shipper's property under the policy, petitioner would remain

liable for any loss or damage within the limits declared and paid

for.41


     41
      Petitioner's service explanation also states that if NUF
fails to pay any claim for loss of or damage to the shipper's
property, petitioner will remain liable for loss or damage within
the declared limits of the Shippers Interest contract.

     The Shippers Interest contract document specifically lists
the shippers under the "name and address of insured". However,
the contract document also lists the address of the insured to be
that of petitioner's world headquarters. Under the cancellation
provision of the Shippers Interest contract, either petitioner or
the "Named Insured" could terminate the contract. Thus,
petitioner had the power to cancel the insurance policy that
petitioner alleges was between its shippers and NUF. Of course,
                                                   (continued...)
                              - 85 -


     Pursuant to tariff provision 510, filing of claims, shippers

were required to allege in writing, among other things, that

petitioner was liable for the loss or damage.   Pursuant to tariff

provision 520, time limit for filing claims, petitioner was

relieved of liability under its tariff if the shipper did not

file a claim with petitioner or institute a lawsuit against

petitioner within 2 years and 1 day from when petitioner notified

the shipper that the claim had been disallowed by petitioner.

Under this provision, shippers were required to bring an action

against petitioner in order to pursue their claims for damage or

loss of packages.   Each of the above-mentioned provisions existed

in petitioner's tariffs before and during 1984.   On the basis of

Federal law and the provisions that remained in petitioner's

tariffs, liability continued to arise under such tariffs in 1984.

     Petitioner treated liability for loss or damages associated

with EVC's as arising from petitioner's tariffs in accordance

with Federal law.   Upon commencement of a relationship with its

shippers, petitioner provided most shippers with a copy of

petitioner's service explanation.   While the service explanation

referred to NUF and the Shippers Interest contract, petitioner

did not generally provide a copy of the Shippers Interest


     41
      (...continued)
petitioner would in any event have remained liable to its
shippers for damage claims.
                              - 86 -


contract to each of its shippers.   As a result of tariff

requirements 510 and 520, rather than filing claims with NUF

under the Shippers Interest contract, shippers were required to

file a claim only "against" petitioner within a specific time in

order to be compensated for loss or damage.   Even at the point

when petitioner adjusted shippers' claims, petitioner does not

appear to have informed the shippers that NUF was the insurer of

the claim or that the shippers had any recourse against NUF.

Thus, shippers' claims were presented to and resolved by

petitioner in accordance with the provisions of the tariff.

Petitioner represented to its customers in its quarterly

publications that petitioner was liable for lost or damaged

packages.   In December 1983, petitioner's Roundups newsletter

informed its customers that petitioner's drivers would leave

packages without signatures at certain delivery locations.     In

the newsletter, petitioner assured its shippers that UPS would

continue to assume liability for lost and damaged packages up to

$100 or the declared value.   On the basis of the foregoing facts,

we find that after January 1, 1984, petitioner remained liable to

shippers who had declared a value in excess of $100.

     There still remains the question of whether the arrangement

with NUF and OPL sufficiently reduced petitioner's financial

exposure to be recognized as having economic substance.     The

Shippers Interest contract provided that NUF was not liable for
                               - 87 -


the first $100 of value, and in no event did NUF's liability

exceed the declared value of a shipper's package.   The Shippers

Interest contract also provided that if petitioner's liability

for loss or damage to a shipper's package was covered by another

insurance policy, then NUF would not be liable for the amount

covered by petitioner's other insurance policy.   Other insurance

did exist.

     Throughout 1984, petitioner maintained an insurance policy

with Affiliated FM Insurance Co. (AFM policy) that covered

petitioner's liability for loss or damage to shipper's

packages.42   Petitioner paid annual installment premiums of

$356,945 of which $86,820 was allocated to property value related

to parcels in transit.   Under the policy, $86,820 of annual

premium provided coverage for an average daily parcel value of

$354,369,000.   The AFM policy provided for a $25,000 deductible

to all loss claims arising out of a loss occurrence.

     To the extent that other insurance did not exist, the

Shippers Interest contract generally did not limit claims to any

maximum amount per loss occurrence.43   The AFM policy covered


     42
      Petitioner's purchase of the AFM policy and its operation
effect of covering "petitioner's liability" for packages shipped
during 1984 is inconsistent with petitioner's argument that it
had no such liability to shippers after Jan. 1, 1984.
     43
      With respect to packages sent "UPS 2nd day Air" or "UPS
next day air", the Shippers Interest contract limited NUF's
                                                   (continued...)
                                - 88 -


petitioner's liability for package losses related to any single

occurrence to the extent the liabilities were greater than

$25,000 but did not exceed $10 million.    Thus, there was a

theoretical exposure for NUF and OPL, to the extent that one or

more loss occurrences resulted in more than $10 million in loss

per occurrence.    For example, if petitioner incurred liability to

shippers as a result of a single occurrence of three times the

$10 million limit that petitioner was insured for under the AFM

policy in 1984, NUF/OPL would have been liable for approximately

$20 million.44    (Twenty million dollars in additional claims

would have reduced the gross profit percentage from EVC's in 1984

from 78 percent to 58 percent.)    Even in this unlikely event,

excess value revenue in 1984 would have exceeded over two times

the amount of claims paid.     Considering the extreme magnitude of

a catastrophe that would have to occur before claims exceeded

excess value revenue in a given year, we again find it

unrealistic that petitioner or NUF/OPL would realize a loss in

its excess value activity.45


     43
      (...continued)
liability to $25,000 per package.
     44
      Disregarding the $25,000 deductible, petitioner would have
coverage of $10 million under the AFM policy, and NUF/OPL would
be liable for claims in excess of that.
     45
      The only potential financial benefit that petitioner could
realize from its arrangement with NUF and OPL was if liabilities
                                                   (continued...)
                                - 89 -


     Petitioner must have drawn the same conclusion.    Through the

AFM policy, petitioner was able to cover its liability for up to

$10 million for any single occurrence in return for premiums of

$86,820.46   This amount of premium is less than one-tenth the

amount petitioner agreed to pay NUF to be a "front" in the

restructuring of the excess value activity.    NUF and OPL were not

liable for losses attributable to a single occurrence, to the

extent such losses were between $25,000 and $10 million.

Petitioner, in turn, was not dependent upon NUF and OPL for

single-occurrence catastrophic losses above the deductible of

$25,000 and under $10 million but would have been able to procure

coverage for such liability in excess of $10 million for a

relatively nominal premium.

     Petitioner had a conservative, risk-averse insurance

philosophy and sought to have sufficient coverage to protect its

assets from a catastrophe.    In 1983, petitioner considered

raising the $10 million AFM policy limit to $20 million.    In a

letter dated May 26, 1983, sent by Mr. Edmund Mihich, of Hall, to

Mr. Johnson and Mr. Eugene Schoenleber of petitioner's insurance

department, Mr. Mihich wrote:


     45
      (...continued)
for lost and damaged shipments were to exceed EVC revenue that it
had given up.
     46
      This AFM coverage excludes liabilities of up to $25,000
per occurrence.
                                  - 90 -


     Please allow this letter to confirm our telephone
     discussion of May 25, 1983 with regard to the * * *
     [AFM policy].

            *        *      *       *       *      *      *

     With regard to your interest in increasing the unnamed
     location and transit sub-limits from $10,000,000 to
     $20,000,000, Allendale has requested to be provided
     with the exposure data which creates this request.
     Gene, as I indicated to you on the telephone, it was
     Allendale's understanding that the present $10,000,000
     limit provided was far more than sufficient. * * *
     With regard to the transit limit, Allendale was under
     the impression that there was no situation in which the
     exposure approached anywhere near the $10,000,000 mark.

Both Allendale (AFM's parent) and Hall considered petitioner's

AFM policy limit of $10 million to be substantially more coverage

than necessary to insure against losses that petitioner's transit

operation exposed petitioner to.        Petitioner chose not to

increase the limits on the AFM policy to $20 million, further

indicating to us that there was no realistic possibility that

petitioner or NUF/OPL would realize a loss in its excess value

activity.       Because the AFM policy was in effect before, during,

and after the time when petitioner restructured its excess value

activity, we do not find any relationship between petitioner's

goal of protecting against catastrophic loss and the

restructuring of petitioner's excess value activity.47


     47
      An endorsement was added to the Affiliated FM policy
effective Jan. 1, 1984, which referred to the Shippers Interest
contract. However, petitioner maintained the same level of
coverage and deductible of the Affiliated FM policy that existed
                                                   (continued...)
                               - 91 -


     The AFM policy did not provide benefits for damage to

packages below the $25,000 single occurrence deductible.   Such

losses could also theoretically have exceeded EVC revenue.

However, petitioner's excess value losses were part of a very

large universe of shipments, and the ratio of losses to EVC's

remained consistent over many years and was therefore

predictable.48   The following schedule reveals the consistency of

claims paid by petitioner for damages in excess of $100:




     47
      (...continued)
before the execution of the Shippers Interest contract.
     48
      Petitioner had been engaged in a declared value program
since the 1950's.
                              - 92 -


                        Claims Over      EVC's less
   Year       EVC's      $100 Paid1     Claims Paid     Ratio2
  1979    $49,200,000   $13,800,000     $35,400,000     72.0%
   1980    57,900,000    16,200,000      41,700,000     72.0
   1981    70,512,000    20,007,000      50,505,000     71.6
   1982    73,816,000    21,372,000      52,444,000     71.0
   1983    78,000,000    23,000,000      55,000,000     70.5
   1984    99,794,790    22,084,012      77,710,778     77.9
   1985   119,077,863    36,236,469      82,841,394     69.6
   1986   140,255,469    43,499,702      96,755,767     69.0
   1987   161,098,590    52,509,376     108,589,214     67.4
   1988   187,106,344    67,230,962     119,875,382     64.1
   1989   208,596,033    77,214,084     131,378,949     63.0

     1
       Amounts in this column for 1979 and 1980 are estimated
amounts.
     2
       This column represents the ratio of excess value income
less claims paid divided by total excess value income.

Petitioner's excess value claims payments over 11 years never

exceeded 40 percent of the total excess value income.

Considering the consistency of the ratio of loss claims payments

to EVC revenue from year to year, we find that the possibility

that total cumulative annual payments for shipping losses from

single occurrences involving less than $25,000 might exceed EVC

revenue was so remote, that for all practical purposes, it was
                               - 93 -


nonexistent.49   As a result, the level of risk, if any, that was

shifted from petitioner to NUF and OPL was insignificant.

     The possibility that cumulative catastrophic losses in

excess of the $10 million per-occurrence limit on the AFM policy

would occur, and that claims for occurrences involving less than

$25,000 would increase dramatically, and that, either

individually or in combination, they would exceed total EVC's,

was improbable, unrealistic, and insignificant.   We find that

these theoretical possibilities had nothing to do with

petitioner's motivation for transferring the EVC profits, less

fronting costs, to OPL and that the insertion of NUF and OPL into

petitioner's EVC activity provided no significant nontax benefit

to either petitioner or its shippers.



     49
      We agree with respondent's expert Mr. Edward T. Kelley,
who concluded as follows:

          As a general rule, the firm would prudently retain
     exposures which could be expected to generate
     reasonably predictable numbers of claims and relatively
     stable and consistent amounts of total loss, and seek
     to transfer exposures with substantially lower
     predictability and greater volatility to an insurer
     willing to assume liability for such exposures at terms
     acceptable to the firm. Since * * * [petitioner], by
     the nature of its operations, generates a very large
     number of relatively homogeneous units of exposure, the
     predictability of expected losses related to shippers'
     property in its custody is very high and year to year
     variability is relatively limited. Its self-insurance
     program for handling claims for loss of or damage to
     shippers' property produced consistently profitable
     results during the years 1979 through 1982 * * *.
                              - 94 -


     Another factor in determining whether a particular

transaction was a sham is the presence or absence of arm's-length

price negotiations and the relationship between the price and

fair market value.   See Helba v. Commissioner, 87 T.C. 983, 1005

(1986), supplemented by T.C. Memo. 1987-529, affd. 860 F.2d 1075

(3d Cir. 1988); see also Karme v. Commissioner, 73 T.C. 1163,

1186-1190 (1980), affd. 673 F.2d 1062 (9th Cir. 1982).    In

deciding such issues, courts often look to expert opinions.    The

Court is not bound by the opinion of any expert, and we may

accept or reject in full or in part experts' opinions proffered

by the parties.   See Helvering v. National Grocery Co., 304 U.S.

282, 294-295 (1938); Seagate Tech., Inc., & Consol. Subs. v.

Commissioner, 102 T.C. 149, 186 (1994); Parker v. Commissioner,

86 T.C. 547, 562 (1986).   Both petitioner and respondent offered

the reports and testimony of various expert witnesses in an

effort to establish an arm's-length price that petitioner could

have obtained for the coverage provided by NUF and OPL.

     Respondent offered the expert report of Mr. Kelley for the

purpose of proving that, within the insurance industry, the

arm's-length price that petitioner could have obtained for

coverage associated with petitioner's excess value activity would

have been substantially less than 25 cents per $100 of excess

value.   Mr. Kelley has in excess of 30 years of experience buying
                             - 95 -


and providing insurance and reinsurance products.   In his report,

Mr. Kelley stated:

     The .25 per $100 of declared value charges used on the
     NUF policy was apparently derived directly from * * *
     [petitioner's] tariff filing, and bore no reasonable
     relationship to the rate that would have been developed
     in a competitive marketplace for a comparable insurance
     arrangement transacted on an "arm's length" basis.
     * * * For the period 1984 through 1989 total premium
     received and losses paid on the NUF policy amounted to
     approximately $845,000,000 and $281,000,000,
     respectively, for an overall loss ratio of 33% * * *.
     There was little or no potential for late reported
     claims or significant adverse reserve development on
     business of this kind, so the numbers reflected on
     NUF's premium and loss bordereaux may be treated as
     final for the years involved.

     In a competitive marketplace such results could never
     be achieved. * * * it should be noted that the U.S.
     property-casualty insurance industry has achieved a
     combined ratio (the sum of the loss ratio (incurred
     losses ÷ earned premium) plus the expense ratio
     (expenses ÷ written premium) of less than 100%, i.e.,
     produced an underwriting profit) in only three of the
     past twenty years * * *.

     It is also extremely unlikely that any insurance broker
     that permitted an insurer to generate such profits at
     the expense of its client could expect to retain that
     client for very long. In this instance, of course, the
     profits were not retained by NUF, but flowed, as
     intended, as ceded reinsurance premiums back to OPL.

Mr. Kelley logically concluded that the 25-cent price per $100 of

excess value set on the NUF policy was not an arm's-length price

that would have been agreed upon in a competitive market.50


     50
      Similarly, respondent's expert Mr. Michael Cohen, an
insurance expert with extensive brokerage experience, agreed that
the 25 cents per $100 of excess value was too high. Referring to
                                                   (continued...)
                                   - 96 -


       This conclusion is also supported by comparing the 25-cent

price paid to NUF with the price that was offered by FFIC and

PIP.    For more than 15 years before 1983, FFIC, through a policy

sold by PIP, solicited and sold excess value coverage to

petitioner's shippers.       Generally, PIP sold the excess value

coverage at a price of $0.125 per $100 of coverage.         PIP retained

approximately 36 percent of the premium in 1983 and 34 percent in

1984.       Thus, of the $0.125 per $100 of coverage, PIP retained

approximately $0.045 and $0.0425 in 1983 and 1984,

respectively.51       On the other hand, FFIC underwrote the coverage

for approximately 8 cents52 per $100 of coverage in 1983 and

$0.082553 in 1984.       FFIC was able to realize a gross profit

margin of 27 percent in 1983, based on an approximate price of 8

cents per $100 of excess value coverage.54         The FFIC/PIP program


       50
      (...continued)
petitioner's loss ratios and declared revenues for 1981 through
1983, Mr. Cohen stated in his expert report:

       In my experience spanning more than thirty years I
       cannot recall one case where the broker would offer the
       insurer on behalf of his client a piece of business at
       such an advantageous rate. * * *
       51
      The $0.125 price times 36 percent and 34 percent equals
$0.045 and $0.0425, respectively.
       52
            $0.125 less $0.045 equals $0.08.
       53
            $0.125 less $0.425 equals ($0.0825).
       54
            Gross profit margin in this instance is defined as
                                                         (continued...)
                             - 97 -


did not offer coverage to certain high-risk shippers.

Nevertheless, the coverage underwritten by FFIC was very similar

to that which was purported to be provided by NUF and OPL and is

an indication that the price of the excess value coverage

provided by NUF and OPL was substantially more than the price

petitioner could have obtained in arm's-length negotiations.55

     Respondent's expert, Prof. Alan Shapiro, Ph.D., professor of

finance and business economics, estimated that $0.092 per $100 of

declared value in excess of $100 would have been an arm's-length

price for insurance covering petitioner's excess value activity.

Professor Shapiro based his analysis on the proposition that an

arm's-length price for OPL's excess value coverage would be one

that over time provided OPL with a fair return on its necessary

equity investment.

     In coming to his conclusion, Professor Shapiro compared what

OPL's return on equity would have been had it been reinsuring the

EVC activity during the years 1979 through 1983 with that of


     54
      (...continued)
premiums minus claims paid minus commissions.
     55
      Had petitioner's customers paid $0.125 per $100 of
declared value (the same as PIP charged), EVC revenues would have
been cut in half, but the gross profit percentage (one-half of
EVC's, less all claims paid, divided by one-half of EVC's) for
the years 1979 through 1989 would have been 37 percent. One-half
of EVC revenue for 1979 through 1989 is $622,678,544 less actual
claims paid of $393,153,605 equals gross profit of $229,524,939.
Gross profit of $229,524,939 divided by $622,678,544 equals a
gross profit percentage of 37 percent.
                                - 98 -


other members of the insurance sector OPL would have operated in.

Professor Shapiro's report contained the following chart, which

includes Value Line56 statistics regarding return on equity in

each year for 22 property/casualty insurers and diversified

insurance companies:

                       1979      1980     1981    1982   1983    Mean
Mean Value Line ROE     23.5%    20.4%   20.5%   13.8%   11.8%   18.0%

Estimated Value         18.5     20.0    22.5    19.2    17.1    19.5
  Line ke1
Minimum Value Line      12.4      8.3     9.7     0.1     0.1     6.1
  ROE
Maximum Value Line      39.6     40.0    42.3    26.6    27.1    35.1
  ROE
OPL's estimated ROE    172.9    170.1    182.3   174.1   168.6   173.6
  ($0.25 charge)
OPL's estimated ROE     15.7     15.8    15.2    13.5    12.8    14.6
  ($0.092 charge)
Estimated OPL ke        13.7     15.2    17.7    14.3    12.3    14.6
Value Line sample       22.0     22.0    22.0    22.0    22.0
  size

     1
      "ke" is the estimated year-by-year cost of equity capital.

Professor Shapiro concluded that had OPL been in existence during

the periods preceding 1984 and had it charged a fee of 25 cents

(instead of $0.092) per $100 in excess value coverage, it would

have earned huge persistent returns and that "OPL's ROE would



     56
        Value Line is a publication widely used as a source of
financial data.
                               - 99 -


have been over four times as large as the highest return earned

by any of the Value Line companies in any year, and its average

ROE of 173.6 percent would have been almost 10 times the average

ROE of 18.0 percent earned by the Value Line companies."

     Respondent also offered the expert report of Mr. Frederick

Kilbourne, an actuary, for his opinion regarding an arm's-length

premium for the coverage associated with petitioner's excess

value activity.    In computing the premium rate, Mr. Kilbourne

analyzed the following premium elements:

     1.   Losses (payments to claimants)

     2.   Claim expenses

     3.   Other expenses (commissions, taxes, etc)

     4.   Investment income

     5.   Risk charge (provision for profit and catastrophes)

Mr. Kilbourne determined on an actuarial basis the following

rates per premium element (in cents per $100 of coverage):

     1.   Losses                7.5¢

     2.   Claims expenses       0.0

     3.   Other expenses        0.4

     4.   Risk charge           0.4

     5.   Investment income     -.2

          Total                 8.1¢

Additionally, Mr. Kilbourne concluded that if claim expenses were

to be covered within the premium rate, as is customary in the
                               - 100 -


industry, the needed rate would increase from 8.1 cents to about

8.6 cents.

       Respondent's expert Dr. Blaine Nye, an insurance economist,

explained in his expert report that an insurance company would

price a policy by calculating the expected losses and expenses

and adding an underwriting profit margin.     Dr. Nye used the

capital asset pricing model to derive an underwriting profit for

petitioner's excess value activity.      Dr. Nye concluded that the

arm's-length price of an insurance arrangement providing coverage

on the liability to shippers declaring values in excess of $100

to be 32 percent of declared value revenues.     Thus, according to

Dr. Nye, petitioner would have paid a price of approximately 8

cents (32 percent of 25 cents) per $100 of coverage to insure its

excess value activity liability.

       One of the experts presented by petitioner at trial

implicitly acknowledged that petitioner could have negotiated a

lower arm's-length price for the coverage provided by NUF and

OPL.    Petitioner presented Dr. Neil Doherty as an expert in the

economics of insurance.    On cross-examination, Dr. Doherty

responded as follows:

            Q.   From purely insurance pricing perspective,
       would you agree that if Overseas Partners, Limited, was
       entirely unrelated to UPS, had no common shareholders,
       no common officers, no common board of directors, that
       this transaction would have made little sense from
       UPS's perspective?
                              - 101 -


          A.   Everything else in the transaction was the
     same except that the ownership of OPL was different, it
     was totally unrelated?

          Q.   And from an insurance pricing perspective,
     the question is whether that -- the transaction would
     make sense from UPS's perspective.

          A.   That's a little difficult to answer. It
     would be very strange to think if UPS had the
     opportunity to sell insurance, either directly or
     indirectly, at the prices which were prevailing in that
     marketplace at that time, it would be a rather strange
     business decision to basically give off that profit to
     an outsider.

     As previously explained, in 1984 the EVC's billed by

petitioner were $99,794,789.67 and claims paid were

$22,084,011.93.   Thus, claims paid in 1984 represented

approximately 22 percent of the total EVC's billed.57     Claims

paid during the years 1979 through 1983 represented approximately

28.6 percent of the total EVC's billed during those years.     After

carefully considering the entire record, including the expert

reports offered by both petitioner and respondent, we are

persuaded that the price of 25 cents per $100 of excess value

liability paid to NUF pursuant to the Shippers Interest contract

that petitioner and NUF agreed to was not a result of arm's-



     57
       $22,084,011.93 divided by $99,794,789.67 equals
approximately 22 percent. When claims are added to fronting
expenses of $1,000,000 and taxes and board and bureau charges of
$4,091,586 for 1984, the claims and fees increase to
$27,175,597.93, and the ratio increases from 22 percent to
approximately 27 percent. $22,084,011.93 plus $1,000,000 plus
$4,091,586 equals $27,175,597.93.
                               - 102 -


length negotiations and that the price of 25 cents per $100 was

far in excess of the price that could have been negotiated by

petitioner.    This is another indication to us that petitioner's

arrangement with NUF and OPL was a sham.

     Finally, unlike petitioner's purported business reasons for

its arrangement with NUF and OPL, there is contemporaneous

documentation to establish that petitioner seriously considered

and was motivated by the reduction of Federal income tax that

would occur by transferring excess value income to OPL.    In July

1982, petitioner's tax manager and another employee prepared a

memorandum to Mr. Danielewski concerning tax and other

implications of the insurance business.    The memorandum was

prompted by a meeting at which petitioner's EVC program was

discussed.    In September 1982, Hall prepared a memorandum

regarding the feasibility of creating a United Parcel Service

Insurance Subsidiary.    Throughout the memorandum, Hall noted that

there were a number of tax benefits if an offshore insurance

company were to be created.    The tax benefits were stated to be

approximately $24 million.

     In summary, the report states:

     It has been the purpose of this brief preliminary
     report to consider in some detail the immediate
     potential available to [petitioner] in maximizing the
     profit potential in the declared value protection which
     you are currently providing shippers and also to
     acquaint you with some of the basic issues involved in
     a captive operating in either a traditional role or
                              - 103 -


     within the context of the declared value program as an
     insurance subsidiary.

     It appears obvious to us that the conversion of the
     declared value program to an insured basis utilizing an
     offshore insurer and F.I.R.S.T. will increase the
     profits generated by this program by approximately
     $24,000,000. It is also obvious that there are many
     complex issues involved in this conversion which should
     be considered by counsel.

The potential increase in after-tax profits appears to be totally

dependent on projected savings in Federal income tax.

     In March 1983, Hall prepared a memorandum that contained a

description of the tax benefits if petitioner used the

alternative structure for the excess value program.    The

memorandum indicated that the projected tax benefit to petitioner

was $16,077,500 for the first year.     Hall arrived at this amount

by calculating the benefit to petitioner to be equal to the

elimination of income tax on petitioner's expected EVC income,

less the fronting fees, premium taxes, Federal excise taxes, and

ceding commission.   Thus, the documents generated by Hall portray

the tax results of creating a Bermuda insurance company as the

focus for improving the economic result of the transaction.    The

memorandum stated that the projection of tax savings prepared by

Hall was to be submitted to petitioner's senior management by Mr.

Danielewski.

     Petitioner subsequently postponed its decision to go forward

with the proposed EVC activity structure because of tax
                              - 104 -


considerations.   NUF had prepared a binder for the Shippers

Interest contract to become effective as of August 8, 1983.    On

the same day the contract was to become effective, Mr. Corde sent

a telex to Mr. Smetana indicating that petitioner postponed the

finalization of the Shippers Interest program to allow for

petitioner's review and evaluation of pending tax legislation.

In April 1984, after restructuring its EVC activities, petitioner

released a report to shareholders in which petitioner indicated

that because OPL was organized as a Bermuda corporation doing no

business in the United States, OPL's earnings were not expected

to be subject to U.S. Federal or State taxes on income.

     The contemporaneous documentation prepared by petitioner and

Hall regarding the plan to restructure the excess value activity

emphasized the resulting tax benefits to petitioner.   Petitioner

produced no documentation, such as corporate minutes, that was

prepared during the period in which petitioner was considering or

executing its EVC restructuring that indicates that petitioner

had motives other than tax reduction.

     Petitioner has failed to prove that the restructuring of its

EVC activity was motivated by nontax business reasons or that the

restructuring had economic substance.   Rather, we find that the

restructuring was done for the purpose of avoiding taxes and that

the arrangement between petitioner, NUF, and OPL had no economic
                                - 105 -


substance or business purpose.58    Petitioner controlled and

performed all activities and functions that resulted in EVC

revenue.   The EVC profits that were transferred to OPL for the

benefit of petitioner's and OPL's shareholders were the fruition

of petitioner's EVC activity.    OPL provided nothing of value to

petitioner.   The purpose of the arrangement with NUF and OPL was

to confer tax-free benefits on petitioner's and OPL's

shareholders.   Obviously, petitioner is not entitled to any

deductions for profits transferred to OPL.    As a result,

petitioner must include EVC revenue in income for 1984 and is

liable for tax on the resulting profits.59


     58
      In arriving at our finding, we recognize that some of
petitioner's witnesses testified that they considered State
insurance regulation and other nontax considerations to be
reasons for restructuring petitioner's EVC program. We have
fully considered that testimony, the demeanor of the witnesses,
and the statements they made before trial (in both
contemporaneous documents and interviews) in addition to the
aforementioned matters discussed in the text. In the final
analysis, we do not believe that nontax business considerations
were the reasons that motivated petitioner.
     59
      Because we have held that petitioner's arrangement with
NUF and OPL was an assignment of income and a sham, we do not
reach the issue of whether an allocation must be made under sec.
482 or 845. Petitioner makes no argument that a sec. 482
analysis should be preferred over an assignment of income
analysis. Nevertheless, we are aware that several court opinions
appear to have expressed a general preference for application of
a sec. 482 analysis over the assignment of income analysis. We
believe those opinions are distinguishable because the facts in
the instant case are both "more extreme" and "heavily freighted
with tax motives". Cf. Foglesong v. Commissioner, 621 F.2d 865
(7th Cir. 1980), revg. and remanding T.C. Memo. 1976-294; Rubin
                                                   (continued...)
                               - 106 -


II.   Section 162 Deductions

      Having held that petitioner's restructuring of its excess

value activity constituted a sham transaction that had no

economic effect, we are presented with the question of whether

petitioner is entitled to deduct the amounts retained by NUF.

The amounts retained consisted of NUF's "commission" of $1

million plus allowances for various costs.

      Section 162 allows as a deduction all ordinary and necessary

expenses paid or incurred during the taxable year in carrying on

any trade or business.   See sec. 162(a).   However, expenses

incurred in furtherance of a sham transaction are not deductible.

As stated by the Court of Appeals for the Eleventh Circuit in

Kirchman v. Commissioner, 862 F.2d at 1490:

           The sham transaction doctrine requires courts and
      the Commissioner to look beyond the form of a
      transaction and to determine whether its substance is
      of such a nature that expenses or losses incurred in
      connection with it are deductible under an applicable
      section of the Internal Revenue Code. If a
      transaction's form complies with the Code's
      requirements for deductibility, but the transaction
      lacks the factual or economic substance that form
      represents, then expenses or losses incurred in
      connection with the transaction are not deductible.

The Court of Appeals for the Second Circuit recently addressed a

similar issue with respect to interest deductions under section



      59
      (...continued)
v. Commissioner, 429 F.2d 650 (2d Cir. 1970), revg. and remanding
51 T.C. 251 (1968).
                                - 107 -


163.    In Lee v. Commissioner, 155 F.3d 584 (2d Cir. 1998), affg.

in part and remanding in part on another ground T.C. Memo. 1997-

172, the taxpayers had entered into a sham investment transaction

solely for the purpose of claiming tax deductions.     See id. at

586.    The taxpayers argued that interest arising from

economically empty transactions may still be deducted so long as

the debt itself has economic substance.    The Court of Appeals for

the Second Circuit declined to accept the taxpayers' argument and

held that in order for an interest deduction to be valid under

section 163, the underlying transaction must have economic

substance.    See id. at 587.   In Brown v. Commissioner, 85 T.C.

968 (1985), affd. sub nom. Sochin v. Commissioner, 843 F.2d 351

(9th Cir. 1988), we held that deductions claimed by the taxpayers

were not allowable because they were connected to sham

transactions.

       We have found that petitioner's restructuring of its EVC

activity was a sham set up to reduce tax.    Following the

reasoning in cases such as Kirchman v. Commissioner, supra; Lee

v. Commissioner, supra; and Brown v. Commissioner, supra, we hold

that the amounts retained by NUF are not deductible.

III. Liberty Transaction

       Respondent disallowed deductions taken by petitioner for

premiums paid to Liberty Mutual Fire for California workers'

compensation and employers' liability insurance coverage.
                              - 108 -


     In 1983, petitioner notified the State of California of its

intention to terminate its self-insurance program for workers'

compensation, and the State acknowledged petitioner's intention.

Petitioner complied with State regulations and received State

approval to terminate its self-insurance activity.   Petitioner's

future obligations for 1984 under California's workers'

compensation were covered by the Liberty Mutual policy.   Liberty

Mutual entered into a reinsurance agreement with OPL wherein OPL

reinsured Liberty Mutual's exposure for claims not exceeding

$250,000 for any one accident.   There is no question that the

Liberty Mutual policy was a valid policy that satisfied

petitioner's workers' compensation responsibilities.

     In calculating taxable income, section 162(a) permits the

deduction from gross income of all ordinary and necessary

expenses incurred in carrying on a business.   Premiums for

insurance, including those for workers' compensation coverage,

are deductible business expenses.   See sec. 1.162-1(a), Income

Tax Regs.   The insuring taxpayer deducts the amounts paid as

premiums but, of course, cannot deduct covered claims because the

source of the payments is the insurance carrier.   See Clougherty

Packing Co. v. Commissioner, 811 F.2d 1297, 1300 (9th Cir. 1987),

affg. 84 T.C. 948 (1985).

     In lieu of purchasing insurance, one may elect to self-

insure, paying off claims as they arise or setting aside fixed
                              - 109 -


sums into a reserve account to pay off intermittent losses.     See

id.   While insurance premiums are deductible, amounts placed into

self-insurance reserves are not.   See id.; Steere Tank Lines,

Inc. v. United States, 577 F.2d 279, 280 (5th Cir. 1978); Spring

Canyon Coal Co. v. Commissioner, 43 F.2d 78, 80 (10th Cir. 1930),

affg. 13 B.T.A. 189 (1928).   Instead, the self-insuring taxpayer

must wait until losses actually occur, at which time the reserve

funds actually paid out may be expensed and deducted from gross

income.   See Clougherty Packing Co. v. Commissioner, supra.

      Neither the Code nor the regulations provides a definition

of insurance.   The accepted definition for purposes of Federal

income taxation dates back to Helvering v. Le Gierse, 312 U.S.

531, 539 (1941), in which the Supreme Court stated that

"Historically and commonly insurance involves risk-shifting and

risk-distributing."   Shifting risk entails the transfer of the

impact of a potential loss from the insured to the insurer.     See

Clougherty Packing Co. v. Commissioner, supra.

      Respondent concedes that the Liberty Mutual policy is a

valid insurance contract which operates to shift the insurance

risk from petitioner to Liberty Mutual with respect to losses in

excess of $250,000.   Respondent seeks to segregate the "premiums"

related to the liability in excess of $250,000 from the amounts

paid to Liberty Mutual for liability below $250,000.   Respondent

argues that amounts paid to Liberty Mutual under the workers'
                              - 110 -


compensation insurance policy related to liability for claims

below $250,000 are not deductible as premiums.60

     Respondent does not argue that the terms of the controlling

documents are insufficient to constitute insurance or that the

contractual terms of Liberty Mutual's reinsurance with OPL negate

the existence of insurance.   Rather, respondent argues that

although petitioner had a formal insurance agreement with Liberty

Mutual, "in practice" petitioner and Liberty Mutual disregarded

the transactional documents in subsequent years and allowed OPL,

through Liberty Mutual, to collect an increased premium when

losses increased in subsequent years.   There is no evidence that

this alleged "practice" in later years was part of any agreement

in 1984.

     Pursuant to the workers' compensation arrangement, Liberty

Mutual accepted a measurable degree of risk in entering the

insurance contract with petitioner.61   Apparently, respondent's

only complaint is that in the 10 years after the year in issue,

petitioner paid Liberty Mutual additional amounts as premiums

(based on loss experience) that it was not required to pay under


     60
      Respondent questions the validity of $11,151,675 of a
total payment to Liberty Mutual of $14,241,915.
     61
      Liberty Mutual was also required to investigate and adjust
all claims made under the policy. Consequently, petitioner
avoided the costs inherent in administrating its own self-
insurance program and avoided the regulatory requirements of that
activity.
                               - 111 -


the terms of the policy and that these amounts were passed on to

OPL.    If that is so, respondent can no doubt question the

deductibility of those payments in subsequent years.    But there

appears to be no question that the premium payments to Liberty

Mutual in 1984 were required by the policy, the policy was valid,

and by the written terms of the policy risk was shifted.      We

reject respondent's argument that premiums paid in 1984 were not

deductible by petitioner.

IV.    Additions to Tax

       Respondent determined that petitioner is liable for

additions to tax for negligence under section 6653(a)(1) and (2)

for 1984.    Section 6653(a)(1) imposes a 5-percent addition to tax

if any part of any underpayment of tax required to be shown on a

return is due to negligence or intentional disregard of rules or

regulations.    Section 6653(a)(2) provides for a separate addition

to tax equal to 50 percent of the interest payable on the portion

of the underpayment attributable to negligence or intentional

disregard of rules or regulations.    Respondent's determination is

presumed correct, and petitioner bears the burden of proving

otherwise.    See Rule 142(a); Bixby v. Commissioner, 58 T.C. 757,

791-792 (1972).

       Negligence within the meaning of section 6653(a) has been

defined as the failure to do what a reasonable and ordinarily
                               - 112 -


prudent person would do under the circumstances.      See Neely v.

Commissioner, 85 T.C. 934, 947 (1985).

     With respect to the restructuring of the excess value

income, we have found that petitioner engaged in ongoing sham

transactions devoid of economic substance during the year at

issue.    Petitioner is a sophisticated taxpayer.    The primary

thrust of petitioner's argument was that it had valid business

purposes for restructuring its EVC activities.      We have not

accepted this explanation.    On the basis of the record as

described above, we reject any contention that petitioner had a

reasonable basis for the positions taken on the returns.      We,

therefore, sustain respondent's determination under section

6653(a)(1).    We further sustain respondent's determination under

section 6653(a)(2) with regard to that portion of the

underpayment of tax that is attributable to the excess value

charges.

     Respondent also determined that petitioner is liable for an

addition to tax for 1984 under section 6661.    Section 6661(a)

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

of the underpayment attributable to a substantial understatement

of income tax.    See Pallottini v. Commissioner, 90 T.C. 498, 503

(1988).    In the case of a corporation, other than an S

corporation or personal holding company, an understatement is

substantial if it exceeds the greater of $10,000 or 10 percent of
                              - 113 -


the tax required to be shown on the return.   See sec.

6661(b)(1)(A) and (B).   The amount of the understatement may be

reduced under section 6661(b)(2)(B) for amounts adequately

disclosed or supported by substantial authority.    Respondent's

determination of the addition to tax is presumed correct, and

petitioner bears the burden of proving otherwise.    See Rule

142(a); Hall v. Commissioner, 729 F.2d 632, 635 (9th Cir. 1984),

affg. T.C. Memo. 1982-337.

     The authority cited by petitioner on brief does not support

its position with respect to its excess value activity.     We

sustain respondent's determination with respect to the

understatement related to the excess value activity.

     Respondent also determined that petitioner is liable for

increased interest under section 6621(c)62 for 1984 on the

portion of the deficiency attributable to EVC's.    Section 6621(c)

provides for an interest rate of 120 percent of the adjusted rate

established under section 6621(b) on substantial underpayments

that exceed $1,000 and are attributable to "tax motivated

transactions".


     62
      The Tax Reform Act of 1986, Pub. L. 99-514, sec. 1535, 100
Stat. 2750, amended sec. 6621 to include sham or fraudulent
transactions in the list of "tax motivated transactions" set
forth in sec. 6621(c)(3). The amendment applies (1) to any
underpayment with respect to which there was not a final court
decision before the enactment of the act (i.e., Oct. 22, 1986),
and (2) to interest accruing after Dec. 31, 1984. See Price v.
Commissioner, 88 T.C. 860, 888 (1987).
                                - 114 -


     Tax-motivated transactions include "any sham or fraudulent

transaction."     Sec. 6621(c)(3)(A)(v).63   We have held that with

respect to the restructuring of the excess value activity,

petitioner engaged in sham transactions lacking in economic

substance.     On the basis of the findings set forth herein, and

the fact that the underpayment of tax will exceed $1,000 in 1984,

section 6621(c) is applicable to the underpayment attributable to

those transactions that we have found to be shams.      See Price v.

Commissioner, 88 T.C. 860, 888-889 (1987).



                                             Decision will be entered

                                      under Rule 155.




     63
          See supra note 62.
