                        T.C. Memo. 2001-43



                      UNITED STATES TAX COURT



         ALAN G. BONE AND KATHLEEN A. BONE, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent

  JEFFREY M. GUERRERO AND GENEDINE R. GUERRERO, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 20220-98, 20221-98.      Filed February 23, 2001.



     James L. McDonald, Sr., for petitioners.

     Larry D. Anderson, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION

     GERBER, Judge:   In separate notices of deficiency,1

respondent determined deficiencies in petitioners’ income taxes

as follows:


     1
       These cases have been consolidated for purposes of trial,
briefing, and opinion.
                                - 2 -

              Docket No.        Year           Deficiency
               20220-98         1993            $524,103
               20221-98         1993             545,324

     After concessions,2 the issues for our consideration are:

(1) Whether A.J. Concrete Services, Inc. (AJCS), is entitled to

deduct $2,261,555 in expenses; (2) whether AJCS overreported its

income by $2,680,500; (3) whether AJCS is entitled to a $269,815

deduction for accrued workmen’s compensation expense.       Unless

otherwise indicated, all section references are to the Internal

Revenue Code in effect for the periods under consideration, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.

                           FINDINGS OF FACT3

     Petitioners Jeffrey and Genedine Guerrero resided at 4215

Osprey Pointe, Woodstock, Georgia, on the date their petition was

filed.   Petitioners Alan and Kathleen Bone resided at 617 North

Lake Drive, Canton, Georgia, at the time their petition was

filed.




     2
       Respondent concedes that A.J. Concrete Services, Inc.
(AJCS), is entitled to $444,766 in 1993 for costs of goods sold.
This represents the depreciation that AJCS claimed on concrete
forming devices.
     3
       The parties’ stipulation of facts is incorporated by this
reference. We also incorporate by this reference our findings of
fact in A.J. Concrete Pumping, Inc. v. Commissioner, T.C. Memo.
2001-42, and Guerrero v. Commissioner, T.C. Memo. 2001-44.
                               - 3 -

A.J. Concrete Services and the Four Affiliates

     Alan Bone (Mr. Bone) and Jeffrey Guerrero (Mr. Guerrero)

owned 49 percent and 51 percent, respectively, of AJCS, an S

corporation incorporated in 1987 and engaged in the business of

supplying construction forming equipment and materials to various

contractors.4   AJCS, a calendar year taxpayer, maintained its

books on the percentage of completion method for financial

accounting purposes and the completed contract method for tax

purposes.

     As of December 31, 1992, AJCS owned ongoing construction

contracts with a total value of $19,975,949 and estimated

projected gross profits of $8,763,221.   AJCS’ schedule of

contracts reflects that, as of December 31, 1992, it had

$2,680,500 of recognized gross profit on its partially completed

contracts.

     On January 1, 1993, AJCS transferred its incomplete

contracts to four C corporations:   A.J. Concrete Forming of

Georgia, Inc. (Georgia); A.J. Concrete Forming Central, Inc.




     4
       Petitioners object to this finding of fact and contend
that AJCS “utilized its own construction forming forms, not
equipment, in the business of concrete forming services.” Our
finding, however, was agreed to and stipulated by the parties. A
party is not permitted to contradict a stipulation in whole or in
part, except in the interest of justice. See Rule 91(e); Stamos
v. Commissioner, 87 T.C. 1451, 1454 (1986). We do not find any
injustice to petitioners here and hold the parties to their
stipulation.
                                - 4 -

(Central); A.J. Concrete Forming East, Inc. (East); and A.J.

Concrete Forming West, Inc. (West).5

     The stock ownership of these four affiliates6 was as

follows:    (1) Georgia was owned 47.5 percent by Mr. Guerrero,

47.5 percent by Jeff Klewein, and 5 percent by Jeff Hoylman; (2)

Central was owned 47.5 percent by Jeff Klewein, 47.5 percent by

Rick Klewein, and 5 percent by Dave Entinghe; (3) East was owned

47.5 percent by Rick Klewein, 47.5 percent by Mr. Bone, and 5

percent by Robb Webb; and (4) West was owned 47.5 percent by Jeff

Klewein, 47.5 percent by Mr. Bone, and 5 percent by Ken Ritter.

     On its 1993 tax return, AJCS reported the $2,680,500 it had

recognized on its partially completed contracts.    On its 1993 tax

return, AJCS claimed deductions on line 20 totaling $2,808,034.

     After transferring all of its outstanding contracts to the

affiliates, AJCS was no longer in the construction forming

business.    AJCS’s primary business, after the transfer of the

contracts, was to provide management services to the four

affiliates that were performing on the contracts.    Under

agreements, AJCS was entitled to charge each affiliate for a

portion of AJCS’s general and administrative expenses incurred in


     5
       Again, petitioners object to this finding as misleading
despite the fact that it was taken verbatim from the stipulation
of facts.
     6
       The term “affiliate” is used for convenience and is not
meant to connote “affiliate” as it is defined with regard to the
application of any Internal Revenue Code section.
                                - 5 -

providing management services to the four affiliates, plus a

markup percentage in the 3-percent range.

     AJCS was entitled to receive the management fees at the time

the affiliates completed the contracts.     All four affiliates used

the completed contract method to report income for Federal tax

purposes.    For the affiliates’ tax years ending in 1993, they

reported gross income as follows:

     Affiliate               TYE            Gross Income
     West               Sept. 30, 1993       $2,394,029
     Georgia            Sept. 30, 1993        5,962,994
     Central            June 30, 1993             -0-
     East               Mar. 31, 1993            76,116

     Georgia deducted $490,000 as management fees paid to AJCS on

its September 30, 1993, tax return.      Central deducted $724,880 as

management fees paid to AJCS on its June 30, 1994, tax return.

AJCS did not report any management fee income on its 1993 tax

return.

     The four affiliates extended loans to AJCS during the 1993

calendar year.    As of the end of the 1993 tax year, the

affiliates had outstanding loans to AJCS as follows:

            Affiliate           Loan Amount
            West                    -0-
            Georgia             $1,674,722
            Central                568,065
            East                    80,201

     AJCS reported taxable income of $117,018, $358,860, and

$309,967 for the 1990, 1991, and 1992 tax years, respectively.

AJCS’s and the four affiliates’ “schedule of contracts” for the
                                - 6 -

1993 calendar year shows a recognized gross profit of $6,405,360.

The 1993 combined operating loss reflected on the combined income

statement for AJCS and the four affiliates is $37,706.    On the

combined financial statements and independent auditors report,

AJCS’s and the four affiliates’ “combined statement of earnings”

is also listed as a loss of $37,706.

     AJCS, for Federal tax purposes, reported a $236,300 loss for

its 1993 tax year.    The four affiliates reported Federal tax

losses for the tax year ending 1993 as follows:

         Affiliate              Reported Loss
           West                  ($72,041)
           Georgia                (5,507)
           Central                (8,873)
           East                     -0-

     The combined Federal tax loss reported for the 1993 calendar

year by AJCS and the four affiliates is $322,721.7    AJCS and the

four affiliates reported tax losses in their subsequent reporting

periods as follows:

     Company                 TYE                Reported Loss
     AJCS               Dec. 31, 1994                ($577)
     West               Sept. 30, 1994            (300,451)
     Georgia            Sept. 30, 1994            (222,782)
     Central            June 30, 1994              (14,627)
     East               Mar. 31, 1994             (354,826)

     The Schedules L, Balance Sheet, attached to AJCS’s 1993 and

1994 tax returns do not reflect the same 1993 ending figures as

the amounts reflected for the 1994 beginning figures with respect


     7
       AJCS and the four affiliates did not file a consolidated
return for the tax periods under consideration.
                                - 7 -

to its assets reported on line 6 and its liabilities reported on

line 18.   On its 1993 Schedule M-1, Reconciliation of Income

(Loss) per Books With Income (Loss) per Return, AJCS reported a

loss of $37,706, which represents the combined income for AJCS

and the four affiliates.

     Respondent determined that $2,261,555 of the $2,808,034

deducted on AJCS’s 1993 tax return was expended for completing

the contracts that had been transferred to the four affiliate

corporations.

Workmen’s Compensation Expenses

     In 1993, AJCS had transferred its contracts to the four

affiliates and, as a result, had no employees performing concrete

forming work.   AJCS, however, deducted $135,194 as insurance on

line 19 of its 1993 return.    AJCS accrued $269,815 as a workmen’s

compensation insurance liability on its 1993 return.    In

computing its 1993 taxable income, AJCS reversed the workmen’s

compensation accrual.

     AJCS made payments of approximately $275,000 to various

insurance companies.    West and Georgia for their years ended

September 30, 1993 and 1994, and Central for its years ended June

30, 1993 and 1994, did not claim a workmen’s compensation or

insurance expense on line 26 of the corporate Federal tax

returns.   West reported a relatively large amount of cost of

goods sold, but no breakdown was provided to reflect whether
                               - 8 -

workmen’s compensation or insurance expense had been claimed

within cost of goods sold.

      East was the only affiliate that was shown to have deducted

an insurance expense for workmen’s compensation.    East’s short

year return for the period ended March 31, 1993, reflects a

$5,332 deduction on line 26 for “W/C insurance”, and East’s

Schedule M-1 reflects a “W/C accrual” of $83,536.    No workmen’s

compensation insurance deduction is listed on East’s March 31,

1994, return.

                             OPINION

      Petitioners were the shareholders of AJCS, an S corporation.

Accordingly, any adjustment to AJCS flows through to petitioners.

Respondent determined that several adjustments were necessary to

items reported on AJCS’s 1993 return, resulting in flowthrough

adjustments and income tax deficiencies for petitioners’ 1993

taxable year.

I.   AJCS’s Expenditures in Connection With the Contracts
     Transferred to the Affiliates

      The first issue for our consideration is whether AJCS’s

expenditure of $2,261,555 is deductible as AJCS’s ordinary and

necessary business expenses or whether those expense obligations

pertained to the four affiliates.8


      8
       With respect to the $2,261,555 adjustment, respondent has
abandoned his alternative argument under which allocations of the
$2,261,555 in expenses would have been made to the four
                                                   (continued...)
                               - 9 -

     Section 162 allows a deduction for all ordinary and

necessary expenses incurred in carrying on a trade or business.

As a general rule, payment by one taxpayer of the obligation of

another taxpayer is not an ordinary and necessary expense.   See

Welch v. Helvering, 290 U.S. 111, 114 (1933).   Generally, courts

have held that where one taxpayer pays expenses on behalf of

another taxpayer, the expenses are not deductible.   See Deputy v.

du Pont, 308 U.S. 488 (1940); Dietrick v. Commissioner, 881 F.2d

336, 339 (6th Cir. 1989), affg. T.C. Memo. 1988-180.

     Respondent contends that AJCS’s claimed $2,261,555 deduction

on its 1993 tax return represents expenses that AJCS paid to

complete the construction projects that had been transferred to

the four affiliates and, therefore, are not deductible expenses

of AJCS.   Petitioners agree that the expenses paid by AJCS were

in aid of the completion of the transferred contracts of the four

affiliates.   Nevertheless, petitioners advance several arguments

in support of the position that the expenses are deductible by

AJCS.

     First, petitioners argue that the facts of this case fit

within the narrow exception carved out by this Court in Lohrke v.

Commissioner, 48 T.C. 679 (1967).   In Lohrke, we held that a

taxpayer may deduct the expenses of another taxpayer in



     8
      (...continued)
affiliates (operational entities), pursuant to sec. 482.
                                - 10 -

situations in which the taxpayer’s payment of the business

expenses of another serves to “protect or promote” the taxpayer’s

own business.   Id. at 685.

     AJCS must show that its motive for paying the affiliates’

expenses was in furtherance or promotion of AJCS’s trade or

business.   See id. at 688.   Secondly, AJCS must show that the

expenses are ordinary and necessary expenditures in furtherance

of its trade or business and not just in furtherance of the

affiliates’ trade or business.    See id.

     To determine AJCS’s motive for payment of the affiliates’

expenses, we can consider whether there is “a clear proximate

danger to the taxpayer and * * * a payment made to protect an

existing business from harm.”    Young & Rubicam, Inc. v. United

States, 187 Ct. Cl. 635, 410 F.2d 1233, 1243 (1969).   The

deduction is not available if the paying taxpayer fails to

demonstrate a direct nexus between the purpose of the payment and

the taxpayer’s business or income-producing activities.    See

Lettie Pate Whitehead Found., Inc. v. United States, 606 F.2d

534, 538 (5th Cir. 1979).

     In an attempt to come within this narrow exception,

petitioners argue that AJCS was bound by contract to pay the

costs of completing the contracts and, further, that the

affiliates could not afford the expenses.   We find petitioners’

arguments unpersuasive.   Petitioners also point out that AJCS was
                              - 11 -

under contract with the affiliates to transfer the contracts and,

also, to pay the expenses in connection with the transferred

contracts.   This contract offered by petitioners was unsigned and

undated and is lacking in the usual earmarks of a contract that

has been negotiated at arm’s length.   In addition, Mr. Bone and

Mr. Guerrero owned significant interests in the affiliates.

Without further explanation, the proffered document appears to be

little more than an attempt to assign expenses from one related

taxpayer to another.   More significantly, petitioners have not

shown that AJCS had a valid business reason for agreeing to pay

the costs to complete contracts from which it would not

automatically or directly receive any part of the gross proceeds.

By way of contrast, the amounts of the affiliates’ expenses paid

by AJCS are substantially more than the management services fees

that it could have earned or did earn.   There was no reasonable

expectation of recovery by AJCS of enhancement to its business

through those expenditures.   Accordingly, we find unpersuasive

petitioners’ evidence that AJCS was contractually bound to pay

the expenses of the affiliates or that any such payment of

expenses by AJCS would have furthered or promoted AJCS’s trade or

business.

     Petitioners also argue that the four affiliates could not

afford to pay their own expenses.   That argument is directly

contradicted by the record.   During the period in question, three
                               - 12 -

of the four affiliates lent money to AJCS in their first fiscal

year, which, to some extent, paralleled AJCS’s 1993 taxable

year.9   The affiliates’ returns disclose outstanding loans to

AJCS at the end of their 1993 fiscal years totaling more than

$2,300,000.   This fact undermines petitioners’ argument that the

affiliates were unable to pay their own expenses.   Arguably, some

of AJCS’s payments of the affiliates’ expenses could have

conferred some benefit on AJCS.   Petitioners, however, have not

shown any such benefit and have failed to show that they

satisfied the Lohrke test.

     Petitioners also argue that AJCS was entitled to deduct the

expenses because AJCS could not allocate its general and

administrative expenses among the various contracts transferred

to the affiliates.   At trial, John Snider, AJCS’s chief financial

officer, testified that the affiliates paid AJCS a “fee based on

the proportional overhead that applies to the revenue and

expenses”, and “the overhead for * * * [general and

administrative] expenses was charged to the * * * [affiliates]

based on their revenues.”    Accordingly, petitioners’ contention

that AJCS could not allocate its general and administrative

expenses to each transferred contract is, in effect, incorrect.


     9
       Petitioners contend that the amounts listed as loans on
the affiliates’ tax returns are actually intercompany accrued
expenses/reimbursements so as to track what each affiliate and
AJCS owed each other. Petitioners have not presented
corroborative evidence to support their characterization.
                              - 13 -

     Petitioners also make the argument that they “were advised

by their respective professionals that the spin-off of the open

jobs in process for 1992 would be tax-free pursuant to IRC 355"

and it was the “specific intention of the shareholders of * * *

[AJCS] to avoid a taxable transaction”.   This argument is not

supported in the record.   Petitioners have not shown that AJCS’s

transfer of its contracts qualified as a tax-free reorganization

or spinoff.   More importantly, whether AJCS’s transfer of open

jobs in process qualifies as a tax-free reorganization has no

bearing on whether AJCS is entitled to deduct the expenses paid

on behalf of other corporations.

     Petitioners also cited several cases without attempting to

analyze the facts and law of those cases and how they apply to

the facts and circumstances in our record.   Petitioners cite Mel

Dar Corp. v. Commissioner, 309 F.2d 525 (9th Cir. 1962), and

Frank Lyon Co. v. United States, 435 U.S. 561 (1978).   Those

cases deal with the claim of right doctrine and a sale and

leaseback, respectively.   We fail to see the relevance of the

above-referenced cases to the dispute currently before us.   In

the absence of any analysis or explanation by petitioners, we

find these case citations unhelpful.

     Petitioners also attempted to show that respondent’s

determination is in error by attempting to show that respondent’s

revenue agent’s examination may have been inadequate.
                              - 14 -

Petitioners have not shown that respondent’s determination is

without substance or that it would be appropriate to go behind

the notices of deficiency.   Petitioners’ attempt to discredit

respondent’s agent appears to be a detour or distraction from

petitioners’ failure to present facts and/or law that would show

their entitlement to the claimed items.

      On the basis of the foregoing, we hold that petitioners have

failed to show that they are entitled to deduct the expenses paid

by AJCS on behalf of the affiliates.   Accordingly, we sustain

respondent’s determination that AJCS is not entitled to deduct

expenses of $2,261,555 that were expenses of the four newly

formed affiliates.

II.   Did AJCS Erroneously Overstate Its Income?

      Next, we consider petitioners’ contention that AJCS

overstated its income by $2,680,500.   On brief and for the first

time in the course of the trial, petitioners raised an issue as

to whether AJCS’s 1993 income was overstated because the four

affiliates may have mistakenly reported the same income.10

Although petitioners included an allegation on this point in

their petitions, it was not addressed in the opening statement at

trial and, accordingly, was not tried by consent and was untimely


      10
       We must make assumptions because this matter was not
factually developed. We assume that petitioners’ argument is
based on their factual assumption that contract gross incomes
reported by AJCS for periods prior to transfer were also reported
by the affiliates.
                               - 15 -

raised.    See Estate of Horvath v. Commissioner, 59 T.C. 551, 556

(1973).

       Even if petitioners had timely raised this issue, it is well

established that the person who earns or otherwise creates the

right to receive income is taxed.    See Lucas v. Earl, 281 U.S.

111 (1930).    The assignment of income doctrine requires

compensation to be taxed to the person who earns it regardless of

the anticipatory arrangements and contracts, however skillfully

devised.    See Leavell v. Commissioner, 104 T.C. 140 (1995).    AJCS

earned the income at issue even though it might have been

erroneously reported by others.    Accordingly, AJCS may not reduce

its income by $2,680,500.

III.    Workmen’s Compensation Insurance Expenses

       Finally, we consider petitioners’ contention that AJCS is

entitled to deduct $269,815 in workmen’s compensation insurance

expenses for its 1993 tax year.

       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”.     Under section 6001 and

section 1.6001-1(a) and (b), Income Tax Regs., a taxpayer must

keep such permanent books of account or records as are sufficient

to establish the amount of gross income, deductions, credits, or

other matters required to be shown on the tax return.
                                - 16 -

Petitioners must show AJCS’s entitlement to the claimed

deduction.   See Rule 142(a).

     Petitioners allege in their petitions that they are entitled

to deduct accrued workmen’s compensation expenses of $269,815.

Respondent contends that, under section 461(h), petitioners are

not entitled to the disputed workmen’s compensation insurance

expense deductions because petitioners failed to substantiate

that the expenses were incurred.

     Petitioners, in their posttrial brief, state as follows:

AJCS “is also entitled to an additional insurance expense of

$269,815 per IRC 162 as this expense was for workers’

compensation insurance premiums, not for tort worker’s

compensation claims that are not allowed until paid per IRC 461.”

At trial, petitioners’ counsel posed to John Snider, chief

financial officer of AJCS, a series of generalized questions

about workmen’s compensation insurance.   That is the extent of

petitioners’ arguments and proof.    Petitioners made no attempt to

explain various exhibits they submitted regarding this issue.

     Petitioners submitted copies of checks written from AJCS to

various insurance companies.    These checks totaled approximately

$275,000.    Petitioners also offered copies of checks remitted by

W&J, Inc., to various insurance companies.   These checks totaled

over $800,000.   On this record, we remain unaware of the

relevance of checks remitted by W&J, Inc.    Finally, petitioners
                             - 17 -

have not provided the means for the Court to delineate which

insurance payments, if any, AJCS is entitled to deduct or were

ordinary and necessary expenses of AJCS’s business.

     Another complicating factor is that AJCS claimed insurance

expenses under several different categories on its tax returns.

It is impossible to tell from the evidence whether the checks

petitioners submitted are already claimed on AJCS’s 1993 tax

return as insurance under other deductions or whether they are

included in other general categories.   Finally, the record in

this case does not reveal whether the amounts in dispute are

AJCS’s expenses or more properly those of the affiliates.11

     Petitioners have failed to show that AJCS is entitled to

deduct workmen’s compensation expenses of $269,815, and,

accordingly, we hold for respondent on this issue.12




     11
       Considering the fact that AJCS transferred its
construction contracts to the four affiliates at the beginning of
1993 and began operating solely as a management company, it is
more likely that the affiliates, and not AJCS, incurred ordinary
and necessary workmen’s compensation insurance expense. We must
note, however, that East was the only affiliate that obviously
claimed a deduction for workmen’s compensation insurance during
the period under consideration.
     12
       Respondent also contends that AJCS is not entitled to the
deduction because there had been no economic performance as
required by sec. 461(h) and the regulations thereunder. Because
of our conclusion above, however, it is unnecessary for us to
consider this argument.
                                - 18 -

     We have considered all other arguments of the parties, and,

to the extent not addressed herein, we find them to be moot,

without merit, or irrelevant.

     To reflect the foregoing,

                                      Decisions will be entered

                                 under Rule 155.
