                        T.C. Memo. 1996-186



                      UNITED STATES TAX COURT



      PETERS, GAMM, WEST & VINCENT, INC., RICHARD L. WEST,
      JUDITH L. WEST, MARC A. VINCENT, DEBORAH S. VINCENT,
         GARY L. GAMM AND CONNIE F. GAMM, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent

         DON S. AND CONSTANCE J. PETERS, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 2722-93, 3735-94.       Filed April 17, 1996.



     Thomas C. Triplett, for petitioners in docket No. 2722-93.

     Jack D. Flesher, for petitioners in docket No. 3735-94.

     Frank M. Schuler and Michael L. Boman, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     KÖRNER, Judge:   Respondent determined deficiencies,

additions, and penalties with respect to petitioners' Federal

income taxes for the years and in the amounts as follows:
                                      2

                            Docket No. 2722-93

         Petitioner              Year          Deficiency

         Richard L. and          1988            $3,719
           Judith L. West        1989             5,588

         Marc A. and             1988             1,961
           Deborah S. Vincent    1989             5,869
                                 1990             7,334

         Gary L. and             1988            14,849
           Connie F. Gamm        1989            21,570
                                 1990            12,857

         Don S. and Constance J. Peters--Docket No. 3735-94

                               Additions to Tax             Penalty
  Year    Deficiency   Sec. 6651(a)(1) Sec. 6653(a)(1)      Sec. 6662

  1988     $66,824          $17,015           $8,092           --
  1989     110,501           14,271             --           $5,600
  1990      98,634            1,215             --            5,750

     The above cases were consolidated for trial, briefing, and

opinion.    All statutory 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, except as

otherwise noted.

     Petitioners Richard L. and Judith L. West filed joint income

tax returns for 1988 and 1989.        Petitioners Marc A. and Deborah

S. Vincent filed joint income tax returns for 1988 through 1990.

Petitioners Gary L. and Connie F. Gamm filed joint income tax

returns for taxable years 1988 through 1990.         The Gamms, the

Vincents, and the Wests resided in Wichita, Kansas, at the time

their respective petitions were filed.       Petitioners Don S. and

Constance J. Peters filed joint income tax returns for 1988
                                   3

through 1990, and lived in Towanda, Kansas, at the time their

petition was filed.     Peters, Gamm & West, Inc.,1 was an S

corporation formed under the laws of the State of Kansas in 1986.

       After concessions2 and settlement of various issues, we must

decide:

       (1)   Whether Peters, Gamm, West & Vincent, Inc. (PGWV), is

entitled to a deduction for legal fees incurred in defending an

action brought by the Securities and Exchange Commission (SEC)

against one of the principals of PGWV.     We hold that it is not.

       (2)   Whether the legal fees are deductible by PGWV as

compensation to petitioner Don S. Peters.     We hold that they are

not.

       (3)   Whether petitioner Don S. Peters, individually, is

entitled to a deduction under section 212(1) in an amount equal

to the previously disallowed amounts paid by PGWV in defending

the legal action brought by the SEC.     We hold that he is.

                           FINDINGS OF FACT

       In August 1983, Gamm, Ivan West (Ivan), and Peters formed an

equal partnership called Investment Management Group (IMG).       The


       1
        In 1989, Marc A. Vincent became a principal of the firm,
and, accordingly, in 1990 the name was amended to Peters, Gamm,
West & Vincent, Inc. (PGWV). Hereinafter, references to PGWV
will be to Peters, Gamm & West, Inc., or Peters, Gamm, West &
Vincent, Inc., depending on the year involved.
       2
        Petitioners Peters conceded the sec. 6651(a)(1) addition
to tax for tax years 1988, 1989, and 1990 and the sec. 6662(a)
penalty for the 1990 tax year. Respondent conceded the sec.
6653(a)(1) addition to tax for the 1988 tax year and the sec.
6662(a) penalty for the 1989 tax year.
                                 4

business purpose of IMG was to act as an investment adviser,

provide advice with respect to the buying and selling of

securities, and manage money for clients on a discretionary

basis.   The partnership filed a Form ADV, dated August 12, 1983,

with the SEC to register as an investment adviser.

     Certain prior activities of the partners were excluded from

IMG's business pursuant to the partnership agreement.   One of the

excluded activities of Ivan was a consulting agreement with

Energy Reserves Group (ERG), a publicly held company located in

Wichita, Kansas.   Pursuant to the consulting agreement, Ivan,

along with Wayne Swearingen, was to obtain debt or equity

financing for ERG.   On November 8, 1984, a public tender offer

was made for all outstanding stock of ERG.   Prior to the tender

offer, several individuals purchased substantial quantities of

ERG stock which they sold for a significant profit after

announcement of the tender offer.    On November 19, 1984, Bernard

Lounsbury (Lounsbury) tendered checks in the amount of $7,500

each to Peters and Gamm.   On November 20, 1985, Mr. Peters

deposited a check into his personal checking account from Kenneth

Mick (Mick) in the amount of $43,000.   Lounsbury and Mick were

business associates of Mr. Peters, but were not clients of IMG.

At the time of these payments, the payors were indebted to Peters

in amounts greater than the payments.   Mr. Peters reported the

$7,500 as income on his Schedule C for 1984.
                                   5

     In October 1986, the IMG partners received subpoenas from

the SEC that sought documents and testimony concerning the

transactions involving ERG stock made around the time of the

tender offer.   The partners met with attorneys from various law

firms located in Wichita, Kansas, and Washington, D.C., to

determine how best to respond to the subpoenas, to determine what

the implications were as to the firm or the individual partners,

and to ascertain what steps needed to be taken.    Initially none

of the partners knew that the investigation was specifically

targeting the conduct of Peters.

     On December 23, 1986, an agreement was executed whereby Ivan

withdrew from the partnership.   Pursuant to such agreement, Ivan

received the value of his capital contribution, as well as a

commitment for one-sixth of the annual net income of the

partnership or any successor to the partnership.

     On December 11, 1986,3 IMG was dissolved and replaced by

Peters, Gamm & West, Inc.   The corporation began conducting

business in January 1987.   The corporation assumed all of the

partnership's assets, retained its clients, kept the same

employees and place of business, and assumed all partnership

obligations and liabilities.   The business of IMG was



     3
       PGWV's 1988 income tax return shows that the date of
election as an S corporation was Dec. 11, 1986. This conflicts
with the withdrawal agreement executed by the Investment
Management Group on Dec. 23, 1986. The validity of the S
election is not in issue, nor is the validity of the partnership
withdrawal agreement.
                                 6

uninterrupted, and the clients of IMG were told that there had

been a name change.   Payments were made to Ivan pursuant to the

deferred compensation agreement previously executed by IMG.

Sometime after Ivan's departure, his son, Richard West (Richard),

who had been employed by IMG and PGWV, became a shareholder of

PGWV.   On January 7, 1987, the corporation adopted a resolution

that stated:

     RESOLVED, that the Corporation continue to pay legal
     expenses for attorneys engaged by Mr. Don Peters in
     connection with the investigation by the Securities
     Exchange Commission with respect to sales of stock of
     ERG. The payment of such expenses is subject to the
     understanding and acknowledgment by Mr. Peters that
     payment of such expenses is not to be construed by
     [sic] any indication that the Corporation has any
     responsibility with respect to the particular matters
     being investigated or obligated as to any liability,
     damages, penalties or fines that may result from said
     investigation. It is to be understood that the
     Corporation may at any time discontinue the payment of
     such legal expenses and thereupon will have no
     obligation with respect to such expenses.

Based on this resolution, we conclude that at the time of

incorporation, the PGWV shareholders knew that the investigation

was focused on the activities of Peters.   Peters owned 42.5

percent, 40 percent, and 35 percent of PGWV during the years 1988

through 1990, respectively.

     On January 9, 1987, the corporation filed an amendment to

the ADV form with the SEC, which indicated that its name had

changed from IMG to PGWV.   At the end of 1990, the name was

amended to Peters, Gamm, West & Vincent, Inc., to reflect the

addition of a shareholder, Mark A. Vincent, in January 1989.
                                  7

     The principals were informed by counsel that if the SEC were

successful against Peters it would rescind his license, and it

would probably turn its attention towards the company and attempt

to revoke its license.

     The principals of PGWV were involved in all aspects of the

representation by counsel and in forming a strategy as to how to

proceed; they did not want Peters to make any decisions without

them, especially regarding any settlements with the SEC.     Their

efforts were aimed at avoiding litigation.    In December 1988, the

SEC filed a complaint against Peters and five other individuals,

alleging acts in violation of the Securities Exchange Act of

1934, and rules promulgated thereunder.    PGWV was not named as a

party to the suit.    Specifically, the SEC alleged in its

complaint that Peters improperly obtained material nonpublic

information from Ivan's files, which he communicated to Mick and

Lounsbury who were able to profit by buying the stock of ERG

themselves or by supplying the information to others who did so.

Pursuant to such scheme, Peters allegedly received a portion of

those profits in the form of repayment of loans previously made

by him to Mick and Lounsbury.    At the time of repayment, Mick had

financial problems.

     The case was heard before a jury, which held for Peters.

The SEC appealed to the Tenth Circuit Court of Appeals, which

reversed and remanded to the trial court.    SEC v. Peters, 978

F.2d 1162 (10th Cir. 1992).    Prior to rehearing, the parties
                                  8

reached a settlement.    Pursuant to the settlement, Peters was to

pay $50,500, representing the profits of the alleged inside

trading.    Such payment was waived in light of Peters' poor

financial condition.    The allegations of the SEC were never

proven by the SEC, and Peters did not admit to any wrongdoing.

     When the complaint was filed, PGWV was told by counsel to

amend its ADV filing with the SEC.    Such amendment, made on

January 3, 1989, disclosed the existence and nature of the suit.

PGWV also disclosed the suit on its audited balance sheets,

indicating that "the company is committed to retaining the

services of this officer and, accordingly, indemnified him for

any legal fees incurred in connection with this complaint".       PGWV

hired Sullivan & Higdon, a public relations firm, to assist in

damage control.    Deductions were claimed for such payment, but

they are not in issue.

     As a result of the SEC's complaint, Merrill Lynch (a

brokerage firm) deleted PGWV from its list of investment managers

available to clients of one of its consulting services.     The

notice from Merrill Lynch acknowledged that PGWV was not

implicated, but indicated that the removal of the latter from the

list was "prudent".    Licensing bureaus for the States of Maine

and Kentucky suggested that PGWV withdraw its application for

investment adviser registration until the matter with the SEC was

resolved.    One of the largest clients of PGWV, the Kansas Public

Employees Retirement System (KPERS), representing about 60
                                   9

percent of the firm's business, was valued at around $100 million

and later grew to almost $500 million.       Trustees of the KPERS

fund informed IMG at a public meeting that the fund would no

longer utilize the services of PGWV if Peters were found to have

committed any of the alleged insider trading or any other

wrongdoing.

     PGWV claimed as a deduction legal fees in the amounts of

$128,854.71, $198,431.67, and $135,659.23 in computing its net

income on its subchapter S return for the tax years 1988 through

1990, respectively.   Respondent disallowed $123,103, $190,245,

and $128,131 of those amounts in her timely notices of

deficiency, stating that it had not been established that those

amounts were for ordinary and necessary business expenses, rather

than nondeductible business expenses of Peters.       The pro rata

share of such deductions claimed by petitioners on their income

tax returns was disallowed.   Respondent has conceded that the

amounts claimed as legal fees were paid by PGWV.

                              OPINION

     The primary issue is whether PGWV, in computing net income

for subchapter S purposes, may deduct legal fees incurred in

defending an action brought by the SEC against petitioner Peters,

one of the shareholders of PGWV.       Section 162(a) allows a

taxpayer to deduct ordinary and necessary expenses paid or

incurred in carrying on a trade or business.       If we determine

that the amounts in question are not deductible as legal fees, we
                                  10

must determine whether they are deductible as compensation to

Peters.    If the fees are not deductible by PGWV, we must

determine whether Peters, individually, is entitled to a

deduction under section 212(1).    Petitioners have the burden of

proof.    Rule 142(a); Welch v. Helvering, 290 U.S. 111 (1933).

1.   Deductibility of Legal Fees by PGWV Under Section 162(a)

      Section 162(a) allows a deduction for "all the ordinary and

necessary expenses paid or incurred during the taxable year in

carrying on any trade or business".    For an expense to be

deductible under section 162(a), it must meet five basic

elements:    (a) It must be ordinary; (b) it must be necessary; (c)

it must be paid or incurred by the taxpayer in the taxable year;

(d) there must be a trade or business; and (e) the expense must

arise in connection with or proximately result from that trade or

business.    O'Malley v. Commissioner, 91 T.C. 352, 361 (1988).

        These elements are in the conjunctive:   if just one is not

satisfied, the deduction is not allowed.    Because we make our

decision based on the last element, whether the expenses arose in

the carrying on of PGWV's trade or business, we do not consider

the other elements.    Respondent has conceded that legal fees of

$128,854.71, $198,431.67, and $135,659.23 were incurred for the

tax years 1988 through 1990, respectively, and that PGWV paid

them.

      Respondent argues that the legal fees are personal in

nature, and they did not arise in connection with or proximately
                                  11

from PGWV's business.   Petitioners take the position that PGWV,

the successor to IMG, incurred the legal fees to protect its

trade or business as well as its reputation, and that because

payment of the fees was helpful to PGWV's trade or business, they

are deductible.

     Expenses which are personal in nature are not generally

deductible.   Sec. 262; Johnson v. Commissioner, 72 T.C. 340, 348

(1979).   An expense must be directly connected with, or

proximately result from, the business of the taxpayer.

Kornhauser v. United States 276 U.S. 145, 153 (1928); see also

Deputy v. du Pont, 308 U.S. 488, 494 (1940).    Where expenses of

litigation are involved, the origin of the claim which gave rise

to the litigation, rather than the consequences of the

litigation, is evaluated to ascertain whether the expenses are

business or personal in nature.    United States v. Gilmore, 372

U.S. 39 (1963).   The expenses of an activity are not

automatically rendered nondeductible merely because the activity

is illegal or inappropriate.    See Johnson v. Commissioner, supra

(legal expenses incurred in unsuccessful defense against criminal

charges brought against taxpayer's husband due to his

participation in a tax fraud scheme treated as deductible under

section 212(1) because the criminal prosecution arose from his

profit-seeking activities).    Additionally, otherwise allowable

deductions under section 162 or 212, which arose from an illegal

activity, will not be disallowed on public policy grounds.
                                 12

Commissioner v. Tellier, 383 U.S. 687 (1966).    In Boagni v.

Commissioner, 59 T.C. 708, 713 (1973), we stated:

          Quite plainly, the "origin of the claim" rule does
     not contemplate a mechanical search for the first in
     the chain of events which led to the litigation but,
     rather, requires an examination of all the facts. The
     inquiry is directed to the ascertainment of the "kind
     of transaction" out of which the litigation arose.
     Consideration must be given to the issues involved, the
     nature and objectives of the litigation, the defenses
     asserted, the purpose for which the claimed deductions
     were expended, the background of the litigation, and
     all the facts pertaining to the controversy.
     [Citations and fn. ref. omitted.]

     We must identify the claim that gave rise to the legal fees

whose deductibility is here in question, and then determine

whether the claim was proximately related to the trade or

business of PGWV.

     In Commissioner v. Heininger, 320 U.S. 467 (1943), a dentist

who sold mail order false teeth was allowed to deduct legal fees

stemming from allegations that he made fraudulent claims

regarding the quality of his product.    Finding that there was "no

doubt that the legal expenses of [taxpayer] were directly

connected with 'carrying on' his business," id. at 470, the Court

determined that the expenditures were ordinary and necessary

under section 23(a) of the Revenue Act of 1936, ch. 690, 49 Stat.

1658.4    Commissioner v. Heininger, supra at 471.

     In United States v. Gilmore, supra, by contrast, the

taxpayer incurred legal fees in a divorce proceeding brought by


     4
          This section is essentially the same as present sec.
162(a).
                                13

his wife, who stood to gain control of his three incorporated

auto dealerships.   The taxpayer argued that because he faced

losing control of his corporations, the legal expenses were

incurred in the defense or preservation of income-producing

property.   The Court declined to attach controlling importance to

the consequences that the taxpayer faced, but rather examined

whether the claim arose in connection with the taxpayer's profit-

seeking activity.   The Court did not allow the deductions because

the wife's claims stemmed from the marital relationship, and not

from any income-producing activity of the taxpayer.   United

States v. Gilmore, supra at 51; see Kornhauser v. United States,

supra at 153.

     Respondent argues that the origin of the SEC's claim did not

arise from PGWV's trade or business, and that under United States

v. Gilmore, supra, the consequences to PGWV are irrelevant to the

analysis.   Respondent also argues that the origin of the claim

was not in PGWV's trade or business because IMG's partnership

agreement specifically excluded the ERG deal, and that Peters'

activities were not a business activity of IMG or PGWV.

Petitioners argue that the alleged claim had its origin in the

trade or business of the firm, which was in the business of

acting as an investment adviser, and therefore deduction of the

legal expenses incurred in defending such action is not barred by

United States v. Gilmore, supra.
                                14

     The actual tender offer, which was excluded from the

partnership agreement, was not the origin of the claim.     Rather,

the origin of the claim was the alleged misappropriation of

inside information, followed by improper trading.

     Peters received $7,500 from Lounsbury and $43,000 from Mick

on November 19 and 20, 1985, respectively.     The SEC alleged in

its suit brought against Peters that although these payments were

debt repayment, they were only made as a result of Peters' having

illicitly obtained inside information concerning the pending

tender offer for stock of ERG, which he then relayed to Mick and

Lounsbury, who profited therefrom by trading in ERG stock.     The

underlying transaction, or set of facts that gave rise to the

claim, is not the actual debt repayment, but rather the facts

giving rise to the claim are that the debt repayment was in

actuality the profits of insider trading.     The claim is the SEC's

allegations.   PGWV was not named as a defendant in the SEC's

suit.   If the gain had been realized by or for the benefit of

PGWV, then the activity, although illicit, would have been within

the company's trade or business.     For instance, if a bank

executive is charged with embezzlement, that conduct would be

within his own profit-seeking activities, not that of the bank,

but if the bank executive were found guilty of causing improper

foreclosures, and such foreclosures benefited the bank, that

activity, although improper, would be in the trade or business of

the bank.
                                15

      Petitioners have introduced evidence that there would have

been injurious consequences to the business reputation of PGWV if

the SEC prevailed.   Although we are instructed by Boagni v.

Commissioner, supra, to consider all the facts and circumstances,

we are bound by the rule established by United States v. Gilmore,

supra, to look to the origin of the underlying claim, and not the

consequences.   The origin of the claim herein was not in the

trade or business of PGWV, but rather in Peters' separate

activities.   The legal expenses were incurred defending a claim

which had its origin in a transaction that was not part of PGWV's

business and which benefited Peters personally.   We find that the

claim did not arise in the trade or business of PGWV, and

therefore the amounts in question are not deductible as legal

fees by PGWV under section 162(a).   To this extent, respondent's

determination is sustained.

2.   Deductibility of the Fees by PGWV as Compensation to Peters

      Having concluded that the amounts in question are not

deductible by PGWV as legal fees, we now consider petitioners'

contention that payment of such fees is deductible by PGWV as

compensation to Peters.5   Section 162(a)(1) allows a deduction

for reasonable salaries or compensation for personal services

actually rendered.   Such payments are deductible only if they

were made with the intention to compensate.   Paula Constr. Co. v.



      5
        This issue was raised by petitioners other than Mr.
Peters in this case.
                                 16

Commissioner, 58 T.C. 1055, 1058 (1972), affd. without published

opinion 474 F.2d 1345 (5th Cir. 1973).    Petitioners have failed

to introduce any evidence that the payment of legal fees was

intended by PGWV to serve as compensation or salary to Mr.

Peters.    Accordingly, PGWV is not allowed to deduct the payment

of the legal fees as compensation to Peters.

3. Whether a Portion of the Firm's Expense Was an Allowable
Deduction to Peters

     Last, we must decide whether the expenses incurred were

deductible by Peters.6    Under section 212(1), individuals may

deduct all the ordinary and necessary expenses paid or incurred

during the tax year for the production or collection of income.

Our analysis is similar to that used for section 162(a), the

difference being that the profit-seeking or income-producing

activity need not amount to a trade or business.    Johnson v.

Commissioner, 72 T.C. 340, 347 (1979).    Accordingly, the expense

must meet four basic elements:    (a) Payment of the legal fees

must be ordinary; (b) it must be necessary; (c) they must be paid

or incurred during the tax year by the taxpayer; and (d) the

expense must arise in connection with, or proximately result from

the taxpayer's profit-seeking activity.    O'Malley v.

Commissioner, 91 T.C. 352, 361 (1988).




     6
          This issue was raised in this case by petitioners Peters.
                                  17

     A.   Ordinary

     Ordinary expenses have been described as "normal, usual, or

customary".   Deputy v. du Pont, 308 U.S. at 495.     Ordinary has

been used to distinguish currently deductible expenses from

capital expenses, such as startup costs or acquisition costs, or

costs in defending title.     Commissioner v. Lincoln Sav. & Loan

Association, 403 U.S. 345 (1971); Woodward v. Commissioner, 397

U.S. 572 (1970); Carl Reimers Co. v. Commissioner, 211 F.2d 66

(2d Cir. 1954), affg. 19 T.C. 1235 (1953).      An expense may be

deductible as one incurred in the ordinary course of business,

even if it is unlikely to recur.       Welch v. Helvering, 289 U.S.

111, 114 (1933).     The Supreme Court in Commissioner v. Heininger,

320 U.S. 467, 471 (1943), allowed a deduction for legal fees

where obtaining legal representation was the normal response of

one whose business was threatened by a law suit.      See also

Kanelos v. Commissioner, a Memorandum Opinion of this Court dated

Sept. 21, 1943.

     Respondent argues that the origin of the claim giving rise

to the legal expenses here in issue was capital in nature because

the claim involved the sale of a capital asset (namely, the ERG

stock), and because Peters undertook to defend against the claim

in order to prevent disgorgement of proceeds of insider trading.

Respondent contends that under Barrett v. Commissioner, 96 T.C.

713 (1991), such legal fees are not currently deductible.
                                18

     Respondent's argument fails for the following reasons.

Although the underlying transaction here did remotely involve a

capital transaction (the purchase of the ERG stock), the relation

of Peters to such transaction is too attenuated.   Peters

allegedly gave inside information to Mick and Lounsbury, who then

profited from such information, and returned some of the profits

by the repayment of loans.   Peters did not buy any stock;

furthermore, the allegations of the SEC were never proven or

admitted by Peters.

     In Barrett v. Commissioner, supra, the taxpayer was sued by

the SEC, inter alia, for alleged inside trading; as part of a

settlement, he disgorged his profits.   The case is

distinguishable because there the taxpayer was a buyer-broker,

and the underlying transaction was the purchase of certain

options by the taxpayer based on inside information.   In our

case, Peters was not a buyer-broker, but was an investment

adviser; he did not personally buy the stock which gave rise to

the claim.

     In the present case, Peters was alleged to have committed an

inside trade, and faced losing his license as an investment

adviser.   There being nothing capital concerning the legal fees

(they were spent to protect Peters and his money-making

activity), we find that defending the SEC allegations was

proximately related to his business, and accordingly we hold that

the payment of the legal fees was ordinary in nature for him.
                                19

     B.   Necessary

     A necessary expense is one that is appropriate or helpful to

the taxpayer in his profit-seeking activities.   Commissioner v.

Heininger, supra at 471.   Peters was an investment adviser.    The

aim of the litigation with the SEC was to revoke his license in

such endeavors.   We find that the legal expenses were necessary

to protect his profit-seeking activities.

     C.   Paid or Incurred During the Tax Year

     Respondent conceded that legal fees of $128,854.71,

$198,431.67, and $135,659.23 were incurred for the tax years 1988

through 1990, respectively, and that PGWV paid them.   Respondent

disallowed deductions of $123,103, $190,245, and $128,131 for the

years 1988 through 1990.   We have held that the payment of the

legal fees was not deductible as an expense by PGWV under section

162(a).

     Petitioner argues that the legal fees were constructively

paid by him, and refers to Broad v. Commissioner, T.C. Memo.

1990-317, for support.   In Broad, a C corporation made payments

on a loan that was a personal obligation of one of the

shareholders.   This Court held that the payment of the loan

obligation was a constructive dividend; we then allowed the

taxpayer a deduction for the interest on the loan.   In other

words, we reasoned that because he was treated as having received

an amount equal to the loan payment by the bank for him, he

should be treated as having paid the interest to the bank which
                                 20

was part of that payment.    Broad v. Commissioner, supra, citing

Hufnagle v. Commissioner, T.C. Memo. 1986-119.     We have

repeatedly held that where a corporation pays the personal

expenses of a shareholder, such payment will be treated as a

constructive dividend to the shareholder to the extent of the

corporation's earnings and profits, and to the extent that the

corporation does not expect repayment.    Falsetti v. Commissioner,

85 T.C. 332 (1985); Henry Schwartz Corp. v. Commissioner, 60 T.C.

728 (1973); Challenge Manufacturing Co. v. Commissioner, 37 T.C.

650 (1962); McWilliams v. Commissioner, T.C. Memo. 1995-454;

Smith v. Commissioner, T.C. Memo. 1995-410.   Generally, the case

law deals with deemed or constructive dividends.    Respondent has

not determined nor argued that Peters received dividend income,

and, accordingly, we analyze only whether there has been a

constructive distribution.   Neither party has sought to

characterize the payment of the legal fees as a dividend to

Peters, nor are the facts necessary for such an analysis before

us.   In our case, legal fees were paid by PGWV, there was no

expectation of repayment, and the payment directly benefited

Peters.   We therefore find that the payment of the legal fees

constituted a distribution to Peters; we make no decision as to

the characterization of the distribution, either as income to

Peters, a loan to him, or a return of capital; it is not

necessary to our conclusion that Peters received a constructive

distribution of the funds which in turn were used to pay the
                                21

legal charges incurred for his benefit.    We hold that Peters was

in constructive receipt of the distribution in the amount of the

legal fees, and for purposes of claiming them as a deduction he

has also constructively paid the legal fees.    Cf. Mueller v.

Commissioner, 496 F.2d 899 (5th Cir. 1974), affg. in part, revg.

in part and remanding 60 T.C. 36 (1973).

     D. Incurred in Connection with Taxpayer's Profit-Seeking
Activity

     The final element will be met where the activity proximately

results from the taxpayer's profit-seeking activity.    Deputy v.

du Pont, 308 U.S. 488, 492 (1940); Kornhauser v. United States,

276 U.S. 145 (1928).   We have held above that the origin of the

claim was not in the trade or business of PGWV, but rather arose

in Peters' own activities.   The question becomes whether the

activity was a profit-seeking activity for purposes of section

212(1).   The transaction in question involved Peters' receipt of

certain payments that the SEC alleged were made only as the

result of an inside trade.   Those allegations were never proven.

If they were true, and Peters did engage in an inside trade, such

trade was a profit-seeking activity, albeit an improper one.     See

Kent v. Commissioner, T.C. Memo. 1986-324 (charter boat captain

arrested for marijuana smuggling allowed to deduct legal fees

paid by an undisclosed third party).   If the allegations were not

true, then the underlying transaction was the repayment of loans

from colleagues who were not clients of PGWV.   The loans resulted

from Peters' profit-making business relationship with such
                                22

colleagues, and we conclude that the payment of the legal fees

cannot reasonably be construed as being personal, as opposed to

business, in nature.   Kornhauser v. United States, supra at 148.

     The necessary elements having been met, we hold that Peters

is entitled to a deduction under section 212(1) for the

previously disallowed legal fees paid on his behalf by PGWV.

                                     Decisions will be entered

                              under Rule 155.
