                         T.C. Memo. 2004-280



                       UNITED STATES TAX COURT



             DELAWARE CORP., ET AL.,1 Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 2040-02, 2041-02,      Filed December 16, 2004.
                 2042-02.



     Harry L. Cohn, for petitioners.

     Dustin M. Starbuck, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     CHIECHI, Judge:    Respondent determined the following defi-

ciencies in, and accuracy-related penalties under section




     1
      Cases of the following petitioners are consolidated here-
with: Frances B. Havens (Ms. Havens), docket No. 2041-02; and
Oscar M. Barber (Mr. Barber), docket No. 2042-02.
                               - 2 -

6662(a)2 on, each petitioner’s Federal income tax (tax):

                                                Accuracy-Related
       Petitioner          Year   Deficiency         Penalty
  Delaware Corporation     1994     $37,794         $3,581.40
                           1997      12,366          2,473.20

         Mr. Barber        1994         6,710       1,342.00
                           1995           495          99.00

         Ms. Havens        1994        12,637       2,527.40
                           1995         7,285       1,457.00

     The issues remaining for decision in these consolidated

cases are:3

     (1) Do Delaware Corporation’s payments during 1994 of

certain expenses with respect to a farm in Caroline County,

Virginia (Caroline County farm), constitute for that year con-

structive dividends to Ms. Havens that Delaware Corporation is

not entitled to deduct?   We hold that they do.

     (2) Do Delaware Corporation’s payments during 1994 and 1995



     2
      All section references are to the Internal Revenue Code
(Code) in effect at all relevant times. All Rule references are
to the Tax Court Rules of Practice and Procedure.
     3
      In addition to the issues remaining for decision listed
below, there are other questions relating to certain determina-
tions in the notice of deficiency (notice) issued to Ms. Havens
(Ms. Havens’s notice) with respect to her taxable years 1994 and
1995 that are computational in that their resolution flows
automatically from our resolution of certain of the issues that
we address herein. Moreover, Delaware Corporation and respondent
agree that the Court’s resolution of certain of the issues
remaining for decision will resolve whether Delaware Corporation
is entitled to a net operating loss (NOL) deduction for 1997 that
is attributable to a claimed NOL carryforward from 1995.
                                   - 3 -

of certain expenses with respect to certain real property in

Virginia Beach, Virginia (Virginia Beach property), constitute

for those years constructive dividends to Ms. Havens that Dela-

ware Corporation is not entitled to deduct?    We hold that they

do.

      (3) Is Delaware Corporation entitled for 1994 and 1995 to

depreciation deductions with respect to the Virginia Beach

property?    We hold that it is not.

      (4) Do Delaware Corporation’s payments during 1994 of

certain legal fees constitute for that year constructive divi-

dends to Mr. Barber that Delaware Corporation is not entitled to

deduct?    We hold that they do.

      (5) Do Delaware Corporation’s payments during 1994 and 1995

of certain child care expenses constitute for those years con-

structive dividends to Mr. Barber that Delaware Corporation is

not entitled to deduct?    We hold that they do.

      (6) Is Delaware Corporation liable for each of the years

1994 and 1997 for the accuracy-related penalty under section

6662(a)?    We hold that it is.

      (7) Is Mr. Barber liable for each of the years 1994 and 1995

for the accuracy-related penalty under section 6662(a)?    We hold

that he is.

      (8) Is Ms. Havens liable for each of the years 1994 and 1995

for the accuracy-related penalty under section 6662(a)?    We hold
                               - 4 -

that she is.

                         FINDINGS OF FACT

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

     At the time it filed its petition, the principal place of

business of Delaware Corporation was in Virginia.   Mr. Barber and

Ms. Havens resided in Virginia at the time they filed their

respective petitions.

Background

     At all relevant times, Delaware Corporation was a commercial

and industrial construction company.   Prior to August 1, 1993,

Mr. Barber owned 100 percent of the stock of Delaware Corpora-

tion.   During 1994 and 1995, Delaware Corporation did not have a

written employee benefits plan.   During at least part of 1994 and

1995, Mr. Barber’s two daughters (Mr. Barber’s daughters) worked

for Delaware Corporation, although not at the same time.

     Some time prior to June 2, 1992, Mr. Barber was convicted of

marijuana conspiracy for which he was incarcerated.   Before Mr.

Barber’s incarceration, he and his then wife Laura Barber (Ms.

Barber) resided on property located in Middlesex County, Virginia

(Mitchums Creek property), which they owned as joint tenants.

After Mr. Barber’s release from prison on June 2, 1992, he did

not return to live at the Mitchums Creek property, where Ms.

Barber continued to reside.

     A few years before Mr. Barber’s release from prison, he
                                - 5 -

applied to a bank for a loan and offered to use the Mitchums

Creek property as collateral.   As a condition to approving that

loan application while Mr. Barber was in prison, the bank re-

quested Mr. Barber to sign a deed (Mitchums Creek deed) conveying

to Ms. Barber his interest as a joint tenant in the Mitchums

Creek property, which he did.   Mr. Barber gave the Mitchums Creek

deed to Ms. Barber but did not intend that she record that deed

unless and until he defaulted on his loan payments.

     While Mr. Barber was incarcerated, he and Ms. Barber di-

vorced.   Thereafter, but while Mr. Barber was still in prison,

Ms. Barber recorded the Mitchums Creek deed.   It was not until

after his release from prison that Mr. Barber discovered that Ms.

Barber had recorded that deed, whereupon he commenced litigation

(litigation with respect to the Mitchums Creek property) against

her in the Circuit Court of Middlesex County (Middlesex Circuit

Court).   In that litigation, Mr. Barber claimed that he and Ms.

Barber as joint tenants, and not Ms. Barber alone, owned the

Mitchums Creek property.   Some time after August 1, 1993, the

Middlesex Circuit Court found that Ms. Barber had fraudulently

induced Mr. Barber to convey to her his interest in the Mitchums

Creek property.   That court ordered a rescission of the Mitchums

Creek deed and a so-called equitable distribution of the Mitchums

Creek property to both Mr. Barber and Ms. Barber.

     In January 1988, Ms. Havens purchased for $300,000 the
                                - 6 -

Virginia Beach property on which was situated a colonial-style,

brick, 2,900 square-foot house.    That house had four bedrooms,

three full baths, a detached two-car garage, and an in-ground

swimming pool.    At all relevant times, including during 1993,

1994, and 1995, Ms. Havens resided at the Virginia Beach prop-

erty.   At some time prior to August 1, 1993, Ms. Havens purchased

the Caroline County farm.

     Some time between June 3, 1992, and August 1, 1993, Mr.

Barber met Ms. Havens at a social gathering.    At that gathering,

Mr. Barber learned from Ms. Havens that she owned 60 percent of

the stock of a very successful corporation known as Management

Systems Applications, Inc. (MSA), and that MSA’s subsidiary

Management Systems Applications, Inc. Kuwait, LLC (MSA-Kuwait),

was having certain problems while conducting its business in

Kuwait.    Mr. Barber offered to assist Ms. Havens in resolving

those problems.    Although wary of Mr. Barber because he had

recently been released from prison, Ms. Havens accepted Mr.

Barber’s offer and caused MSA-Kuwait to hire Mr. Barber.    Mr.

Barber’s work with MSA-Kuwait lasted approximately one year,

during which time he traveled to Kuwait several times.

     At a time not disclosed by the record after June 2, 1992,

and before August 1, 1993, Ms. Havens and Mr. Barber formed and

owned Marion-Booker (Marion-Booker), a Virginia limited liability

company.    Marion-Booker purchased certain real property (Chick
                               - 7 -

Cove property) at Chick Cove Manor in Middlesex County, Virginia,

which it intended to sell after it caused a house to be built

thereon.

     During 1993, 1994, and 1995, Mr. Barber stayed at various

times at the Virginia Beach property, at the Chick Cove property,

and at a house located in Topping, Virginia.

Certain Transactions Involving Delaware
Corporation, Ms. Havens, and Mr. Barber

     At least during the period June 2, 1992, to August 1, 1993,

Delaware Corporation did not have the assets or capitalization

that Mr. Barber believed was necessary to secure the financing

and the bonding that it required in order to bid successfully on

major construction projects.   During that period, Ms. Havens and

Mr. Barber discussed between themselves and with Robert L. Braun

(Mr. Braun)4 the use by Delaware Corporation of certain of Ms.

Havens’s assets and certain of Mr. Barber’s assets for the

purpose of enhancing Delaware Corporation’s ability to secure

such financing and such bonding (Ms. Havens’s and Mr. Barber’s

plan).

     Mr. Braun recommended that Delaware Corporation, Ms. Havens,

and Mr. Barber use a so-called contract of purchase, and not a

deed of trust, in order to effect Ms. Havens’s and Mr. Barber’s



     4
      Mr. Braun is a certified public accountant who since 1978
provided various professional services to Delaware Corporation
and Mr. Barber.
                               - 8 -

plan.   In recommending the use of a contract of purchase, Mr.

Braun advised Delaware Corporation, Ms. Havens, and Mr. Barber

that such a contract (1) would not trigger the due-on-sale clause

in favor of the first mortgage holder of any mortgage loan with

respect to any property that they wished to use to carry out Ms.

Havens’s and Mr. Barber’s plan and (2) would be reflected in

Delaware Corporation’s financial statements as a stockholder loan

that would be treated as equity for purposes of that company’s

ability to obtain bonding.   Mr. Braun also advised Delaware

Corporation, Ms. Havens, and Mr. Barber that no recording costs

would have to be paid if a contract of purchase were used since

under such a contract no deed would be recorded.   In addition,

based on information provided to him, Mr. Braun advised petition-

ers that the respective properties of Ms. Havens and Mr. Barber

that they intended to use in effecting Ms. Havens’s and Mr.

Barber’s plan were rental properties and that Delaware Corpora-

tion would be entitled to deduct the operating expenses relating

to any such rental property provided that the rent was paid for

such property.

     Some time shortly before August 1, 1993, Delaware Corpora-

tion, Ms. Havens, and Mr. Barber caused contracts of purchase to

be prepared in order to implement Ms. Havens’s and Mr. Barber’s

plan, and Mr. Braun reviewed those contracts.

     Delaware Corporation, Ms. Havens, and Mr. Barber entered
                              - 9 -

into an agreement (1993 global agreement), effective as of August

1, 1993, which provided in pertinent part:

          THIS AGREEMENT, made as of and effective this 1st
     day of August, 1993, by and between FRANCES B. HAVENS
     (“Havens”), and OSCAR M. BARBER (“Barber”), and DELA-
     WARE CORPORATION (“DC”),

                           STATEMENTS:

     A.   Barber is 100% owner of all of the stock of DC.

     B.   Havens is the owner of property known as 1316
          Harris Road, Virginia Beach, Virginia, (the “Vir-
          ginia Beach property) and 185 acres, Reedy Church
          District, Caroline County, Virginia (the “Caroline
          County property”).

     C.   Havens and Barber are the owners of Marion-Booker,
          a Virginia limited liability company, which owns a
          lot with improvements thereon at Chick Cove Manor,
          Middlesex County, Virginia.

     D.   Barber has and/or is asserting an ownership inter-
          est in property on Mitchum’s Creek in Middlesex
          County, Virginia.

     E.   Havens is a 60% owner of Management Systems Appli-
          cations, Inc., a Virginia corporation.

     F.   Havens owns a 30% interest in MSA-Kuwait, LLC
          [MSA-Kuwait] a Virginia limited liability company
          and DC owns a 30% interest in MSA-Kuwait, LLC.

     G.   The parties have agreed and desire that the Caro-
          line County property, the Virginia Beach property,
          the interest in MSA-Kuwait owned by Havens and the
          Mitchum Creek property, and the Marion-Booker
          property be transferred to DC, for DC to enter
          into a management contract with Management Sys-
          tems Applications, Inc. (“MSA”) and for Havens to
          acquire a stock ownership in DC as set forth be-
          low:

                           WITNESSETH:

          NOW, THEREFORE IN CONSIDERATION of $10.00 cash in
                        - 10 -

hand paid by DC to Havens and to Barber and the receipt
of which is hereby acknowledged and for other good and
valuable considerations including the mutual promises
contained herein the parties agree as follows:

1.   The Caroline County property will be transferred
     to DC for consideration of $715,000.00, which
     includes the assumption by DC of the existing
     indebtedness in favor of Colonial Farm Credit ACA
     [in] the approximate amount of $394,800.00. This
     transfer will be by way of a land sales contract.
     The difference between the present indebtedness of
     $394,800.00 and $715,000.00 will be evidenced by a
     promissory note payable to Havens bearing interest
     at the lowest rate allowed by law to prevent the
     imputation of interest. Such note shall be due
     and payable upon the sale of the Caroline County
     property. If the parties terminate this agreement
     or at DC’s option if the management contract re-
     ferred to herein is not renewed, DC will convey
     its interest in the property back to Havens, the
     aforesaid note shall be cancelled and DC will be
     relieved from any further obligations for payment
     under the indebtedness to Colonial Farm Credit
     ACA. Any moneys spent by DC for maintenance or
     for interest on the indebtedness will be at DC’s
     expense not to be reimbursed to DC if the Caroline
     property is reconveyed to Havens.

2.   The Virginia Beach property will be transferred to
     DC for consideration of $300,000.00, which in-
     cludes the assumption by DC of the existing in-
     debtedness in favor of Crestar Mortgage Corp. [in]
     the approximate amount of $172,000.00. This
     transfer will be by way of a land sales contract.
     The difference between the present indebtedness of
     $172,000.00 and $300,000.00 will be evidenced by a
     promissory note payable to Havens bearing interest
     at the lowest interest rate allowed by law to
     prevent the imputation of interest. Such note
     shall be due and payable upon the sale of the
     Virginia Beach property. If the parties terminate
     this agreement or at DC’s option if the management
     contract referred to herein is not renewed, DC
     will convey its interest in the property back to
     Havens, the aforesaid note shall be cancelled and
     DC will be relieved from any further obligations
     for payment under the indebtedness to Nations
                        - 11 -

     Bank. Any moneys spent by DC for maintenance or
     for interest on the indebtedness will be at DC’s
     expense not to be reimbursed to DC if the Virginia
     Beach property is reconveyed to Havens.

3.   Havens will transfer to DC a 30% interest in MSAK.
     If a dispute arises, the operating agreement dated
     August 1, 1993 will prevail. If the parties ter-
     minate this agreement or at the option of DC if
     the management agreement is not renewed, the 30%
     interest in MSAK will revert to Havens without
     regard to increase in value. Provided, however,
     DC will be entitled to keep its 30%.

4.   Barber will convey his interest in the Mitchum’s
     Creek property to DC by land sales contract for
     $50,000.00 plus the payment of debts to Rumsey,
     Breeden, Hubbard, Bugg & Terry and to Braun,
     Dehnert, Clarke & Co. DC will pay all expenses in
     recovering the house and anything that has to be
     paid to Laura Barber. The deed of Barber’s inter-
     est will be delivered to DC at the earliest time
     he is able to convey such interest.

5.   Havens will cause MSA to enter into a management
     agreement with DC on the terms and conditions set
     forth in that management agreement dated August 1,
     1993 which is made a part hereof by this refer-
     ence.

6.   Upon execution and delivery of all of the docu-
     ments enumerated herein to DC, DC will issue to
     Havens sufficient stock so that after the issuance
     51% of DC will be owned by Barber and 49% will be
     owned by Havens. Notwithstanding this stock own-
     ership percentages, all profit and loss distribu-
     tions and capital distributions will be split 50-
     50. Also notwithstanding anything contained
     herein to the contrary, with regard to matters
     involving MSA, Havens will have the right to di-
     rect same, such not to be overridden by Barber.

7.   Should this agreement be terminated by the mutual
     agreement of the parties, or should DC elect to
     terminate this agreement because of the management
     contract not being renewed, generally except as
     otherwise regarded herein, the parties agree to
     take all actions necessary to place themself in a
                               - 12 -

            position that they were in immediately prior to
            the effective date of this agreement. For pur-
            poses of illustration the Caroline property, the
            Virginia Beach property, half of the MSAK interest
            would be returned to Havens. The Mitchums Creek
            property would be split 50-50. In the event of
            such termination or dissolution, the parties agree
            that total assets of DC will be assigned a fair
            market value, with Havens being entitled to 50% of
            the total fair market value and Barber entitled to
            50% of the total fair market value; provided,
            however, Havens shall be entitled to receive as
            part of her 50% share, the equities accumulated in
            the aforementioned properties. In the event of
            termination or dissolution, Havens agrees to con-
            vey all of her right, title and interest in DC
            back to DC or to Barber. [Reproduced literally.]

     Pursuant to the 1993 global agreement, Delaware Corporation

and MSA entered into a management contract (1993 management

contract).    The 1993 management contract, which was effective as

of August 1, 1993, provided in pertinent part as follows:

          THIS MANAGEMENT CONTRACT [is] made and effective
     as of August 1, 1993, between The Delaware Corporation
     * * * (“DC”) and Management Systems Applications, Inc.
     * * * (“MSA”).

                             STATEMENTS:

        *        *       *       *         *      *       *

          C.   MSA desires to enter into a Management con-
     tract with DC for DC to supply management services to
     MSA.

        *        *       *       *         *      *       *
                                 - 13 -

     1.       DURATION AND CANCELLATION

          The initial term of this contract shall be for one
     (1) year; beginning on the effective date of this
     contract and ending at 12:00 midnight on July 31, 1994.
     After the expiration of the initial term, this agree-
     ment will continue in effect on a year to year basis on
     the saine [sic] terms and conditions until canceled by
     either party. * * *

          *        *       *       *       *        *      *

     9.       MANAGEMENT FEES

          A.   In return for the management services pro-
     vided by DC to MSA under this contract, MSA shall
     negotiate the fees for each contract function assigned
     to DC.

          B.   As an incentive under this Agreement, in
     addition to the fees under Paragraph A above, DC shall
     be paid an amount equal to 5% of the pre-tax profits of
     MSA resulting from or because of management improve-
     ments by DC, for each calender year. * * *

Pursuant to paragraph 9(A) of the 1993 management contract, MSA

paid Delaware Corporation $30,000 per month for a period not

disclosed by the record.

     Pursuant to the 1993 global agreement, Ms. Havens entered

into a contract of purchase that purported to sell to Delaware

Corporation the Caroline County farm (Caroline County farm

contract).      The Caroline County farm contract, which was effec-

tive as of August 1, 1993, provided in pertinent part:

          THIS CONTRACT OF PURCHASE, entered into as of the
     1st day of August, 1993, by and between FRANCES B.
     HAVENS (hereinafter referred to as “Seller”) and DELA-
     WARE CORPORATION (hereinafter referred to as “Pur-
     chaser”).
                         - 14 -

                       STATEMENTS:

     A.   The Seller agrees to sell and the Purchaser
agrees to buy the property described on Exhibit A
attached hereto and made a part hereof by this refer-
ence (the “Caroline County property”) upon certain
terms and conditions contained therein; and

     B.   The parties hereto have agreed that such sale
and purchase be by contract and that the deed of con-
veyance be delivered when such contract has been com-
pleted in full.

   *       *       *       *         *     *       *

     2.   The Property and Restrictions.   The Pur-
chaser agrees to purchase and the Sellers [sic] agree
to sell the property described in Exhibit A.

     3.   Purchase Price and Terms of Payment.   The
price of the property shall be $715,000.00 with the
present indebtedness being assumed by the Purchaser and
the balance evidenced by a promissory note payable by
the Purchaser upon the sale of such parcel.

     The Purchaser agrees that the unpaid balance shall
bear interest at the lowest rate allowed by law to
prevent the imputation of interest per annum from the
date hereof, such interest to be payable annually. Any
payments are to be applied first to the payment of
interest on any unpaid balances of the purchase price
and second to the reduction of the principal amount of
the purchase price.

     Until the sale of the parcel, Delaware Corp. shall
be responsible for payment of all indebtedness which
constitute[s] a lien against the parcel.

     4.   Deed Upon Full Payment.   Upon the entire
balance of the purchase price of the parcel being paid
in full, the Purchaser shall be entitled to receive a
deed for that parcel * * *.

   *       *       *       *         *     *       *

     8.   Risk of Loss.   From the date hereof, risk of
loss or damage to the properties by fire, windstorm,
casualty or other cause is assumed by the Purchaser.
                        - 15 -

     9.   Insurance.   Purchaser is to procure and
carry at Purchaser’s expense fire and casualty insur-
ance on improvements to the property in an amount not
less than the replacement value with such policies
naming Seller as first loss payee and Purchaser as
second loss payee. Purchaser shall also procure and
carry out at its expense liability insurance in favor
of the Seller affording protection to the limit of
$500,000.00 in respect to injury or death to a single
person and to the limit of $500,000.00 in respect of
any one accident. Purchaser shall provide the Seller
with a copy of such policies and agree to maintain same
during the term of this contract.

   *       *       *       *       *       *         *

     12. Possession of Property. The Purchaser may
enter into possession of such property as of August 1,
1993, and continue in such possession for and during
the life of this agreement. The Purchaser shall main-
tain such premises and all improvements thereon in good
repair, shall permit no waste thereof, and shall take
the same care thereof that a prudent owner would take.
During the life of this agreement Purchaser may not
improve such property without the Seller’s consent in
writing. * * *

     13. Assignment.    No transfer or assignment of
any rights hereunder shall be made by anyone having an
interest herein, unless made in writing and in such
manner and on such terms and conditions required by the
Seller.

   *       *       *       *       *       *         *

     16. Loans.    Notwithstanding anything contained
herein to the contrary, the Purchaser may mortgage the
property to pay off the purchase price, with the con-
sent of Seller.

   *       *       *       *       *       *         *

     20. Construction.    This agreement shall be
interpreted under the laws of the Commonwealth of
Virginia and shall not be construed against either
party as drafter.

Pursuant to the Caroline County farm contract, Delaware
                              - 16 -

Corporation assumed the balance of Ms. Havens’s $394,800 mortgage

loan with respect to the Caroline County farm and gave Ms. Havens

a promissory note (Caroline County farm note) for the remaining

$320,200 of the $715,000 purchase price set forth in that con-

tract.   The Caroline County farm note provided in pertinent part:

     Delaware Corporation, a Virginia corporation, promises
     to pay to the order of Frances B. Havens * * * the sum
     of $320,200 due and payable upon the sale of the prop-
     erty at Reedy Church District, Caroline County, Vir-
     ginia * * *.

          This note bears interest at the lowest rate of
     interest per annum allowed by law from time to time to
     prevent the imputation of interest. * * *

At all relevant times after July 31, 1993, the Caroline County

farm remained unsold, and Delaware Corporation did not make any

payments to Ms. Havens on the Caroline County farm note.

     Pursuant to the 1993 global agreement, Ms. Havens entered

into a contract for purchase that purported to sell to Delaware

Corporation the Virginia Beach property (Virginia Beach property

contract).   The Virginia Beach property contract, which was

effective as of August 1, 1993, provided in pertinent part:

          THIS CONTRACT OF PURCHASE, entered into as of the
     1st day of August, 1993, by and between FRANCES B.
     HAVENS (hereinafter referred to as “Seller”) and DELA-
     WARE CORPORATION (hereinafter referred to as “Pur-
     chaser”).

                            STATEMENTS:

          A.   The Seller agrees to sell and the Purchaser
     agrees to buy the property described on Exhibit A
     attached hereto and made a part hereof by this refer-
     ence (the “Virginia Beach property”) upon certain terms
                        - 17 -

and conditions contained therein; and

     B.   The parties hereto have agreed that such sale
and purchase be by contract and that the deed of con-
veyance be delivered when such contract has been com-
pleted in full.

   *       *       *       *       *       *       *

     2.   The Property and Restrictions.   The Pur-
chaser agrees to purchase and the Sellers [sic] agree
to sell the property described in Exhibit A.

     3.   Purchase Price and Terms of Payment.   The
price of the property shall be $300,000.00 with the
present indebtedness being assumed by the Purchaser and
the balance evidenced by a promissory note payable by
the Purchaser upon the sale of such parcel.

     The Purchaser agrees that the unpaid balance shall
bear interest at the lowest rate allowed by law to
prevent the imputation of interest per annum from the
date hereof, such interest to be payable annually. Any
payments are to be applied first to the payment of
interest on any unpaid balances of the purchase price
and second to the reduction of the principal amount of
the purchase price.

     Until the sale of the parcel, Delaware Corp. shall
be responsible for payment of all indebtedness which
constitute[s] a lien against the parcel.

     4.   Deed Upon Full Payment.   Upon the entire
balance of the purchase price of the parcel being paid
in full, the Purchaser shall be entitled to receive a
deed for that parcel * * *.

   *       *       *       *       *       *       *

     8.   Risk of Loss.   From the date hereof, risk of
loss or damage to the properties by fire, windstorm,
casualty or other cause is assumed by the Purchaser.

     9.   Insurance.   Purchaser is to procure and
carry at Purchaser’s expense fire and casualty insur-
ance on improvements to the property in an amount not
less than the replacement value with such policies
naming Seller as first loss payee and Purchaser as
                             - 18 -

     second loss payee. Purchaser shall also procure and
     carry out at its expense liability insurance in favor
     of the Seller affording protection to the limit of
     $500,000.00 in respect to injury or death to a single
     person and to the limit of $500,000.00 in respect of
     any one accident. Purchaser shall provide the Seller
     with a copy of such policies and agree to maintain same
     during the term of this contract.

        *       *       *       *       *       *         *

          12. Possession of Property. The Purchaser may
     enter into possession of such property as of August 1,
     1993, and continue in such possession for and during
     the life of this agreement. The Purchaser shall main-
     tain such premises and all improvements thereon in good
     repair, shall permit no waste thereof, and shall take
     the same care thereof that a prudent owner would take.
     During the life of this agreement Purchaser may not
     improve such property without the Seller’s consent in
     writing. * * *

          13. Assignment.    No transfer or assignment of
     any rights hereunder shall be made by anyone having an
     interest herein, unless made in writing and in such
     manner and on such terms and conditions required by the
     Seller.

        *       *       *       *       *       *         *

          16. Loans.    Notwithstanding anything contained
     herein to the contrary, the Purchaser may mortgage the
     property to pay off the purchase price, with the con-
     sent of Seller.

        *       *       *       *       *       *         *

          20. Construction.    This agreement shall be
     interpreted under the laws of the Commonwealth of
     Virginia and shall not be construed against either
     party as drafter.

     Pursuant to the Virginia Beach property contract, Delaware

Corporation assumed the balance of Ms. Havens’s $172,000 mortgage

loan with respect to the Virginia Beach property and gave Ms.
                               - 19 -

Havens a promissory note (Virginia Beach property note) for the

remaining $128,000 of the $300,000 purchase price set forth in

that contract.    The Virginia Beach property note provided in

pertinent part:

     Delaware Corporation, a Virginia corporation, promises
     to pay to the order of Frances B. Havens * * * the sum
     of $128,000.00 due and payable upon the sale of the
     * * * [Virginia Beach property].

          This note bears interest at the lowest rate of
     interest per annum allowed by law from time to time to
     prevent the imputation of interest. * * *

At all relevant times after July 31, 1993, the Virginia Beach

property remained unsold, and Delaware Corporation did not make

any payments to Ms. Havens on the Virginia Beach note.

     Pursuant to the 1993 global agreement, Delaware Corporation

and Mr. Barber entered into a contract of purchase (Mitchums

Creek contract) that purported to sell to Delaware Corporation

his interest in the Mitchums Creek property.    The Mitchums Creek

contract, which was effective as of August 1, 1993, while the

litigation with respect to the Mitchums Creek property was

pending in the Middlesex Circuit Court, provided in pertinent

part:

          THIS CONTRACT OF PURCHASE, entered into as of the
     1st day of August, 1993, by and between OSCAR M. BARBER
     (hereinafter referred to as “Seller”) and DELAWARE
     CORPORATION (hereinafter referred to as “Purchaser”).

                             STATEMENTS:

          A.   The Seller agrees to sell and the Purchaser
     agrees to buy the property described on Exhibit A
                        - 20 -

attached hereto and made a part hereof by this refer-
ence (the “Middlesex County property”) [Mitchums Creek]
upon certain terms and conditions contained therein;
and

     B.   The parties hereto have agreed that such sale
and purchase be by contract and that the deed of con-
veyance be delivered when such contract has been com-
pleted in full.

   *       *       *       *       *       *       *

     2.   The Property and Restrictions.   The Pur-
chaser agrees to purchase and the Sellers [sic] agree
to sell all of the Seller’s right, title and interest
in and to the property described in Exhibit A.

     3.   Purchase Price and Terms of Payment.   The
price of the property shall be $50,000.00 with the
present indebtedness being assumed by the Purchaser
together with all legal and accounting fees with the
balance evidenced by a promissory note payable by the
Purchaser upon the sale of such parcel.

     The Purchaser agrees that the unpaid balance shall
bear interest at the lowest rate allowed by law to
prevent the imputation of interest per annum from the
date hereof, such interest to be payable annually. Any
payments are to be applied first to the payment of
interest on any unpaid balances of the purchase price
and second to the reduction of the principal amount of
the purchase price.

     Until the sale of the parcel, Delaware Corp. shall
be responsible for payment of all indebtedness which
constitute[s] a lien against the parcel.

     4.   Deed Upon Full Payment.   Upon the entire
balance of the purchase price of the parcel being paid
in full, the Purchaser shall be entitled to receive a
deed for that parcel * * *.

   *       *       *       *       *       *       *

     8.   Risk of Loss.   From the date hereof, risk of
loss or damage to the properties by fire, windstorm,
casualty or other cause is assumed by the Purchaser.
                             - 21 -


          9.   Insurance.   Purchaser is to procure and
     carry at Purchaser’s expense fire and casualty insur-
     ance on improvements to the property in an amount not
     less than the replacement value with such policies
     naming Seller as first loss payee and Purchaser as
     second loss payee. Purchaser shall also procure and
     carry out at its expense liability insurance in favor
     of the Seller affording protection to the limit of
     $500,000.00 * * *. Purchaser shall provide the Seller
     with a copy of such policies and agree to maintain same
     during the term of this contract.

        *       *       *       *       *       *         *

          12. Possession of Property. The Purchaser may
     enter into possession of such property as of August 1,
     1993, and continue in such possession for and during
     the life of this agreement. The Purchaser shall main-
     tain such premises and all improvements thereon in good
     repair, shall permit no waste thereof, and shall take
     the same care thereof that a prudent owner would take.
     During the life of this agreement Purchaser may not
     improve such property without the Seller’s consent in
     writing. * * *

          13. Assignment.    No transfer or assignment of
     any rights hereunder shall be made by anyone having an
     interest herein, unless made in writing and in such
     manner and on such terms and conditions required by the
     Seller.

        *       *       *       *       *       *         *

          16. Loans.    Notwithstanding anything contained
     herein to the contrary, the Purchaser may mortgage the
     property to pay off the purchase price, with the con-
     sent of Seller.

        *       *       *       *       *       *         *

          20. Construction.    This agreement shall be
     interpreted under the laws of the Commonwealth of
     Virginia and shall not be construed against either
     party as drafter.

As made clear in paragraph 4 of the 1993 global agreement, the

term “present indebtedness” referred to in paragraph 3 of the
                             - 22 -

Mitchums Creek contract included, inter alia, any mortgage

indebtedness outstanding on the Mitchums Creek property and any

legal fees that Mr. Barber owed as of the effective date of the

Mitchums Creek contract for services rendered in connection with

the litigation with respect to the Mitchums Creek property.

     Pursuant to the Mitchums Creek contract, Delaware Corpora-

tion gave Mr. Barber a promissory note for $50,000.   That promis-

sory note provided in pertinent part:

     Delaware Corporation, a Virginia corporation, promises
     to pay to the order of Oscar M. Barber * * * the sum of
     $50,000.00 due and payable upon the sale of the prop-
     erty at Mitchums Creek Property, Middlesex County,
     Virginia * * *.

          This note bears interest at the lowest rate of
     interest per annum allowed by law from time to time to
     prevent the imputation of interest. * * *

     Pursuant to the 1993 global agreement, Marion-Booker5 en-

tered into a contract with Delaware Corporation under which

Marion-Booker purported to sell to Delaware Corporation its

interest in the Chick Cove property.    Although, as discussed

above, Mr. Barber stayed at the Chick Cove property at various

times during the period 1993 through 1995, he did not pay rent to

Delaware Corporation during that period for his use of that

property.

     At a time not disclosed by the record after the respective



     5
      As discussed above, Marion-Booker was a Virginia limited
liability company that Ms. Havens and Mr. Barber formed and
owned.
                               - 23 -

effective dates of the Caroline County farm contract and the

Virginia Beach property contract, Delaware Corporation completed

several major construction projects for which it had been able to

obtain the financing and the bonding that permitted it to bid

successfully on such projects.

     At all relevant times, including the respective effective

dates of the Caroline County farm contract and the Virginia Beach

property contract and all relevant times thereafter during the

taxable years in question,6 petitioners did not intend that Ms.

Havens transfer to Delaware Corporation equitable ownership of

and legal title to the Caroline County farm and the Virginia

Beach property.    Thus, Delaware Corporation assigned its interest

in the Caroline County farm contract (Caroline County farm

assignment) to MSG-STG L.P., a family limited partnership con-

trolled by Ms. Havens.   The Caroline County farm assignment,

which was effective as of November 9, 1994, provided in pertinent

part as follows:

          THIS ASSIGNMENT of Contract Interest, made Novem-
     ber 9, 1994, by and between DELAWARE CORPORATION, a
     Virginia Corporation (Assignor), and MSG-STG L.P., a
     Virginia Limited Partnership (Assignee).



     6
      The taxable years for which respondent determined deficien-
cies and penalties against Ms. Havens and Mr. Barber are 1994 and
1995. The taxable years for which respondent determined defi-
ciencies and penalties against Delaware Corporation are 1994 and
1997. The deficiency and the penalty that respondent determined
for Delaware Corporation’s taxable year 1997 are attributable to
respondent’s disallowance of a claimed NOL carryforward from its
taxable year 1995.
                        - 24 -

   *       *       *       *       *       *       *

     WHEREAS, the parties to this Assignment wish to
assign to MSG-STG L.P., a Virginia Limited Partnership,
all rights of DELAWARE CORPORATION in and to the August
1, 1993 contract of purchase, to cancel the August 1,
1993 Note in the amount of Three Hundred Twenty Thou-
sand Two Hundred and NO/100 Dollars ($320,200.00), and
to relinquish any and all claims so that DELAWARE
CORPORATION shall not have any equitable claim under
color of title to the property located in Caroline
County, Virginia, purchased by Frances B. HAVENS in
1991, and the legal title to which is still vested in
the name of Frances B. HAVENS under the Court record
documents in Caroline County, Virginia and

     WHEREAS, the parties wish the Assignment to allow
Frances B. HAVENS to freely transfer and/or convey or
sell her ownership in the One Hundred Eighty-five (185)
acres, more or less, located in Caroline County, Vir-
ginia, free and clear of any claims of interest or
ownership by DELAWARE CORPORATION under the August 1,
1993 contract of purchase.

     NOW, THEREFORE, in consideration of the sum of Ten
and NO/100 Dollars ($10.00) paid by MSG-STG L.P., a
Virginia Limited Partnership, to DELAWARE CORPORATION,
receipt of which is hereby acknowledged, and other good
and valuable considerations, the parties hereto agree
as follows:

     1. DELAWARE CORPORATION assigns to MSG-STG L.P.,
a Virginia Limited Partnership, all of its legal and
equitable rights in and to the contract of purchase
dated August 1, 1993, by and between Frances B. HAVENS
and DELAWARE CORPORATION for the Caroline County prop-
erty, reference to which contract is hereby expressly
made and which contract is incorporated into this
agreement.

     2. DELAWARE CORPORATION assigns all claims which
it may have, legal or equitable, under any contract or
color of title, to any interest in the One Hundred
Eighty-five (185) acres, more or less, located in
Caroline County, Virginia.

     3. The August 1, 1993 Note from DELAWARE CORPORA-
TION payable to Frances B. HAVENS in the amount of
                              - 25 -

     Three Hundred Twenty Thousand Two Hundred and NO/100
     Dollars ($320,200.00) is cancelled effective upon the
     date of this agreement.

          4. This Assignment and release of contractual
     rights and claim under any color of title shall not be
     recorded.

     Delaware Corporation also assigned its interest in the

Virginia Beach property contract (Virginia Beach assignment) to

Ms. Havens.   The Virginia Beach assignment, which was effective

as of June 1, 1995, provided in pertinent part:

          THIS ASSIGNMENT of Contract Interest, made June 1,
     1995 by and between DELAWARE CORPORATION, a Virginia
     Corporation (Assignor), and Frances B. Havens (As-
     signee).

        *       *       *       *       *         *     *

          WHEREAS, the parties to this Assignment wish to
     re-assign to Frances Havens all rights of DELAWARE
     CORPORATION in and to the August 1, 1993 contract of
     purchase, to cancel the August 1, 1993 Note in the
     amount of One Hundred Twenty Eight Thousand and No/100
     Dollars ($128,000.00), and to relinquish any and all
     claims so that DELAWARE CORPORATION shall not have any
     equitable claim of title to the property located in
     Virginia Beach, Virginia, purchased by Frances B.
     Havens in January 1988, and the legal title to which is
     still vested in the name of Frances B. HAVENS under the
     Court record documents in Virginia Beach, Virginia and

          WHEREAS, the parties wish the Assignment to allow
     Frances B. HAVENS to freely transfer and/or convey or
     sell her ownership in the House and Real Estate, lo-
     cated in Virginia Beach, Virginia free and clear of any
     claims of interest or ownership by DELAWARE CORPORATION
     under the August 1, 1993 contract of purchase.

          NOW, THEREFORE, in consideration of the sum of Ten
     and NO/100 Dollars ($10.00) paid by Frances Havens, to
     DELAWARE CORPORATION, receipt of which is hereby ac-
     knowledged, and other good and valuable considerations,
                             - 26 -

     the parties hereto agree as follows:

          1. DELAWARE CORPORATION assigns to Frances Ha-
     vens, all of its legal and equitable rights in and to
     the contract of purchase dated August 1, 1993, by and
     between Frances B. HAVENS and DELAWARE CORPORATION for
     the Virginia Beach property, reference to which con-
     tract is hereby expressly made and which contract is
     incorporated into this agreement.

          2. DELAWARE CORPORATION assigns all claims which
     it may have, legal or equitable, under any contract or
     color of title, to any interest in the House and
     Realestate [sic] located in Virginia Beach, Virginia.

          3. The August 1, 1993 Note from DELAWARE CORPORA-
     TION payable to Frances B. HAVENS in the amount of One
     Hundred Twenty Eight Thousand and NO/100 Dollars
     ($128,000.00) is cancelled effective upon the date of
     this agreement.

          4. Frances Havens will re-assume the liability of
     the pay off balance to Crestar Mortgage Corporation in
     the amount of One Hundred Fifty Nine Thousand Nine
     Hundred Forty Five and 94/100 Dollars ($159,945.94) and
     commence making the monthly payments.

          5. Delaware Corporation will deduct from Frances
     Havens Loan from Stockholder account Twelve Thousand
     Fifty Four and 06/100 Dollars ($12,054.06), which
     represents Delaware Corporation’s Equitable interest in
     the Virginia Beach Property.

          6. This Assignment and release of contractual
     rights and claim under any color of title shall not be
     recorded.

     Some time after the conclusion of the litigation with

respect to the Mitchums Creek property, Ms. Barber purchased for

$75,000 the one-half of that property that the Middlesex Circuit

Court had found she did not own and that Mr. Barber had purported

to sell to Delaware Corporation pursuant to the Mitchums Creek

contract.
                               - 27 -

Certain Payments by Delaware Corporation

     During the years in question, Delaware Corporation made

certain payments as described below.

     Caroline County Farm

     During 1994, Delaware Corporation paid the following ex-

penses (1994 Caroline County farm expenses) totaling $49,817 with

respect to the Caroline County farm:

            Type of Expense              Amount
             Mortgage Loan              $44,170
           Real Estate Taxes              2,418
          Electric Utilities              2,917
               Telephone                    312

     Virginia Beach Property

     During 1994, Delaware Corporation paid the following ex-

penses (1994 Virginia Beach property expenses) totaling $29,202

with respect to the Virginia Beach property:

            Type of Expense              Amount
             Mortgage Loan              $18,627
           Real Estate Taxes              2,963
          Electric Utilities              4,805
                Telephone                 1,682
               Television                   251
                  Propane                   200
                 Security                   482
             Miscellaneous                  192

     During 1995, Delaware Corporation paid the following ex-

penses (1995 Virginia Beach property expenses) totaling $23,654

with respect to the Virginia Beach property:
                                  - 28 -

               Type of Expense              Amount
                Mortgage Loan              $18,649
              Real Estate Taxes              2,963
             Electric Utilities              1,771
                  Telephone                    271

     Mitchums Creek Property

     During 1994, pursuant to the Mitchums Creek contract,

Delaware Corporation paid a total of $17,807 in legal fees (legal

fees with respect to the Mitchums Creek property) for legal

services provided to Mr. Barber in connection with the litigation

with respect to the Mitchums Creek property.

     Child Care

     During 1994 and 1995, Delaware Corporation paid $7,762 (1994

child care expenses) and $3,321 (1995 child care expenses),

respectively, for the care of the children of Mr. Barber’s

daughters.    Delaware Corporation did not treat those payments as

taxable fringe benefits.

Petitioners’ Respective Federal Income Tax Returns

     Each petitioner filed tax returns (returns) for the years in

question as described below.

     Delaware Corporation’s Returns

     Delaware Corporation filed Form 1120, U.S. Corporation

Income Tax Return (Form 1120), for its taxable year 1994 (Dela-

ware Corporation’s 1994 return).      Failes & Associates, P.C., was

the paid preparer (preparer) of that return.         In Delaware Corpo-

ration’s 1994 return, Delaware Corporation claimed the following
                              - 29 -

deductions:   (1) $49,817 for the 1994 Caroline County farm

expenses, (2) $29,202 for the 1994 Virginia Beach property

expenses, (3) $17,807 for the legal fees with respect to the

Mitchums Creek property, (4) $7,762 for the 1994 child care

expenses, and (5) $10,909 for depreciation with respect to the

Virginia Beach property (1994 Virginia Beach property deprecia-

tion deduction).   In Delaware Corporation’s 1994 return, Delaware

Corporation reported $7,200 as gross rent received with respect

to the Virginia Beach property (1994 claimed rent of $7,200).

     Delaware Corporation filed Form 1120 for its taxable year

1995 (Delaware Corporation’s 1995 return).7   In Delaware Corpora-

tion’s 1995 return, Delaware Corporation claimed the following

deductions:   (1) $23,654 for the 1995 Virginia Beach property

expenses, (2) $3,321 for the 1995 child care expenses, and

(3) $5,454 for depreciation with respect to the Virginia Beach

property (1995 Virginia Beach property depreciation deduction).

In Delaware Corporation’s 1995 return, Delaware Corporation

claimed an NOL.8   Delaware Corporation carried part of that NOL

back to its taxable years 1993 and 1994 and, as discussed below,



     7
      Delaware Corporation’s 1995 return is not part of the
record in this case. We are unable to determine from that record
whether a preparer prepared Delaware Corporation’s 1995 return
and, if so, the identity of such preparer.
     8
      The record does not disclose the amount of the NOL that
Delaware Corporation claimed in Delaware Corporation’s 1995
return.
                                - 30 -

carried the balance (i.e., $74,021) forward to its taxable year

1997.

     Delaware Corporation filed Form 1120 for its taxable year

1997 (Delaware Corporation’s 1997 return).     Failes & Associates,

P.C., was the preparer of that return.     In Delaware Corporation’s

1997 return, Delaware Corporation claimed an NOL deduction of

$74,021 that was attributable to a claimed NOL carryforward from

1995.

     Ms. Havens’s Returns

        Ms. Havens filed Form 1040, U.S. Individual Income Tax

Return (Form 1040), for her taxable year 1994 (Ms. Havens’s 1994

return).     Braun, Dehnert, Clarke & Co., PC, was the preparer of

that return.     In Ms. Havens’s 1994 return, Ms. Havens did not

report as income the following payments that Delaware Corporation

made during 1994:     (1) $49,817 for the 1994 Caroline County farm

expenses and (2) $29,202 for the 1994 Virginia Beach property

expenses.     In Ms. Havens’s 1994 return, Ms. Havens did not report

as income Delaware Corporation’s assignment in 1994 of its

interest in the Caroline County farm contract to MSG-STG L.P., a

family limited partnership controlled by Ms. Havens.

        Ms. Havens filed Form 1040 for her taxable year 1995 (Ms.

Havens’s 1995 return).     “KROBOTHs” was the preparer of that

return.     In Ms. Havens’s 1995 return, Ms. Havens did not report

as income $23,654 for the 1995 Virginia Beach property expenses
                               - 31 -

that Delaware Corporation paid during 1995.   In Ms. Havens’s 1995

return, Ms. Havens did not report as income Delaware Corpora-

tion’s assignment of its interest in the Virginia Beach property

contract to her.

     Mr. Barber’s Returns

     Mr. Barber filed Form 1040 for his taxable year 1994 (Mr.

Barber’s 1994 return).   A preparer prepared that return.9    In Mr.

Barber’s 1994 return, Mr. Barber did not report as income the

following payments that Delaware Corporation made during 1994:

(1) $17,807 for legal fees with respect to the Mitchums Creek

property and (2) $7,762 for the 1994 child care expenses.

     Mr. Barber filed Form 1040 for his taxable year 1995 (Mr.

Barber’s 1995 return).   Failes & Associates, P.C., was the

preparer of that return.    In Mr. Barber’s 1995 return, Mr. Barber

did not report as income $3,321 for the 1995 child care expenses

that Delaware Corporation paid during 1995.

Respondent’s Examination of Petitioners’ Respective Returns

     Respondent’s examination of petitioners’ respective returns

for the taxable years in question began prior to July 23, 1998.

     Delaware Corporation’s Notice of Deficiency

     Respondent issued a notice to Delaware Corporation (Delaware

Corporation’s notice) with respect to its taxable years 1994 and



     9
      The record does not disclose the identity of the preparer
of Mr. Barber’s 1994 return.
                                - 32 -

1997.     In that notice, respondent determined, inter alia, to

disallow the following deductions claimed in Delaware Corpora-

tion’s 1994 return:     (1) Real estate taxes of $2,418 attributable

to the Caroline County farm, (2) real estate taxes of $2,963

attributable to the Virginia Beach property, (3) mortgage loan

interest of $29,820 attributable to the Caroline County farm,

(4) mortgage loan interest of $6,350 attributable to the Virginia

Beach property,10 (5) utility expenses of $8,847,11 (6) legal fees

of $17,807 attributable to the litigation with respect to the




     10
      The parties stipulated that Delaware Corporation made for
1994, and deducted in its 1994 return, $44,170 of mortgage loan
payments with respect to the Caroline County farm and $18,627 of
mortgage loan payments with respect to the Virginia Beach prop-
erty. Delaware Corporation’s notice showed that for the taxable
year 1994 respondent disallowed $29,820 of mortgage loan interest
deductions with respect to the Caroline County farm and $6,350 of
mortgage loan interest deductions with respect to the Virginia
Beach property. The record does not disclose the reason for the
discrepancies between the respective total amounts of mortgage
loan payments that the parties stipulated Delaware Corporation
made during 1994, and deducted in Delaware Corporation’s 1994
return, with respect to the Caroline County farm and the Virginia
Beach property (i.e., $44,170 and $18,627, respectively) and the
respective total amounts of mortgage loan interest deductions
that respondent disallowed for that year with respect to those
properties (i.e., $29,820 and $6,350, respectively).
     11
      In Delaware Corporation’s notice, respondent did not show
the disallowed portion of the total expense deductions of $8,847
for utilities that Delaware Corporation claimed in its 1994
return (1) that was attributable to the Caroline County farm and
(2) that was attributable to the Virginia Beach property. The
record establishes that Delaware Corporation paid during 1994
utility expenses of $2,917 attributable to the Caroline County
farm and $5,930 attributable to the Virginia Beach property.
                             - 33 -

Mitchums Creek property, (7) telephone expenses of $2,700,12

(8) child care expenses of $7,762, and (9) depreciation of

$10,909 attributable to the Virginia Beach property.   In Delaware

Corporation’s notice, respondent also determined that the 1994

claimed rent of $7,200 should not be included in Delaware Corpo-

ration’s gross income for 1994.

     In Delaware Corporation’s notice, respondent determined,

inter alia, to disallow the following deductions claimed in

Delaware Corporation’s 1995 return:   (1) Real estate taxes of

$2,963 attributable to the Virginia Beach property, (2) mortgage

loan interest of $11,676 attributable to the Virginia Beach

property,13 (3) utility expenses of $1,777 attributable to the


     12
      In Delaware Corporation’s notice, respondent did not show
the disallowed portion of the total telephone expense deductions
of $2,700 that Delaware Corporation claimed in its 1994 return
(1) that was attributable to the Caroline County farm and
(2) that was attributable to the Virginia Beach property. The
record establishes that Delaware Corporation paid during 1994
telephone expenses of $312 attributable to the Caroline County
farm and $1,682 attributable to the Virginia Beach property.
Although the record is not clear regarding the property or
properties to which the remaining expenses of $706 are attribut-
able, the parties do not dispute that for 1994 the total tele-
phone expense deductions in dispute are $2,700.
     13
      The parties stipulated that Delaware Corporation made for
1995, and deducted in its 1995 return, $18,649 of mortgage loan
payments with respect to the Virginia Beach property. Delaware
Corporation’s notice showed that for the taxable year 1995
respondent disallowed $11,676 of mortgage loan interest deduc-
tions with respect to that property. The record does not dis-
close the reason for the discrepancies between the total amount
of mortgage loan payments that the parties stipulated Delaware
Corporation made during 1995, and deducted in Delaware Corpora-
                                                   (continued...)
                               - 34 -

Virginia Beach property, (4) telephone expenses of $271 attribut-

able to the Virginia Beach property, (5) child care expenses of

$3,321, and (6) depreciation of $5,454 attributable to the

Virginia Beach property.

     As a result of the disallowance of the foregoing deductions,

respondent determined:   (1) To decrease (a) the amount of the NOL

that Delaware Corporation claimed in Delaware Corporation’s 1995

return and (b) the amount of the NOL carryback from 1995 that

Delaware Corporation claimed in its 1993 return and 1994 return

and (2) to eliminate the NOL carryforward from 1995 that Delaware

Corporation claimed in its 1997 return.   In Delaware Corpora-

tion’s notice, respondent further determined that Delaware

Corporation is liable for each of the years 1994 and 1997 for the

accuracy-related penalty under section 6662(a).

     Ms. Havens’s Notice of Deficiency

     Respondent issued a notice to Ms. Havens with respect to her

taxable years 1994 and 1995.   In that notice, respondent deter-

mined that during 1994 Ms. Havens received constructive dividends

of $79,019 from Delaware Corporation, of which (1) $49,817 was

attributable to the 1994 Caroline County farm expenses that

Delaware Corporation paid during 1994 and (2) $29,202 was attrib-


     13
      (...continued)
tion’s 1995 return, with respect to the Virginia Beach property
(i.e., $18,649) and the total amount of mortgage loan interest
deductions that respondent disallowed for that year with respect
to the Virginia Beach property (i.e., $11,676).
                              - 35 -

utable to the 1994 Virginia Beach property expenses that Delaware

Corporation paid during that year.     In Ms. Havens’s notice,

respondent also determined that during 1995 Ms. Havens received

constructive dividends of $23,654 from Delaware Corporation

attributable to the 1995 Virginia Beach property expenses that

Delaware Corporation paid during that year.     Respondent further

determined in Ms. Havens’s notice that she is liable for each of

the years 1994 and 1995 for the accuracy-related penalty under

section 6662(a).

     Mr. Barber’s Notice of Deficiency

     Respondent issued a notice to Mr. Barber (Mr. Barber’s

notice) with respect to his taxable years 1994 and 1995.     In that

notice, respondent determined that during 1994 Mr. Barber re-

ceived constructive dividends of $25,569 from Delaware Corpora-

tion, of which (1) $17,807 was attributable to the legal fees

with respect to the Mitchums Creek property that Delaware Corpo-

ration paid during 1994 and (2) $7,762 was attributable to the

1994 child care expenses that Delaware Corporation paid during

that year.   In Mr. Barber’s notice, respondent also determined

that during 1995 Mr. Barber received constructive dividends of

$3,321 from Delaware Corporation attributable to the 1995 child

care expenses that Delaware Corporation paid during that year.

Respondent further determined in Mr. Barber’s notice that he is

liable for each of the years 1994 and 1995 for the accuracy-
                                - 36 -

related penalty under section 6662(a).

                                OPINION

     Each petitioner bears the burden of proving that respon-

dent’s determinations in the notice that respondent issued to

such petitioner is erroneous.    See Rule 142(a); Welch v.

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

     We must determine whether:    (1) Delaware Corporation’s

payments during 1994 of the 1994 Caroline County farm expenses

and the 1994 Virginia Beach property expenses and during 1995 of

the 1995 Virginia Beach property expenses (collectively, the

disputed property expenses) constitute constructive dividends to

Ms. Havens for those respective years that Delaware Corporation

is not entitled to deduct; (2) Delaware Corporation is entitled

for 1994 to the 1994 Virginia Beach property depreciation deduc-

tion and for 1995 to the 1995 Virginia Beach property deprecia-

tion deduction (collectively, the Virginia Beach property depre-

ciation deductions); (3) Delaware Corporation’s payments during

1994 of the legal fees with respect to the Mitchums Creek prop-

erty constitute constructive dividends to Mr. Barber for that

year that Delaware Corporation is not entitled to deduct;

(4) Delaware Corporation’s payments during 1994 of the 1994 child

care expenses and during 1995 of the 1995 child care expenses

(collectively, the disputed child care expenses) constitute

constructive dividends to Mr. Barber for those respective years
                              - 37 -

that Delaware Corporation is not entitled to deduct; and

(5) petitioners are liable for the respective years at issue for

the accuracy-related penalties.

     It is petitioners’ position that respondent erred in deter-

mining:   (1) That Delaware Corporation’s payments of (a) the

disputed property expenses, (b) the legal fees with respect to

the Mitchums Creek property, and (c) the disputed child care

expenses constitute constructive dividends to Ms. Havens or Mr.

Barber, as the case may be, that Delaware Corporation is not

entitled to deduct;14 (2) that Delaware Corporation is not enti-

tled to the Virginia Beach property depreciation deductions; and

(3) that petitioners are liable for the accuracy-related penal-

ties at issue.   In support of their position, petitioners rely

on, inter alia, Mr. Barber’s testimony.    We found his testimony

to be questionable, vague, general, conclusory, and/or uncorrobo-

rated in certain material respects.    We shall not rely on any




     14
      Petitioners do not argue that Ms. Havens and Mr. Barber
did not receive constructive dividends during the years at issue
because of insufficient earnings and profits of Delaware Corpora-
tion. See secs. 301(c)(1), 316(a). Nor do petitioners contend
that Delaware Corporation intended (1) the payments of the
disputed property expenses to be compensation to Ms. Havens, and
(2) the payments of the legal fees with respect to the Mitchums
Creek property and the disputed child care expenses to be compen-
sation to Mr. Barber that is deductible by it for the respective
years in question. See Paula Constr. Co. v. Commissioner, 58
T.C. 1055, 1058-1059 (1972), affd. without published opinion 474
F.2d 1345 (5th Cir. 1973).
                              - 38 -

such testimony to support petitioners’ position in the instant

cases.

     Petitioners did not call Ms. Havens to testify in support of

their position in these cases.   We presume that Ms. Havens did

not testify because her testimony would not have been favorable

to petitioners’ position.   See Wichita Terminal Elevator Co. v.

Commissioner, 6 T.C. 1158, 1165 (1946), affd. 162 F.2d 513 (10th

Cir. 1947).

1994 Caroline County Farm Expenses, 1994 Virginia Beach
Property Expenses, and 1995 Virginia Beach Property Expenses

     In support of their position with respect to the disputed

property expenses, petitioners argue:

     Because the Caroline County Farm was investment prop-
     erty held for rent and for resale, DC [Delaware Corpo-
     ration] may deduct real estate taxes, mortgage interest
     and utilities and operating expenses paid by it. * * *

     * * * DC can deduct mortgage interest paid on the
     Virginia Beach property in 1994 and 1995 and mortgage
     interest paid on the Caroline County farm in 1995,
     because the Virginia Beach property was rental prop-
     erty. Both pieces were investment property held for
     rent and resale. * * *

         *      *       *        *       *       *       *

          Assets sold to DC were Caroline County farm,
     $715,000; Virginia Beach property $300,000; Marion-
     Booker spec house [Chick Cove property], $99,000;
     Mitchum’s [sic] Creek property $75,000 and 60% interest
     in MSA-Kuwait, total in excess of $1,000,000. This
     infusion of capital enabled DC to get back into the
     construction business and make a profit.

          * * * All these transactions had substantial
     economic, commercial and legal effects other then
     expected tax benefits. They were in no way an economic
                             - 39 -

     sham without effect for Federal income tax purposes.
     * * *

     Respondent counters:

     A fundamental principle of income tax law is that
     economic substance prevails over form, and in this case
     the real estate transactions between petitioners were
     without economic substance because petitioner Havens
     remained the true owner of the equity in the proper-
     ties. * * *

        *       *       *       *       *       *       *

     It is abundantly clear that the real estate transac-
     tions between Havens and Delaware Corporation are
     without economic substance. Havens always remained in
     possession of the properties and controlled the proper-
     ties as she had done before the transfers. Once the
     Court looks through the alleged transfer to Delaware
     Corporation, no economic relationships were altered,
     and Havens remained the owner of the Virginia Beach and
     Caroline County properties.

     On the record before us, we reject petitioners’ argument

that as of August 1, 1993, or any time thereafter during the

years in question, Ms. Havens transferred the Caroline County

farm and the Virginia Beach property to Delaware Corporation and

that Delaware Corporation became the owner of those properties.

On that record, we agree with respondent that during the years in

question Ms. Havens remained the owner of both of those proper-

ties.

     In determining whether the benefits and burdens of ownership

of the Caroline County farm and of the Virginia Beach property

passed from Ms. Havens to Delaware Corporation, we look to Keith

v. Commissioner, 115 T.C. 605 (2000), for guidance.   In Keith v.
                             - 40 -

Commissioner, supra at 611-612, we stated:

          Case law * * * sets forth the standard for deter-
     mining when a sale is complete for tax purposes. With
     respect to real property, a sale and transfer of owner-
     ship is complete upon the earlier of the passage of
     legal title or the practical assumption of the benefits
     and burdens of ownership. See Major Realty Corp. &
     Subs. v. Commissioner, 749 F.2d 1483, 1486 (11th Cir.
     1985), affg. in part and revg. in part T.C. Memo. 1981-
     361; Dettmers v. Commissioner, 430 F.2d 1019, 1023 (6th
     Cir. 1970), affg. Estate of Johnston v. Commissioner,
     51 T.C. 290 (1968); Baird v. Commissioner, 68 T.C. 115,
     124 (1977). This test reaffirms the longstanding
     principle, evidenced by the following early statement,
     that transfer of legal title is not a prerequisite for
     a completed sale: “A closed transaction for tax pur-
     poses results from a contract of sale which is absolute
     and unconditional on the part of the seller to deliver
     to the buyer a deed upon payment of the consideration
     and by which the purchaser secures immediate possession
     and exercises all the rights of ownership.” Commis-
     sioner v. Union Pac. R.R. Co., 86 F.2d 637, 639 (2d
     Cir. 1936), affg. 32 B.T.A. 383 (1935).

          In determining whether passage either of title or
     of benefits and burdens has occurred, we look to State
     law. It is State law that creates, and governs the
     nature of, interests in property, with Federal law then
     controlling the manner in which such interests are
     taxed. See United States v. National Bank of Commerce,
     472 U.S. 713, 722 (1985). Here, execution of the
     contracts for deed was not accompanied by a transfer of
     legal title, so we must decide whether these instru-
     ments were sufficient under State law to confer upon
     the purchaser the benefits and burdens of ownership.
     This inquiry is a practical one to be resolved by
     examining all of the surrounding facts and circum-
     stances. * * *

          Among the factors which this and other courts have
     cited as indicative of the benefits and burdens of
     ownership are: A right to possession; an obligation to
     pay taxes, assessments, and charges against the prop-
     erty; a responsibility for insuring the property; a
     duty to maintain the property; a right to improve the
     property without the seller’s consent; a bearing of the
     risk of loss; and a right to obtain legal title at any
                             - 41 -

     time by paying the balance of the full purchase price.
     See Goldberg v. Commissioner, T.C. Memo. 1997-74; see
     also Major Realty Corp. v. Commissioner, supra at 1487;
     Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C.
     1221, 1237-1238 (1981); Musgrave v. Commissioner, T.C.
     Memo. 2000-285; Berger v. Commissioner, T.C. Memo.
     1996-76; Spyglass Partners v. Commissioner, T.C. Memo.
     1995-452. When a buyer, by virtue of such incidents,
     would be considered to have obtained equitable owner-
     ship under State law, a sale will generally be deemed
     completed for Federal tax purposes. * * *

     As required by Keith v. Commissioner, supra, we shall

examine the law of the Commonwealth of Virginia (Virginia law)15

to determine whether as of August 1, 1993, or any time thereafter

during the years in question, the Caroline County farm contract

and the Virginia Beach contract conferred on Delaware Corporation

the benefits and burdens of ownership (i.e., equitable ownership)

of the Caroline County farm and the Virginia Beach property.

     Under Virginia law, generally when a contract for the sale

and purchase of real property is executed, the equitable owner-

ship (i.e., the benefits and burdens of ownership) of the real

property is transferred from the seller to the buyer.   See Lipps

v. First Am. Serv. Corp., 286 S.E.2d 215, 220 (Va. 1982); Sale v.

Swann, 120 S.E. 870, 873 (Va. 1924).   Where a contract for the

sale and purchase of real property contains a condition prece-

dent, that condition must be satisfied before a party to such

contract may seek specific performance of such contract, see


     15
      The Caroline County contract and the Virginia Beach con-
tract provided that Virginia law was to govern the interpretation
of those respective contracts.
                                - 42 -

Flippo v. F & L Land Co., 400 S.E.2d 156, 160 (Va. 1991), and

before the equitable ownership (i.e., the benefits and burdens of

ownership) of such real property will pass from the seller to the

buyer, see Bauserman v. Digiulian, 297 S.E.2d 671 (Va. 1982).

Virginia law thus is consistent with tax law which requires that

a contract of sale of real property be “absolute and uncondi-

tional” in order for such contract to be considered a closed

transaction for tax purposes.    Commissioner v. Union Pac. R.R.,

86 F.2d 637, 639 (2d Cir. 1936), affg. 32 B.T.A. 383 (1935).

     In the instant cases, both the Caroline County farm contract

and the Virginia Beach property contract contained conditions

precedent that had to be satisfied.      Delaware Corporation had no

obligation to make any payments of principal to Ms. Havens with

respect to the Caroline County farm note, which under the Caro-

line County farm contract was part of the purchase price, unless

and until the Caroline County farm was sold.16     Similarly, Dela-

ware Corporation had no obligation to make any payments of

principal to Ms. Havens with respect to the Virginia Beach

property note, which under the Virginia Beach property contract

was part of the purchase price, unless and until the Virginia




     16
      Ms. Havens had no obligation under the Caroline County
farm contract to deliver a deed for the Caroline County farm
unless and until Delaware Corporation paid the Caroline County
farm note in full.
                               - 43 -

Beach property was sold.17   At all relevant times after July 31,

1993, the Caroline County farm and the Virginia Beach property

remained unsold, and Delaware Corporation did not make any

payments to Ms. Havens on the Caroline County farm note or the

Virginia Beach property note.18

     In addition, the Caroline County farm contract and the

Virginia Beach contract contained other provisions which indicate

that Ms. Havens did not transfer to Delaware Corporation as of

August 1, 1993, or any time thereafter during the years in

question, the respective benefits and burdens of ownership of the

Caroline County farm and of the Virginia Beach property.   Pursu-

ant to those respective contracts, Delaware Corporation was not

permitted to (1) make any improvements to the respective proper-

ties without first obtaining Ms. Havens’s written approval or

(2) mortgage such respective properties to pay the Caroline

County farm note and the Virginia Beach property note, respec-

tively, without the consent of Ms. Havens.

     Another factor indicating that Ms. Havens did not transfer


     17
      Ms. Havens had no obligation under the Virginia Beach
property contract to deliver a deed for the Virginia Beach
property unless and until Delaware Corporation paid the Virginia
Beach property note in full.
     18
      The Caroline County farm contract and the Virginia Beach
property contract did not specify any dates by which the Caroline
County farm and the Virginia Beach property, respectively, were
to be sold. As a result, the respective maturity dates for the
Caroline County farm note and the Virginia Beach property note
were open-ended.
                             - 44 -

to Delaware Corporation as of August 1, 1993, or any time there-

after during the years in question, the benefits and burdens of

ownership of the Virginia Beach property is that Ms. Havens

continued to reside at that property during those years without

paying any rent.19

     It is also significant that at all relevant times, including

the respective effective dates of the Caroline County farm

contract and the Virginia Beach property contract and all rele-

vant times thereafter during the taxable years in question,

petitioners did not intend that Ms. Havens transfer to Delaware

Corporation equitable ownership of and legal title to the

Caroline County farm and the Virginia Beach property.   Indeed,


     19
      Petitioners contend that during 1994 Ms. Havens and Mr.
Barber each paid $3,600 to Delaware Corporation for the rental of
the Virginia Beach property, or a total of $7,200, which they
concede did not equal the annual fair rental value of that
property. In support of that contention, petitioners rely on Mr.
Barber’s testimony. We found such testimony to be questionable,
vague, and uncorroborated, and we shall not rely on it to estab-
lish that Mr. Barber paid any amount to Delaware Corporation in
1994 as rent for his use of the Virginia Beach property. More-
over, Mr. Barber’s testimony on which petitioners rely does not
address whether Ms. Havens paid any rent to Delaware Corporation
in 1994 for her use of that property. Petitioners have not
presented any evidence, and make no argument, that during the
years in question Delaware Corporation received any rent for the
Caroline County farm. On the record before us, we find that
petitioners have failed to establish that Ms. Havens and Mr.
Barber (1) paid during 1994 a total of $7,200 as rent for the
Virginia Beach property and (2) paid during the years in question
any rent for the Caroline County farm and the Virginia Beach
property. On that record, we further find that petitioners have
failed to carry their burden of establishing that during the
years in question the Caroline County farm and the Virginia Beach
property were rental properties that Delaware Corporation owned.
                              - 45 -

Mr. Braun advised them to treat the Caroline County farm contract

and the Virginia Beach property contract as stockholder loans in

Delaware Corporation’s financial statements.

     In addition, both the Caroline County farm assignment and

the Virginia Beach property assignment, which assigned Delaware

Corporation’s respective interests in the Caroline County farm

contract and the Virginia Beach property contract to a family

limited partnership (i.e., MSG-STG L.P.) controlled by Ms. Havens

and to Ms. Havens, respectively, contained acknowledgments that

Ms. Havens continued to own the Caroline County farm and the

Virginia Beach property as of the effective dates of those

assignments.   Those assignments stated in pertinent part:

     WHEREAS, the parties wish the Assignment to allow
     Frances B. Havens to freely transfer and/or convey or
     sell her ownership in the * * * [Caroline County Farm
     or the Virginia Beach property] free and clear of any
     claims of interest or ownership by DELAWARE CORPORATION
     under the August 1, 1993 contract of purchase. [Empha-
     sis added.]

     On the record before us, we find that petitioners have

failed to carry their burden of establishing that the Caroline

County farm contract and the Virginia Beach property contract

conferred on Delaware Corporation as of August 1, 1993, or any

time thereafter during the years in question, the respective

benefits and burdens of ownership (i.e., equitable ownership) of

the Caroline County farm and the Virginia Beach property.

     With respect to Delaware Corporation’s payments of the
                              - 46 -

respective disputed property expenses relating to the Caroline

County farm and the Virginia Beach property that we have found

Delaware Corporation did not own during the years in question, it

is well established that when a corporation confers an economic

benefit on a stockholder in his or her capacity as such, without

an expectation of reimbursement, that benefit constitutes a

constructive dividend to the stockholder.   E.g., Hagaman v.

Commissioner, 958 F.2d 684, 690 (6th Cir. 1992), affg. in part

and remanding in part on another ground T.C. Memo. 1987-549;

Magnon v. Commissioner, 73 T.C. 980, 993-994 (1980).   The exis-

tence of a constructive dividend is a question of fact.   Hagaman

v. Commissioner, supra; Loftin & Woodard, Inc. v. United States,

577 F.2d 1206, 1215 (5th Cir. 1978).   Generally, a corporation

may not claim a deduction in computing its taxable income for a

payment that constitutes a constructive dividend to its stock-

holder.   See Hillsboro Natl. Bank v. Commissioner, 460 U.S. 370,

392-393 (1983); Va. Natl. Bank v. United States, 450 F.2d 1155,

1157-1158 (4th Cir. 1971); Berkley Mach. Works & Foundry, Inc. v.

Commissioner, 422 F.2d 362 (4th Cir. 1970), affg. per curiam T.C.

Memo. 1968-278.

     On the record before us, we find that petitioners have

failed to carry their burden of establishing that during 1994 and

1995 Ms. Havens intended to reimburse Delaware Corporation for

its payments of the respective disputed property expenses with
                                - 47 -

respect to the Caroline County farm and the Virginia Beach

property that we have found she owned during the years in ques-

tion.     On that record, we further find that petitioners have

failed to carry their burden of establishing that during 1994 and

1995 Delaware Corporation’s payments of such expenses did not

confer an economic benefit on Ms. Havens.

     Based upon our examination of the entire record before us,

we find that petitioners have failed to carry their burden of

establishing (1) that Delaware Corporation’s payments during 1994

and 1995, respectively, of the disputed property expenses do not

constitute constructive dividends to Ms. Havens for those years

and (2) that Delaware Corporation is entitled to deduct such

expenses for those years.     Based upon that examination, we

further find that petitioners have failed to carry their burden

of establishing that Delaware Corporation is entitled for 1994 to

the 1994 Virginia Beach property depreciation deduction and for

1995 to the 1995 Virginia Beach property depreciation deduction.

See sec. 167(a).

Legal Fees With Respect to the Mitchums Creek Property

        In support of their position with respect to the legal fees

with respect to the Mitchums Creek property, petitioners argue:

        The payment of the legal fee by Delaware did not result
        in a constructive dividend to Barber because he had
        already contracted with Delaware that it would pay all
        expenses in recovering the house as part of the consid-
        eration for the purchase. * * *
                              - 48 -

        *       *       *       *       *       *       *

          The legal fee was clearly incurred and paid for by
     Delaware, which had purchased the property from Barber.
     The suit was filed to protect Delaware’s $50,000 in-
     vestment in the property.

     Respondent counters:

     the payment of * * * legal fees associated with Bar-
     ber’s suit against his ex-wife involving their marital
     residence constitute[s] constructive dividends to
     Barber and petitioners have not argued that the pay-
     ments constituted compensation to him, deductible by
     Delaware Corporation on that basis. * * *

        *       *       *       *       *       *       *

          * * * In this case, petitioner Barber brought suit
     against his ex-wife because she defrauded him out of
     their marital residence and he sought rent from his ex-
     wife as part of the equitable distribution of marital
     property. * * * But for the divorce, Barber would not
     have had to bring suit against his ex-wife. Moreover,
     Barber brought suit against his ex-wife in his own name
     and he, not Delaware Corporation was awarded the prop-
     erty at the conclusion of the litigation. * * * What-
     ever business justifications petitioners put forward
     are simply not sufficient substance to alter the con-
     clusion that the payment was primarily for Barber’s
     benefit and a constructive dividend [is] warranted.

     On the record before us, we reject petitioners’ argument

that during 1994 Delaware Corporation’s payments of the legal

fees with respect to the Mitchums Creek property do not consti-

tute constructive dividends to Mr. Barber for that year and that

Delaware Corporation is entitled to deduct such legal fees for

that year.   On that record, we agree with respondent that during

1994 such payments constitute constructive dividends to Mr.
                             - 49 -

Barber for that year that Delaware Corporation is not entitled to

deduct.

     Ms. Barber recorded the Mitchums Creek deed and Mr. Barber

commenced litigation against her in the Middlesex Circuit Court

before he entered into the 1993 global agreement and the Mitchums

Creek contract with Delaware Corporation.   Mr. Barber commenced

that litigation against Ms. Barber in order to assert his inter-

est in the Mitchums Creek property, and not to protect any

interest Delaware Corporation might have had in that property.

Moreover, the Middlesex Circuit Court did not award any interest

in the Mitchums Creek property to Delaware Corporation.   Instead,

that court ordered a rescission of the deed conveying Mr. Bar-

ber’s interest in that property to Ms. Barber and a so-called

equitable distribution of the Mitchums Creek property to both Mr.

Barber and Ms. Barber.

     On the record before us, we find that petitioners have

failed to carry their burden of establishing that the legal fees

that Mr. Barber incurred in connection with the litigation with

respect to the Mitchums Creek property did not become his obliga-

tion to pay as the relevant legal services were rendered.     On

that record, we further find that petitioners have failed to

carry their burden of establishing that during 1994 Mr. Barber

intended to reimburse Delaware Corporation for its payments of

the legal fees with respect to the Mitchums Creek property.     On
                                 - 50 -

the record before us, we find that petitioners have failed to

carry their burden of establishing that during 1994 Delaware

Corporation’s payments of those legal fees did not confer an

economic benefit on Mr. Barber.

     Based upon our examination of the entire record before us,

we find that petitioners have failed to carry their burden of

establishing (1) that Delaware Corporation’s payments during 1994

of the legal fees with respect to the Mitchums Creek property do

not constitute constructive dividends to Mr. Barber for that year

and (2) that Delaware Corporation is entitled to deduct such

legal fees for that year.20

1994 Child Care Expenses and 1995 Child Care Expenses

     In support of their position with respect to the disputed

child care expenses, petitioners argue:

     Payment of childcare expenses for employees is a de-
     ductible expense.

          *        *       *        *       *       *       *

              * * * Barber received neither benefit nor income

     20
      Although not altogether clear, petitioners may also be
arguing that Delaware Corporation’s payments of the legal fees
with respect to the Mitchums Creek property do not constitute
constructive dividends to Mr. Barber because such payments were
part of the “consideration for the purchase” of the Mitchums
Creek property. Any such argument not only ignores that a
corporation’s conferring an economic benefit on a stockholder is
a constructive dividend to that stockholder, see, e.g., Magnon v.
Commissioner, 73 T.C. 980, 993-994 (1980), it also is inconsis-
tent with petitioners’ position that Delaware Corporation is
entitled to deduct its payments of the legal fees with respect to
the Mitchums Creek property.
                              - 51 -

     from DC’s payment of childcare for its employees in
     1994 and 1995. Just because the employee [sic] hap-
     pened to be Barber’s daughters, doesn’t impute receipt
     of income to Barber. If there is any imputed income,
     it is to the employee [sic], the daughters, not to
     Barber.

Respondent counters:

     the payment of child care expenses for Barber’s grand-
     children * * * constitute constructive dividends to
     Barber and petitioners have not argued that the pay-
     ments constituted compensation to him, deductible by
     Delaware Corporation on that basis. * * * The payment
     of Barber’s grandchildren’s child care expenses was
     inherently personal and primarily benefited petitioner
     Barber and not Delaware Corporation. * * *

     On the record before us, we reject petitioners’ argument

that Delaware Corporation’s payments during 1994 and 1995,

respectively, of the disputed child care expenses do not consti-

tute constructive dividends to Mr. Barber for those years and

that Delaware Corporation is entitled to deduct such expenses for

those years.   On that record, we agree with respondent that

Delaware Corporation’s payments during 1994 and 1995, respec-

tively, of the disputed child care expenses constitute construc-

tive dividends to Mr. Barber for those years that Delaware

Corporation is not entitled to deduct.

     Payments by a corporation for the benefit of relatives of a

stockholder may constitute constructive dividends to such stock-

holder when made at the direction of, or to satisfy the personal
                                 - 52 -

wishes of, such stockholder.21    On the record before us, we find

that petitioners have failed to carry their burden of establish-

ing that Delaware Corporation’s payments during 1994 and 1995,

respectively, of the disputed child care expenses were not made

at the direction of, or to satisfy the personal wishes of, Mr.

Barber.   On that record, we further find that petitioners have

failed to carry their burden of establishing that during 1994 and

1995, respectively, Mr. Barber intended to reimburse Delaware

Corporation for its payments of the disputed child care expenses.

On the record before us, we find that petitioners have failed to

carry their burden of establishing that Delaware Corporation’s

payments during 1994 and 1995, respectively, of the disputed

child care expenses did not confer an economic benefit on Mr.

Barber for those years.

     Based upon our examination of the entire record before us,

we find that petitioners have failed to carry their burden of

establishing (1) that Delaware Corporation’s payments during 1994

and 1995, respectively, of the disputed child care expenses do

not constitute constructive dividends to Mr. Barber for those

years and (2) that Delaware Corporation is entitled to deduct

such expenses for those years.




     21
      See, e.g., Hufnagle v. Commissioner, T.C. Memo. 1986-119;
Bongiovanni v. Commissioner, T.C. Memo. 1976-131.
                              - 53 -

Accuracy-Related Penalties

     Respondent determined that Delaware Corporation is liable

for each of the years 1994 and 1997, that Ms. Havens is liable

for each of the years 1994 and 1995, and that Mr. Barber is

liable for each of the years 1994 and 1995 for the accuracy-

related penalty under section 6662(a) because of:   (1) Negligence

under section 6662(b)(1) or (2) a substantial understatement of

income tax under section 6662(b)(2).

     Section 6662(a) imposes an accuracy-related penalty equal to

20 percent of the underpayment of tax resulting from, inter alia,

negligence or disregard of rules or regulations, sec. 6662(b)(1),

or a substantial understatement of income tax, sec. 6662(b)(2).

For purposes of section 6662(a), the term “negligence” includes

any failure to make a reasonable attempt to comply with the Code,

and the term “disregard” includes any careless, reckless, or

intentional disregard.   Sec. 6662(c).   Negligence has also been

defined as a lack of care or failure to do what a reasonable

person would do under the circumstances.    Leuhsler v. Commis-

sioner, 963 F.2d 907, 910 (6th Cir. 1992), affg. T.C. Memo.

1991-179; Antonides v. Commissioner, 91 T.C. 686, 699 (1988),

affd. 893 F.2d 656 (4th Cir. 1990).    An understatement is equal

to the excess of the amount of tax required to be shown in the

tax return over the amount of tax shown in the tax return, sec.

6662(d)(2)(A), and is substantial (1) in the case of an individ-
                                - 54 -

ual if it exceeds the greater of 10 percent of the tax required

to be shown or $5,000, sec. 6662(d)(1)(A), and (2) in the case of

a corporation if it exceeds the greater of 10 percent of the tax

required to be shown or $10,000, sec. 6662(d)(1)(B).

     The accuracy-related penalty under section 6662(a) does not

apply to any portion of an underpayment if it is shown that there

was reasonable cause for, and that the taxpayer acted in good

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

determination of whether the taxpayer acted with reasonable cause

and in good faith depends on the pertinent facts and circum-

stances, including the taxpayer’s efforts to assess his or her

proper tax liability, the knowledge and experience of the tax-

payer, and the reliance on the advice of a professional, such as

an accountant.   Sec. 1.6664-4(b)(1), Income Tax Regs.       Reliance

on the advice of a professional, such as an accountant, does not

necessarily demonstrate reasonable cause and good faith, unless,

under all the circumstances, such reliance was reasonable and the

taxpayer acted in good faith.    Id.     In the case of claimed

reliance on the accountant who prepared the taxpayer’s tax

return, the taxpayer must establish that correct information was

provided to the accountant and that the item incorrectly omitted,

claimed, or reported in the return was the result of the accoun-

tant’s error.    Westbrook v. Commissioner, 68 F.3d 868, 881 (5th

Cir. 1995), affg. T.C. Memo. 1993-634; Weis v. Commissioner, 94
                              - 55 -

T.C. 473, 487 (1990); Ma-Tran Corp. v. Commissioner, 70 T.C. 158,

173 (1978).

     Although not entirely clear, it appears that petitioners are

arguing that they are not liable for the accuracy-related penal-

ties at issue because they sought and received tax advice from

professionals and relied upon such advice in ascertaining the tax

treatment of the disputed property expenses, the Virginia Beach

property depreciation deductions, the legal fees with respect to

the Mitchums Creek property, and the disputed child care expenses

that was reflected in their respective tax returns.

     The record establishes that a preparer prepared each of the

following tax returns:   Delaware Corporation’s 1994 return,

Delaware Corporation’s 1997 return, Ms. Havens’s 1994 return, Ms.

Havens’s 1995 return, Mr. Barber’s 1994 return, and Mr. Barber’s

1995 return (collectively, returns in question).   The only

professional on whom petitioners claim to have relied and who

testified at the trial in these cases was Mr. Braun.   No other

professional, including the preparers of the respective returns

in question, testified at trial.

     The following colloquy took place on direct examination of

Mr. Braun:

          Q    What about the tax aspects of the deductions
     that the Delaware Corporation could take or would take
     as a result of acquiring these properties where they
     assumed debt [i.e., the Caroline County farm and the
     Virginia Beach property]?
                                - 56 -


          A    These properties were basically rental prop-
     erties. As long as the rent was paid, I felt that they
     were valid rental properties.

          Q    Could the corporation therefore deduct oper-
     ating expenses?

           A      That’s correct.

           Q      Of the rental properties?

           A      Yes, sir.

     Mr. Braun’s characterization in his testimony of the Caro-

line County farm and the Virginia Beach property as “basically

rental properties” must have been based on information provided

to him.    We presume that petitioners provided such information to

Mr. Braun.     We have found that petitioners have failed to carry

their burden of establishing that during the years in question

the Caroline County farm and the Virginia Beach property were

rental properties that Delaware Corporation owned.    See supra

note 19.     On the record before us, we find that petitioners have

failed to carry their burden of establishing that they were

correct in informing Mr. Braun that during the years at issue the

Caroline County farm and the Virginia Beach property were rental

properties that Delaware Corporation owned.

     On the record before us, we find that petitioners have

failed to carry their burden of establishing that they supplied

correct information to Mr. Braun and to the respective preparers

of the returns in question and that the errors in each of those

returns were the results of errors on the part of Mr. Braun and
                               - 57 -

any of such preparers.    Westbrook v. Commissioner, supra; Weis v.

Commissioner, supra; Ma-Tran Corp. v. Commissioner, supra.     On

that record, we further find that petitioners have failed to

carry their burden of establishing that they had reasonable cause

for, and that they acted in good faith with respect to, relying

on any advice of Mr. Braun, or any other professional, regarding

the disputed property expenses, the Virginia Beach property

depreciation deductions, the legal fees with respect to the

Mitchums Creek property, and the disputed child care expenses.

See sec. 6664(c)(1).

     Based upon our examination of the entire record before us,

we find that each petitioner has failed to show that such peti-

tioner was not negligent and did not disregard rules or regula-

tions within the meaning of section 6662(b)(1), or otherwise did

what a reasonable person would do, with respect to any portion of

the underpayment for any of the years at issue.    Based on that

examination, we further find that each petitioner has failed to

show that such petitioner acted with reasonable cause and in good

faith with respect to any portion of the underpayment for any of

the years at issue.    See sec. 6664(c).   Based upon our examina-

tion of the entire record before us, we find that each petitioner

has failed to establish that such petitioner is not liable for

the years at issue for the accuracy-related penalties under
                             - 58 -

section 6662(a).22

     We have considered all of the contentions and arguments of

the parties that are not discussed herein, and we find them to be

without merit, irrelevant, and/or moot.

     To reflect the foregoing and the concessions of Delaware

Corporation,

                                   Decisions will be entered

                              for respondent.




     22
      We have found that petitioners are liable for the years at
issue for the accuracy-related penalties at issue because of
negligence or disregard of rules or regulations under sec.
6662(b)(1). In light of that finding, we shall not address
respondent’s alternative argument that petitioners are liable for
the years at issue for those accuracy-related penalties because
of substantial understatements of income tax under sec.
6662(b)(2).
