                        T.C. Memo. 1997-231



                      UNITED STATES TAX COURT



     FLOYD L. GARRETT AND DOROTHY G. GARRETT, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No.   16771-94.            Filed May 19, 1997.



     James V. Walker and Steven C. Koegler, for petitioners.

     William R. McCants, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     RUWE, Judge:   Respondent determined deficiencies, an

addition to tax, and accuracy-related penalties in petitioners'

Federal income taxes as follows:
                                  - 2 -

                        Addition to Tax   Accuracy-related Penalties
Year       Deficiency   Sec. 6651(a)(1)   Sec. 6662(h) Sec. 6662(a)

1989        $381,230           --          $89,600        $31,446
                            1
1990         113,333         $30,784           --           22,667
1991          53,347           --             --           10,478

       1
      Respondent has conceded the addition to tax under sec.
6651(a)(1) in the amount of $30,784, and petitioners have
conceded the addition to tax of $2,005.11 assessed per return
under sec. 6651(a)(1).


       After concessions, the issues remaining for decision are:

(1) Whether petitioners are entitled to any basis in a collection

of "muscle cars"1 they sold in 1989; (2) whether petitioners were

engaged in a trade or business that would entitle them to a

business expense deduction regarding certain disallowed corporate

expenses; (3) whether petitioners underreported ordinary income

from Blumenstock Enterprises, Ltd., an S corporation; (4) whether

petitioner Dorothy G. Garrett is entitled to innocent spouse

relief pursuant to section 6013(e);2 (5) whether petitioners are

liable for accuracy-related penalties under section 6662(a) for

1989, 1990, and 1991 and under section 6662(h) for 1989.


       1
      On brief, petitioners describe muscle cars as "factory hot
rods * * * [with] high-performance, high-horsepower engines
* * * with [a] four-speed manual transmission." Most muscle cars
in petitioners' 1989 collection were manufactured in the 1960's
to early 1970's, and include, for example, a 1970 Ford Mustang
Boss 429, a 1970 Plymouth Super Bird, a 1966 Corvette, and a 1967
Ford Fairlane.
       2
      Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable years in
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure
                                 - 3 -

                          FINDINGS OF FACT


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

The stipulation of facts is incorporated herein by this

reference.


Petitioners


     Petitioners were married and resided in Fernandina Beach,

Florida, at the time their petition was filed.   Petitioners filed

joint Federal income tax returns for 1989, 1990, and 1991.

     Petitioners began divorce proceedings in 1992.   On October

10, 1994, petitioners signed a mediated settlement agreement with

respect to their divorce.    In that agreement, Mr. Garrett agreed

to indemnify Mrs. Garrett for all Federal income taxes,

penalties, and interest accruing during their marriage through

the calendar year 1992.   In addition, the indemnification

agreement provides Mrs. Garrett with a lien interest against Mr.

Garrett's collection of automobiles until such time as the

Federal income tax liability has been fully discharged and

released.    Although the marriage was dissolved in 1995, certain

property issues are on appeal.


Mr. Garrett's Corporations


     Mr. Garrett was the sole owner of Floyd Garrett, Inc. (FGI),

a trucking company located in Fernandina Beach, Florida.     FGI was
                                - 4 -

incorporated in 1979 and was in the business of hauling sludge

and other waste products from pulp mill plants in the area to

dump sites.    During the years in issue, FGI was an S corporation

under section 1366 and filed U.S. Income Tax Returns for an S

Corporation (Forms 1120S).

     During the years in issue, Mr. Garrett also owned 100

percent of Timber Transfer, Inc. (TTI), another trucking

operation.    TTI was incorporated in 1981.   TTI was also an S

corporation under section 1366 and filed Forms 1120S for the

taxable years 1989, 1990, and 1991.

     Mr. Garrett ran the day-to-day operations of both FGI and

TTI until he sold both corporations in 1993.

     Mr. Garrett also had an ownership interest in Blumenstock

Enterprises, Ltd. (BEL), a mechanical construction company.       BEL,

an S corporation under section 1366, filed a Form 1120S for the

taxable year 1991.    Attached to this return was a single Schedule

K-1 (Shareholder's Share of Income, Credits, Deductions, etc.),

which showed that 100 percent of the claimed corporate loss in

1991 flowed to Mr. Garrett.    There were no other shareholders

listed on BEL's 1991 return, nor were there any other Schedule

K-1's attached.

     The following expenditures claimed by FGI, TTI, and BEL were

among corporate expenses considered personal, nondeductible

expenses by respondent during her audit of petitioners' 1989,

1990, and 1991 tax returns:
                                    - 5 -

  Corporation              1989               1990          1991

         FGE             $243,682           $291,930       $10,615
         TTI              152,838             16,259          --
         BEL                --                 --           40,503

         Total           $396,520           $308,189       $51,118


Petitioners do not dispute respondent's determination that these

expenses were improperly deducted by the corporations or that the

amounts are taxable income to them.          Most, but not all, of the

above expenses for FGI and TTI related to Mr. Garrett's

personally owned muscle cars.       Additionally, the expenses

disallowed to BEL were checks that were written by or for Mr.

Garrett.


Muscle Cars


     1.     1989 Sale


     Prior to 1989, Mr. Garrett collected muscle cars as a hobby.

In January 1989, Mr. Garrett sold 25 automobiles from his muscle

car collection for $1.2 million.3       On their Federal income tax

return for 1989, petitioners claimed a basis of $800,000 in the

muscle cars sold.       In the notice of deficiency, respondent

determined that petitioners failed to demonstrate that they were

entitled to any basis in the capital assets sold and, therefore,

realized a gain of $1.2 million from the sale of the muscle cars.


     3
      After this sale, Mr. Garrett had 10 muscle cars remaining
from his original collection.
                                 - 6 -

     Mr. Garrett admits that collecting muscle cars was a

personal hobby prior to the sale in 1989 and that he has no

written documentation substantiating the claimed basis in the

cars sold.   Mr. Garrett also admits that prior to 1989, FGI and

TTI issued checks to pay for the acquisition of the muscle cars.

One or two years prior to trial, Mr. Garrett prepared from memory

a reconstructed summary of expenses associated with the muscle

cars sold in 1989.     This reconstructed summary indicates purchase

and renovation expenses totaling approximately $683,000 on the 25

cars sold in 1989.     Mr. Garrett claims that this figure does not

include any of the expenses improperly deducted by FGI, TTI, and

BEL during 1989 and that a portion of the disallowed expenses

should be added to this reconstructed figure to arrive at a total

basis of $800,000.     Petitioners did not produce any evidence that

any corporate expenditures incurred during the years in issue

were related to the specific cars sold in 1989.

     2.   Activities After 1989 Sale


     After the sale of the 25 muscle cars in 1989, Mr. Garrett

began purchasing and refurbishing additional cars to add to his

remaining collection of 10 cars.    Other than the cars sold in

1989, Mr. Garrett did not sell any muscle cars during or after

the years in issue.4    Petitioners did not claim any depreciation



     4
      Mr. Garrett made occasional trades to get a better example
of a particular car.
                                - 7 -

deductions or other expenses or report any other income on their

1989, 1990, or 1991 individual income tax returns relating to the

muscle car collection.   In contrast, FGI, TTI, and BEL claimed

considerable expenses during these years, primarily for the

acquisition and renovation of petitioners' muscle car collection.

Respondent has determined that these expenses were improperly

deducted by the corporations.    Although petitioners do not

dispute respondent's determination, they now contend that they

were in the muscle car business during the years in issue and are

entitled to deduct these expenses under section 162(a) on their

individual Federal income tax returns.

     During the years in issue, it was Mr. Garrett's general

intention to open a muscle car museum at some future time in

order to exhibit his collection of muscle cars and possibly sell

some of the cars on display.    In 1993, Mr. Garrett incorporated

Floyd Garrett's Muscle Cars, Inc. (FGMCI), under the laws of the

State of Tennessee.   At the time of trial, Mr. Garrett had chosen

a location in Sevierville, Tennessee, and was in the final stages

of constructing a building on this site to house his collection

of muscle cars.   However, the muscle car museum was not open to

the public at any time during the years in issue and had not yet

opened at the time of trial.    FGMCI owns the realty and the

museum building and will have the occupational licenses and

insurance to run Mr. Garrett's proposed muscle car museum.      It is
                               - 8 -

Mr. Garrett's intention to transfer ownership of the muscle cars

to FGMCI as well.


Preparation of Petitioners' Tax Returns


     Petitioners' tax returns were prepared in accordance with

information that Mr. Garrett supplied to his certified public

accountant, James Knutzen.   Mr. Knutzen's firm performed

accounting work for petitioners from 1978 until 1991.   In

addition to preparing petitioners' Federal income tax returns,

Mr. Knutzen's firm prepared monthly financial statements, as well

as quarterly and annual payroll tax returns for FGI and TTI.    In

preparing these documents, Mr. Knutzen's firm relied on bank

statements, coded checks, receipts, and other information

provided by Mr. Garrett or a representative of his corporations.

Knutzen never audited petitioners or any of Mr. Garrett's

companies.   Although Mr. Knutzen was aware of Mr. Garrett's

muscle car collection activities, his firm never reflected those

activities as a business on petitioners' income tax returns for

the years in issue.


                              OPINION


Issue One:   Basis in the Muscle Cars Sold in 1989


     The first issue for decision involves petitioners' proper

basis in a collection of muscle cars sold in 1989 for $1.2
                                - 9 -

million.   On their 1989 Federal income tax return, petitioners

claimed capital gain income of $400,000 on the sale of 25 muscle

cars.   Petitioners reported a sale price of $1.2 million and

claimed a basis of $800,000 in the cars sold.     Respondent

determined that petitioners are not entitled to any part of the

$800,000 basis claimed on the muscle cars and that petitioners

thus have additional income in 1989 of $800,000.

     Petitioners bear the burden of demonstrating that they are

entitled to a basis in the muscle cars in excess of that

determined by respondent.    Rule 142(a); Burnet v. Houston, 283

U.S. 223, 227-228 (1931).    Section 1012 provides that a taxpayer

generally has a basis in property equal to its cost.     Cost is

defined as "the amount paid for such property in cash or other

property."   Sec. 1.1012-1(a), Income Tax Regs.    Under the

circumstances present here, cost means the amount paid by

petitioners.   Detroit Edison Co. v. Commissioner, 319 U.S. 98,

102 (1943); Borg v. Commissioner, 50 T.C. 257, 263 (1968).      Thus,

we must determine what amount, if any, petitioners paid for the

muscle car collection.

     Mr. Garrett testified that he began collecting muscle cars

in the mid-to-late 1970's.   Although petitioners admit that FGI

and TTI issued checks to pay for some of the muscle car

expenditures, petitioners contend that they had sufficient funds

to acquire the collection using after-tax income from the
                               - 10 -

following sources:   (1) Distributed income from the operation of

FGI and TTI; (2) more than $300,000 borrowed from FGI and TTI

from 1979 through 1988; (3) corporate bonuses of approximately

$100,000 per year; and (4) proceeds from the sale of several

parcels of real estate.   In their attempt to support their

position that they actually paid for the muscle cars, petitioners

submitted their individual Federal income tax returns for taxable

years 1984 through 1988, as well as Forms 1120 and 1120S for FGI

and TTI for taxable years 1983 through 1988.

     On the other hand, respondent argues that she disallowed the

claimed basis in the muscle car collection because petitioners

failed to present any evidence that established they actually

paid for the property.    See sec. 1012.   Respondent contends that

Mr. Garrett's corporations paid for the purchase and restoration

of the muscle cars; therefore, petitioners paid nothing from

their own funds for the collection sold in 1989.

     We have reviewed petitioners' returns and do not find the

figures stated in these documents persuasive.    Petitioners have

not provided this Court with any supporting documentation for

either their individual Federal income tax returns or the

corporate returns for the taxable years prior to 1989.    Without

supporting documentation, such as bank statements, canceled

checks, and other corporate records, it is impossible to

determine conclusively the true origin of the funds used to
                                - 11 -

acquire the muscle car collection.       Petitioners' failure to

produce evidence within their possession and which, if true,

would be favorable to them, raises the presumption that if

produced, it would be unfavorable to them.       Wichita Terminal

Elevator Co. v. Commissioner, 6 T.C. 1158, 1165 (1946), affd. 162

F.2d 513 (10th Cir. 1947).

     The only evidence offered by petitioners to carry their

burden is Mr. Garrett's own testimony and that of his accountant,

Mr. Knutzen.     We find much of Mr. Garrett's testimony on this

subject to be vague, confused, self-serving, and uncorroborated.

Under the circumstances, we are not required to, and we do not,

rely on that testimony to support petitioners' position in this

case.    See Estate of DeNiro v. Commissioner, 746 F.2d 327, 330-

331 (6th Cir. 1984), affg. in part and remanding in part T.C.

Memo. 1982-497; Lovell & Hart, Inc. v. Commissioner, 456 F.2d

145, 148 (6th Cir. 1972), affg. T.C. Memo. 1970-335; Tokarski v.

Commissioner, 87 T.C. 74, 77 (1986); Hradesky v. Commissioner, 65

T.C. 87, 90 (1975), affd. per curiam 540 F.2d 821 (5th Cir.

1976).

     Nor do we find Mr. Knutzen's testimony any more persuasive

on this issue.    When asked by petitioners' attorney what steps he

took to verify the $800,000 basis claimed by Mr. Garrett, Mr.

Knutzen provided the following testimony:
                        - 12 -

A. Well, first of all I asked Mr. Garrett if he could
come up with something to verify that basis in more
detail. He went--he came back and said that he had
acquired these cars over years and years, and he had
traded some, and he had improved some, and he didn't
really have the detailed records.

     But I did require him to sign, not exactly an
affidavit but something that was to the best of his
ability. And then I also, since I had known him for
ten years, and I have a reputation as a CPA, I wanted
to at least be satisfied that he had acquired enough
net worth outside of the company to allow him to
acquire that kind of inventory of vehicles.

     So I did a little worksheet, kind of a mental
worksheet, as to if that would be possible, and I
decided that, yes, he would have had enough personal
assets to acquire that.

Q.   So at that point, you were satisfied that he had
the after-tax resources to have invested $800,000 in
the cars he sold in 1988?

A.   Yes, I did.

Q.   Okay. Would you step us through the mental
process you went through in proving that $800,000 basis
to yourself?

A.   Well, just in--there is three aspects of that
calculation, and the biggest one is that each year,
pretty much from 1980 through '89, which is nine years,
we would bonus him out approximately $100,000 a year at
the end of the year to cover some of the items that we
considered to be personal.

     And I presumed the majority of that was for muscle
cars, because he had a regular salary of 3,000 a month
for his living expenses. So that is approximately 8-or
900,000; after tax, it would be maybe $500,000.

     That was the first and largest part of the
calculation. The second one was the loan balance.
Even after these bonuses, he still had a loan balance
with the company of in excess of $300,000. And there
again, I presumed that the majority of that was for
these type of personal muscle cars.
                              - 13 -

          And the last item was Mr. Garrett had bought and
     sold some real estate. He was also a shrewd investor
     in real estate, and I presumed that some of those
     profits from real estate transactions had probably gone
     into this.

          So I satisfied myself that he could have put up to
     that 800,000, and I was--and on that basis, I--you
     know, our firm did prepare the return. [Emphasis
     added.]


     It is clear from his testimony that Mr. Knutzen did not have

any independent knowledge of the origin of the funds used to

acquire the muscle car collection.     Rather, he relied solely on

the representations of Mr. Garrett.    His presumptions regarding

the source of the funds for the muscle car collection do not rise

to the level of fact.   Mr. Knutzen testified that he never

audited Mr. Garrett's corporations.    He also admitted on cross-

examination that Mr. Garrett could have expended $200,000 of the

corporations' funds for personal expenses in 1987 or 1988 without

Mr. Knutzen's knowledge.

     Furthermore, FGI, TTI, and BEL made substantial expenditures

for the benefit of petitioners that were claimed as deductible

business expenses by these corporations.    These expenses total

$755,827 for the 3 years in issue, most of which relate to Mr.

Garrett's muscle car collection.

     Based on our review of the entire record in this case,

including the lack of any documentation supporting petitioners'

expenditures for the purchase and renovation of the muscle cars,

the pattern of disallowed deductions taken during the years in
                               - 14 -

issue, and the fact that FGI and TTI issued corporate checks to

pay for the muscle cars prior to 1989, we are inclined to believe

that Mr. Garrett's wholly owned companies, FGI and TTI, were the

source of funds for the acquisition and renovation of the muscle

cars sold in 1989.5   We find that petitioners do not satisfy

their burden of proving that they paid for the muscle car

collection.    We, therefore, sustain respondent's determination

that petitioners are not entitled to any basis in the automobiles

sold in 1989.6

Issue Two:    Disallowed Corporate Deductions




     5
      The pattern of improper deductions taken by the
corporations during the years in issue suggests that similar
deductions were taken in prior years. Any deductions taken by
Mr. Garrett's S corporations would have reduced the profits
reflected and, thus, reduced the taxable income of petitioners.
If this is what occurred, petitioners would receive a double tax
benefit if they were now allowed a basis with respect to
previously deducted amounts. See Hughes & Luce, L.L.P. v.
Commissioner, T.C. Memo 1994-559, affd. on other grounds 70 F.3d
16 (5th Cir. 1995).
     6
      Petitioners urge us to apply Cohan v. Commissioner, 39 F.2d
540 (2d Cir. 1930), affg. in part and remanding in part 11 B.T.A.
743 (1928). Under the so-called Cohan rule, where the taxpayer
is unable to substantiate expenses through adequate records or
other proof, we may estimate the deductible amount, if some
deductible amount is suggested by other evidence, bearing
heavily, if we choose, upon the taxpayer whose inexactitude is of
his own making. Id. at 543-544. However, in order for us to
estimate the amount of an expense, we must have some basis upon
which an estimate may be made. Vanicek v. Commissioner, 85 T.C.
731, 742-743 (1985). There must be sufficient evidence assuring
this Court that some amount was in fact spent or incurred by the
taxpayer for the stated purpose. Without such confirmation,
"relief to the taxpayer would be unguided largesse." Williams v.
United States, 245 F.2d 559, 560 (5th Cir. 1957).
                              - 15 -

     The second issue for decision is whether petitioners were

engaged in a trade or business that would allow them to deduct

the expenses of acquiring and refurbishing their muscle car

collection after the sale in 1989.     Respondent disallowed certain

expenses deducted by FGI, TTI, and BEL on their respective Forms

1120S for tax years 1989, 1990, and 1991.    Respondent determined

that these expenses were personal, nondeductible payments by the

corporations.   Petitioners do not dispute respondent's

determination that these amounts should not have been deducted by

the corporations.   Rather, petitioners argue that these expenses

are deductible by them under section 162(a) on their individual

tax returns as expenses incurred in the trade or business of

muscle cars.7

     Petitioners have identified and classified certain of these

expenses that relate to the refurbishment and acquisition of

petitioners' muscle car collection during the years 1989, 1990,

and 1991.   The information provided by petitioners may be

summarized on a year-by-year basis and compared to the total

amount of deductions disallowed by respondent as follows:8



     7
      Petitioners apparently contend that the resulting increase
in distributable income from the corporations caused by the
disallowance of these deductions was then, in turn, deductible by
them on their individual income tax returns as trade or business
expenses.
     8
      We make no finding as to the accuracy of the information
provided by petitioners. We include it merely to show the
approximate amount of expenses improperly deducted by the
corporations during the years in issue with respect to
petitioners' muscle car collection.
                               - 16 -

Year        Corporation     Muscle Car Expense   Improper Deduction

1989          FGI               $202,453             $243,682
              TTI                136,645              152,838
              BEL                   --                   --

1990          FGI               257,604              291,930
              TTI                16,259               16,259
              BEL                  --                   --

1991          FGI                 2,123               10,615
              TTI                  --                   --
              BEL                 9,487               40,503

Totals                          $624,571             $755,827


       Respondent agrees that these expenses relate to petitioners'

muscle car collection; however, she disagrees that the

expenditures constitute deductible expenses.     Respondent argues

that petitioners have not established that these expenditures are

ordinary and necessary, as opposed to capital expenditures, and

that petitioners had not yet entered into a trade or business in

1989, 1990, or 1991; i.e., petitioners' activities were

preparatory, at best, to future business activities.     We agree.

       A taxpayer who is carrying on a trade or business may deduct

all the ordinary and necessary expenses paid or incurred in

connection with the operation of the business.    Sec. 162(a).

However, an expense paid or incurred must be capitalized and may

not be deducted if it materially enhances the value, use, life

expectancy, strength, or capacity of the property.     Sec.

1.263(a)-1(b), Income Tax Regs.    Petitioners have not proven that

the expenditures in question did not materially enhance the

value, use, life expectancy, or strength of the muscle cars.
                              - 17 -

Indeed, the evidence available suggests that these expenditures

were capital expenditures.

     To be deductible, the expenses must also have been paid or

incurred after the taxpayer's trade or business actually

commenced; expenses incurred prior to that time are nondeductible

preopening expenses.   Richmond Television Corp. v. United States,

345 F.2d 901, 907 (4th Cir. 1965), vacated and remanded on other

issues 382 U.S. 68 (1965), original holding on this issue reaffd.

354 F.2d 410, 411 (4th Cir. 1965), overruled on other grounds

NCNB Corp. v. United States, 684 F.2d 285, 288-289 (4th Cir.

1982); Jackson v. Commissioner, 86 T.C. 492, 514 (1986), affd.

864 F.2d 1521 (10th Cir. 1989); Goodwin v. Commissioner, 75 T.C.

424, 433 (1980), affd. without published opinion 691 F.2d 490 (3d

Cir. 1982); McManus v. Commissioner, T.C. Memo. 1987-457, affd.

without published opinion 865 F.2d 255 (4th Cir. 1988); see also

sec. 195.9


     Section 162 does not allow deductions for otherwise
     deductible expenses until such time as the trade or
     business begins to function as a going concern even
     though the taxpayer may have made a firm decision to
     enter into business and has expended considerable sums
     of money in preparation of commencing business. * * *
     [Jackson v. Commissioner, supra at 514.]



     9
      Sec. 195 provides that preopening or startup   expenses are
not fully deductible in the year incurred and must   be amortized
over a period of not less than 60 months beginning   with the month
in which the taxpayer begins business. We make no    determination
as to whether these expenses would qualify as sec.   195 expenses
if and when the trade or business begins.
                              - 18 -

     Mr. Garrett testified that prior to the sale in 1989, he

considered his muscle car collection activity to be a hobby.    On

brief, petitioners recognize that Mr. Garrett's activity will not

be considered a trade or business if he does not show that he

engaged in the activity with continuity and regularity and with

the primary purpose of earning income or profit.   Further, they

recognize that sporadic activity, a hobby, or an amusement

diversion will not qualify as a business.

     The evidence does not support Mr. Garrett's claim that his

activity shifted from a hobby to a trade or business during the

years in issue.   Mr. Garrett's method of acquiring and paying for

muscle cars by using corporate funds, which were then improperly

deducted, apparently remained the same.   There is no proof that

petitioners' record keeping (or lack thereof) changed and no

business activity with respect to the muscle cars was reported on

petitioners' income tax returns.   In fact, Mr. Garrett referred

to his muscle car collecting activities as a hobby as recently as

1991 in an interview for a local newspaper.   Therefore, we find

that Mr. Garrett's activities during the years in issue were

simply a continuation of Mr. Garrett's hobby and not a trade or

business.

     Even if Mr. Garrett hoped to establish a museum in the

future, his purchase and refurbishment of muscle cars were, at

most, preparations for entry into the trade or business of

operating a muscle car museum and not activities that constituted
                               - 19 -

an active trade or business.   Certainly, if purchasing and

renovating muscle cars were to be considered a business, it would

have to be a business that would produce income.   Here, income

could be produced by using the cars in the business of collecting

admission from museum patrons and from the sale of the

refurbished muscle cars.   Petitioners contend that they were

involved in both of these activities and that each was a separate

business.

     In determining whether a taxpayer engages in two or more

separate activities, section 1.183-1(d)(1), Income Tax Regs.,

provides that


     all the facts and circumstances of the case must be
     taken into account. Generally, the most significant
     facts and circumstances in making this determination
     are the degree of organizational and economic
     interrelationship of various undertakings, the business
     purpose which is (or might be) served by carrying on
     the various undertakings separately or together in a
     trade or business or in an investment setting, and the
     similarity of various undertakings. Generally, the
     Commissioner will accept the characterization by the
     taxpayer of several undertakings either as a single
     activity or as separate activities. The taxpayer's
     characterization will not be accepted, however, when it
     appears that his characterization is artificial and
     cannot be reasonably supported under the facts and
     circumstances of the case. * * *


     Contrary to petitioners' assertion, we do not find that,

during the years in issue, Mr. Garrett was in the trade or

business of refurbishing muscle cars for resale.   There is no

evidence that Mr. Garrett sold any muscle cars during the years
                              - 20 -

in issue other than the collection sold in 1989, which Mr.

Garrett admitted was before he decided to enter the muscle car

business.   Rather, the record indicates that Mr. Garrett

considered the operation of the muscle car museum essential to

his muscle car business.   Mr. Garrett testified that it was his

intention to make a profit from his muscle car business in only

two ways:   (1) From museum ticket and souvenir sales generated by

the exhibition of the museum's muscle car collection; and (2)

from the sale of some muscle cars displayed in the museum.

Consistent with this statement of intention, the majority of the

evidence presented by petitioners on this issue involved

testimony related to Mr. Garrett's plans for a muscle car museum.

Furthermore, Mr. Garrett testified that no part of his muscle car

business would be viable if the planned museum is unsuccessful.

Therefore, the facts of this case do not reasonably support a

characterization of petitioners' undertakings as separate

activities.   Rather, we find that petitioners' business purpose

would be served by carrying out the various activities as a

single enterprise, the muscle car museum.

     Petitioners' prospective muscle car business--the muscle car

museum--could not function as a going concern until such time as

it was open to the public.   Walsh v. Commissioner, T.C. Memo.

1988-242, affd. without published opinion 884 F.2d 1393 (6th Cir.

1989)(holding that a restaurant could not function as a going

concern until it was open to the public).   Mr. Garrett testified
                              - 21 -

that, even as of the date of this trial, the museum doors had not

yet been opened to the public.   Petitioners have not carried

their burden of proving that they are entitled to deduct the

claimed expenses under section 162(a).10    We, therefore, sustain

respondent's determination on this issue.


Issue Three: Income From Blumenstock Enterprises, Ltd.


     To resolve the next issue, we must determine Mr. Garrett's

ownership percentage in BEL during 1991.    Respondent disallowed

certain expenses claimed by BEL in 1991, thus increasing

petitioners' ordinary income by $34,895.    After inspecting

canceled checks, paid invoices, and adjusting journal entries of

BEL, respondent submitted lists of these specific items to BEL's

corporate representative who confirmed that these items

represented nonbusiness, personal expenditures.    Petitioners

acknowledge that the expenses were not allowable deductions of



     10
      Petitioners contend that if they cannot deduct all the
muscle car expenditures during the years in issue, then they
should be allowed to depreciate the muscle cars under sec. 167.
Depreciation is not allowed on assets acquired for a business
that has not begun operations. Piggly Wiggly Southern, Inc. v.
Commissioner, 84 T.C. 739, 745-746 (1985), affd. on other issues
803 F.2d 1572 (11th Cir. 1986). Petitioners themselves have not
treated the muscle car collection as a depreciable asset. They
have never taken a depreciation deduction expense for the muscle
cars on their individual Federal income tax returns. In light of
our finding that petitioners' operations did not function as a
going concern, we conclude that they are not entitled to any
depreciation expense under sec. 167. In addition, petitioners
have failed to provide any substantiation of their alleged basis
in the specific cars they wish to depreciate.
                               - 22 -

BEL.    However, Mr. Garrett testified that he owned only 50

percent, not 100 percent, of the S corporation.    Therefore,

petitioners contend that only 50 percent of the additional income

is taxable to them.

       Section 1366 provides that a shareholder of an S corporation

shall take into account the shareholder's pro rata share of

income earned by the corporation as if such income were realized

directly from the source as realized or incurred by the

corporation.    The burden is on petitioners to prove the

respondent's determinations are incorrect.    Rule 142(a); Welch v.

Helvering, 290 U.S. 111, 115 (1933).

       The evidence in this case does not support petitioners'

argument that Mr. Garrett was only a 50-percent shareholder in

BEL.    The corporate return of BEL treats Mr. Garrett as the sole

shareholder for the taxable year 1991.    Only one Schedule K-1 is

attached to BEL's Form 1120S for 1991.    This Schedule K-1 lists

Mr. Garrett as owning 100 percent of the stock of BEL for 1991.

Petitioners failed to produce evidence of any other BEL

shareholders to support Mr. Garrett's self-serving testimony.

Consequently, we find that Mr. Garrett was the sole shareholder

of BEL in 1991 and that petitioners understated their

distributive share of ordinary income from BEL by $34,895 for

1991.


Issue Four:    Innocent Spouse Relief
                                - 23 -

     The fourth issue for decision is whether Mrs. Garrett

qualifies as an innocent spouse pursuant to section 6013(e) with

respect to the deficiencies for 1989, 1990, and 1991.       Generally,

a husband and wife are jointly and severally liable for the total

tax due on their joint Federal income tax returns.     Sec. 6013(d).

In limited circumstances, however, a spouse may qualify as an

"innocent spouse" and be relieved of joint and several liability.

Sec. 6013(e).    The spouse seeking relief under section 6013(e)

has the burden of proof.     Rule 142(a); Bokum v. Commissioner, 94

T.C. 126, 138 (1990), affd. 992 F.2d 1132 (11th Cir. 1993).

     For Mrs. Garrett to qualify for innocent spouse status, she

must prove:     (1) She and Mr. Garrett filed a joint tax return;

(2) on that joint tax return, there was a substantial

understatement of tax attributable to grossly erroneous items of

the other spouse; (3) in signing the joint tax return, she did

not know, nor had reason to know of the substantial

understatement; and (4) taking into account all the facts and

circumstances, it is inequitable to hold her liable for any

deficiency attributable to the substantial understatement.      Sec.

6013(e)(1)(A)-(D).     Failure to prove any one of these

requirements will prevent Mrs. Garrett from qualifying as an

innocent spouse.     Bokum v. Commissioner, supra at 138.

Respondent concedes that petitioners filed joint tax returns for

1989, 1990, and 1991 and that the understatements on those

returns were substantial.
                              - 24 -

     We find that Mrs. Garrett has failed to show that it would

be inequitable to hold her jointly and severally liable for the

disputed taxes.   An important factor in determining whether it is

inequitable to hold a spouse liable is whether that spouse

significantly benefited, either directly or indirectly, from the

understatement of taxes.   Belk v. Commissioner, 93 T.C. 434, 440

(1989); Purcell v. Commissioner, 86 T.C. 228, 242 (1986), affd.

826 F.2d 470 (6th Cir. 1987); sec. 1.6013-5(b), Income Tax Regs.

Normal support is not considered a significant benefit.    Terzian

v. Commissioner, 72 T.C. 1164, 1172 (1979).    Mrs. Garrett bears

the burden of proving that she received no significant benefit

from the unreported income other than normal support, and this

burden must be supported with specific evidence of lifestyle

expenditures, as well as asset acquisitions.    Bokum v.

Commissioner, 94 T.C. at 157; Estate of Krock v. Commissioner, 93

T.C. 672, 681 (1989).

     Mrs. Garrett failed to provide any evidence of lifestyle

expenditures or asset acquisitions.    In fact, she did not even

testify at trial.   Thus, Mrs. Garrett failed to show that she did

not significantly benefit from the understatements in a manner

that was above her normal support.

     Moreover, Mr. Garrett signed an indemnification agreement

promising to pay all tax liabilities resulting from the filing of

their joint tax returns through 1992.    The effect of such a

promise has been considered by this Court on several occasions
                              - 25 -

with regard to granting innocent spouse relief.   See, e.g.,

Stiteler v. Commissioner, T.C. Memo. 1995-279, affd. without

published opinion 108 F.3d 339 (9th Cir. 1997); Foley v.

Commissioner, T.C. Memo. 1995-16; Buchine v. Commissioner, T.C.

Memo. 1992-36, affd. 20 F.3d 173 (5th Cir. 1994); Henninger v.

Commissioner, T.C. Memo. 1991-574; Knapp v. Commissioner, T.C.

Memo. 1988-109.   The degree to which Mr. Garrett's promise

influences the inequity of holding Mrs. Garrett liable depends

upon whether his promise is reliable or speculative.    Stiteler v.

Commissioner, supra.   Mrs. Garrett has not demonstrated that Mr.

Garrett would not honor his obligation to pay the underlying tax

deficiencies for the years in issue.   Furthermore, the indemnity

agreement provides for a lien against Mr. Garrett's muscle car

collection until such time as the Federal income tax liability

has been fully discharged and released.11

     In addition to demonstrating that it would be inequitable to

hold her liable for any deficiency, Mrs. Garrett must also show

that she had no reason to know of the understatement.   As to

having reason to know, the standard is whether "a reasonably

prudent taxpayer under the circumstances of the spouse at the

time of signing the return could be expected to know that the tax

liability stated was erroneous or that further investigation was

warranted."   Stevens v. Commissioner, 872 F.2d 1499, 1505 (11th


     11
      Mr. Garrett testified that, at the time of trial, he has
over $3 million invested in a total of 64 muscle cars.
                              - 26 -

Cir. 1989) (fn. ref. omitted), affg. T.C. Memo. 1988-63.      The

test for constructive knowledge of an understatement is a

subjective one, focusing on the following factors:     (1)   The

spouse's level of education; (2) the spouse's involvement in the

business and financial affairs of the marriage and in the

transactions that gave rise to the understatement; (3) the

presence of expenditures that appear lavish or unusual when

compared to the taxpayers' accustomed standard of living and

spending patterns; and (4) the culpable spouse's evasiveness and

deceit concerning family finances.     Edmondson v. Commissioner,

T.C. Memo. 1996-393.

     Mrs. Garrett has presented no evidence as to any of these

factors.   In contrast, Mr. Garrett testified that Mrs. Garrett

was aware of his muscle car collection and that he did not hide

any assets or transactions from her.     Accordingly, we find that

Mrs. Garrett failed to demonstrate that she neither knew, nor had

reason to know, about the substantial understatements at the time

petitioners' returns were signed.

     Mrs. Garrett has not satisfied her burden of proof with

respect to two essential elements.     Therefore, she does not

qualify as an innocent spouse within the meaning of section

6013(e).


Issue Five:   Accuracy-Related Penalties
                                  - 27 -

       Finally, we must decide whether accuracy-related penalties

are appropriate for any of the years in issue.        Respondent

determined that petitioners are liable for section 6662 accuracy-

related penalties for 1989, 1990, and 1991.        Section 6662(a)

imposes a penalty in an amount equal to 20 percent of the portion

of the underpayment of tax attributable to one or more of the

items set forth in subsection (b).         Respondent asserts that the

section 6662(a) penalties for 1989, 1990, and 1991 were due to

negligence or disregard of rules or regulations and represent

substantial understatements of income tax.        Sec. 6662(b)(1) and

(2).

       The accuracy-related penalty does not apply with respect to

any portion of the underpayment if it is shown that there was

reasonable cause for such portion and that the taxpayer acted in

good faith with respect to such portion.        Sec. 6664(c)(1).   The

determination of whether a taxpayer acted with reasonable cause

and in good faith is made on a case-by-case basis, taking into

account all the pertinent facts and circumstances.        Sec. 1.6664-

4(b)(1), Income Tax Regs.    The most important factor is the

extent of the taxpayer's effort to assess his proper tax

liability for the year.     Id.

       Petitioners contend that the accuracy-related penalties are

inappropriate in this case, because they relied on their

certified public accountant, Mr. Knutzen, to prepare their tax

returns accurately.    Generally, the duty of filing accurate
                              - 28 -

returns cannot be avoided by placing the responsibility on a tax

return preparer.   Metra Chem Corp. v. Commissioner, 88 T.C. 654,

662 (1987).   However, reliance on a qualified adviser may

demonstrate reasonable cause and good faith if the evidence shows

that the taxpayer contacted a competent tax adviser and provided

the adviser with all necessary and relevant information.     Jackson

v. Commissioner, 86 T.C. 492, 539-540 (1986), affd. 864 F.2d 1521

(10th Cir. 1989); Daugherty v. Commissioner, 78 T.C. 623, 641

(1982); Magill v. Commissioner, 70 T.C. 465, 479 (1978), affd.

651 F.2d 1233 (6th Cir. 1981); Pessin v. Commissioner, 59 T.C.

473, 489 (1972).   In addition, even if petitioners can establish

the above requirements, they still have a duty at least to read

and make a cursory review of the return and make sure all income

items are included.   Metra Chem Corp. v. Commissioner, supra at

662; Magill v. Commissioner, supra at 479-480.

     Petitioners failed to establish that they supplied Mr.

Knutzen with complete and accurate information.   Taxpayers who

control the affairs of a corporation cannot establish that they

provided correct information to their return preparer if the

corporate records they provide incorrectly reflect that alleged

business expenses did not benefit the individual.   Magill v.

Commissioner, supra at 479.   Mr. Garrett either failed to

disclose or concealed from Mr. Knutzen the true extent of

personal expenditures made with the corporate funds of FGI and

TTI by providing canceled checks, check stubs, and receipts that
                                 - 29 -

did not accurately reflect the personal nature of the

expenditures.     Moreover, petitioners failed to demonstrate what

advice they relied on.     Finally, petitioners did not establish

that they reviewed the returns in issue to make sure that all

income items were included.     Accordingly, we sustain respondent's

determination and find that petitioners are liable for the

accuracy-related penalties under section 6662(a) in 1989, 1990,

and 1991.

     Respondent also determined that petitioners are liable for

the 40-percent penalty for gross valuation misstatements provided

under section 6662(h) with respect to the adjusted basis of the

muscle car collection stated on petitioners' 1989 return.12

There is a "gross valuation misstatement" if the value or

adjusted basis on any property claimed on a return is 400 percent

or more of the correct amount.     Sec. 6662(e), (h); sec. 1.6662-

5(e)(2), Income Tax Regs.     Section 1.6662-5(g), Income Tax Regs.,

provides that "The value or adjusted basis claimed on a return of

any property with a correct value or adjusted basis of zero is

considered to be 400 percent or more of the correct amount."     On

their 1989 Federal income tax return, petitioners claimed a basis

of $800,000 on the muscle cars sold in 1989.    We find that

     12
          Sec. 6662(h) provides in part:

     To the extent that a portion of the underpayment to
     which this section applies is attributable to one or
     more gross valuation misstatements, subsection (a)
     shall be applied with respect to such portion by
     substituting "40 percent" for "20 percent".
                             - 30 -

petitioners did not prove that they had a basis in the collection

sold and, thus, petitioners had a zero basis in the cars.

Therefore, we sustain respondent's determination and find that

petitioners are liable for the 40-percent accuracy-related

penalty on the adjusted basis of the muscle car collection.



                                        Decision will be entered

                                   under Rule 155.
