                       T.C. Memo. 2006-36



                     UNITED STATES TAX COURT



   PK VENTURES, INC. AND SUBSIDIARIES, ET AL.,1 Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent*



     Docket Nos. 5836-99, 6395-99,      Filed March 7, 2006.
                 10154-99.



     B. Gray Gibbs, Daniel C. Johnson, and Philip Alan Diamond,

for petitioners (at trial).   Sheldon M. Kay and Thomas Cullinan,

for petitioners (on reconsideration).

     Kirk S. Chaberski and Benjamin A. de Luna, for respondent.



     1
       Cases of the following petitioners are consolidated
herewith: P.K. Ventures I Limited Partnership, Robert L. Rose,
Tax Matters Partner, docket No. 6395-99; Robert L. and Alice N.
Rose, docket No. 10154-99.

     *This opinion supersedes T.C. Memo. 2005-56, which is
withdrawn by order served this date, as a result of a motion for
reconsideration filed subsequent to the release of T.C. Memo.
2005-56.
                               - 2 -

             MEMORANDUM FINDINGS OF FACT AND OPINION


                         Table of Contents


FINDINGS OF FACT   ..........................................    7

     Background ...........................................      7
          A.   Rose .......................................      7
          B.   Printon Kane and Co. and the Printon Kane
               Group, Inc. ................................      8
          C.   PK Ventures ................................      9
          D.   PKVI LP ....................................     11

     PK Ventures’ Purchase of the Stock of SLPC, TBPC, TPC,
     and TPTC .............................................     15

     Rose’s Initial Receipt of an Equity Interest in
     PK Ventures ..........................................     25

     The Purchase of Zephyr   ...............................   26

     Transfers From PK Ventures, TBPC, and TPTC to Zephyr
     and Zephyr’s Bankruptcy ..............................     29
          A.   As Described in the Business’s Financial
               Statements and Income Tax Returns ..........     30
               1.   1987 ..................................     30
               2.   1988 ..................................     31
               3.   1989 ..................................     32
               4.   1990 ..................................     33
          B.   Internal Revenue Service (IRS)
               Determinations .............................     34

     Rose’s Acquisition of Control of PK Ventures and
     PKVI LP ..............................................     35

     Transfers From PK Ventures to the Zephyr Purchasers ..     42
          A.   As Described in the Financial Statements
               and Income Tax Returns for PK Ventures and
               PKV&S ......................................     43
          B.   As Described in the Roses’ Income Tax
               Returns ....................................     46
          C.   IRS Determinations .........................     47

     Transfers to PKVI LP .................................     47
          A.   Transfers From Unrelated Parties to
               PKVI LP ....................................     47
                        - 3 -

    B.   Transfers From PK Ventures and/or Its
         Subsidiaries to PKVI LP ....................    55
         1.   As Described in the Business’s
              Financial Statements and Income Tax
              Returns ...............................    58
              a.   1986 .............................    58
              b.   1987 .............................    59
              c.   1988 .............................    60
              d.   1989 .............................    61
              e.   1990 .............................    63
              f.   1991 .............................    64
              g.   1992 .............................    66
              h.   1993 .............................    67
         2.   IRS Determinations ....................    67

Other Circumstances Surrounding PK Ventures’
Operations and Financial Arrangements ................   70
     A.   Going Concern Notes in the Business’s
          Financial Statements .......................   70
          1.   PK Ventures, SLPC, TBPC, and TPTC .....   70
          2.   PKVI LP ...............................   70
     B.   Litigation Involving SLPC, TBPC, and TPTC ..   72
     C.   Transfers From Rose to PK Ventures .........   73

Rose’s Wages for 1986 Through 1993 ...................   74
     A.   Wages Received From Printon Kane and the
          Printon Kane Group .........................   76
     B.   Wages Recorded on PK Ventures’ Books and
          Records ....................................   76
     C.   Wages Reported on Income Tax Returns .......   79
     D.   IRS Determinations .........................   82

PK Ventures’ Share of PKVI LP’s Items of Income and
Loss .................................................   85
     A.   As Reported on PK Ventures’ Schedules K-1 ..   85
     B.   As Reported on the Income Tax Returns for
          PK Ventures and PKV&S ......................   86
     C.   IRS Determinations .........................   87

The Roses’ Share of PKVI LP’s Items of Income and
Loss .................................................   88
     A.   As Reported on Rose’s Schedules K-1 ........   88
     B.   As Reported on the Roses’ Income Tax
          Returns ....................................   89
     C.   IRS Determinations .........................   92
                                 - 4 -

     The Roses’ Share of Zephyr’s Items of Income and
     Loss .................................................       94
          A.   As Reported on Rose’s Schedules K-1 ........       94
          B.   As Reported on the Roses’ Income Tax
               Returns ....................................       95
          C.   IRS Determinations .........................       96

     Transactions Involving SLPC, TPC, and the Roses
     During 1994 and 1995 .................................       97
          A.   As Described in SLPC and the Roses’ Income
               Tax Returns ................................       99
          B.   IRS Determinations .........................      100

     Imposition of Accuracy-Related Penalties by the IRS    ..   101

OPINION   ...................................................    102

     Procedural Matters    ...................................   102

     Issue #1--Transfers From PK Ventures to the Zephyr
               Purchasers .................................      104

     Issue #2--Transfers From PK Ventures, TBPC, and TPTC
               to PKVI LP .................................      111

     Issue #3--Transfers From PK Ventures, TBPC, and TPTC
               to Zephyr ..................................      118

     Issues #4 and #5--Partners’ Basis in PKVI LP    .........   119

     Issue #6--The Roses’ Basis in Their Zephyr Interest    ..   123

     Issue #7--The Roses’ Basis in Their SLPC Interest    ....   132

     Issue #8--Reasonable Compensation    ....................   138

     Issue #9--Penalties    ..................................   151


     COHEN, Judge:     Respondent determined deficiencies and

penalties with respect to the Federal income taxes for petitioner

PK Ventures, Inc. and Subsidiaries (PKV&S), for 1990, 1991, 1992,

and 1993 as follows:
                                 - 5 -

                                             Penalty
                Year     Deficiency       Sec. 6662(a)

                1990       $211,278            $2,269
                1991        791,480             9,517
                1992        649,700             1,316
                1993        750,743               –-

     By Notice of Final Partnership Administrative Adjustment

(FPAA) dated January 11, 1999, respondent determined an upward

adjustment of $100,661 with respect to the ordinary income of

P.K. Ventures I Limited Partnership (PKVI LP) for 1991.

Robert L. Rose (Rose), the designated tax matters partner for

PKVI LP, filed a Petition for Readjustment of Partnership Items

Under Code Section 6226.

     Respondent determined deficiencies, an addition to tax, and

penalties with respect to the Federal income taxes for

petitioners Robert L. and Alice N. Rose (the Roses) for 1990,

1991, 1992, 1993, 1994, and 1995 as follows:

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

      1990     $11,729                  –-                 $2,346
      1991      90,133                  --                 18,027
      1992     503,928                  --                100,786
      1993     177,286                  --                 35,457
      1994     248,981                  --                   –-
      1995     397,096                $8,446                 --

     The principal issues tried and briefed in these consolidated

cases were:

     (1) Whether a transfer of $1 million from PK Ventures, Inc.

(PK Ventures), to 10 individuals, 9 of whom were shareholders of
                              - 6 -

PK Ventures, in 1987 to enable them to purchase Zephyr Rock &

Lime, Inc. (Zephyr), was a bona fide loan and, if so, whether

that debt ever became worthless (Issue #1);

     (2) whether transfers of funds from PK Ventures and/or its

subsidiaries to PKVI LP prior to and during 1990 and during 1991

were bona fide loans and, if so, whether such debts ever became

worthless (Issue #2);

     (3) whether transfers of funds from PK Ventures and two of

its subsidiaries to Zephyr prior to 1990 were bona fide loans

and, if so, whether such debts ever became worthless (Issue #3);

     (4) whether PK Ventures had sufficient basis in its PKVI LP

interest during 1990, 1991, 1992, and 1993 to deduct the losses

that it claimed from PKVI LP on PKV&S’s consolidated Federal

income tax returns for those years (Issue #4);

     (5) whether the Roses had sufficient basis in their PKVI LP

interest during 1990, 1991, 1992, 1993, 1994, and 1995 to deduct

the losses that they claimed from PKVI LP on their joint Federal

income tax returns for those years (Issue #5);

     (6) whether the Roses had sufficient basis in their Zephyr

interest during 1990, 1991, and 1992 to deduct the losses that

they claimed from that S corporation on their joint Federal

income tax returns for those years (Issue #6);

     (7) whether the Roses had sufficient basis in their

St. Louis Pipeline Corp. interest during 1994 and 1995 to deduct
                                - 7 -

the losses that they claimed from that S corporation on their

joint Federal income tax returns for those years (Issue #7);

     (8) whether the compensation that Rose received from PKV&S

during 1992 and 1993 was reasonable (Issue #8); and

     (9) whether the Roses are liable for accuracy-related

penalties under section 6662(a) for 1990, 1991, 1992, and 1993

(Issue #9).

     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the years in issue, and

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

Procedure.    Most amounts have been rounded to the nearest dollar.

                          FINDINGS OF FACT

     Some of the facts have been stipulated, and the stipulated

facts are incorporated in our findings by this reference.    The

principal place of business of PKV&S was in Sarasota, Florida, at

the time that the petition was filed at docket No. 5836-99.    The

principal place of business of PKVI LP was in Tampa, Florida, at

the time that the petition was filed at docket No. 6395-99.    The

Roses resided in Florida at the time that the petition was filed

at docket No. 10154-99.

Background

     A.   Rose

     Rose obtained a bachelor’s degree in physics from Lancaster

University in England, an M.B.A. and a master’s degree in
                                 - 8 -

education from Lehigh University, and a master’s degree from the

University of Pennsylvania.   Prior to 1985, Rose was employed by

Evantash Associates, Chemical Bank, Soloman Bros., Thompson

McKenan, Kidder Peabody, J.J. Lowry & Co., and Community College

of Philadelphia, among others.    Through his employment, Rose

gained experience in budgeting, financial futures, hedging

transactions, foreign currencies, and loan transactions.

     B.   Printon Kane and Co. and the Printon Kane Group, Inc.

     Printon Kane and Co. (Printon Kane), a Delaware limited

partnership, was, at all relevant times, in the business of

dealing in bonds and other investment opportunities.     Printon

Kane’s business was eventually transferred to the Printon Kane

Group, Inc. (Printon Kane Group), a Delaware corporation, during

1989.

     Rose began working for Printon Kane in 1985 and was a

full-time employee of Printon Kane through 1988.     Rose remained

employed by Printon Kane during 1989 and by the Printon Kane

Group during 1989 and 1990.   Rose worked in the area of corporate

finance at Printon Kane and the Printon Kane Group.     In that

capacity, Rose acted as a loan broker and would attempt to find

lenders to fund small hydroelectric projects, cogeneration

projects, and coal mining projects.      In addition, Rose’s duties

at Printon Kane and the Printon Kane Group included seeking out

and developing investment opportunities for the firm.
                               - 9 -

     C.   PK Ventures

     On or about September 12, 1986, PK Ventures was organized as

a Delaware corporation for the purposes of acquiring, owning,

leasing, holding, operating, maintaining, and disposing of assets

such as pipelines and alternate energy facilities and engaging in

any and all activities related or incidental thereto.   Rose was

responsible for organizing PK Ventures as part of his duties to

develop investment opportunities for Printon Kane.   Sometime

before Rose organized PK Ventures, Rose and Printon Kane’s

management had agreed that he would receive an equity interest in

PK Ventures as part of his compensation for arranging this

investment opportunity for the firm.

     PK Ventures was initially authorized to issue 1,000 shares

of stock.   As of September 16, 1986, PK Ventures had issued all

of those authorized shares to 11 individuals.   These initial

owners of PK Ventures included G. Clifford McCarthy, Jr.

(McCarthy), and 10 individuals who were either partners in or

employees of Printon Kane--Amos Beason (Beason), Francis Cerosky

(Cerosky), Robert Grimmig (Grimmig), Thomas Kane (Kane), Thomas

Kane, Jr. (Kane Jr.), Eugene Kirkwood (Kirkwood), Louis Krutoy

(Krutoy), Joseph Mannello (Mannello), Joel Marshall (Marshall),

and John Parker (Parker).   As of that date, PK Ventures’ stock

was owned in the following proportions:
                              - 10 -

                           Number of      Percentage of
           Shareholder   Shares Owned      Shares Owned

            McCarthy            3                .3%
            Beason              6                .6
            Cerosky            36               3.6
            Grimmig           156              15.6
            Kane              407              40.7
            Kane Jr.           21               2.1
            Kirkwood           16               1.6
            Krutoy            160              16.0
            Mannello           24               2.4
            Marshall           21               2.1
            Parker            150              15.0

The purchase price for these shares was $0.50 per share.

     On September 15, 1986, Rose was elected by the shareholders

of PK Ventures as its sole director.    Rose then elected himself

as the president, treasurer, and secretary of the corporation.

Rose held the positions of sole director, president, treasurer,

and secretary of PK Ventures and operated PK Ventures out of his

office at Printon Kane until he resigned from those positions in

November 1988.   Krutoy replaced Rose as president of PK Ventures

from November 1988 through March 1990.   Although he resigned the

position of president of PK Ventures, Rose continued to run the

day-to-day operations of PK Ventures from his office at Printon

Kane or the Printon Kane Group from November 1988 through March

1990.   He then regained the positions of sole director and

president of PK Ventures and held those positions through 1993.

Rose’s duties for PK Ventures and later for PK Ventures and its

wholly owned subsidiaries--St. Louis Pipeline Corp. (SLPC), Tampa

Bay Pipeline Co. (TBPC), Tampa Pipeline Corp. (TPC), and Tampa
                               - 11 -

Pipeline Transport Co. (TPTC)–-included handling cash management

functions, payroll, insurance and risk management functions,

customer relations, and marketing.

     During 1990, 1991, 1992, and 1993, PK Ventures operated as a

C corporation, used the accrual method of accounting, and was the

holding company for SLPC, TBPC, TPC, and TPTC.    During 1991,

1992, and 1993, PK Ventures and its subsidiaries employed

approximately 20 people.    Neither PK Ventures nor any of its

subsidiaries paid any dividends to their shareholders from 1986

through 1993.

     D.   PKVI LP

     On September 15, 1986, Rose, as sole director of

PK Ventures, adopted a resolution that PK Ventures, Rose, and

Herbert Patrick (Patrick), as general partners, would form

PKVI LP for the purposes of acquiring, owning, leasing, holding,

operating, maintaining, mortgaging, and disposing of

hydroelectric, cogeneration, and other energy projects.    PKVI LP

was subsequently organized as a Delaware limited partnership.

Rose was responsible for organizing PKVI LP as part of his duties

to develop investment opportunities for Printon Kane.    Sometime

before Rose organized PKVI LP, Rose and Printon Kane’s management

had agreed that he would receive an equity interest in PKVI LP as

part of his compensation for arranging this investment

opportunity for the firm.
                              - 12 -

     The initial partners in PKVI LP included PK Ventures,

Patrick, Rose, McCarthy, and 10 other individuals who were

associated with Printon Kane--Beason, Cerosky, Grimmig, Kane,

Kane Jr., Kirkwood, Krutoy, Mannello, Marshall, and Parker.

Under the terms of the Agreement of Limited Partnership of

PK Ventures I Limited Partnership (agreement of limited

partnership), these partners made initial capital contributions

to PKVI LP in the following amounts and held the following

interests in PKVI LP as of September 15, 1986:

                Initial Capital   Participating     Limited or
    Partner       Contribution      Percentage        General

  PK Ventures         $500              1.000%       General
  Patrick                0             40.000        General
  Rose                   0             30.000        General
  McCarthy             148               .087        Limited
  Beason               297               .174        Limited
  Cerosky            1,782              1.044        Limited
  Grimmig            7,722              4.524        Limited
  Kane              20,146             11.803        Limited
  Kane Jr.           1,040               .609        Limited
  Kirkwood             792               .464        Limited
  Krutoy             7,920              4.640        Limited
  Mannello           1,188               .696        Limited
  Marshall           1,040               .609        Limited
  Parker             7,425              4.350        Limited

     The initial capital contributions to PKVI LP totaled

$50,000.   No other amounts transferred to PKVI LP were identified

as capital contributions on its books.     The terms of the

agreement of limited partnership required that, as of the end of

each fiscal year of the partnership, PKVI LP pay to each of its

partners interest on their capital contributions (as adjusted for
                                - 13 -

any subsequent contributions and withdrawals) at a rate equal to

the greater of (1) the prime rate as published in the Wall Street

Journal on the last business day of the fiscal year plus

2 percent or (2) such other floating or fixed rate authorized by

PK Ventures, the corporate general partner of PKVI LP.

     In their roles as general partners of PKVI LP, Patrick was

responsible for the management of the partnership’s daily

operations, and Rose was responsible for the partnership’s

ongoing financial activities.    The terms of the agreement of

limited partnership provided that neither Rose nor Patrick would

be compensated for their services to the partnership.    As

corporate general partner of PKVI LP, PK Ventures had, inter

alia, the exclusive right, power, and authority to authorize

distributions of cash on behalf of PKVI LP.    PK Ventures also had

the exclusive right, power, and authority, subject to written

approval of the partnership’s limited partners holding at least

67 percent of the aggregate voting percentages of the limited

partners, to do the following:    (1) Make calls for additional

capital contributions on behalf of PKVI LP; (2) permit a

withdrawal of capital by any partner; (3) admit an additional

partner to the partnership; (4) permit the withdrawal of any

partner from the partnership; (5) designate any additional

investments for the partnership and determine the participating

percentages of the partners in such additional investments;
                               - 14 -

(6) sell or otherwise dispose of all or substantially all of the

partnership’s property attributable to any investment; (7) permit

any agreement between the partnership and any general partner or

any person controlled by or controlling or under common control

with a general partner; and (8) permit the transfer or

assignment, in whole or in part, by a partner of his interest in

the partnership.

     The terms of the agreement of limited partnership provided

that the general partners of PKVI LP were under no obligation to

make any additional capital contributions to the partnership in

response to any capital calls made on behalf of the partnership

by PK Ventures.    A general partner’s participating percentage

could not be decreased as a result of not making any additional

capital contributions to PKVI LP, but it could be increased as a

result of making such a contribution.    A limited partner’s

participating percentage could be adjusted upward or remain the

same if that partner did make an additional capital contribution

to PKVI LP in response to a capital call, or it could be adjusted

downward if that partner did not make an additional capital

contribution in response to a capital call.

     Patrick, Rose, and PK Ventures were the general partners of

PKVI LP from September 15, 1986, until sometime in 1989.    During

that time, PK Ventures owned a 1-percent interest, Rose owned a

30-percent interest, and Patrick owned a 40-percent interest.
                              - 15 -

Sometime during 1989, Patrick relinquished his interest in

PKVI LP.   As a result of Patrick’s withdrawal from PKVI LP, Rose

and PK Ventures became the partnership’s only general partners.

At that time, Rose held a 70-percent general partnership interest

in PKVI LP.   From May 1988 through January 1990, PK Ventures was

both a 1-percent general partner and a 4.35-percent limited

partner of PKVI LP.

PK Ventures’ Purchase of the Stock of SLPC, TBPC, TPC, and TPTC

     On December 10, 1986, PK Ventures entered into separate

Stock Purchase Agreements for the purchase of 100 percent of the

outstanding stock of SLPC, TBPC, TPC, and TPTC.   At the time that

PK Ventures entered into these agreements, SLPC, TBPC, and TPC

were owned by Joyce Western Corp. (Joyce Western), and TPTC was

owned by Joyce Western, Kathleen Biondo, Christine Joyce, Helma

Joyce, and James Joyce (the TPTC sellers).   At all relevant

times, these corporations were engaged in the following

operations:   (1) SLPC owned a pipeline that transported aviation

fuel from Illinois to the Lambert Airport in St. Louis, Missouri;

(2) TBPC and TPTC owned pipelines that transported anhydrous

ammonia from the port of Tampa Bay, Florida, to Hillsborough

County, Florida, and Polk County, Florida; and (3) TPC held a

general partnership interest and/or a limited partnership

interest in Tampa Pipeline Limited Partnership, a business that

operated an aviation fuel pipeline that serviced the Tampa
                                  - 16 -

International Airport.       As of December 10, 1986, TBPC and TPTC

owned two of the four existing anhydrous ammonia pipelines in the

United States.     Also as of that date, TBPC had leased the use of

its pipeline to W.R. Grace & Co. and Royster Co. (Royster), and

TPTC had leased the use of its pipeline to International

Minerals & Chemical Corp.

        Under the terms of the Stock Purchase Agreements,

PK Ventures agreed to pay the following base purchase prices for

the stock of SLPC, TBPC, TPC, and TPTC:

                  Corporation     Base Purchase Price

                      SLPC              $150,000
                      TBPC             1,000,000
                      TPC                 50,000
                      TPTC             1,300,000

The parties agreed that these base purchase prices would be

adjusted to reflect the amount by which each corporation’s

current assets differed from its current liabilities as of the

closing date.

     On December 30, 1986, PK Ventures agreed to pay to Joyce

Western the following portions of the base purchase prices for

the stock of SLPC, TBPC, and TPC on the transaction’s closing

date:

                  Corporation         Amount Paid

                      SLPC              $40,000
                      TBPC              350,000
                      TPC                10,000
                              - 17 -

In addition, PK Ventures agreed to deliver to Joyce Western

nonnegotiable promissory notes in the following principal amounts

for the balances of the base purchase prices:

                Corporation Promissory Note Amount

                    SLPC            $110,000
                    TBPC             650,000
                    TPC               40,000

     Also on December 30, 1986, PK Ventures entered into an

Interim Loan Agreement (ILA) with Norstar Bank (Norstar) in

connection with its purchase of the stock of SLPC, TBPC, TPC, and

TPTC.   The ILA was a precursor to the permanent financing

arrangement that PK Ventures was to enter into with Norstar in

connection with this transaction.   The ILA required Norstar,

inter alia, to make a loan to PK Ventures in the form of a

revolving line of credit in the maximum principal amount of

$1.6 million.   This loan was secured by an irrevocable letter of

credit that the Summit Trust Co. (Summit Trust) issued in favor

of PK Ventures on December 31, 1986.   The terms of the loan

required that all outstanding principal amounts bear interest at

a rate equal to three-fourths of 1 percent above Norstar’s stated

prime rate, that payments of accrued interest and outstanding

principal amounts be made monthly, and that the entire

outstanding principal balance plus accrued interest become due

and payable at the time that the permanent financing was

finalized.   Advances under this loan were to be made, inter alia,
                              - 18 -

to pay to James Joyce or Joyce Western a total of $600,000 in two

installments--$400,000 was due to be paid at the closing of the

loan, and the balance was due to be paid at the earlier of the

closing of the permanent financing or February 1, 1987.

     The ILA also set forth the details of the permanent

financing arrangement that was being negotiated between

PK Ventures and Norstar.   As set forth in the ILA, Norstar had

agreed to make one term loan to SLPC in the amount of

$1.1 million and one or more term loans to TBPC, TPC, and/or TPTC

in the total amount of $10.5 million.   The purpose of these term

loans was, inter alia, to refinance the indebtedness that SLPC,

TBPC, TPC, and TPTC owed to Norstar.    In addition to these term

loans, Norstar agreed to establish a 5-year revolving line of

credit in the maximum principal amount of $2.5 million for

PK Ventures ($2.5 million revolving line of credit).    Under the

terms of the permanent financing arrangement, the term loans to

SLPC, TBPC, TPC, and TPTC and the first $1.3 million of

outstanding principal on the $2.5 million revolving line of

credit were to be secured by a pledge of all of the stock of

SLPC, TBPC, TPC, and TPTC as well as a first mortgage on and

security interest in all of the assets of those corporations.

     On December 31, 1986, PK Ventures closed on the purchase of

the stock of SLPC, TBPC, and TPC from Joyce Western.    On that

date, PK Ventures executed documents entitled “Non-Negotiable
                             - 19 -

Promissory Note” in favor of Joyce Western for the balances of

the base purchase prices for the stock of SLPC, TBPC, and TPC.

The terms of the Non-Negotiable Promissory Note for the balance

of the base purchase price for the stock of SLPC required that

the principal amount bear interest at a rate of 9 percent, that a

$10,000 principal installment payment be made on January 31,

1987, and that the remaining principal balance plus accrued

interest become due and payable no later than February 15, 1987.

The terms of the Non-Negotiable Promissory Note for the balance

of the base purchase price for the stock of TBPC required that

the principal amount bear interest at a rate of 9 percent, that a

$185,000 principal installment payment be made on January 31,

1987, and that the remaining principal balance plus accrued

interest become due and payable no later than February 15, 1987.

The terms of the Non-Negotiable Promissory Note for the balance

of the base purchase price for the stock of TPC required that the

principal amount bear interest at a rate of 9 percent, that a

$5,000 principal installment payment be made on January 31, 1987,

and that the remaining principal balance plus accrued interest

become due and payable no later than February 15, 1987.   These

promissory notes were subordinate to the indebtedness incurred by

PK Ventures, SLPC, TBPC, TPC, and TPTC to Norstar in connection

with PK Ventures’ acquisition of SLPC, TBPC, TPC, and TPTC.
                              - 20 -

     Also on December 31, 1986, PK Ventures executed documents

entitled “Subordinated Note” in favor of the TPTC sellers in

exchange for the stock of TPTC.   The Subordinated Notes were

issued in the following amounts and were, in the aggregate, equal

to the base purchase price for the stock of TPTC:

             TPTC Seller      Subordinated Note Amount

            Joyce Western              $780,000
            Kathleen Biondo             130,000
            Christine Joyce             130,000
            Helma Joyce                 130,000
            James Joyce                 130,000

The terms of the Subordinated Notes required that the principal

balances bear interest at a rate of 7.6923 percent, that payments

of accrued interest be made monthly beginning on February 1,

1987, and that the principal balances become due and payable on

January 1, 1992.   The Subordinated Notes were subordinate to the

indebtedness incurred by PK Ventures, SLPC, TBPC, TPC, and TPTC

to Norstar in connection with PK Ventures’ acquisition of SLPC,

TBPC, TPC, and TPTC.

     On or about February 3, 1987, SLPC, TBPC, and TPTC executed

documents entitled “Promissory Note” in favor of Norstar in which

they promised to pay to Norstar the principal amounts of

$1.1 million, $6.5 million, and $4 million, respectively.   The

terms of SLPC’s Promissory Note to Norstar required that the

outstanding principal balance bear interest at a rate of

10.25 percent, that the interest on the outstanding principal
                              - 21 -

amount be calculated on the basis of a 360-day year, that

payments of principal and accrued interest be made in equal

quarterly installments of $55,532 beginning on February 15, 1987,

and that any remaining balance of principal and accrued interest

become due and payable on February 3, 1994.   The terms of TBPC’s

Promissory Note to Norstar required that the outstanding

principal balance bear interest at a rate of 10.40 percent, that

the interest on the outstanding principal amount be calculated on

the basis of a 360-day year, that payments of principal and

accrued interest be made in equal monthly installments of $87,345

beginning on March 15, 1987, and that any remaining balance of

principal and accrued interest become due and payable on

February 3, 1997.   The terms of TPTC’s Promissory Note to Norstar

required that the outstanding principal balance bear interest at

a rate of 10.40 percent, that the interest on the outstanding

principal amount be calculated on the basis of a 360-day year,

that payments of principal and accrued interest be made in equal

monthly installments of $53,751 beginning on February 15, 1987,

and that any remaining balance of principal and accrued interest

become due and payable on February 3, 1997.

     Also on or about February 3, 1987, PK Ventures executed a

document entitled “Master Note” in favor of Norstar in which it

promised to pay to Norstar the principal amount of $2.5 million

or, if less, the aggregate unpaid principal amount of all
                                - 22 -

advances made by Norstar to PK Ventures under the $2.5 million

revolving line of credit.   The terms of this Master Note required

that all outstanding principal amounts bear interest at a rate

equal to three-fourths of 1 percent above Norstar’s stated prime

rate, that the interest on the outstanding principal amounts be

calculated on the basis of a 360-day year, that PK Ventures make

payments of all accrued interest on the outstanding principal

amounts on a monthly basis, and that the line of credit expire on

January 1, 1992, with all amounts thereunder becoming immediately

due and payable.

     On February 9, 1987, Norstar sent a letter to Rose to inform

him that it had transferred a total of $12.5 million in loan

proceeds to PK Ventures’ Norstar account.    This letter indicated

that, effective February 3, 1987, Norstar had advanced the

following loans:

                     Borrower       Loan Amount

                    SLPC             $1,100,000
                    TBPC              6,500,000
                    TPTC              4,000,000
                    PK Ventures         900,000

Norstar made the $900,000 advance to PK Ventures under the

$2.5 million revolving line of credit.    In addition, the letter

indicated that Norstar had “closed-out” previously outstanding

notes of SLPC, TBPC, TPC, and TPTC totaling $12,493,009.

Pursuant to Rose’s instructions, Norstar debited PK Ventures’

account for this amount.
                              - 23 -

     On or about June 23, 1987, TBPC executed a document entitled

“Restated Promissory Note” in favor of Contel Credit Corp.

(Contel) in which it promised to pay to Contel the principal

amount of $5.3 million.   This Restated Promissory Note restated

and superseded the Promissory Note that TBPC had executed in

favor of Norstar on February 3, 1987, in the original principal

amount of $6.5 million.   The terms of the Restated Promissory

Note required that the outstanding principal balance bear

interest at a rate of 9.9 percent through June 14, 1992, and

10.25 percent thereafter, that the interest on the outstanding

principal amount be calculated on the basis of a 360-day year,

that payments of principal and accrued interest be made monthly

beginning on July 15, 1987, and that any remaining balance of

principal and accrued interest become due and payable on December

15, 1995.

     Also on or about June 23, 1987, TPTC executed a document

entitled “Consolidation Note” in favor of Contel in which it

promised to pay to Contel the principal amount of $6.5 million.

The principal amount of this Consolidation Note included and

consolidated the principal balance of the Promissory Note that

TPTC had executed in favor of Norstar on February 3, 1987, in the

original principal amount of $4 million as well as the principal

balance of an Additional Advance Note that TPTC had executed in

favor of Contel in the original principal amount of $2.5 million.
                             - 24 -

The terms of the Consolidation Note required that the outstanding

principal balance bear interest at a rate of 9.9 percent through

June 14, 1992, and 10.25 percent thereafter, that the interest on

the outstanding principal amount be calculated on the basis of a

360-day year, that payments of principal and accrued interest be

made monthly beginning on July 15, 1987, and that any remaining

balance of principal and accrued interest become due and payable

on December 15, 1996.

     Also on or about June 23, 1987, PK Ventures agreed to

guarantee the loans between TBPC and Contel and between TPTC and

Contel (collectively, the Contel debt) and to pledge all of the

stock of TBPC, TPC, and TPTC to secure the Contel debt.   In

addition, TBPC, TPC, and TPTC agreed to encumber all of their

assets to secure the Contel debt, and PK Ventures decided that

TBPC, TPC, and TPTC no longer had to guarantee or to secure the

first $1.3 million of outstanding principal on the $2.5 million

revolving line of credit or any other indebtedness owed by SLPC,

TBPC, TPC, or TPTC to Norstar.   PK Ventures also decided that

SLPC no longer had to guarantee or to secure the first

$1.3 million of outstanding principal on the revolving line of

credit.

     PK Ventures, SLPC, TBPC, TPC, and TPTC (jointly referred to

as petitioner PKV&S) filed consolidated Federal income tax

returns for 1987 through 1993.   Prior to 1990, PK Ventures, SLPC,
                              - 25 -

TBPC, TPC, and TPTC each prepared separate financial statements.

Beginning in 1990 and continuing through 1993, PK Ventures, SLPC,

TBPC, TPC, and TPTC prepared consolidated financial statements.

These consolidated financial statements will be referred to as

PKV&S’s consolidated financial statements.   Any references to

PK Ventures in this Opinion should not be construed to include

its subsidiaries.

Rose’s Initial Receipt of an Equity Interest in PK Ventures

     On or about August 19, 1987, PK Ventures adopted a

resolution to amend its Certificate of Incorporation to increase

the number of shares of stock that it was authorized to issue

from 1,000 to 20,000.   In connection with this amendment, the

150 shares of PK Ventures stock owned by Parker and the 36 shares

of PK Ventures stock owned by Cerosky were redeemed by

PK Ventures at a price of $0.50 per share.   Also in connection

with this amendment, Rose and the PK Ventures shareholders were

given the opportunity to purchase 9,186 shares of PK Ventures

stock at a price of $0.05 per share.   As a result of these

transactions, the stock of PK Ventures was owned in the following

proportions as of August 19, 1987:
                               - 26 -

                                 Total Shares      Percentage of
                Additional        Owned After   Shares Owned After
 Shareholder Shares Acquired      Acquisition       Acquisition

   McCarthy              7              10               .10%
   Beason               14              20               .20
   Grimmig           1,073           1,229             12.29
   Kane              2,802           3,209             32.09
   Kane Jr.             48              69               .69
   Kirkwood             37              53               .53
   Krutoy            1,101           1,261             12.61
   Mannello             56              80               .80
   Marshall             48              69               .69
   Rose              4,000           4,000             40.00
        Total        9,186          10,000            100.00

The Purchase of Zephyr

     Zephyr, a Florida corporation, operated as an S corporation

during 1987.    Zephyr’s primary business was mining, processing,

and selling limestone from a quarry that it owned in Pasco

County, Florida.   As of August 19, 1987, Zephyr’s balance sheets

showed that its current liabilities exceeded its current assets

by $6,030,986.

     Sometime before August 20, 1987, PK Ventures entered into a

stock purchase agreement with Elli M.A. Mills (Mills) to purchase

all of Zephyr’s issued and outstanding stock.    Prior to closing

this agreement, it was decided that, for certain business and tax

reasons, PK Ventures would assign its rights under the stock

purchase agreement to 10 individuals--Beason, Cerosky, Grimmig,

Kane, Kane Jr., Krutoy, Mannello, Marshall, McCarthy, and Rose

(collectively, the Zephyr purchasers)–-9 of whom were

shareholders of PK Ventures (i.e., Cerosky was no longer a
                                  - 27 -

shareholder of PK Ventures) and 9 of whom were associated with

Printon Kane.    McCarthy was neither a partner in nor an employee

of Printon Kane.

     On or about August 20, 1987, PK Ventures transferred

$1 million to the Zephyr purchasers.       Of this $1 million, Rose

received $400,000.    Rose and the other Zephyr purchasers used

this $1 million to purchase Zephyr’s stock from Mills, to cure

delinquent payments to Zephyr’s creditors, and to provide Zephyr

with working capital.       As of August 20, 1987, the Zephyr

purchasers owned interests in Zephyr and in PK Ventures as

follows:

                 Zephyr Shares     Percentage of     Percentage of
 Shareholder         Owned          Zephyr Owned   PK Ventures Owned

   Beason              36                .610%            .20%
   Cerosky             18                .305               0
   Grimmig            708              12.000           12.29
   Kane             1,451              24.593           32.09
   Kane Jr.           177               3.000             .69
   Krutoy             708              12.000           12.61
   Mannello           177               3.000             .80
   Marshall           177               3.000             .69
   McCarthy            88               1.492             .10
   Rose             2,360              40.000           40.00
        Total       5,900             100.000           99.47

     PK Ventures obtained the $1 million that it transferred to

the Zephyr purchasers from Summit Trust (Summit Trust loan).       An

entity named Printon Kane Government Securities pledged a

$1 million certificate of deposit as collateral for the Summit

Trust loan.     PK Ventures accounted for the Summit Trust loan by
                              - 28 -

crediting a liability account, “Due to Summit Trust”, and

debiting an asset account, “Due from Shareholders”.

     Also on or about August 20, 1987, PK Ventures and Zephyr

agreed to enter into a Management and Guaranty Inducement

Agreement.   Under the terms of the Management and Guaranty

Inducement Agreement, PK Ventures and Zephyr agreed that

PK Ventures would provide certain management services to Zephyr,

guarantee certain debts of Zephyr and the Zephyr purchasers, and

indemnify Mills with respect to his existing guarantees of

Zephyr’s debt.   In connection with the Management and Guaranty

Inducement Agreement, PK Ventures agreed to guarantee the

following:   (1) $500,000 of the purchase price to be paid by the

Zephyr purchasers for Zephyr’s stock; (2) payment of the amounts

due under Zephyr’s promissory note to NCNB National Bank of

Florida in the original principal amount of $2,615,000;

(3) payment of the amounts due under Zephyr’s promissory note to

Southeast Bank, N.A., in the principal amount $950,000; and

(4) liabilities that Zephyr incurred in the ordinary course of

its business.

     On or about November 23, 1987, Summit Trust approved a

6-month renewal of the Summit Trust loan.   The terms of the

renewal required that the principal balance of the Summit Trust

loan bear interest at a rate of 1.5 percent over the rate of the

$1 million certificate of deposit being held as collateral, that
                                 - 29 -

payments of accrued interest be made monthly beginning on

December 20, 1987, and that the principal balance and accrued

interest become due and payable on May 20, 1988.       On or about

June 6, 1988, the Summit Trust loan was renewed until May 20,

1989, under terms similar to those contained in the renewal of

November 23, 1987.

Transfers From PK Ventures, TBPC, and TPTC to Zephyr and Zephyr’s
Bankruptcy

     After its acquisition by the Zephyr purchasers in 1987,

Zephyr continued to operate as a limestone mining business.

During 1987 and 1988, Zephyr received transfers totaling

$2,281,818 from the following sources:

                        Source            Amount

                     Printon Kane     $1,450,000
                     PK Ventures         446,215
                     TBPC                263,296
                     TPTC                122,307

During 1988, Zephyr unsuccessfully attempted to obtain financing

from ITT Commercial Finance Corp. and Tarmac Florida, Inc.

     On December 6, 1988, Zephyr filed for bankruptcy under

Chapter 11 of the Bankruptcy Code.        Among the creditors listed in

its bankruptcy documents were Printon Kane, PK Ventures, TBPC,

and TPTC.   The bankruptcy documents indicated that PK Ventures,

TBPC, and TPTC had transferred $831,818 to Zephyr, as set forth

above.   PK Ventures, TBPC, and TPTC each filed claims in Zephyr’s

bankruptcy proceeding on September 12, 1989.       Copies of canceled
                              - 30 -

checks and promissory notes were attached to each of these claims

as substantiation of the amounts owed.

     Zephyr’s bankruptcy was finalized in late 1989.     Sometime

between the time that the bankruptcy was finalized and the end of

March 1990, a third party purchased Zephyr’s assets, and the

proceeds of that sale were distributed to specific secured and

unsecured creditors of Zephyr.   Neither Printon Kane,

PK Ventures, TBPC, nor TPTC received any of those proceeds.

     As of December 31, 1990, the general ledger account used by

PK Ventures to account for certain transfers that it had made to

Zephyr had a net or remaining balance of $64,888.

     A.   As Described in the Business’s Financial Statements
          and Income Tax Returns

           1.   1987

     No direct references were made and no explanations were

provided in Zephyr’s Form 1120S, U.S. Income Tax Return for an

S Corporation, for 1987 as to the amounts that Zephyr received

from Printon Kane, PK Ventures, TBPC, or TPTC during that year.

On the Schedule L, Balance Sheets, attached to that return,

Zephyr reported $6,961,306 of “Mortgages, notes, bonds payable in

less than 1 year” and $902,669 of “Mortgages, notes, bonds

payable in 1 year or more” as of the end of 1987.   There were no

amounts separately identified as interest payments made and/or

imputed by Zephyr to PK Ventures, TBPC, or TPTC on Zephyr’s

Form 1120S for 1987.
                                   - 31 -

     No direct references were made and no explanations were

provided in PK Ventures, TBPC, or TPTC’s financial statements for

the year ended December 31, 1987, as to the amounts that

PK Ventures, TBPC, and TPTC transferred to Zephyr during that

year.

     No direct references were made and no explanations were

provided in PKV&S’s consolidated income tax return for 1987 as to

the amounts that PK Ventures, TBPC, and TPTC transferred to

Zephyr during that year.        There were also no amounts separately

identified as interest payments received and/or imputed by

PK Ventures, TBPC, or TPTC from Zephyr on PKV&S’s consolidated

income tax return for 1987.

             2.   1988

        No direct references were made and no explanations were

provided in Zephyr’s Form 1120S for 1988 as to the amounts that

Zephyr received from Printon Kane, PK Ventures, TBPC, or TPTC

during that year.        On the Schedule L attached to that return,

Zephyr reported $7,318,462 of “Mortgages, notes, bonds payable in

less than 1 year”, $677,132 of “Other current liabilities”, and

$730,189 of “Mortgages, notes, bonds payable in 1 year or more”

as of the end of 1988.        There were no amounts separately

identified as interest payments made and/or imputed by Zephyr to

PK Ventures, TBPC, or TPTC on Zephyr’s Form 1120S for 1988.
                                   - 32 -

     No direct references were made and no explanations were

provided in PK Ventures, TBPC, or TPTC’s financial statements for

the year ended December 31, 1988, as to the amounts that

PK Ventures, TBPC, and TPTC transferred to Zephyr during that

year.     Furthermore, no mention of Zephyr’s bankruptcy was made in

PK Ventures, TBPC, or TPTC’s financial statements for the year

ended December 31, 1988.

     On the Schedule L attached to PKV&S’s consolidated income

tax return for 1988, TBPC and TPTC reported a total of $385,603

due from Zephyr under “Other assets” as of the end of that year.

Of this amount, $263,296 was attributable to TBPC and $122,307

was attributable to TPTC.        These amounts were described as “DUE

FROM UNCONSOLIDATED SUBSIDIARIES”.          There were no amounts

separately identified as interest payments received and/or

imputed by PK Ventures, TBPC, or TPTC from Zephyr on PKV&S’s

consolidated income tax return for 1988.

             3.   1989

        No direct references were made and no explanations were

provided in Zephyr’s Form 1120S for 1989 as to the amounts that

Zephyr received from Printon Kane, PK Ventures, TBPC, or TPTC

during that year.        Furthermore, no Schedule L was attached to

this return.      There were no amounts separately identified as

interest payments made and/or imputed by Zephyr to PK Ventures,

TBPC, or TPTC on Zephyr’s Form 1120S for 1989.
                                   - 33 -

     No direct references were made and no explanations were

provided in PK Ventures, TBPC, or TPTC’s financial statements for

the year ended December 31, 1989, as to the amounts that

PK Ventures, TBPC, and TPTC transferred to Zephyr during that

year.     Furthermore, no mention of Zephyr’s bankruptcy was made in

PK Ventures, TBPC, or TPTC’s financial statements for the year

ended December 31, 1989.

     PKV&S claimed a $953,652 bad debt deduction on its

consolidated income tax return for 1989 for cash transfers that

PK Ventures, TBPC, and TPTC had made to Zephyr.          PKV&S did not

attach to this return an explanation for claiming this bad debt

deduction.        On the Schedule L attached to PKV&S’s consolidated

income tax return for 1989, PK Ventures and its subsidiaries

reported a total of $90,000 due from Zephyr under “Other assets”

as of the end of that year.        This amount was described as “DUE

FROM UNCONSOLIDATED SUBSIDIARIES”.          There were no amounts

separately identified as interest payments received and/or

imputed by PK Ventures, TBPC, or TPTC from Zephyr on PKV&S’s

consolidated income tax return for 1989.

             4.     1990

        On its Form 1120S for 1990, Zephyr represented that “No

income or expense items where [sic] reported on the tax return

due to the fact that the corporation was not solvent after the

completion of the bankruptcy.”
                                - 34 -

     PKV&S claimed a $664,888 bad debt deduction on its

consolidated income tax return for 1990 for cash transfers that

PK Ventures, TBPC, and TPTC had made to Zephyr and for the cash

transfers that PK Ventures had made to the nine Zephyr purchasers

other than Rose.   With respect to this bad debt deduction,

$64,888 was attributable to the cash transfers that PK Ventures

and/or its subsidiaries had made to Zephyr in prior years.      PKV&S

did not attach to this return an explanation for claiming this

bad debt deduction.

     B.   Internal Revenue Service (IRS) Determinations

     The IRS determined that PKV&S was not allowed to claim a bad

debt deduction of $953,652 on its consolidated income tax return

for 1989 for cash transfers that PK Ventures and/or its

subsidiaries had made to Zephyr because it had not established

that a true debtor-creditor relationship was intended by these

transfers.   Furthermore, the IRS determined that, if a debt had

been intended, PKV&S had not established that such debt had

become worthless during 1989.    The effect of this determination

was to reduce the net operating loss carryover that PKV&S could

report on its consolidated income tax return for 1990 (as

amended) from $1,023,245 to $69,593.     Accordingly, the IRS

increased PKV&S’s taxable income by $953,652 for 1990.

     The IRS also determined that PKV&S was not allowed to claim

a bad debt deduction of $64,888 on its consolidated income tax
                                - 35 -

return for 1990 for cash transfers that PK Ventures and/or its

subsidiaries had made to Zephyr because it had not established

that a true debtor-creditor relationship was intended by these

transfers.   Furthermore, the IRS determined that, if a debt had

been intended, PKV&S had not established that such debt had

become worthless during 1990.    Accordingly, the IRS increased

PKV&S’s taxable income by $64,888 for 1990.

     The IRS determined that, with respect to the $64,888 of

transfers from PK Ventures and/or its subsidiaries to Zephyr for

which PKV&S had claimed a bad debt deduction on its consolidated

income tax return for 1990, 40 percent of that amount constituted

a constructive dividend to the Roses in 1990.    Consequently, the

IRS increased the Roses’ taxable income by $25,955 for 1990.

Rose’s Acquisition of Control of PK Ventures and PKVI LP

     At the beginning of 1990, PK Ventures was experiencing

difficulty servicing its debt.    On February 16, 1990, Kane, Kane

Jr., Krutoy, Mannello, Rose, and PK Ventures executed a document

entitled “Agreement” (debt service agreement) whereby PK Ventures

agreed to repay the loans that it had outstanding with Norstar

and Summit Trust according to the schedule set forth in that

agreement.   As of that date, PK Ventures had an $800,000

outstanding principal balance with respect to its $2.5 million

revolving line of credit with Norstar and had not repaid the

Summit Trust loan.
                               - 36 -

     According to the schedule set forth in the debt service

agreement, PK Ventures agreed to pay the outstanding principal

balance of the $2.5 million revolving line of credit plus any

accrued interest within 5 days from the date of the debt service

agreement.    Furthermore, PK Ventures agreed to make a $400,000

payment on the Summit Trust loan at the earlier of September 30,

1990, or the date that Rose acquired a majority interest in

PK Ventures.    PK Ventures was to repay the remaining $600,000 of

the Summit Trust loan at the loan’s maturity date, 12 months from

the date of the debt service agreement or as extended by Summit

Trust.   The debt service agreement also contained the following

provision:

          3.3   Compensation. Until October 1, 1990, Robert
     Rose’s salary, as Chief Executive Officer, will be
     fixed at $80,000 per annum, payable bi-weekly.

     The debt service agreement provided that PK Ventures was to

borrow funds from Rose if it did not have sufficient funds to

make the scheduled payments to Norstar and Summit Trust.      If

PK Ventures borrowed any funds from Rose, it was required to

execute a promissory note in Rose’s favor and to secure repayment

of the loan by placing a priority lien (as permitted) on all of

its assets.    In addition, any such loans between Rose and

PK Ventures were to be secured by an escalating pledge of the

shares of PK Ventures’ stock owned by Kane, Kane Jr., Krutoy, and

Mannello in an amount identified in a Pledge Agreement.
                               - 37 -

     Certificates of deposit had been pledged as security for the

loans that PK Ventures had taken out with Norstar and Summit

Trust.   Specifically, an $800,000 certificate of deposit secured

the outstanding principal balance of the $2.5 million revolving

line of credit and a $1 million certificate of deposit from

Printon Kane Government Securities secured the Summit Trust loan.

Under the terms of the debt service agreement, PK Ventures was to

instruct Norstar and Summit Trust to release a like amount of the

certificates of deposit that they had been holding as collateral

to the receiving agent for Kane, Kane Jr., Krutoy, and Mannello

as it made the scheduled payments to these institutions.

     As contemplated by the debt service agreement, PK Ventures

borrowed $800,000 from Rose on February 16, 1990, in order to

make its scheduled payment to Norstar.   Rose obtained a portion

of the funds for this loan by placing a $675,000 mortgage on his

New Jersey residence with First Fidelity Bank (First Fidelity).

Rose gathered the remaining $125,000 for this loan from other

sources.   In exchange for this $800,000 loan, PK Ventures

executed documents entitled “Promissory Note” and “Security

Agreement” in favor of Rose.   The terms of the Promissory Note

required that the principal amount bear interest at a rate equal

to 3 percent above First Fidelity’s stated prime rate, that

PK Ventures make payments of accrued interest on a monthly basis

beginning March 1, 1990, and that the principal balance become
                               - 38 -

due and payable on September 30, 1990.      In addition, Kane, Kane

Jr., Krutoy, and Mannello executed a document entitled “Pledge

Agreement” in favor of Rose.   Under the terms of the Pledge

Agreement, Kane, Kane Jr., Krutoy, and Mannello agreed to pledge

44 percent of their total shares of PK Ventures’ stock to Rose in

order to secure repayment of Rose’s $800,000 loan to PK Ventures.

As a result of entering into the Pledge Agreement, Kane, Kane.

Jr., Krutoy, and Mannello pledged a combined total of 2,032.36

shares of PK Ventures’ stock to Rose.

     Also on February 16, 1990, Kane, Kane Jr., Krutoy, and

Mannello executed a document entitled “Voting Trust Agreement”

whereby they agreed to place all of their shares of PK Ventures’

stock into a voting trust in exchange for voting trust

certificates.   The voting trust certificates indicated their

ownership rights in the shares of stock held by the trustee.

Rose was designated as trustee of this voting trust and was given

sole authority to vote the shares.      As trustee of the voting

trust, Rose had voting rights to 86.19 percent of the shares of

PK Ventures’ stock.   (The Voting Trust Agreement granted Rose

voting rights to 46.19 percent of PK Ventures’ stock; he already

held voting rights to 40 percent of the shares of PK Ventures’

stock prior to becoming trustee of the voting trust.)      The shares

of PK Ventures’ stock placed into the voting trust included the

shares that had been pledged to Rose under the Pledge Agreement.
                              - 39 -

The voting trust was to last for 21 years from February 16, 1990,

unless terminated earlier by the death, resignation, or

incapacity of Rose.

     Also on February 16, 1990, Kane, Kane Jr., Krutoy, and

Mannello executed documents entitled “Assignment” whereby they

agreed to transfer all of their respective interests in PKVI LP

to PK Ventures.   In sum, they transferred a 17.748-percent

limited partnership interest in PKVI LP to PK Ventures.    With

that transfer, PK Ventures held a 22.098-percent limited

partnership interest and a 1-percent general partnership interest

in PKVI LP.

     PK Ventures satisfied its obligation to Norstar with the

$800,000 loan that it received from Rose.   PK Ventures repaid

this loan by making various cash payments to Rose and to First

Fidelity.

     On December 7, 1990, a document entitled “Stock Redemption

Agreement” was executed by Cerosky (as a holder of an interest in

PKVI LP), the shareholders of PK Ventures (i.e., Beason, Grimmig,

Kane, Kane Jr., Kirkwood, Krutoy, Mannello, Marshall, McCarthy,

and Rose), and PK Ventures.   Under the terms of the Stock

Redemption Agreement, (1) PK Ventures agreed to redeem a total of

5,295 shares of its stock from the shareholders of PK Ventures

other than Rose (the withdrawing shareholders); (2) the

withdrawing shareholders agreed to sell, assign, and transfer
                               - 40 -

their ownership interests in all of PK Ventures’ subsidiaries

(i.e., SLPC, TBPC, TPC, and TPTC) to PK Ventures; and (3) Beason,

Cerosky, Grimmig, Kirkwood, Marshall, and McCarthy agreed to

transfer their ownership interests in PKVI LP to PK Ventures.

     At the completion of the stock redemption on December 7,

1990, Kane and Rose were the only shareholders of PK Ventures,

with Rose owning 85.016 percent of PK Ventures’ outstanding

shares.    Rose and PK Ventures also became the only owners of

PKVI LP.   In sum, Beason, Cerosky, Grimmig, Kirkwood, Marshall,

and McCarthy transferred a 6.902-percent limited partnership

interest in PKVI LP to PK Ventures.      Consequently, as of

December 7, 1990, PK Ventures owned a 1-percent general

partnership interest and the entire 29-percent limited

partnership interest in PKVI LP, and Rose owned a 70-percent

general partnership interest in PKVI LP.

     As consideration for the stock redemption and purchases

described above, PK Ventures agreed to repay the Summit Trust

loan based on the following schedule:      $400,000 on December 7,

1990, $50,000 within 9 months of December 7, 1990, and $550,000

within 1 year of December 7, 1990.      In addition, PK Ventures

agreed to instruct Summit Trust to release a like amount of the

$1 million certificate of deposit that it held as collateral for

the Summit Trust loan to the receiving agent for the withdrawing
                              - 41 -

shareholders with each scheduled payment that it made.     The

parties to the Stock Redemption Agreement also agreed as follows:

               7.1 Release. The Company, Rose, and the
     Shareholders acknowledge that there are certain
     obligations and indebtedness existing between Rose and
     the Company on the one hand and the Shareholders on the
     other hand. It is the intent of the parties in
     executing this Agreement that all such debts and
     obligations, except as otherwise provided herein, be
     hereby expressly extinguished. Accordingly, the
     Shareholders hereby release Rose and the Company and
     the Company and Rose, jointly and severally, release
     the Shareholders with respect to any and all claims
     which the Shareholders on the one hand may have against
     Rose and/or the Company (including obligations of the
     Company to repay the indebtedness to Summit as set
     forth in the Agreement among Rose, the Certificate
     Holders and the Company dated February 16, 1990) or,
     respecting claims which Rose and/or the company may
     have against the Shareholders excepting, as to all
     parties, claims and obligations arising pursuant to
     this Agreement, the * * * Pledge Agreement, the Voting
     Trust Agreement, and any agreement executed in
     conjunction with this Agreement * * *

     In accordance with the Stock Redemption Agreement, Rose

loaned $400,000 to PK Ventures on December 7, 1990.     Rose paid

the $400,000 directly to Summit Trust.     Rose refinanced his

New Jersey home in order to obtain the funds for this loan.      In

exchange for the $400,000 loan, PK Ventures gave Rose a

promissory note.   PK Ventures accounted for the promissory note

by debiting the liability account to Summit Trust and crediting

the account “Due To/From PKV/RLR”.     PK Ventures repaid the

$400,000 directly to Rose’s mortgagee.

     The series of agreements executed on February 16, 1990, were

amended, but not voided, by the Stock Redemption Agreement.
                                - 42 -

Under the terms of the Stock Redemption Agreement, the 705 shares

of PK Ventures’ stock that were not redeemed from Kane remained

subject to both the Voting Trust Agreement and the Pledge

Agreement.

     Also on December 7, 1990, Rose, PK Ventures, and the Printon

Kane Group executed a document entitled “Agreement” (litigation

agreement) whereby they agreed to share the litigation costs

incurred to sue Raymond James & Associates.    The litigation

subject to the litigation agreement involved the business and

activities of Zephyr.    As a result of Zephyr’s bankruptcy, the

Zephyr purchasers had lost all of the cash that they had

contributed to Zephyr.

Transfers From PK Ventures to the Zephyr Purchasers

     PK Ventures did not receive promissory notes from the Zephyr

purchasers in exchange for the $1 million that it transferred to

them.   No accrued interest attributable to this transfer was

posted to PK Ventures’ general ledger or reported in its audited

financial statements.

     The Zephyr purchasers did not repay any portion of the

$1 million that had been transferred to them from PK Ventures.

PK Ventures neither took legal action against the Zephyr

purchasers to force repayment of the $1 million transfer nor did

it attempt to negotiate a partial collection of this amount with

any of the Zephyr purchasers.    PK Ventures issued Forms 1099 to
                               - 43 -

each of the Zephyr purchasers reflecting cancellation of

indebtedness income.

     On August 5, 1991, the Roses sold their home in New Jersey

for $422,500.   The Roses purchased a home in Florida for $481,555

sometime between August 5, 1991, and March 16, 1992.   The Roses

paid the entire $481,555 purchase price with cash from their

savings.

     On December 31, 1991, PK Ventures’ financial books and

records indicated that Rose owed $437,469 to PK Ventures.     This

balance was reduced to zero by “reclassifying” $400,000 as a bad

debt attributable to Rose’s portion of the $1 million that

PK Ventures had transferred to the Zephyr purchasers and by

“reclassifying” the remaining $37,469 as compensation expense

attributable to Rose.

     A.    As Described in the Financial Statements and Income Tax
           Returns for PK Ventures and PKV&S

     Note 3 to PK Ventures’ audited financial statements for the

year ended December 31, 1987, stated:   “The company has advanced

$1,000,000 to the stockholders.   This money was advanced for the

sole purpose to acquire a company that would be compatible with

the business objectives of the Company.”   The same statement was

included in the notes to PK Ventures’ financial statements for

the years ended December 31, 1988, and December 31, 1989.     A

$1 million amount “Due from stockholders” was listed as an asset

on PK Ventures’ audited financial statements for the years ended
                              - 44 -

December 31, 1987, December 31, 1988, and December 31, 1989,

respectively.

     A $1 million “Loans to stockholders” amount was listed as an

asset on the Schedules L attached to PKV&S’s consolidated income

tax returns for 1987, 1988, and 1989.   There were no amounts

separately identified as interest payments received and/or

imputed by PK Ventures from the Zephyr purchasers on PKV&S’s

consolidated income tax returns for 1987 through 1989.

     On its audited consolidated financial statements for the

year ended December 31, 1990, PKV&S claimed a bad debt expense of

$664,888, $600,000 of which was attributable to the transfers

that PK Ventures had made to the nine Zephyr purchasers other

than Rose.   Note B to these financial statements offered the

following explanation for PKV&S asserting a bad debt expense with

respect to this $600,000 transfer:

     The Company advanced $1,000,000 interest free to the
     shareholders of the Company in 1987 which was invested
     in Zephyr Rock & Lime, Inc. (“Zephyr”). In March 1990,
     Zephyr sold all its assets and there were no funds left
     to distribute to shareholders after paying liabilities.
     Thereupon the Company ascertained that $600,000 of the
     advances to shareholders was uncollectible and,
     accordingly, charged $600,000 to 1990 operations. The
     remaining balance of $400,000 at December 31, 1990 is
     due from the Company’s majority shareholder and has
     been netted against other advances from the
     shareholder.

There is no explanation in these financial statements as to what

the balance of the $664,888 bad debt expense was attributable.
                               - 45 -

     PKV&S claimed a $664,888 bad debt deduction on its

consolidated income tax return for 1990 for cash transfers that

PK Ventures, TBPC, and TPTC had made to Zephyr and for the cash

transfers that PK Ventures had made to the nine Zephyr purchasers

other than Rose.   With respect to this bad debt deduction,

$600,000 was attributable to the cash transfers that PK Ventures

had made to the nine Zephyr purchasers other than Rose.    PKV&S

did not attach to this return an explanation for claiming this

bad debt deduction.    There were no amounts separately identified

as interest payments received and/or imputed by PK Ventures from

the Zephyr purchasers on PKV&S’s consolidated income tax return

for 1990.

     PKV&S claimed a bad debt expense of $1,712,151 on its

audited consolidated financial statements for the year ended

December 31, 1991.    Of this amount, $400,000 was attributable to

the transfer that PK Ventures had made to Rose in connection with

the Zephyr purchase.   Note 2 to these financial statements

offered the following explanation for PKV&S asserting a bad debt

expense with respect to this $400,000 transfer:

     The Company advanced $1,000,000 interest free to the
     shareholders of the Company in 1987 which was invested
     in Zephyr Rock & Lime, Inc. (Zephyr). In March 1990,
     Zephyr sold all its assets and there were no funds left
     to distribute to shareholders after paying liabilities.
     Thereupon the Company ascertained that $600,000 of the
     advances to shareholders was uncollectible and,
     accordingly, charged $600,000 to 1990 operations. The
     remaining balance of $400,000 at December 31, 1990 was
     due from the Company’s majority shareholder and netted
                                - 46 -

     against other advances due to the shareholder. During
     1991, the remaining $400,000 was determined to be
     uncollectible and charged to 1991 operations.

     PKV&S claimed a $1,916,246 bad debt deduction on its

consolidated income tax return for 1991 for the cash transfers

that PK Ventures, TBPC, and TPTC had made to PKVI LP and for the

cash transfer that PK Ventures had made to Rose in connection

with the Zephyr purchase.     With respect to this bad debt

deduction, $400,000 was attributable to the transfer that

PK Ventures had made to Rose in connection with the Zephyr

purchase.     There were no amounts separately identified as

interest payments received and/or imputed by PK Ventures from the

Zephyr purchasers on PKV&S’s consolidated income tax return for

1991.

     B.     As Described in the Roses’ Income Tax Returns

        There were no amounts separately identified as interest

payments made and/or imputed by the Roses to PK Ventures on their

joint income tax returns for 1990 or 1991.     On their joint income

tax return for 1991, the Roses reported $1,461,372 of

cancellation of indebtedness income.     The Roses reported that

$400,000 of this amount was attributable to the transfer that

PK Ventures had made to Rose in connection with the Zephyr

purchase.
                               - 47 -

     C.   IRS Determinations

     The IRS determined that PKV&S was not allowed to claim bad

debt deductions of $600,000 and $400,000 on its consolidated

income tax returns for 1990 and 1991, respectively, for the cash

transfers that PK Ventures had made to the Zephyr purchasers

because it had not established that a true debtor-creditor

relationship was intended by these transfers.   Furthermore, the

IRS determined that, if a debt had been intended, PKV&S had not

established that such debt had become worthless during either

1990 or 1991.   Accordingly, the IRS increased PKV&S’s taxable

income by $600,000 for 1990 and by $400,000 for 1991.

     The IRS determined that PK Ventures’ transfer of $400,000 to

Rose in connection with the Zephyr purchase constituted a

constructive dividend to him in 1990.   Consequently, the IRS

increased the Roses’ taxable income by $400,000 for 1990 and

determined that the Roses should not have reported $400,000 of

cancellation of indebtedness income on their joint income tax

return for 1991.

Transfers to PKVI LP

     A.   Transfers From Unrelated Parties to PKVI LP

     At the time of its organization, PKVI LP was engaged in the

acquisition of three hydroelectric projects that were located in

or near Bynum, North Carolina; Henrietta, North Carolina; and

Columbus, Georgia, respectively.   A small portion of the
                              - 48 -

acquisition of these three hydroelectric projects was financed by

the initial capital contributions that were made to PKVI LP.

During the years in issue, the bulk of PKVI LP’s assets consisted

of hydroelectric powerplant projects in North Carolina and

Georgia.   PKVI LP’s debts to unrelated parties were generally

nonrecourse in nature and were secured by these hydroelectric

properties.

     As of December 31, 1986, PKVI LP had loan agreements

outstanding with First Fidelity, Liberty Life Insurance Co.

(Liberty Life), and Middle Georgia Fuel Products, Inc. (MGFP), as

follows:

                                                   Outstanding
                                    Interest    Principal Balance
      Lender        Maturity Date     Rate       as of 12/31/86

  First Fidelity    Jan. 27, 1987       9.00%       $200,000
  Liberty Life       Dec. 1, 1998      10.50         672,644
  MGFP               July 1, 1988      10.00         328,500

As of that date, the outstanding principal balances of the

transfers associated with these agreements totaled $1,201,144.

     Of this $1,201,144, $227,326 was listed as a current

liability on the Statement of Financial Condition included in

PKVI LP’s audited financial statements for the year ended

December 31, 1986, and as “Mortgages, notes, and bonds payable in

less than 1 year” on the Schedule L attached to PKVI LP’s

Form 1065, U.S. Partnership Return of Income, for 1986.     The

balance of this amount was listed as a long-term liability on the
                                - 49 -

Statement of Financial Condition included in PKVI LP’s audited

financial statements for the year ended December 31, 1986, and as

“Mortgages, notes, and bonds payable in 1 year or more” on the

Schedule L attached to PKVI LP’s Form 1065 for 1986.

     As of December 31, 1987, PKVI LP had loan agreements

outstanding with First Fidelity, Liberty Life, MGFP, and Trio

Manufacturing Co. (Trio) as follows:

                                                     Outstanding
                                     Interest     Principal Balance
      Lender       Maturity Date       Rate        as of 12/31/87

  First Fidelity    Feb. 1,   1988       10.50%       $320,000
  First Fidelity    Feb. 1,   1988       10.25          15,000
  Liberty Life      Dec. 1,   1998       10.50         645,318
  MGFP              July 1,   1988       10.00         328,500
  Trio             Mar. 12,   1988       10.00         517,500

As of that date, the outstanding principal balances of the

transfers associated with these agreements totaled $1,826,318.

     Of this $1,826,318, $1,213,953 was listed as a current

liability on the Balance Sheet included in PKVI LP’s audited

financial statements for the year ended December 31, 1987, and as

“Mortgages, notes, and bonds payable in less than 1 year” on the

Schedule L attached to PKVI LP’s Form 1065 for 1987.      The balance

of this amount was listed as a long-term liability on the Balance

Sheet included in PKVI LP’s audited financial statements for the

year ended December 31, 1987, and as “Mortgages, notes, and bonds

payable in 1 year or more” on the Schedule L attached to

PKVI LP’s Form 1065 for 1987.
                                  - 50 -

     As of December 31, 1988, PKVI LP had the following loan

agreements outstanding:

                                                       Outstanding
                                        Interest    Principal Balance
      Lender          Maturity Date       Rate       as of 12/31/88

  Daley Corp.          July 1,   1989        --           $3,416
  First Fidelity      Jan. 18,   1989      11.50%         75,000
  First Fidelity      Jan. 18,   1989      12.00          50,000
  Liberty Life         Dec. 1,   1998      10.50         612,365
  Liberty Life         Apr. 1,   2001      10.70         800,000
  Liberty Life        Aug. 20,   2001      11.35         400,000
  MGFP                Mar. 31,   1990      10.00         328,500

As of that date, the outstanding principal balances of the

transfers associated with these agreements totaled $2,269,281.

     Of this $2,269,281, $193,060 was listed as a current

liability on the Statement of Financial Condition included in

PKVI LP’s audited financial statements for the year ended

December 31, 1988, and as “Mortgages, notes, and bonds payable in

less than 1 year” on the Schedule L attached to PKVI LP’s

Form 1065 for 1988.    The balance of this amount was listed as a

long-term liability on the Statement of Financial Condition

included in PKVI LP’s audited financial statements for the year

ended December 31, 1988, and as “Mortgages, notes, and bonds

payable in 1 year or more” on the Schedule L attached to

PKVI LP’s Form 1065 for 1988.

     As of December 31, 1989, PKVI LP had the following loan

agreements outstanding:
                               - 51 -

                                                    Outstanding
                                     Interest    Principal Balance
        Lender       Maturity Date     Rate       as of 12/31/89

  First Fidelity     Jan. 16, 1990      12.00%       $125,000
  MGFP               Mar. 31, 1990      10.00         328,500

PKVI LP entered into the $125,000 loan agreement with First

Fidelity on or before October 16, 1989.

     PKVI LP also had the same loan agreements outstanding with

Liberty Life on December 31, 1989, as it did on December 31,

1988.   The outstanding principal balances of PKVI LP’s loan

agreements with Liberty Life totaled $1,778,241 as of

December 31, 1989; $1,652,584 of this amount was treated as

long-term debt on PKVI LP’s audited financial statements for the

year ended December 31, 1989, and the balance was treated as a

current liability.

     The outstanding principal balances of the transfers

associated with the agreements described in the preceding two

paragraphs totaled $2,231,741 as of December 31, 1989.     Of this

amount, $579,157 was listed as a current liability on the

Statement of Financial Condition included in PKVI LP’s audited

financial statements for the year ended December 31, 1989, and as

“Mortgages, notes, and bonds payable in less than 1 year” on the

Schedule L attached to PKVI LP’s Form 1065 for 1989.     The balance

of this amount was listed as a long-term liability on the

Statement of Financial Condition included in PKVI LP’s audited

financial statements for the year ended December 31, 1989, and as
                                  - 52 -

“Mortgages, notes, and bonds payable in 1 year or more” on the

Schedule L attached to PKVI LP’s Form 1065 for 1989.

     PKVI LP renegotiated its loan agreement with MGFP during

1990.    The renegotiated loan agreement between PKVI LP and MGFP

was for the principal balance of $401,284, an amount that

included the $328,500 principal balance from their original loan

agreement plus $72,784 of accrued interest.

     As of December 31, 1990, PKVI LP had the following loan

agreements outstanding:

                                                       Outstanding
                                        Interest    Principal Balance
         Lender       Maturity Date       Rate       as of 12/31/90

   Liberty Life        Dec. 1,   1998      10.50%        $559,372
   Liberty Life        Apr. 1,   2001      10.70          762,224
   Liberty Life       Aug. 20,   2001      11.35          387,716
   MGFP               Dec. 31,   1991      10.00          401,284

As of that date, the outstanding principal balances of the

transfers associated with these agreements totaled $2,110,596.

        On the Balance Sheet included in PKVI LP’s audited financial

statements for the year ended December 31, 1990, PKVI LP’s

“Current portion of long-term debt” was listed as $403,473, and

its “LONG-TERM DEBT DUE AFTER ONE YEAR” was listed as $1,829,201.

On the Schedule L attached to PKVI LP’s Form 1065 for 1990,

“Mortgages, notes, and bonds payable in less than 1 year” was

listed as $425,000 as of the end of that year, and “Mortgages,

notes, and bonds payable in 1 year or more” was listed as

$1,685,596.
                               - 53 -

     On February 15, 1991, PKVI LP and Liberty Life agreed to

consolidate their three outstanding loan agreements into one

agreement.   The principal balance of this consolidated loan

agreement was $1,854,939, an amount that included the $1,709,312

of outstanding principal balances from the three original loan

agreements between PKVI LP and Liberty Life plus $145,628 of

accrued interest.    The interest rate for this consolidated loan

agreement was 10.78 percent, i.e., the weighted average of the

interest rates from the original loan agreements.

     PKVI LP experienced difficulties with its Georgia

hydroelectric facilities, City Mills and Juliette, during 1991.

As a result, PKVI LP defaulted on the loan agreement it had

entered with MGFP to finance the Juliette facility.     As noted

above, PKVI LP and MGFP had renegotiated this loan agreement

during 1990.    In addition, PKVI LP failed to make the required

payments of principal on its consolidated loan agreement with

Liberty Life.    These payments were scheduled to begin on August

15, 1991.

     As of December 31, 1991, PKVI LP had the following loan

agreements outstanding:

                                                    Outstanding
                                     Interest    Principal Balance
      Lender         Maturity Date     Rate       as of 12/31/91

   Liberty Life      Aug. 15, 2003      10.78%      $1,854,939
   MGFP              Dec. 31, 1991      10.00          401,284
                               - 54 -

As of that date, the outstanding principal balances of the

transfers associated with these agreements totaled $2,256,223.

     PKVI LP’s financial statements for the year ended

December 31, 1991, are not part of the record in these cases.    On

the Balance Sheets included in PKVI LP’s reviewed financial

statements for the year ended December 31, 1992, PKVI LP’s total

and current liabilities were listed as $2,334,551 as of

December 31, 1991.   The $2,334,551 included $2,256,223 for

long-term debt in default, $76,058 for accrued expenses, and

$2,270 for accounts payable.   On the Schedule L attached to

PKVI LP’s Form 1065 for 1991, $2,256,223 was listed under

“Mortgages, notes, and bonds payable in less than 1 year” as of

the end of that year.

     As of December 31, 1992, PKVI LP had loan agreements

outstanding with Liberty Life and MGFP.   As of that date, the

outstanding principal balances of the transfers associated with

these agreements remained $2,256,223.   This entire amount was

listed as a current liability on the Balance Sheets included in

PKVI LP’s reviewed financial statements for the year ended

December 31, 1992.   On the Schedule L attached to PKVI LP’s

Form 1065 for 1991, $335,448 was listed under “Mortgages, notes,

and bonds payable in less than 1 year” as of the end of that

year, and $2,528,779 was listed under “All nonrecourse loans”.
                               - 55 -

     As of December 31, 1993, the loan agreement that PKVI LP had

with Liberty Life remained outstanding.    As of that date, the

outstanding principal balance of this loan agreement remained

$1,854,939.    This entire amount was listed as a current liability

on the Balance Sheets included in PKVI LP’s reviewed financial

statements for the year ended December 31, 1993.    There was no

Schedule L attached to PKVI LP’s Form 1065 for 1993.

     B.   Transfers From PK Ventures and/or Its Subsidiaries to
          PKVI LP

     Between 1986 and the end of 1991, PK Ventures, TBPC, and

TPTC made cash transfers to PKVI LP.    On PK Ventures’ general

ledger, these transfers were treated as loans.    Rose executed

one-page documents entitled “Promissory Note” (PKVI LP promissory

note) with respect to some, but not all, of these transfers.      The

terms of the PKVI LP promissory notes required that (1) the

transfers be repaid on demand with an interest rate of either

8.75 or 9 percent; (2) payment of interest was due only with the

payment of principal; and (3) payment of principal was not to be

made if payment to PK Ventures would have caused PKVI LP to

default or breach any other note or agreement to which PKVI LP

was a party.    This last provision subordinated PK Ventures’ right

to demand payment of the transfers to the rights of PKVI LP’s

creditors.    Unlike the basic structure of PKVI LP’s debt to

unrelated parties, the PKVI LP promissory notes were not secured

by the hydroelectric properties owned by PKVI LP.    The PKVI LP
                              - 56 -

promissory notes were signed by Rose alone; they were neither

attested to by a witness nor notarized.

     On December 31, 1989, Rose executed a PKVI LP promissory

note in favor of PK Ventures in which PKVI LP promised to pay

PK Ventures the principal amount of $448,646 ($448,646 promissory

note).   The $448,646 promissory note reflected the aggregate

amount of cash that had been transferred from PK Ventures, TBPC,

and TPTC to PKVI LP from 1986 through 1989.

     PK Ventures, TBPC, and TPTC made cash transfers to PKVI LP

totaling $647,605 during 1990.   On December 31, 1990, Rose

executed a PKVI LP promissory note in favor of PK Ventures in

which PKVI LP promised to pay PK Ventures the principal amount of

$1,096,250 ($1,096,250 promissory note).   The $1,096,250

promissory note reflected the aggregate amount of cash that had

been transferred from PK Ventures, TBPC, and TPTC to PKVI LP from

1986 through 1990.

     PK Ventures, TBPC, and TPTC made transfers to PKVI LP

totaling $419,995 during 1991.   On December 31, 1991, Rose

executed a PKVI LP promissory note in favor of PK Ventures in

which PKVI LP promised to pay PK Ventures the principal amount of

$1,516,246 ($1,516,246 promissory note).   The $1,516,246

promissory note reflected the aggregate amount of cash that had

been transferred from PK Ventures, TBPC, and TPTC to PKVI LP from

1986 through 1991.   At the time that Rose signed the $1,516,246
                              - 57 -

promissory note, he did not intend to have PKVI LP repay any of

this amount to PK Ventures.   In addition, Rose, as a general

partner with a 70-percent interest in PKVI LP, did not intend to

repay any of this amount to PK Ventures at the time that he

signed the $1,516,246 promissory note.

     No legal action was taken by PK Ventures against Rose to

force repayment of the $1,516,246 promissory note.   Rose owned

approximately 85 percent of the stock of PK Ventures during 1991.

     In a letter dated July 6, 1992, to Douglas W. Kroske,

C.F.A., senior vice president of Liberty Capital Advisors, Inc.,

Rose made the following statements concerning the transfers from

PK Ventures, TBPC, and TPTC to PKVI LP:

     Since 1986, PK Ventures Inc has invested over
     $1.5 million in these hydroelectric projects, and is
     willing to continue but needs some help from Liberty
     Life. * * *

               *    *    *     *    *     *   *

     There has been a delay on the financial statements for
     the year ending 12/31/91. During the year based on
     Ernst & Young’s review, $419,996 cash was provided to
     the Partnership from PK Ventures, Inc. Since inception
     to 12/31/91 a total amount of $1,516,246 has been
     injected, and our auditors are now going to make
     PK Ventures Inc write this off as it is an
     uncollectible claim against the Partnership. The
     $419,996 cash of 1991, was used approximately for
     equipment and Bynum canal repairs of $225,661, and the
     balance used in payments to Liberty Life.
                                 - 58 -

          1.   As Described in the Business’s Financial Statements
               and Income Tax Returns

                a.   1986

     No direct references were made and no explanations were

provided in PKVI LP’s audited financial statements for the year

ended December 31, 1986, as to the amounts that PKVI LP received

from PK Ventures during that year.

     On PK Ventures’ Schedule K-1, Partner’s Share of Income,

Credits, Deductions, etc., attached to PKVI LP’s Form 1065 for

1986, PK Ventures was reported to have made a $500 capital

contribution to PKVI LP during that year and to have a capital

account with a balance of $242 as of the end of that year.      No

other direct references were made and no other explanations were

provided in PKVI LP’s Form 1065 for 1986 as to the amounts that

PKVI LP received from PK Ventures during that year.      There were

also no amounts separately identified as interest payments made

and/or imputed by PKVI LP to PK Ventures on its Form 1065 for

1986.

     On the Statement of Financial Condition included in

PK Ventures’ audited financial statements for the year ended

December 31, 1986, a $242 “Investment in affiliated partnership”

was listed as an asset.      This entry referred to PK Ventures’

investment in PKVI LP.      The $242 was listed under “Other

investments” on the Schedule L attached to PK Ventures’ income

tax return for 1986.   No other direct references were made and no
                               - 59 -

other explanations were provided in PK Ventures’ financial

statements for 1986 as to the amounts that it transferred to

PKVI LP during that year.

     No direct references were made and no explanations were

provided in PK Ventures’ income tax return for 1986 as to the

amounts that it transferred to PKVI LP during that year.    There

were no amounts separately identified as interest payments

received and/or imputed by PK Ventures from PKVI LP on

PK Ventures’ income tax return for 1986.

                b.   1987

     No direct references were made and no explanations were

provided in PKVI LP’s financial statements for 1987 as to the

amounts that PKVI LP received from PK Ventures, TBPC, or TPTC

during that year.    On the Balance Sheet included in PKVI LP’s

audited financial statements for the year ended December 31,

1987, $48,300 “Due to affiliated company” was listed as a current

liability.

     No direct references were made and no explanations were

provided in PKVI LP’s Form 1065 for 1987 as to the amounts that

PKVI LP received from PK Ventures, TBPC, or TPTC during that

year.   On the Schedule L attached to PKVI LP’s Form 1065 for

1987, $48,300 was listed under “Other liabilities” as of the end

of that year.   There were no amounts separately identified as
                                - 60 -

interest payments made and/or imputed by PKVI LP to PK Ventures,

TBPC, or TPTC on its Form 1065 for 1987.

     No direct references were made and no explanations were

provided in PK Ventures, TBPC, or TPTC’s financial statements for

the year ended December 31, 1987, as to the amounts that

PK Ventures, TBPC, and TPTC transferred to PKVI LP during that

year.

     No direct references were made and no explanations were

provided in PKV&S’s consolidated income tax return for 1987 as to

the amounts that PK Ventures, TBPC, and TPTC transferred to

PKVI LP during that year.     There were no amounts separately

identified as interest payments received and/or imputed by

PK Ventures, TBPC, or TPTC from PKVI LP on PKV&S’s consolidated

income tax return for 1987.

                  c.   1988

        Note 4 to PKVI LP’s audited financial statements for the

year ended December 31, 1988, stated, in pertinent part:     “At

December 31, 1988, the Partnership owed $20,580 to P.K. Ventures,

Inc. and $105,978 to affiliated entities which are respectively

owned by the Partnerships’ general partners.”     On the Statement

of Financial Condition included in PKVI LP’s audited financial

statements for the year ended December 31, 1988, $126,558 “Due to

affiliated company” was listed as a current liability.
                                - 61 -

     On the Schedule L attached to PKVI LP’s Form 1065 for 1988,

$126,558 “Due to Affiliated Company” was listed under “Other

current liabilities” as of the end of that year.     There were no

amounts separately identified as interest payments made and/or

imputed by PKVI LP to PK Ventures, TBPC, or TPTC on its Form 1065

for 1988.

     No direct references were made and no explanations were

provided in PK Ventures, TBPC, or TPTC’s financial statements for

the year ended December 31, 1988, as to the amounts that

PK Ventures, TBPC, and TPTC transferred to PKVI LP during that

year.

     On the Schedule L attached to PKV&S’s consolidated income

tax return for 1988, PK Ventures, TBPC, and TPTC reported

$118,558 due from PKVI LP under “Other assets” as of the end of

that year.     Of this amount, $20,580 was attributable to

PK Ventures, $48,000 was attributable to TBPC, and $49,978 was

attributable to TPTC.     There were no amounts separately

identified as interest payments received and/or imputed by

PK Ventures, TBPC, or TPTC from PKVI LP on PKV&S’s consolidated

income tax return for 1988.

                  d.   1989

        Note 4 to PKVI LP’s audited financial statements for the

year ended December 31, 1989, stated, in pertinent part:     “At

December 31, 1989, the Partnership owed $448,646 to
                              - 62 -

P.K. Ventures, Inc. and $107,978 to companies affiliated with

P.K. Ventures, Inc.”   On the Statement of Financial Condition

included in PKVI LP’s audited financial statements for the year

ended December 31, 1989, $556,624 “Due to affiliated company” was

listed as a liability.

     No direct references were made and no explanations were

provided in PKVI LP’s Form 1065 for 1989 as to the amounts that

PKVI LP received from PK Ventures, TBPC, or TPTC during that

year.   On the Schedule L attached to PKVI LP’s Form 1065 for

1989, $556,624 “Due to Affiliated Company” was listed under

“Other current liabilities” as of the end of that year.    There

were no amounts separately identified as interest payments made

and/or imputed by PKVI LP to PK Ventures, TBPC, or TPTC on its

Form 1065 for 1989.

     No direct references were made and no explanations were

provided in PK Ventures, TBPC, or TPTC’s financial statements for

the year ended December 31, 1989, as to the amounts that

PK Ventures, TBPC, and TPTC transferred to PKVI LP during that

year.

     On the Schedule L attached to PKV&S’s consolidated income

tax return for 1989, PK Ventures and its subsidiaries reported

$556,624 due from PKVI LP under “Other assets” as of the end of

that year.   There were no amounts separately identified as

interest payments received and/or imputed by PK Ventures, TBPC,
                               - 63 -

or TPTC from PKVI LP on PKV&S’s consolidated income tax return

for 1989.

                 e.   1990

     Contrary to the terms of the PKVI LP promissory notes,

Note D to PKVI LP’s audited financial statements for the year

ended December 31, 1990, stated that the transfers that had been

received by PKVI LP from PK Ventures (totaling $1,096,250) did

not bear interest.    Note D also stated that there was no stated

maturity date with respect to these transfers and that PKVI LP

anticipated that it would repay PK Ventures when cash was

available.   On the Balance Sheets included in these financial

statements, $1,096,250 “DUE TO AFFILIATED COMPANY” was listed as

a liability.

     On the Schedule L attached to PKVI LP’s Form 1065 for 1990,

$1,096,250 “DUE TO AFFILIATED COMPANIES” was listed under “Other

liabilities” as of the end of that year.   On its Form 1065 for

1990, PKVI LP reported imputed interest payments totaling

$67,772.    There were no amounts separately identified as interest

payments made and/or imputed by PKVI LP to PK Ventures, TBPC, or

TPTC on its Form 1065 for 1990.

     Note C to the audited consolidated financial statements of

PKV&S for the year ended December 31, 1990, stated the following:

     The Company has a receivable of $1,096,250 from
     PK Ventures I Limited Partnership (“LTD”) in which it
     has a 1% general partnership interest and a 29% limited
     partnership interest. The Company’s investment in and
                             - 64 -

     advances to LTD have been reduced by $75,000 under the
     equity method of accounting. At December 31, 1990, LTD
     has a deficit of $667,000 and incurred a net loss of
     $262,000 in 1990. The management of LTD is completing
     construction of certain operating facilities and
     believes that LTD will become profitable in the future
     and be able to repay the advances from the Company.
     The collectibility of the receivable is dependent upon
     future events which cannot be predicted at this time.

On the Consolidated Balance Sheets included in these financial

statements, $1,027,577 for “INVESTMENT IN AND ADVANCES TO LIMITED

PARTNERSHIPS” was listed as an asset.   Of the $1,027,577,

$1,021,250 was attributable to an amount “Due from Limited

Partnership” for PK Ventures and $6,327 was attributable to an

“Investment in limited partnerships” by TPC.   On the Consolidated

Statements of Cash Flows included in these financial statements,

$539,626 for “Advances to limited partnership” was listed under

investing activities.

     On the Schedule L attached to PKV&S’s consolidated income

tax return for 1990, PK Ventures reported $1,116,250 due from

PKVI LP under “Other current assets” as of the end of that year.

On its consolidated income tax return for 1990, PKV&S reported

that PK Ventures had imputed interest payments from PKVI LP under

section 7872 totaling $67,772.

               f.   1991

     PKVI LP’s financial statements for the year ended

December 31, 1991, are not part of the record in these cases.
                              - 65 -

     On the Schedule L attached to PKVI LP’s Form 1065 for 1990,

no amount “DUE TO AFFILIATED COMPANIES” was listed under “Other

liabilities” as of the end of that year.   On its Form 1065 for

1991, PKVI LP reported imputed interest payments totaling

$100,661.   There were no amounts separately identified as

interest payments made and/or imputed by PKVI LP to PK Ventures,

TBPC, or TPTC on its Form 1065 for 1991.

     PKV&S claimed a bad debt expense of $1,712,151 on its

audited consolidated financial statements for the year ended

December 31, 1991.   Of this amount, $1,312,151 was attributable

to the transfers that PK Ventures had made to PKVI LP in 1991 and

prior years.   Note 3 to these financial statements offered the

following explanation for PKV&S’ claiming a bad debt expense with

respect to these transfers:

     At December 31, 1990, the Company had made $1,096,250
     of noninterest-bearing advances to PK Ventures I
     Limited Partnership (LTD) in which it has a 1% general
     partnership interest and a 29% limited partnership
     interest. The Company made additional advances to LTD
     in 1991 of $419,996, principally to fund operating
     losses. Management of the Company believes that
     recovery of its advances to and investment in LTD is
     unlikely and, accordingly, has forgiven advances
     amounting to $1,312,151 in 1991 and charged bad debts
     expense. The Company also recorded losses under the
     equity method of $129,095 in 1991 and $75,000 in 1990.

     PKV&S claimed a $1,916,246 bad debt deduction on its

consolidated income tax return for 1991 for the cash transfers

that PK Ventures, TBPC, and TPTC had made to PKVI LP and for the

cash transfer that PK Ventures had made to Rose in connection
                              - 66 -

with the Zephyr purchase.   With respect to this bad debt

deduction, PKV&S reported that $1,516,246 was attributable to the

$1,516,246 promissory note’s being uncollectible.   On its

consolidated income tax return for 1991, PKV&S reported that

PK Ventures had imputed interest payments from PKVI LP under

section 7872 totaling $100,661.

                g.   1992

     The reviewed financial statements of PKVI LP for the year

ended December 31, 1992, indicate that PK Ventures, as PKVI LP’s

sole limited partner, continued to transfer funds to PKVI LP

during 1992.   Note 4 to these financial statements stated the

following:

     At December 31, 1991, the general partner,
     P K Ventures, Inc. forgave advances totaling
     $1,516,246. At December 31, 1992, the Partnership owed
     the limited partner $335,448 in the form of demand
     notes at 9% interest. These notes cannot be repaid if
     such payment causes defaults with regard to other debt
     agreements. Interest of $10,645 was incurred but not
     paid during 1992 related to these notes.

On the Balance Sheets included in these financial statements,

$335,448 for “Notes payable to limited partner” was listed as a

current liability.

     On the Consolidated Statements of Cash Flows included in

PKV&S’s audited consolidated financial statements for the year

ended December 31, 1992, there was no amount listed for “Advances

to limited partnership” under the “Investing activities” section.

Note 3, “Due From Limited Partnership”, to these financial
                               - 67 -

statements does not mention that any transfers had been made from

PK Ventures to PKVI LP during 1992.

                h.   1993

     PKVI LP’s reviewed financial statements for the year ended

December 31, 1993, indicate that PKVI LP received transfers from

PK Ventures totaling $242,073 during 1993.   Note 4 to PKVI LP’s

reviewed financial statements for the year ended December 31,

1993, stated:   “At December 31, 1993, the Partnership owed one

limited partner $577,521 in the form of demand notes at interest

rates ranging from 8% to 9%.   Interest of $31,201 and $10,645 was

incurred but not paid during 1993 and 1992, respectively.”    On

the Balance Sheets included in these financial statements,

$577,521 for “Notes payable to limited partner” was listed as a

current liability.

     On the Consolidating Balance Sheet included in PKV&S’s

audited consolidated financial statements for the year ended

December 31, 1993, there were no amounts listed as “Due from

affiliated partnership” or as “Investments in limited

partnerships” with respect to PK Ventures.

          2.    IRS Determinations

     The IRS determined that PKV&S should not have imputed

$67,772 of interest income from PKVI LP on its consolidated

income tax return for 1990 or $100,661 of interest income from

PKVI LP on its consolidated income tax return for 1991 because
                                - 68 -

the cash transfers that PK Ventures had made to PKVI LP were

contributions to capital instead of loans.    Accordingly, the IRS

decreased PKV&S’s interest income by $67,772 for 1990 and by

$100,661 for 1991.

     The IRS also determined that PKV&S was not allowed to claim

a bad debt deduction of $1,516,246 on its consolidated income tax

return for 1991 for cash transfers that PK Ventures and/or its

subsidiaries had made to PKVI LP because these transfers were

contributions to capital instead of loans.    Alternatively, the

IRS determined that, if these transfers were not contributions to

capital, they were made for the benefit of the partners of

PKVI LP and, thus, were distributions to the partners.    As a

further alternative, the IRS determined that, if these transfers

were bona fide loans, the bad debt deduction should not be

allowed because PKV&S had not established that the debt had

become worthless during 1991.    Accordingly, the IRS increased

PKV&S’s taxable income by $1,516,246 for 1991.

     The IRS determined that PKVI LP should not have imputed

$100,661 of interest expense to PK Ventures on its Form 1065 for

1991 because it had not been established that the interest

expense was attributable to a bona fide debt.    Rather, the IRS

determined that the funds that had been transferred from

PK Ventures and/or its subsidiaries to PKVI LP were capital
                               - 69 -

contributions.   Accordingly, the IRS increased PKVI LP’s ordinary

income by $100,661 for 1991.

     The IRS determined that the cash transfers that had been

made by PK Ventures and/or its subsidiaries to PKVI LP were made

on behalf of the Roses and that the transfers constituted

constructive dividends to them.    After making certain

concessions, the IRS determined that the Roses should have

reported a constructive dividend of $411,338 on their joint

income tax return for 1990 and a constructive dividend of

$293,997 on their joint income tax return for 1991.    Accordingly,

the IRS increased the Roses’ taxable income by $411,338 for 1990

and by $293,997 for 1991.

     The IRS notified the Roses that, with respect to 1991,

PKVI LP was subject to partnership-level proceedings pursuant to

the partnership audit and litigation procedures of sections 6221

through 6233.    Consequently, the IRS removed the amount that the

Roses had reported as their distributive share of PKVI LP’s

cancellation of indebtedness income from their income for that

year.   The IRS made these adjustments pursuant to Munro v.

Commissioner, 92 T.C. 71 (1989).
                                - 70 -

Other Circumstances Surrounding PK Ventures’ Operations and
Financial Arrangements

     A.   Going Concern Notes in the Business’s Financial
          Statements

           1.    PK Ventures, SLPC, TBPC, and TPTC

     Note 10 to PK Ventures’ audited financial statements for the

year ended December 31, 1989, set forth the going concern

position of the corporation.    Note 10 stated, in pertinent part,

the following with respect to the corporation’s financial status:

“Management’s plans include several steps which may mitigate the

current adverse financial condition.     * * * The Company’s

management extended payment terms related to certain accrued

payables such as officer’s salaries, indefinitely, subject to

cash availability.”    The notes to SLPC, TBPC, and TPTC’s audited

financial statements for the year ended December 31, 1989, also

include “going concern” notes that state that each corporation’s

management had “extended payment terms related to certain accrued

payables such as officer’s salary, indefinitely, subject to cash

availability.”    No corporate resolutions and/or other agreements

by PK Ventures, SLPC, TBPC, or TPTC set forth the terms of these

extended payment arrangements.

           2.    PKVI LP

     Note 8 to PKVI LP’s audited financial statements for the

year ended December 31, 1989, set forth the going concern

position of the partnership.    Note 8 stated the following with
                               - 71 -

respect to the partnership’s financial status:   “Management’s

plans include several steps which may mitigate the current

adverse financial condition.   These steps include renegotiation

and reduction of short term debt * * * and reduction of certain

operating costs.”

     Note E to PKVI LP’s audited financial statements for the

year ended December 31, 1990, set forth the going concern

position of the partnership.   Note E stated, in pertinent part,

the following with respect to the partnership’s financial status:

     The Partnership’s financial statements have been
     presented on a going concern basis which contemplates
     the realization of assets and the satisfaction of
     liabilities in the normal course of business. At
     December 31, 1990, partners’ capital is in a deficit
     position of $667,182. Management plans to mitigate the
     current adverse financial position by restoring one of
     its plants to operating condition during 1991 and
     completing construction projects on two hydroelectric
     plants which are not yet operational to generate
     revenues. In addition, P.K. Ventures, Inc., the
     general and a limited partner, will continue to advance
     cash to the Partnership as needed. * * *

     Note 6 to PKVI LP’s reviewed financial statements for the

year ended December 31, 1992, set forth the going concern

position of the partnership.   Note 6 stated, in pertinent part,

the following with respect to the partnership’s financial status:

     The Partnership’s financial statements have been
     presented on a going-concern basis which contemplates
     the realization of assets and the satisfaction of
     liabilities in the normal course of business. Cash
     flow deficits and capital needs were supplied and
     funded in 1991 by P K Ventures, Inc. In 1992, cash
     flow deficits and capital needs were funded by a loan
     from the limited partner. Management is exploring the
                               - 72 -

     possibility of renegotiating higher rates on the sales
     of power and intends to maintain tight expense control
     at all three of its operational plants. The
     Partnership may be able to obtain additional funding
     from the limited partner. Management is also exploring
     a possible reorganization or merger. The outcome of
     these matters cannot be predicted at this time.

     Note 6 to PKVI LP’s reviewed financial statements for the

year ended December 31, 1993, set forth the going concern

position of the partnership.   Note 6 stated, in pertinent part,

the following with respect to the partnership’s financial status:

     The Partnership’s financial statements have been
     presented on a going-concern basis which contemplates
     the realization of assets and the satisfaction of
     liabilities in the normal course of business. Cash
     flow deficits and capital needs were funded in 1993 and
     1992 by loans from the limited partner. Management is
     also exploring a possible reorganization or merger.
     The outcome of these matters cannot be predicted at
     this time.

     B.   Litigation Involving SLPC, TBPC, and TPTC

     A majority of PK Ventures’ income was generated by the

operations of its pipeline subsidiaries (i.e., SLPC, TBPC, TPC,

and TPTC).   PK Ventures’ largest investments were in TBPC and

TPTC.

     As of December 31, 1991, SLPC, TBPC, and TPTC were all

litigating separate matters.   The matters being litigated

affected the corporations’ revenue streams.   In particular, TBPC

did not receive any of the $483,000 of lease payments that it was

owed by Royster between April 1991 and June 1992.     In addition,
                              - 73 -

SLPC’s pipeline was taken out of service sometime prior to

January 1, 1992, for environmental reasons.

     There were no direct references made to this litigation in

PKV&S’s audited consolidated financial statements for the year

ended December 31, 1991.   Note 5 of these financial statements,

however, stated, in pertinent part, that:   “The Company has not

repaid $1,300,000 of subordinated notes payable to the former

shareholders of its subsidiaries pending the resolution of

various claims against the former shareholders.”

     C.   Transfers From Rose to PK Ventures

     As of the beginning of October 1992, PK Ventures owed

$1.3 million to the TPTC sellers.   This amount was to have been

paid by January 1, 1992.   This debt was settled in October 1992

when PK Ventures agreed to pay the TPTC sellers $590,000.    Rose

transferred the $590,000 to PK Ventures in October 1992 so that

it could pay the TPTC sellers.   PK Ventures was relieved of the

remaining balance of this $1.3 million debt.

     In sum, Rose made cash transfers to PK Ventures totaling

$990,000 during 1992.   Of this $990,000, Rose transferred

$940,000 during the last quarter of 1992.   PK Ventures executed

documents that were identical to the PKVI LP promissory notes

described above in favor of Rose with respect to these transfers.

These documents were signed by Rose alone; they were neither

attested to by a witness nor notarized.
                             - 74 -

     During 1993, Rose made cash transfers to PK Ventures and its

subsidiaries totaling $2,863,500.    Note 3 to PKV&S’s audited

consolidated financial statements for the year ended December 31,

1993, stated the following with respect to these transfers:

     Notes payable to shareholder represent cash advances
     contributed to the Company by the major shareholder for
     operations. The notes bear interest at 12% and are due
     on demand. The shareholder advanced $2,863,500 and
     $990,000 to the Company during 1993 and 1992,
     respectively.

     Interest expense on notes payable to shareholder was
     $292,350 and $19,313 during 1993 and 1992,
     respectively.

Rose’s Wages for 1986 Through 1993

     The following table breaks down the percentage of time that

Rose devoted to his duties for Printon Kane and/or the Printon

Kane Group, PK Ventures and its subsidiaries, PKVI LP, and Zephyr

during 1986 through 1993:

             Printon Kane/   PK Ventures and
     Year Printon Kane Group   Subsidiaries PKVI LP Zephyr

     1986         40%                50%         10%    –-
     1987         20                 40          10     30%
     1988         15                 40          15     30
     1989         15                 50          15     20
     1990         –-                 78          15      7
     1991         –-                 85          15     –-
     1992         –-                 85          15     –-
     1993         –-                 85          15     –-

During these years, Rose routinely worked long hours and rarely

took vacations.

     PK Ventures reported the following amounts from its

operations on its income tax return for 1986, and PKV&S reported
                                  - 75 -

the following amounts from its operations on its consolidated

income tax returns for 1987 through 1993:

          Gross Receipts                   Total Income    Net Income
  Year       or Sales       Gross Profit      (Loss)         (Loss)

  1986          --               --            ($1,307)      ($9,318)
  1987      $3,054,478       $3,054,478      3,569,218      (228,055)
  1988       4,026,675        2,805,981      3,217,948       579,061
  1989       4,457,954        3,368,325      3,700,349       (43,069)
  1990       5,300,792        4,620,576      4,815,805       650,781
  1991       5,002,606        4,490,177      5,783,636     1,037,967
  1992       4,777,238        4,193,245      4,775,526       802,979
  1993       4,638,025        3,884,120      4,591,313       230,435

     PKVI LP reported the following amounts from its operations

on its Forms 1065 for 1986 through 1993:

                                                             Ordinary
                                                          Income (Loss)
         Gross Receipts                    Total Income   From Business
 Year       or Sales    Gross Profit          (Loss)        Activities

 1986       $11,093         $11,093          $12,488       ($132,332)
 1987       158,501          61,358           61,358        (203,653)
 1988       151,381          28,755           28,755        (346,069)
 1989       227,616          35,120           35,120        (495,274)
 1990       144,153        (260,619)        (260,619)       (603,756)
 1991        61,071        (183,635)        (181,635)       (604,235)
 1992       100,250         100,250          100,250        (839,738)
 1993       101,703         101,703          101,703        (627,306)

     Zephyr reported the following amounts from its operations on

its Forms 1120S for 1987 through 1989:

                                                             Ordinary
                                                          Income (Loss)
         Gross Receipts                    Total Income   From Business
 Year       or Sales    Gross Profit          (Loss)        Activities

 1987     $1,623,593        ($211,807)       ($85,237)      ($964,830)
 1988      2,022,492         (569,839)       (563,666)     (1,993,131)
 1989        516,969       (1,117,281)     (1,117,281)     (1,628,388)
                                - 76 -

     In addition to the wages discussed below, PK Ventures

provided health insurance to Rose and his family during the years

in issue.    Sometime in 1991, PK Ventures purchased a Honda Civic

and provided that car to Rose.     PK Ventures replaced the Honda

Civic with a Mercedes Benz in 1993 and provided the Mercedes Benz

to Rose throughout that year and the remaining years in issue.

Rose determined that PK Ventures would not provide him with any

retirement benefits.

     A.   Wages Received From Printon Kane and the Printon Kane
          Group

     Rose’s salaries from Printon Kane during 1986, 1987, and

1988 were $65,000, $67,500, and $65,000, respectively.     In 1989,

Rose received salaries from Printon Kane and the Printon Kane

Group totaling $34,423 and $12,115, respectively.     In 1990, Rose

received a salary from the Printon Kane Group totaling $6,923.

Rose did not receive any compensation from either Printon Kane or

the Printon Kane Group after 1990.

     B.     Wages Recorded on PK Ventures’ Books and Records

     PK Ventures’ general ledger for 1990 indicated that, during

1990, PK Ventures paid Rose compensation totaling $350,000.

PK Ventures’ general ledger for 1990 also indicated that, of this

$350,000, PK Ventures had accrued $65,000 prior to 1990 and that

SLPC, TBPC, and TPTC had accrued the balance prior to and during

1990 in the following proportions:
                                     - 77 -

                  Total
              Compensation            Portion Attributable To:
      Year       Accrued            SLPC        TBPC        TPTC

      1987      $75,000        $15,000        $30,000    $30,000
      1988       75,000         15,000         30,000     30,000
      1989       75,000         15,000         30,000     30,000
      1990       60,000           –-           30,000     30,000
      Total     285,000         45,000        120,000    120,000

     As of December 31, 1991, PK Ventures’ books indicated that,

during 1991, PK Ventures had accrued $90,000 of “Salary” and an

additional $37,469 of “Compensation & Benefits” with respect to

Rose, that TBPC had accrued $30,000 of “Compensation & Benefits”

with respect to Rose, and that TPTC had accrued $30,000 of “Mgt

Salaries” with respect to Rose.

     During March 1992, Rose made journal entries to PK Ventures’

general ledger to reflect “deferred compensation” payable to him

for 1986 through 1991 in the following amounts:

                             Year       Amount

                             1986      $500,000
                             1987       600,000
                             1988       720,000
                             1989       840,000
                             1990       900,000
                             1991       900,000

According to this “Deferred Compensation” account, PK Ventures

owed Rose $4,460,000 as of March 30, 1992.         Prior to Rose’s

making these journal entries, there had never been a written

agreement between Rose and PK Ventures as to deferred

compensation, and Rose had never discussed deferred compensation
                              - 78 -

with anyone who had an equity interest or financial interest in

PK Ventures.

     PK Ventures’ general ledger for 1992 indicated that, during

1992, PK Ventures paid Rose $500,000 for 1986 and $246,948 for

1987.   As of December 31, 1992, the “Deferred Compensation”

account included in PK Ventures’ general ledger showed a current

balance of $3,713,052.   At the advice of the auditors of PKV&S’s

consolidated financial statements, this balance was “reversed”

off of PK Ventures’ general ledger.    Consequently, there was no

liability for deferred compensation reported on PKV&S’s audited

consolidated financial statements for the year ended December 31,

1992, or on PKV&S’s audited consolidated financial statements for

the year ended December 31, 1993.   Moreover, there was no

liability for deferred compensation reported on the Schedules L

attached to PKV&S’s consolidated income tax returns for 1992 and

1993.

     PK Ventures’ general ledger for 1992 also indicated that,

during 1992, PK Ventures paid Rose $900,000 for his services to

it and its subsidiaries.   Of this $900,000, $32,500 was

attributable to “MGT SAL TPTC” and $32,500 was attributable to

“MGT SAL TBPC”.

     PK Ventures’ general ledger for 1993 indicated that, during

1993, PK Ventures paid Rose compensation totaling $2,031,993.

The general ledger did not clearly indicate what portion of this
                              - 79 -

$2,031,993 was attributable to current compensation and what part

(if any) was attributable to deferred compensation.

     Rose, as sole director of PK Ventures, determined the

amounts of compensation that PK Ventures paid to him during the

years in issue.   With respect to the $4,460,000 of “deferred

compensation” that was recorded in PK Ventures’ general ledger

for 1992, Rose first determined this amount sometime between the

beginning of 1992 and March 30, 1992.   Included in the

determination of the $4,460,000 was the amount of compensation

that Rose believed that he should have received from Zephyr

during a 16-month period in 1987 and 1988.   There had never been

an amount accrued as a salary for Rose on Zephyr’s books and

records, and PK Ventures had never been a shareholder of Zephyr.

Furthermore, the total compensation that Rose determined that

PK Ventures should pay him for 1992 and 1993 related to his

providing services over an “8.3-year” period that included a

portion of 1985 and the entirety of 1986 through 1993.

     C.   Wages Reported on Income Tax Returns

     PK Ventures deducted the following amounts as compensation

paid to officers and salaries and wages paid on its income tax

return for 1986, and PKV&S deducted the following amounts as

compensation paid to officers and salaries and wages paid on its

consolidated income tax returns for 1987 through 1993:
                                 - 80 -

                       Compensation Paid      Salaries and
                Year      to Officers          Wages Paid

                1986             --               --
                1987             -–            $173,844
                1988             -–             192,211
                1989          $170,000            -–
                1990            80,068          276,190
                1991           103,000          396,247
                1992         1,646,948          306,718
                1993         2,031,993          352,974

All of the amounts that PKV&S reported as compensation paid to

officers on these returns were attributable to Rose.

     On the Roses’ joint income tax returns for 1990 through

1995, Rose reported that he received the following amounts of

compensation:

                    Wages      Gross Income    Miscellaneous
                     and        Reported on     Income from
          Year    Salaries      Schedule C       Form 1099

          1990      $6,923       $17,000             -–
          1991         –-           –-            $103,000
          1992         –-           –-           1,646,948
          1993         –-           -–           2,031,993
          1994     606,250          -–               -–
          1995     250,000          -–               -–

Rose did not report any compensation from PK Ventures or its

subsidiaries in 1987 or 1988.

     On its consolidated income tax return for 1990, PKV&S

claimed a $50,068 deduction for officer compensation paid to Rose

and a $30,000 deduction for a “salary transfer to Tampa Bay

Pipeline Co.” from PK Ventures.      PKV&S reported that $17,000 of

the $50,068 was paid by TPTC and that the balance was paid by

PK Ventures.    Neither the $30,000 attributable to TBPC nor the
                              - 81 -

$50,068 attributable to PK Ventures and TPTC appears on the

Roses’ joint income tax return for 1990 as wages received.    Rose

did, however, report $33,068 of imputed interest from PK Ventures

on that return as well as $17,000 of gross income from his

involvement in an “investment company” on a Schedule C, Profit or

Loss From Business, that was attached to the return.

     On its consolidated income tax return for 1991, PKV&S

claimed a $103,000 deduction for officer compensation paid to

Rose.   PKV&S reported that $30,000 of this amount was paid by

TBPC, that $30,000 was paid by TPTC, and that the balance was

paid by PK Ventures.   In addition, PKV&S claimed a $37,469

deduction for other salaries and wages paid to Rose.   This latter

deduction was attributable to the “reclassification” of an

account showing that Rose owed PK Ventures $437,469 as of

December 31, 1991.   As discussed above, this “reclassification”

resulted in PKV&S’s claiming a $400,000 bad debt deduction as

well as the $37,469 deduction for other salaries and wages paid

to Rose.   The Roses reported the $103,000 of officer compensation

on their joint income tax return for 1991, but they failed to

report the $37,469 of other salaries and wages.

     On its consolidated income tax return for 1992, PKV&S

claimed a $1,646,948 deduction for officer compensation paid to

Rose.   PKV&S reported that $32,500 of this amount was paid by

TBPC, that $32,500 was paid by TPTC, and that the balance was
                                 - 82 -

paid by PK Ventures.     The Roses reported the $1,646,948 of

officer compensation on their joint income tax return for 1992.

     On its consolidated income tax return for 1993, PKV&S

claimed a $2,031,993 deduction for officer compensation paid to

Rose.     PKV&S reported that $32,500 of this amount was paid by

TBPC, that $32,500 was paid by TPTC, and that the balance was

paid by PK Ventures.     The Roses reported the $2,031,993 of

officer compensation on their joint income tax return for 1993.

In addition to this amount, the Roses reported interest from

PK Ventures of $292,350.

     Rose received the amounts of wages and salaries that he

reported on the Roses’ joint income tax returns for 1994 and 1995

from TPC.     TPC issued Forms W-2, Wage and Tax Statement, to Rose

with respect to these amounts.

     D.     IRS Determinations

        With respect to 1990, the IRS determined that Rose should

have reported a total of $350,000 of compensation from

PK Ventures and its subsidiaries.     The IRS determined that this

amount included $285,000 of compensation that had been accrued by

SLPC, TBPC, and TPTC during 1987, 1988, 1989, and 1990 and paid

to Rose in 1990 and included $65,000 of compensation that had

been accrued by PK Ventures prior to 1990 and paid to Rose in

1990.     After taking into account the $17,000 of gross income that

Rose had reported on a Schedule C that was attached to the Roses’
                             - 83 -

joint income tax return for 1990 and shifting $13,000 of the

compensation that Rose reported in 1991 to 1990, the IRS

increased the Roses’ taxable income for 1990 by $320,000.

     With respect to 1991, the IRS determined that Rose should

have reported an additional $97,469 of compensation from

PK Ventures and its subsidiaries.   The IRS determined that this

amount included $60,000 of compensation that had been accrued by

TBPC and TPTC during 1991 and included $37,469 of compensation

that had been accrued by PK Ventures during that year.

Accordingly, the IRS increased the Roses’ taxable income for 1991

by $97,469.

     The Roses conceded these adjustments for 1990 and 1991.

Taking into account these concessions, Rose received the

following amounts of compensation for his services to PK Ventures

and its subsidiaries during 1986 through 1991:
                                - 84 -

               Entity       1986-89      1990      1991

            PK Ventures $170,000        $98,068   $67,469
            SLPC            --           45,000      --
            TBPC            –-          120,000    60,000
            TPTC           --           120,000    60,000
                   Total 170,000        383,068   187,469

In sum, Rose received $740,537 for his services to PK Ventures

and its subsidiaries during these years.

     With respect to 1992, the IRS determined that the deduction

that PKV&S claimed for compensation paid to Rose should be

reduced by $1,208,893.   The IRS determined this reduction by

subtracting (1) reasonable salary for 1992 totaling $143,317 and

(2) deferred compensation totaling $294,738 from the $1,646,948

that PKV&S deducted in that year.       The IRS determined the

reasonable salary for 1992 by multiplying PKV&S’s gross receipts

for that year by 3 percent.    The IRS determined deferred

compensation as follows:

              Salary
           Deducted on     Reasonable                    Deferred
   Year       Return         Salary       Difference   Compensation

   1987         -–          $91,634       ($91,634)         $91,634
   1988         -–          120,800       (120,800)         120,800
   1989     $170,000        133,739         36,261          (36,261)
   1990       50,068        159,024       (108,956)         108,956
   1991      140,469        150,078         (9,609)           9,609
   Total     360,537        655,275       (294,738)         294,738

As it did in 1992, the IRS determined reasonable salary for 1987

through 1991 by multiplying PKV&S’s gross receipts for each of

those years by 3 percent.    Accordingly, the IRS increased PKV&S’s

taxable income by $1,208,893 for 1992.
                              - 85 -

     With respect to 1993, the IRS determined that the deduction

that PKV&S claimed for compensation paid to Rose should be

reduced by $1,892,852.   The IRS determined this reduction by

subtracting reasonable salary for 1993 totaling $139,141 from the

officer compensation that PKV&S deducted in that year.   As it did

in 1992, the IRS determined reasonable salary for 1993 by

multiplying PKV&S’s gross receipts for that year by 3 percent.

Accordingly, the IRS increased PKV&S’s taxable income by

$1,892,852 for 1993.

PK Ventures’ Share of PKVI LP’s Items of Income and Loss

     A.   As Reported on PK Ventures’ Schedules K-1

     The following items were listed on PK Ventures’

Schedules K-1 that were attached to PKVI LP’s Forms 1065 for 1986

through 1993:
                                - 86 -

                                                        Amount
                                                  General Limited
 Year                    Item                     Interest Interest

 1986    Capital contributed during year            $500      --
         Net long-term capital gain                   29      -–
         Withdrawals and distributions               --       -–
         Ordinary loss from business activities   (1,323)     -–
         Net short-term capital loss                 (13)     -–

 1987    Capital contributed during year             --       --
         Interest income                              69      -–
         Withdrawals and distributions               --       -–
         Ordinary loss from business activities   (2,036)     -–

 1988    Capital contributed during year          3,540       --
         Withdrawals and distributions              -–        --
         Ordinary loss from business activities (18,515)      -–

 1989    Capital contributed during year            --        --
         Withdrawals and distributions              -–        --
         Ordinary loss from business activities (26,497)      -–

 1990    Capital contributed during year            --   ($95,640)
         Net gain under section 1231                708     2,105
         Withdrawals and distributions              -–       --
         Ordinary loss from business activities (32,301) (96,097)

 1991    Capital contributed during year            --       --
         Cancellation of indebtedness income     81,119   373,755
         Withdrawals and distributions              -–       --
         Ordinary loss from business activities (32,327) (148,944)

 1992    Capital contributed during year            --       --
         Withdrawals and distributions              -–       --
         Ordinary loss from business activities (44,925) (206,996)

 1993    Capital contributed during year            --       --
         Withdrawals and distributions              -–       --
         Ordinary loss from business activities (33,561) (154,631)
         Net loss under section 1231             (4,405) (20,296)

    B.    As Reported on the Income Tax Returns for PK Ventures
          and PKV&S

     PK Ventures reported the following amount with respect to

its interest in PKVI LP on its income tax return for 1986, and
                                 - 87 -

PKV&S reported the following amounts with respect to PK Ventures’

and/or its subsidiaries’ interests in PKVI LP on its consolidated

income tax returns for 1987 through 1993:

                 Income (Loss)             Cancellation of
          Year    from PKVI LP Bad Debts Indebtedness Income

          1986     ($1,323)        -–            -–
          1987      (2,036)        -–            --
          1988     (18,515)        -–            -–
          1989     (26,497)        -–            —-
          1990    (124,687)        --            --
          1991    (181,271)    $1,516,246     $454,874
          1992    (251,921)        -–            --
          1993    (212,893)        -–            --

     C.   IRS Determinations

     The IRS determined that PKV&S could deduct PK Ventures’

distributive share of PKVI LP’s losses for 1990, 1991, 1992, and

1993 to the extent of PK Ventures’ basis in its PKVI LP interest.

Before taking into account any of PKVI LP’s losses, the IRS

determined that PK Ventures’ basis in its PKVI LP interest was

$114,936 as of December 31, 1990.     The IRS determined this amount

by subtracting the amount of PKVI LP’s losses that PKV&S deducted

in 1986, 1987, 1988, and 1989 from the cash advances that it

determined that PK Ventures had made to PKVI LP in 1990 and prior

years and the capital contribution that it determined that

PK Ventures had made to PKVI LP in 1988.    The IRS allowed as a

deduction against this basis $114,936 of PK Ventures’

distributive share of PKVI LP’s losses for 1990.    Accordingly,

the IRS increased PKV&S’s taxable income by $9,751 for 1990.
                                - 88 -

     Before taking into account any of PKVI LP’s losses, the IRS

determined that PK Ventures’ basis in its PKVI LP interest was

zero as of December 31, 1991.    With respect to 1991, the IRS

notified PKV&S that PKVI LP was subject to partnership-level

proceedings pursuant to the partnership audit and litigation

procedures of sections 6221 through 6233.     Consequently, the IRS

removed the amounts that PKV&S had reported as PK Ventures’

distributive shares of PKVI LP’s loss and cancellation of

indebtedness income from PKV&S’s taxable income for that year.

The IRS made these adjustments pursuant to Munro v. Commissioner,

92 T.C. 71 (1989).   PKV&S’s taxable income for 1991 was not

affected as a result of these adjustments.

     Before taking into account any of PKVI LP’s losses, the IRS

determined that PK Ventures’ basis in its PKVI LP interest was

zero as of December 31, 1992, and zero as of December 31, 1993.

Consequently, the IRS did not allow PKV&S to deduct any of

PKVI LP’s losses during those years.     The IRS increased PKV&S’s

taxable income by $251,921 for 1992 and by $212,893 for 1993.

The Roses’ Share of PKVI LP’s Items of Income and Loss

     A.   As Reported on Rose’s Schedules K-1

     The following items were listed on Rose’s Schedules K-1 that

were attached to PKVI LP’s Forms 1065 for 1986 through 1993:
                             - 89 -

     Year                  Item                    Amount

     1986 Capital contributed during year             --
          Net long-term capital gain                   $865
          Withdrawals and distributions               --
          Ordinary loss from business activities    (39,700)
          Net short-term capital loss                  (388)

     1987 Capital contributed during year             --
          Interest income                             2,077
          Withdrawals and distributions               --
          Ordinary loss from business activities    (61,096)

     1988 Capital contributed during year             --
          Withdrawals and distributions               --
          Ordinary loss from business activities   (103,820)

     1989 Capital contributed during year           (94,525)
          Withdrawals and distributions               --
          Ordinary loss from business activities   (346,692)

     1990 Capital contributed during year             --
          Net gain under section 1231                 9,256
          Withdrawals and distributions               --
          Ordinary loss from business activities   (422,629)

     1991 Capital contributed during year            --
          Cancellation of indebtedness income    1,061,372
          Withdrawals and distributions              --
          Ordinary loss from business activities (422,964)

     1992 Capital contributed during year             --
          Withdrawals and distributions               --
          Ordinary loss from business activities   (587,817)

     1993 Capital contributed during year             --
          Withdrawals and distributions               --
          Ordinary loss from business activities   (439,114)
          Net loss under section 1231               (57,635)

    B.   As Reported on the Roses’ Income Tax Returns

     On their joint income tax returns for 1990 through 1995, the

Roses reported the following amounts of income and loss with

respect to their interest in PKVI LP:
                                 - 90 -

                       Income (Loss)   Cancellation of
                Year    from PKVI LP Indebtedness Income

                1990         –-               –-
                1991    ($654,236)        $1,061,372
                1992   (1,008,745)            -–
                1993     (689,766)            --
                1994     (373,590)            --
                1995     (679,795)            -–

     The Roses attached the following statement, in pertinent

part, to their joint income tax return for 1990:

     The above mentioned taxpayers have elected to
     carryforward the net operating lossess [sic] of the
     following companies for the tax period ending 12/31/90:

                  *    *    *    *    *     *    *

     2.      PK Ventures I Limited Partnership, (1990) the
             aggregate amount of $422,629, which appears on the
             taxpayer’s Schedule K-1 (Form 1065) line 1, * * *

                  *    *    *    *    *     *    *

     In addition, unused outstanding amounts have been
     carried forward: * * * PK Ventures I Limited
     Partnership (1988) of $103,820 * * * and
     PK Ventures I Limited Partnership (1989) of $318,768.

This statement was signed by the Roses and dated October 12,

1991.     In sum, the Roses carried forward losses from PKVI LP

totaling $845,217.

     The Roses attached the following statement, in pertinent

part, to their joint income tax return for 1991:

     The above mentioned taxpayers have elected to
     carryforward the net operating lossess [sic] of the
     following companies for the tax period ending 12/31/91:

     1.      The amount of $318,768 of unapplied net operating
             loss from PK Ventures I LP (1989) * * * was
             carried forward to 1991. Of this amount, $127,452
                                - 91 -

             was applied in 1991 (Schedule E2, line 31H) and
             the balance of $191,316 carried forward.

     2.      The amount of $422,629 unapplied net operating
             loss from PK Ventures LP (1990) * * * has been
             carried forward.

This statement was signed by the Roses and dated October 14,

1992.     In sum, the Roses carried forward losses from PKVI LP

totaling $613,945.

     The Roses attached the following statement to their joint

income tax return for 1992:

     The above mentioned taxpayers have elected to apply
     * * * the net operating losses of the following company
     for the tax period ending 12/31/92:

     1.   The amount of $394,800 of net operating losses
     from PK Ventures I Limited Partnership (1992) * * *
     have been applied. The taxpayer has elected to
     carryforward the balance of $193,017 of unapplied net
     operating losses.

     2.   The amount of $191,316 of net operating losses
     from PK Ventures I Limited Partnership (1989) * * *
     have been applied.

     3.   The amount of $422,629 of net operating losses
     from PK Ventures I Limited Partnership (1990) * * *
     have been applied.

In sum, the Roses carried forward losses from PKVI LP totaling

$193,017.

     The Roses attached the following statement, in pertinent

part, to their joint income tax return for 1993:     “The above

mentioned taxpayers have elected to apply * * * the net operating

loss carryforward for the tax period ending 12/31/93 for the
                                - 92 -

amount of $193,017 from PK Ventures I Limited Partnership

(1992)”.

     C.    IRS Determinations

     The IRS determined that the Roses could deduct their

distributive share of PKVI LP’s losses for 1990, 1991, 1992,

1993, 1994, and 1995 to the extent of the basis in their PKVI LP

interest.    Before taking into account any of PKVI LP’s losses,

the IRS determined that the Roses’ basis in their PKVI LP

interest was $667,056 as of December 31, 1990.       The IRS

determined this amount by subtracting the amount of PKVI LP’s

losses that the Roses deducted in 1988 and 1989 from the amount

of constructive dividends that it determined that the Roses

recognized as a result of the transfers from PK Ventures, TBPC,

and TPTC to PKVI LP prior to 1991.       The IRS included a note

stating that this basis computation “will need to be adjusted if

the level of constructive dividends shown in Adjustment H are

[sic] changed.”    The IRS allowed as a deduction against this

basis (1) a $103,820 loss carryover from PKVI LP’s 1988

partnership year; (2) a $318,788 loss carryover from PKVI LP’s

1989 partnership year; and (3) $244,468 of the Roses’

distributive share of PKVI LP’s losses for 1990.       Accordingly,

the IRS decreased the Roses’ taxable income by $667,056 for 1990.

     Before taking into account any of PKVI LP’s losses, the IRS

determined that the Roses’ basis in their PKVI LP interest was
                              - 93 -

$293,997 as of December 31, 1991.    The IRS determined that the

Roses recognized this amount of constructive dividends as a

result of the transfers from PK Ventures, TBPC, and TPTC to

PKVI LP during 1991.   The IRS included a note stating that this

basis computation “will need to be adjusted if the level of

constructive dividends shown in Adjustment H are [sic] changed.”

As discussed above, the IRS notified the Roses that PKVI LP was

subject to partnership-level proceedings pursuant to the

partnership audit and litigation procedures of sections 6221

through 6233 with respect to 1991.     Consequently, the IRS removed

the amounts that had been reported as the Roses’ distributive

share of PKVI LP’s losses and cancellation of indebtedness income

from the Roses’ taxable income for 1991.    After making these

adjustments, the IRS determined that the Roses could deduct the

balance of their distributive share of PKVI LP’s losses for 1990,

$178,161.   Because the balance of the Roses’ distributive share

of PKVI LP’s losses for 1990 was $53,111 less than the amount of

PKVI LP’s losses that the Roses claimed on their joint income tax

return for 1991 (after removal of the Roses’ distributive share

of PKVI LP’s losses for 1991 from that amount), the IRS increased

the Roses’ taxable income by $53,111 for 1991.

     Before taking into account any of PKVI LP’s losses, the IRS

determined that the Roses’ basis in their PKVI LP interest was

$335,448 as of December 31, 1992.    The IRS determined that this
                                 - 94 -

amount had been advanced to PKVI LP on behalf of the Roses during

1992.     The IRS allowed as a deduction against this basis $98,782

of the Roses’ distributive share of PKVI LP’s losses for 1992.

Accordingly, the IRS increased the Roses’ taxable income by

$909,963 for 1992.

     Before taking into account any of PKVI LP’s losses, the IRS

determined that the Roses’ basis in their PKVI LP interest was

$242,073 as of December 31, 1993.      The IRS determined that this

amount had been advanced to PKVI LP on behalf of the Roses during

1993.     The IRS allowed as a deduction against this basis $242,073

of the Roses’ balance of their distributive share of PKVI LP’s

losses for 1992.     Accordingly, the IRS increased the Roses’

taxable income by $447,693 for 1993.

     Before taking into account any of PKVI LP’s losses, the IRS

determined that the Roses’ basis in their PKVI LP interest was

zero as of December 31, 1994, and zero as of December 31, 1995.

Consequently, the IRS did not allow the Roses to deduct any of

PKVI LP’s losses during those years.      The IRS increased the

Roses’ taxable income by $373,590 for 1994 and $679,795 for 1995.

The Roses’ Share of Zephyr’s Items of Income and Loss

        A.   As Reported on Rose’s Schedules K-1

        The following items were listed as Rose’s pro rata share of

Zephyr’s items of income, loss, and deduction on Rose’s

Schedules K-1, Shareholder’s Share of Income, Credits,
                               - 95 -

Deductions, etc., that were attached to Zephyr’s Forms 1120S for

1987 through 1989:

     Year                     Item                  Amount

     1987 Ordinary loss from business activities ($179,025)
          Interest income                              511
          Net long-term capital gain                 4,323

     1988 Ordinary loss from business activities (797,252)
          Interest income                             838

     1989 Ordinary loss from business activities (651,355)
          Interest income                              75

     B.   As Reported on the Roses’ Income Tax Returns

     On their joint income tax returns for 1990 through 1992, the

Roses reported losses of $11,941, $868,812, and $651,355,

respectively, with respect to their interest in Zephyr.

     The Roses attached the following statement, in pertinent

part, to their joint income tax return for 1990:

     The above mentioned taxpayers have elected to
     carryforward the net operating lossess [sic] of the
     following companies for the tax period ending 12/31/90:

                *    *    *     *    *   *    *

     The amount of $83,501.00 of unapplied net operating
     loss from Zephyr Rock & Lime Inc., (1987) * * * was
     carried forward to 1990. Of this amount, $11,941 was
     applied in 1990 (Schedule E, line 31a) and the balance
     of $71,560 carried forward.

     In addition, unused outstanding amounts have been
     carried forward: Zephyr Rock & Lime Inc., (1988)
     $797,252, * * * Zephyr Rock & Lime Inc (1989) of
     $651,355 * * *
                                  - 96 -

This statement was signed by the Roses and dated October 12,

1991.     In sum, the Roses carried forward losses from Zephyr

totaling $1,520,167.

     The Roses attached the following statement, in pertinent

part, to their joint income tax return for 1991:

     The above mentioned taxpayers have elected to
     carryforward the net operating lossess [sic] of the
     following companies for the tax period ending 12/31/91:

                   *     *    *    *    *    *    *

        4.    The amount of $651,355 unapplied net operating
              loss from Zephyr Rock & Lime, Inc. (1989) * * *
              has been carried forward.

This statement was signed by the Roses and dated October 14,

1992.

        The Roses attached the following statement, in pertinent

part, to their joint income tax return for 1992:

        The above mentioned taxpayers have elected to apply
        * * * the net operating losses of the following company
        for the tax period ending 12/31/92:

                   *     *    *    *    *    *    *

        5.   The amount of $651,355 of net operating losses
        from Zephyr Rock & Lime Inc. (1989) * * * have been
        applied.

        C.   IRS Determinations

        The IRS determined that the Roses could deduct the losses

that they reported from Zephyr on their joint income tax returns

for 1990, 1991, and 1992 to the extent of the basis in their

Zephyr interest.       The IRS determined that, as of January 1, 1990,
                              - 97 -

the Roses’ basis in their Zephyr interest was $810,431, which

included the following amounts:

                         Source            Amount

                Original investment        $400,000
                Note given to Mills         480,000
                Constructive dividends       25,955
                Loss deducted in 1988       (56,825)
                Loss deducted in 1989       (38,699)

Furthermore, the IRS determined that, as of January 1, 1990, the

Roses had not deducted $1,532,106 of their share of the losses

that Zephyr had incurred during 1987, 1988, and 1989.    After

taking into consideration the $11,941 loss that the Roses claimed

on their joint income tax return for 1990 with respect to their

interest in Zephyr, the IRS determined that the Roses could

deduct an additional $798,490 of Zephyr’s losses in that year.

The IRS determined that the Roses were not entitled to deduct any

additional amount of Zephyr’s losses on their joint income tax

returns for 1991 and 1992.   Accordingly, the IRS decreased the

Roses’ taxable income by $798,490 for 1990 and increased the

Roses’ taxable income by $868,812 for 1991 and $651,355 for 1992.

Transactions Involving SLPC, TPC, and the Roses During 1994 and
1995

     Effective January 1, 1994, PK Ventures and its subsidiaries

reorganized their corporate structure, which resulted in two

surviving corporations--SLPC and TPC.    As of that date,

PK Ventures, TPTC, and TBPC were merged into TPC through

transfers of stock.   Both SLPC and TPC elected to be treated as
                               - 98 -

S corporations during 1994 and 1995.    SLPC was wholly owned by

Rose during 1994 and 1995.   Rose also held an ownership interest

in TPC during 1994 and 1995.

     SLPC realized gross receipts or sales of zero in 1991, 1992,

and 1993 and had a combined total income of $21,720 for those

years.   SLPC became insolvent during 1993.   During 1994, SLPC

incurred large losses because its pipeline was shut down for

major repairs.

     On December 31, 1994, Rose paid $350,000 of the amount that

SLPC owed to TPC by reducing the amount that TPC owed to him.

This transaction was recorded on TPC’s books by journal entries

that reduced the amount that it owed to Rose by $350,000 as well

as the amount that SLPC owed to it by $350,000.    The transaction

was reflected on the books of SLPC by journal entries that

reflected a $350,000 reduction in the amount that it owed to TPC

and a $350,000 increase in the amount that it owed to Rose.

     The Roses deducted losses from SLPC totaling $455,151 on

their joint income tax return for 1994.

     Rose paid an additional $800,000 of SLPC’s debt to TPC

during 1995 by reducing the amount that TPC owed to him.    This

transaction was recorded on TPC’s books by journal entries that

reduced the amount that it owed to Rose by $800,000 as well as

the amount that SLPC owed to it by $800,000.    The transaction was

reflected on the books of SLPC by journal entries that reflected
                              - 99 -

an $800,000 reduction in the amount that it owed to TPC and an

$800,000 increase in the amount that it owed to Rose.

     The Roses deducted losses from SLPC totaling $322,973 on

their joint income tax return for 1995.

     As of February 5, 2004, the outstanding principal balance of

the transactions between SLPC and the Roses was no less than the

outstanding principal balance of those transactions as of 1995.

Furthermore, between 1995 and February 5, 2004, the outstanding

principal balance of the transactions between SLPC and the Roses

remained substantially unchanged.

     A.   As Described in SLPC and the Roses’ Income Tax Returns

     On the Schedule L attached to SLPC’s Form 1120S for

1994, SLPC’s “Other current liabilities” were reported to be

$1,732,262 as of the beginning of that year and $2,727,575 as of

the end of that year.   Of these amounts, SLPC reported that

$1,730,997 and $2,711,734, respectively, were “DUE TO AFFILIATE”.

Also on this Schedule L, SLPC’s “Loans from shareholders” were

reported to equal $350,000 as of the end of 1994.   There were no

amounts separately identified as interest payments made and/or

imputed by SLPC to the Roses on its Form 1120S for 1994.

     There were no amounts separately identified as interest

payments received and/or imputed by the Roses from SLPC on their

joint income tax return for 1994.
                               - 100 -

     On the Schedule L attached to SLPC’s Form 1120S for 1995,

SLPC’s “Other current liabilities” were reported to be $2,208,733

as of the end of that year.    Of that amount, SLPC reported that

$2,171,155 was “DUE TO AFFILIATE”.    Also on this Schedule L,

SLPC’s “Loans from shareholders” were reported to equal

$1,219,000 as of the end of 1995.    There were no amounts

separately identified as interest payments made and/or imputed by

SLPC to the Roses on its Form 1120S for 1995.

     There were no amounts separately identified as interest

payments received and/or imputed by the Roses from SLPC on their

joint income tax return for 1995.

     B.   IRS Determinations

     The IRS determined that the Roses could deduct the losses

that they reported from SLPC on their joint income tax returns

for 1994 and 1995 to the extent of the basis in their SLPC

interest.    In calculating the Roses’ basis in their SLPC interest

for those years, the IRS determined that the $350,000 transaction

between TPC and SLPC in 1994 and the $800,000 transaction between

TPC and SLPC in 1995 did not constitute debt owed to the Roses

and did not increase the Roses’ basis in their SLPC interest.

The IRS determined that “there was not an actual economic outlay”

by the Roses and that “the debt was not directly attributable to”

the Roses.
                              - 101 -

     The IRS determined that the Roses had a $200,000 basis in

their SLPC interest as of the end of 1994 and had no basis in

their SLPC interest as of the end of 1995.   Consequently, the IRS

determined that the Roses could deduct $200,000 of SLPC’s losses

in 1994 and none of SLPC’s losses in 1995.   The IRS increased the

Roses’ taxable income by $255,151 for 1994 and by $322,973 for

1995.

Imposition of Accuracy-Related Penalties by the IRS

     The Roses signed their joint income tax returns for 1990,

1991, 1992, and 1993 on October 12, 1991, October 14, 1992,

October 15, 1993, and October 14, 1994, respectively.   There was

no paid preparer’s information listed on any of these returns.

There were no Forms 8275, Disclosure Statement, attached to these

returns.

     The IRS determined accuracy-related penalties under section

6662(a) with respect to the Roses for 1990, 1991, 1992, and 1993.

The accuracy-related penalties were determined to be due to

substantial understatements of income tax by the Roses for those

years.   The IRS determined that all or part of the underpayments

of tax for those years was attributable to non-tax-shelter items

(1) for which there was no substantial authority or (2) that were

not adequately disclosed in the returns or in statements attached

to the returns.   Furthermore, the IRS determined that it had not
                               - 102 -

been established that these underpayments were due to reasonable

cause.

                               OPINION

Procedural Matters

     PKV&S and the Roses filed their respective petitions with

the Court on March 25 and June 1, 1999.   Rose, as the designated

tax matters partner for PKVI LP, filed a Petition for

Readjustment of Partnership Items Under Code Section 6226 with

the Court on April 25, 1999.

     By notices served on October 7, 1999, August 3, 2000, and

May 10, 2001, these cases were set for trial 5 months after the

dates of the respective notices.   Attached to each of the Notices

Setting Case for Trial was the Court’s Standing Pretrial Order.

The Standing Pretrial Order provided, in pertinent part, as

follows:

          To facilitate an orderly and efficient disposition
     of all cases on the trial calendar, it is hereby

          ORDERED that all facts shall be stipulated to the
     maximum extent possible. All documentary and written
     evidence shall be marked and stipulated in accordance
     with Rule 91(b), unless the evidence is to be used
     solely to impeach the credibility of a witness. * * *
     Any documents or materials which a party expects to
     utilize in the event of trial (except solely for
     impeachment), but which are not stipulated, shall be
     identified in writing and exchanged by the parties at
     least 14 days before the first day of the trial
     session. The Court may refuse to receive in evidence
     any document or material not so stipulated or
     exchanged, unless otherwise agreed by the parties or
     allowed by the Court for good cause shown. * * *
                                - 103 -

On each of these occasions, the cases were continued on the joint

motion (or request) of the parties.       On three subsequent

occasions, the cases were set for trial, Standing Pretrial Orders

were served, and the cases were continued on motion of one of the

parties.

     On January 15, 2003, the Court issued Orders that, inter

alia, required the parties to exchange all nonstipulation

material, including any schedules, charts, and other documents

that collected or summarized testimony or documents that were for

impeachment purposes, by March 14, 2003, and required the parties

to exchange a list of all documents already in the possession of

opposing counsel.

     On August 26, 2003, these cases were set for trial to

commence on February 2, 2004.    The parties were directed to

comply with the Standing Pretrial Order that was served on

April 22, 2003, a copy of which was attached.

     During trial of these cases on February 4-6, 2004,

petitioners attempted to move into evidence a large number of

documents that had not been provided to respondent until sometime

on or after January 19, 2004.    A significant portion of these

documents had not been provided to respondent until the morning

of February 4, 2004.   Respondent objected to many of these

documents’ being received in evidence on the grounds that the

documents were hearsay and had not been exchanged in accordance
                              - 104 -

with the numerous Standing Pretrial Orders that the Court had

issued in these cases.   We sustained respondent’s objections to

those documents and summaries of those documents offered in

evidence by petitioners.   There was no excuse for the belated

tender of documents, and we reaffirm our rulings on respondent’s

objections.   The documents not received in evidence have not been

considered in our findings of fact.

Issue #1–-Transfers From PK Ventures to the Zephyr Purchasers

     Whether a withdrawal of funds from a business by one of its

owners or an advance made to a business by one of its owners

creates a true debtor-creditor relationship is a factual question

to be decided based on all of the relevant facts and

circumstances.   See Haag v. Commissioner, 88 T.C. 604, 615

(1987), affd. without published opinion 855 F.2d 855 (8th Cir.

1988); see also Haber v. Commissioner, 52 T.C. 255, 266 (1969),

affd. 422 F.2d 198 (5th Cir. 1970); Roschuni v. Commissioner, 29

T.C. 1193, 1201-1202 (1958), affd. 271 F.2d 267 (5th Cir. 1959).

For disbursements to constitute bona fide loans, there must have

been, at the time that the funds were transferred, an

unconditional obligation on the part of the transferee to repay

the money and an unconditional intention on the part of the

transferor to secure repayment.   Haag v. Commissioner, supra at

615-616; see also Haber v. Commissioner, supra at 266.   Direct

evidence of a taxpayer’s state of mind is generally unavailable,
                              - 105 -

so courts have focused on certain objective factors to

distinguish bona fide loans from disguised dividends and other

distributions, compensation, and contributions to capital.    The

factors considered relevant for purposes of identifying bona fide

loans include (1) the existence or nonexistence of a debt

instrument; (2) provisions for security, interest payments, and a

fixed payment date; (3) the right to enforce the payment of

principal and interest; (4) whether repayments were made; (5) the

source of the funds used to repay the creditor; (6) the failure

of the debtor to pay on the due date or to seek a postponement;

(7) a status equal to or inferior to that of regular business

creditors; (8) “thin” or adequate capitalization; (9) the

debtor’s ability to obtain loans from outside lending

institutions; (10) identity of interest between the business

owner and the debtor or creditor; (11) the extent of a business

owner/creditor’s participation in management; and (12) treatment

of the transferred funds on the business’s books.   See Estate of

Mixon v. United States, 464 F.2d 394, 402 (5th Cir. 1972); In re

Indian Lake Estates, Inc., 448 F.2d 574, 578-579 (5th Cir. 1971);

see also Haag v. Commissioner, supra at 616-617 & n.6; Haber v.

Commissioner, supra at 266.   Each case turns on its own factors,

and “‘differing circumstances may bring different factors to the

fore.’”   Jones v. United States, 659 F.2d 618, 622 (5th Cir.

1981) (quoting Slappey Drive Ind. Park v. United States, 561 F.2d
                               - 106 -

572, 581 (5th Cir. 1977)).   When the transferee or transferor is

in substantial control of the business, such control invites a

special scrutiny of the situation.   See Haber v. Commissioner,

supra at 266; Roschuni v. Commissioner, supra at 1202; see also

Tulia Feedlot, Inc. v. United States, 513 F.2d 800, 805 (5th Cir.

1975).   We have applied these principles when analyzing transfers

between two closely held businesses that share a common ownership

but are otherwise unrelated.   See, e.g., Stinnett’s Pontiac

Serv., Inc. v. Commissioner, T.C. Memo. 1982-314, affd. 730 F.2d

634 (11th Cir. 1984); see also Marcy v. Commissioner, T.C. Memo.

1994-534.

     Petitioners contend that the facts and circumstances of

these cases establish that transfers from PK Ventures to the

Zephyr purchasers were bona fide loans.     Furthermore, petitioners

contend that these alleged debts became worthless during the

years in which PKV&S claimed bad debt deductions on its

consolidated income tax returns.   Conversely, respondent contends

that the facts and circumstances of these cases establish that

the transfers were not bona fide loans.     Respondent also contends

that, in any event, none of these alleged debts became worthless

during the years in which PKV&S claimed bad debt deductions on

its consolidated income tax returns.     We consider these

contentions below.
                              - 107 -

     Petitioners contend that, because the Summit Trust loan was

a bona fide loan, the transfers from PK Ventures to the Zephyr

purchasers were also bona fide loans.   Petitioners are

essentially relying on the circumstances surrounding the Summit

Trust loan to establish that the transfers from PK Ventures to

the Zephyr purchasers were bona fide loans.   Petitioners do not

cite any authority to support this contention.   After considering

the relevant factors and weighing the evidence, we reject

petitioners’ contention that the transfers from PK Ventures to

the Zephyr purchasers were bona fide loans for the reasons

discussed below.

     First, PK Ventures did not receive promissory notes from the

Zephyr purchasers in exchange for its transfer of $1 million to

them.

     Second, no evidence indicates that the Zephyr purchasers

made any agreement with PK Ventures as to the time of repayment

or the interest to be paid.

     Third, while PK Ventures provided security for its repayment

of the Summit Trust loan to Summit Trust, no evidence indicates

that the Zephyr purchasers provided any collateral or security

for repayment of the transfers that they received from

PK Ventures.

     Fourth, the Zephyr purchasers did not make any payments of

principal or interest to PK Ventures, and no accrued interest
                              - 108 -

attributable to these transfers was posted to PK Ventures’

general ledger or reported in its audited financial statements.

Furthermore, there is no indication that any accrued interest

attributable to these transfers was reported in PKV&S’s

consolidated income tax returns for 1987, 1988, 1989, 1990, or

1991.

     Fifth, no evidence indicates that PK Ventures had the right

to enforce the payment of principal and interest with respect to

its transfers to the Zephyr purchasers.

     Sixth, 9 of the 10 Zephyr purchasers were shareholders of

PK Ventures.   As of August 20, 1987, these nine Zephyr purchasers

owned 99.47 percent of the stock of PK Ventures.   Of the

$1 million transferred from PK Ventures to the Zephyr purchasers,

Rose received $400,000, an amount proportional to his 40-percent

interest in PK Ventures.   There is no evidence of the specific

amounts transferred from PK Ventures to each of the nine other

Zephyr purchasers.

     Seventh, based upon Rose’s experience in corporate finance,

we are convinced that he could have documented the transfers from

PK Ventures to the Zephyr purchasers with promissory notes and

arranged for these transfers to occur under terms significantly

closer to arm’s length than those that were actually chosen.

This conclusion is bolstered by our consideration of the

structure and formality of (1) the financing arrangements into
                               - 109 -

which PK Ventures had entered in connection with the purchase of

the stock of SLPC, TBPC, TPC, and TPTC; (2) the Summit Trust

loan; (3) the financing arrangements into which Rose had entered

in connection with his acquisition of control of PK Ventures

during 1990; and (4) the financing arrangements between PKVI LP

and unrelated parties.

     Eighth, the labels given to the transfers from PK Ventures

to the Zephyr purchasers on PK Ventures’ audited financial

statements for the years ended December 31, 1987, December 31,

1988, and December 31, 1989, and on the Schedules L attached to

PKV&S’s consolidated income tax returns for 1987, 1988, and 1989

cannot overcome the substance of these transfers.   See Estate of

Mixon v. United States, 464 F.2d at 403-404; cf. Gregory v.

Helvering, 293 U.S. 465, 468-470 (1935).   Based upon our analysis

of the relevant factors, we conclude that these transfers were,

in substance, distributions of property from PK Ventures to its

shareholders.

     Because the transfers from PK Ventures to the Zephyr

purchasers were not bona fide loans, we need not decide questions

of worthlessness and timing.   See sec. 1.166-1(c), Income Tax

Regs. (“Only a bona fide debt qualifies for purposes of section

166.”).   Accordingly, we sustain respondent’s determination that

PKV&S is not entitled to bad debt deductions of $600,000 and

$400,000 on its consolidated income tax returns for 1990 and
                              - 110 -

1991, respectively, for the transfers from PK Ventures to the

Zephyr purchasers.

     Respondent determined that PK Ventures’ transfer of $400,000

to Rose in connection with the Zephyr purchase constituted a

constructive dividend to him in 1990.   Consequently, respondent

increased the Roses’ taxable income by $400,000 in 1990 and

determined that the Roses should not have reported $400,000 of

cancellation of indebtedness income on their joint income tax

return for 1991.   We agree that the Roses should not have

reported $400,000 of cancellation of indebtedness income on their

joint income tax return for 1991 because, as we discussed above,

PK Ventures’ transfer of $400,000 to Rose in connection with the

Zephyr purchase was not a bona fide loan.   With respect to

respondent’s treatment of the $400,000 transfer as a dividend

distribution in 1990, petitioners contend that, because the

transfer occurred in 1987, the transfer could only be a dividend

distribution to Rose in that year rather than in 1990.

Respondent has not offered an explanation as to why this $400,000

transfer should be treated as a dividend distribution to Rose in

1990.   Because we have decided that the transfer from PK Ventures

to Rose in connection with the Zephyr purchase was not a bona

fide loan, we agree with petitioners, and we hold that the

transfer is not a dividend distribution to Rose in 1990 (or in

any of the other years before the Court in these cases).     See
                              - 111 -

sec. 1.301-1(b), Income Tax Regs.; see also R&T Developers, Inc.

v. Commissioner, T.C. Memo. 1973-128; Gurtman v. United States,

237 F. Supp. 533, 537-538 (D.N.J. 1965), affd. per curiam on

other issues 353 F.2d 212 (3d Cir. 1965).

Issue #2--Transfers From PK Ventures, TBPC, and TPTC to PKVI LP

     Approximately two-thirds ($1,096,250 out of $1,516,246)

transferred from PK Ventures and its subsidiaries to PKVI LP was

transferred during 1986 through 1990.   An FPAA was issued to

PKVI LP only for 1991.   PKVI LP was a partnership subject to the

provisions of the Tax Equity and Fiscal Responsibility Act of

1982 (TEFRA), partially codified at secs. 6221-6233.   The parties

agree that the characterization of transfers from a partner to a

TEFRA partnership as debt or equity is a “partnership item” that

can be adjusted only upon issuance of an FPAA.   See sec.

301.6231(a)(3)-1(a)(4), 301-6231(a)(3)-1(c)(2)(i), Proced. &

Admin. Regs.   In the absence of a valid FPAA for a particular

year, neither respondent nor the Court may adjust partnership

items for that year.   See generally Maxwell v. Commissioner, 87

T.C. 783, 788-789 (1986).

     For 1991, however, in the FPAA sent to PKVI LP, respondent

disallowed interest expense in the amount of $100,661 because it

had not been established that the interest expense was

attributable to a bona fide debt.   Thus, in determining whether

that interest expense deduction is allowable, we have found facts
                              - 112 -

relating to the transfers and applied the factors discussed in

the preceding section to determine whether the transfers were

bona fide debt or capital contributions.

     Petitioners argue that the following factors support their

contention that the transfers from PK Ventures, TBPC, and TPTC to

PKVI LP during 1986 through 1991 were bona fide loans:

(1) Formal indicia of debt, (2) risk involved, (3) participation

in management and identity of interest, (4) intent of the parties

(5) capitalization, (6) independent financing, and

(7) acquisition of capital assets and failure to repay on the due

date.   In making their argument, petitioners do not attempt to

distinguish the transfers from TBPC and TPTC to PKVI LP from the

transfers between PK Ventures and PKVI LP.   Accordingly, from

this point forward, we refer to these transfers as occurring

between PK Ventures and PKVI LP.   After considering the relevant

factors and weighing the evidence, we reject petitioners’

contention that the transfers from PK Ventures to PKVI LP were

bona fide loans for the reasons discussed below.

     First, we are unpersuaded that the PKVI LP promissory notes

are reliable evidence of any indebtedness between PKVI LP and

PK Ventures.   There is no indication that the PKVI LP promissory

notes were completed contemporaneously with PKVI LP’s receipt of

funds from PK Ventures.   Rather, Rose testified that his

preparation of the PKVI LP promissory notes was “ministerial” and
                              - 113 -

completed on a cumulative basis, so as to account for the total

amount of the transfers from PK Ventures to PKVI LP in

preparation for the yearly audit of these businesses’ financial

records.   Moreover, at the time that Rose signed the $1,516,246

promissory note (i.e., the note representing the aggregate amount

of the transfers from PK Ventures to PKVI LP during 1986 through

1991), Rose, as a general partner with a 70-percent interest in

PKVI LP, neither intended to have PKVI LP repay any of this

amount to PK Ventures nor intended to repay any of this amount

himself.   These facts undermine the reliability of the PKVI LP

promissory notes.   In addition, the purported terms of the

PKVI LP promissory notes were contradicted by the statements made

in PKVI LP’s audited financial statements for the year ended

December 31, 1990, and PKV&S’s audited consolidated financial

statements for the year ended December 31, 1991, that the

transfers from PK Ventures, TBPC, and TPTC to PKVI LP did not

bear interest.   Accordingly, we are unpersuaded that the

existence of the PKVI LP promissory notes justifies a conclusion

that the transfers from PK Ventures to PKVI LP were bona fide

loans.

     Second, unlike the basic structure of PKVI LP’s debt to

unrelated parties, the transfers from PK Ventures to PKVI LP were

not secured by the hydroelectric properties owned by PKVI LP; did

not have a fixed payment date; and, as established by PKVI LP’s
                                - 114 -

audited financial statements for the year ended December 31,

1990, and PKV&S’s audited consolidated financial statements for

the year ended December 31, 1991, did not bear interest.

     Third, no evidence indicates that PKVI LP actually made any

payments of principal or interest to PK Ventures.    Moreover,

PKV&S’s inconsistent reporting of imputed interest payments from

PKVI LP on its consolidated income tax returns for 1987 through

1991 does not persuade us that the transfers from PK Ventures to

PKVI LP were bona fide loans.

     Fourth, no evidence indicates that PK Ventures had the right

to enforce the payment of principal or interest with respect to

its transfers to PKVI LP.   Rather, PK Ventures and PKVI LP agreed

that PKVI LP would not make any payments of principal or interest

if such payments would have caused it to default or breach any

other note or agreement to which it was a party.    This agreement

subordinated the right of PK Ventures to demand payment of its

transfers to PKVI LP to the rights of PKVI LP’s creditors.

     Fifth, PKVI LP was thinly capitalized.   PKVI LP reported

$50,000 of capital contributions on its books.   PKVI LP had

approximately 24 times more debt to unrelated parties than it had

equity at the end of 1986, 37 times more at the end of 1987,

45 times more at the end of 1988 and 1989, 42 times more at the

end of 1990, and 45 times more at the end of 1991.    If the

transfers from PK Ventures to PKVI LP are treated as debt and
                               - 115 -

included in this analysis, these ratios would increase to

approximately 54:1 at the end of 1989, 64:1 at the end of 1990,

and 75:1 at the end of 1991.   PKVI LP was experiencing serious

financial difficulties as of 1989, and these difficulties

continued through 1990 and 1991.

     Sixth, after 1988, PKVI LP was unable to obtain any

additional financing from unrelated parties other than a $125,000

loan from First Fidelity.   PKVI LP entered into this loan

agreement with First Fidelity on or before October 16, 1989.

PKVI LP was also able to renegotiate its outstanding loan

agreements with Liberty Life and MGFP between December 31, 1989,

and December 31, 1991, but no additional financing was provided

to PKVI LP by either Liberty Life or MGFP as part of these

renegotiated agreements.    Furthermore, a substantial portion (if

not all) of the $1,516,246 that was transferred from PK Ventures

to PKVI LP was received by PKVI LP during and after 1989.    The

timing of the transfers from PK Ventures to PKVI LP coupled with

PKVI LP’s inability to obtain additional financing from unrelated

parties does not support a conclusion that the transfers from

PK Ventures to PKVI LP were bona fide loans.

     Seventh, besides the initial capital contributions that were

made to PKVI LP, no evidence indicates that any of PKVI LP’s

limited partners other than PK Ventures transferred funds to the

partnership between September 15, 1986, and December 7, 1990.
                             - 116 -

During that period, PK Ventures’ limited partnership interest in

PKVI LP increased from zero to 29 percent (i.e., PK Ventures

acquired the entire limited partnership interest in PKVI LP).

PK Ventures’ increased ownership interest in PKVI LP was due, in

large part, to partners owning at least 24.65 percent of

PKVI LP’s limited partnership interests assigning their interests

in the partnership to PK Ventures for apparently no consideration

other than relief from the partnership’s liabilities.

Furthermore, these assignments occurred during the time in which

PKVI LP was experiencing serious financial difficulties.    These

facts do not support a conclusion that the transfers from

PK Ventures to PKVI LP were bona fide loans.   Rather, these facts

indicate that PK Ventures gained a greater ownership interest in

PKVI LP by its willingness to assume the liabilities of the

partnership and to provide the partnership with capital to pay

those liabilities.

     Eighth, as a result of holding approximately 76 percent of

the partnership interests in PKVI LP as of February 16, 1990,

Rose and PK Ventures gained the exclusive right, power, and

authority to make calls for additional capital contributions on

behalf of PKVI LP, to permit a withdrawal of capital by any

partner, to admit an additional partner to the partnership, to

permit the withdrawal of any partner from the partnership, to

designate any additional investments for the partnership and to
                                - 117 -

determine the participating percentages of the partners in such

additional investments, to sell or otherwise dispose of all or

substantially all of the partnership’s property attributable to

any investment, to permit any agreement between the partnership

and any general partner or any person controlled by or

controlling or under common control with a general partner, and

to permit the transfer or assignment, in whole or in part, by a

partner of his interest in the partnership.    Prior to

February 16, 1990, PK Ventures needed the approval of limited

partners holding at least 67 percent of the aggregate voting

percentages of the limited partners of PKVI LP to exercise its

authority over these matters.    PK Ventures’ increased

participation in PKVI LP’s affairs during the time in which it

was transferring significant amounts of funds to the partnership

does not support a conclusion that the transfers from PK Ventures

to PKVI LP were bona fide loans.

     Ninth, based upon Rose’s experience in corporate finance, we

are convinced that he could have arranged for the transfers from

PK Ventures to PKVI LP to occur under terms significantly closer

to arm’s length than those that were actually chosen.     This

conclusion is bolstered by our consideration of the structure and

formality of (1) the financing arrangements into which

PK Ventures had entered in connection with the purchase of the

stock of SLPC, TBPC, TPC, and TPTC; (2) the Summit Trust loan;
                               - 118 -

(3) the financing arrangements into which Rose had entered in

connection with his acquisition of control of PK Ventures during

1990; and (4) the financing arrangements between PKVI LP and

unrelated parties.

     Tenth, although some of the labels used to describe the

transfers from PK Ventures to PKVI LP on these businesses’ books

classified the transfers as debt, these labels cannot overcome

the substance of these transfers.   See Estate of Mixon v. United

States, 464 F.2d at 403-404; cf. Gregory v. Helvering, 293 U.S.

at 468-470.   Based upon our analysis of the relevant factors, we

conclude that these transfers were, in substance, contributions

of capital from PK Ventures to PKVI LP.

     Based on the foregoing, we sustain respondent’s

determination that PKVI LP should not have deducted $100,661 of

interest expense on its Form 1065 for 1991 with respect to these

transfers.    The parties agree, and the Court is persuaded, that

we do not have jurisdiction over the adjustments made in the

notice of deficiency sent to PKV&S with respect to imputed

interest income reported on Forms 1120 for 1990 and 1991 and a

bad debt deduction claimed on Form 1120 for 1991.

Issue #3--Transfers From PK Ventures, TBPC, and TPTC to Zephyr

     The characterization of transfers from PK Ventures and its

subsidiaries to Zephyr is relevant only to the bad debt

deductions claimed by PKV&S and disallowed in the notice of
                                - 119 -

deficiency for 1989 and 1990.    For those years, the treatment of

Zephyr’s liabilities was an S corporation item, to be determined

at the corporate level.    See sec. 301.6245-1T(a)(5), Temporary

Income Tax Regs., 52 Fed. Reg. 3003 (Jan. 30, 1987).     (For years

beginning after December 31, 1996, these procedures do not apply.

See Small Business Job Protection Act of 1996, Pub. L. 104-188,

110 Stat. 1755.)   Because no notice of administrative adjustment

(FSAA) was issued to Zephyr, the nature of the transfers as

reported by Zephyr cannot be redetermined here.

Issues #4 and #5–-Partners’ Basis in PKVI LP

     Generally, a partner may deduct the partner’s distributive

share of losses of a partnership in which the partner is a

member.   Sec. 702(a).   A partner’s distributive share of

partnership loss is limited to the extent of the adjusted basis

(before reduction by current year’s losses) of the partner’s

interest in the partnership at the end of the partnership year in

which such loss occurred.    Sec. 704(d); sec. 1.704-1(d)(1),

Income Tax Regs.   A partner’s share of loss in excess of the

partner’s adjusted basis at the end of the partnership year will

not be allowed for that year.    Sec. 1.704-1(d)(1), Income Tax

Regs.   Any excess of such loss over such basis shall be allowed

as a deduction at the end of the partnership year in which such

excess is repaid to the partnership.      Sec. 704(d); see also sec.

1.704-1(d)(1), Income Tax Regs. (“[A]ny loss so disallowed shall
                               - 120 -

be allowed as a deduction at the end of the first succeeding

partnership taxable year, and subsequent partnership taxable

years, to the extent that the partner’s adjusted basis for his

partnership interest at the end of any such year exceeds zero

(before reduction by such loss for such year).”).

     Section 465 imposes a further limitation on a partner’s

distributive share of partnership losses.     Under section 465,

losses relating to activities engaged in by a taxpayer in

carrying on a trade or business or for the production of income

are allowed as deductions only to the extent that the taxpayer is

at risk financially with respect to the activities.     Sec.

465(a)(1), (c)(3).    Investors generally are considered to be at

risk financially to the extent that they contribute money to the

activities.    Sec. 465(b)(1)(A).   In addition, investors are

considered to be at risk financially with respect to third-party

debt obligations relating to the activities to the extent that

they are personally liable for repayment of the debt obligations

or to the extent that they have pledged property, other than

property used in the activities, as security for the debt

obligations.    Sec. 465(b)(1)(B) and (2).   The determination of

whether a taxpayer is to be regarded as at risk on a particular

debt obligation is to be made at the end of each taxable year.

Sec. 465(a)(1); Levy v. Commissioner, 91 T.C. 838, 862 (1988).
                                - 121 -

     Section 465 does not affect either the amount of a partner’s

distributive share of partnership loss that the partner is

otherwise allowed to deduct under section 704(d) or the

adjustment that must be made to the basis of the partner’s

interest in the partnership under section 705(a)(2)(A) as a

result of that loss deduction.    See, e.g., Allen v. Commissioner,

T.C. Memo. 1988-166.   If the amount of partnership loss that a

partner is allowed to deduct under section 704(d) exceeds the

amount for which the partner is at risk under section 465,

however, such excess is subject to the carryover provisions of

section 465(a)(2).   See, e.g., id.       Section 465(a)(2) provides

that this excess amount shall be carried over to succeeding

years.   These losses will be deductible when the taxpayer injects

more funds into the activity.     Id.

     In these cases, the parties dispute whether PK Ventures had

sufficient basis in its PKVI LP interest during 1990, 1991, 1992,

and 1993 to deduct the losses that it claimed from PKVI LP on

PKV&S’s consolidated income tax returns for those years and

whether the Roses had sufficient basis in their PKVI LP interest

during 1990, 1991, 1992, 1993, 1994, and 1995 to deduct the

losses that they claimed from PKVI LP on their joint Federal

income tax returns for those years.       The parties also dispute

whether PK Ventures and the Roses are limited by the “at risk”

rules of section 465 with respect to these loss deductions.
                               - 122 -

     A partner’s adjusted basis in the partner’s interest in the

partnership is the basis of such interest determined under

section 722, increased by the partner’s distributive share of

income and decreased by the partner’s distributive share of loss

and applicable expenditures.   Sec. 705(a)(1) and (2).    The basis

of an interest in a partnership acquired by a contribution of

property, including money, is the amount of money and the

adjusted basis of such property to the partner at the time of

contribution, increased by the amount of any gain recognized

under section 721(b) at the time.   Sec. 722.    Any increase in a

partner’s share of the liabilities of the partnership is

considered a contribution of money by such partner to the

partnership and, consequently, increases the basis of the

partner’s interest in the partnership.   Secs. 705(a), 722,

752(a).   Any decrease in a partner’s share of the liabilities of

the partnership is considered a distribution of money to the

partner by the partnership and, consequently, decreases the basis

of the partner’s interest in the partnership.     Secs. 705(a)(2),

733, 752(b).   The basis of a partner’s interest in the

partnership cannot be decreased below zero.     See sec. 705(a).

     Calculation of the Roses’ basis and of PK Venture’s basis in

their respective PKVI LP interests for purposes of these cases

must be consistent with treatment of the transfers from PK

Ventures and its subsidiaries to PKVI LP on the latter’s returns
                             - 123 -

for the years of the transfers.    With respect to 1991, however,

we have determined the character of those transfers and have

jurisdiction to do so as a result of respondent’s disallowance of

imputed interest expense in the FPAA issued for 1991.

     Petitioners argue that respondent did not specifically

recharacterize the transfers in the FPAA and that respondent

waived any adjustments other than interest expense based on

recharacterization of those transfers and is precluded from

raising them in this proceeding.   Respondent argues that the

Court does have jurisdiction to resolve the character of the

transfers for all of the years but acknowledges that the tax

effects of our conclusions require separate analysis.    The nature

of the transfers was tried by consent and was the predominant

issue during trial and in the briefs of the parties.    Thus,

transfers during 1991 should be regarded as equity contributions

to PKVI LP in the calculation of the partners’ basis, but

transfers prior to and subsequent to 1991 shall be treated for

basis purposes consistent with reporting on PKVI LP’s returns.

Similarly, any other adjustments over which we have no

jurisdiction should not be included in the basis calculations for

purposes of this case.

Issue #6–-The Roses’ Basis in Their Zephyr Interest

     An S corporation’s income, losses, and deductions are passed

through pro rata to its shareholders.   See sec. 1366(a).   The
                              - 124 -

total amount of the S corporation’s losses and deductions that

can be passed through to a shareholder in any taxable year is

limited to the sum of that shareholder’s adjusted basis in his or

her stock and the adjusted basis of any indebtedness owed by the

corporation to that shareholder.   Sec. 1366(d)(1).   A taxpayer’s

share of any S corporation loss in excess of his or her adjusted

basis may be carried over indefinitely.   Sec. 1366(d)(2).

     In these cases, the parties dispute whether the Roses had a

sufficient basis in their Zephyr interest during 1990, 1991, and

1992 to deduct the losses that they claimed from that

S corporation on their joint Federal income tax returns for those

years.   Whether or not an FSAA was sent to Zephyr for 1990, no

such notice is before the Court in these cases.   Thus, we do not

have jurisdiction to redetermine Zephyr’s actual income or loss

and the consequential increases or decrease in basis.

     The Roses did not assign error in their petition to

respondent’s determination of their basis in their Zephyr

interest during 1990, 1991, and 1992.   Under Rule 34(b)(4), any

issue not raised in the assignment of errors is deemed conceded

by the taxpayer.   Jarvis v. Commissioner, 78 T.C. 646, 658

(1982); Gordon v. Commissioner, 73 T.C. 736, 739 (1980).

Furthermore, the Roses made the following concession in their

petition with respect to that determination:

          a.   The Petitioners concede the adjustments
     proposed by the Respondent with respect to Zephyr Rock
                               - 125 -

     & Lime, Inc. (Adjustment C) wherein the Respondent
     proposes to allow the Petitioners an additional
     deduction in 1990 in the amount of $798,490.00 and to
     disallow deductions in 1991 and 1992 in the amounts of
     $868,812.00 and $615,355.00, respectively.

     Subsequent to the Roses’ filing their petition with the

Court, the Supreme Court issued its opinion in Gitlitz v.

Commissioner, 531 U.S. 206 (2001).    In Gitlitz v. Commissioner,

supra, the Supreme Court held that shareholders of an insolvent

S corporation may increase their basis in their interest in the

S corporation by their pro rata share of cancellation of

indebtedness (COD) income to the S corporation.    Id. at 212-216.

     Petitioners filed their trial memorandum with the Court on

February 4, 2004.    In their trial memorandum, petitioners made

the following assertion:

          The Commissioner has failed to increase Mr. Rose’s
     basis in Zephyr to account for Rose’s proportionate
     share of excluded cancellation of indebtedness income
     arising from the Zephyr Bankruptcy. Mr. Rose’s basis
     should be increased by approximately $1,900,000 to
     reflect the amount of this Gitlitz adjustment. * * *

In respondent’s trial memorandum, also filed with the Court on

February 4, 2004, respondent claimed that the following issue was

unresolved:   “22.   Whether petitioners have sufficient basis to

deduct claimed flow-through losses from Zephyr Rock & Lime, Inc.

in 1990, 1991, and 1992?”

     In their posttrial briefs dealing with basis issue,

petitioners contended that the Supreme Court’s holding in Gitlitz

v. Commissioner, supra, should allow the Roses to increase their
                                - 126 -

basis in their Zephyr interest by their share of Zephyr’s COD

income resulting from its bankruptcy.     Petitioners further

contended that Zephyr recognized COD income in 1989 and that the

Roses’ share of Zephyr’s COD income was, at a minimum,

approximately $1,110,570.   Petitioners supported their argument

by Rose’s testimony at trial concerning Zephyr’s outstanding

liabilities in 1988 and 1989.    Petitioners concluded:

     With the upward adjustment of Rose’s basis resulting
     from the pass through of income from discharge of
     indebtedness that is excluded from gross income under
     section 108(a), Rose may deduct his share of Zephyr’s
     losses up to the amount of his basis, including any
     losses that were previously suspended at the corporate
     level because of a lack of basis in prior years.

Conversely, respondent contended that Gitlitz v. Commissioner,

supra, “does not create a situation in which a taxpayer is

allowed an increase in basis without any proof that a debt has

been discharged or the amount thereof.”     Respondent further

contended that “petitioners have offered no proof whatsoever

regarding the amount of any debt which was discharged in Zephyr

Rock’s Chapter 11 proceeding, seeking instead to rely on the

principle established by the Supreme Court in Gitlitz without

proving the amount of the purported debt discharged.”      Respondent

concluded that “petitioners have failed to present any evidence

establishing or to otherwise support a tax basis in excess of the

amount which the respondent has agreed to allow.”     In

respondent’s supplemental brief, respondent conceded, however,
                              - 127 -

that, as of November 20, 1989, the Roses had additional basis of

$149,109 in their Zephyr interest as a result of the discharge of

Zephyr’s indebtedness through its bankruptcy proceeding.    In

making this concession, respondent asserted:   “The evidence

relied upon by the respondent in support of this concession is

not part of the record of these cases; this concession is based

upon documentation that was supplied to the respondent several

months after the trial record for these cases was closed”.

     Petitioners raised two additional contentions for the first

time in their supplemental brief filed August 19, 2004.    The

first contention dealt with respondent’s determination to include

a $480,000 note that Rose gave to Mills in the calculation of

Roses’ basis in their Zephyr interest.   The second contention

dealt with treating the entire amount of the transfers from

PK Ventures, TBPC, and TPTC to Zephyr as constructive dividends

to Rose.   Because these contentions were raised by petitioners

for the first time in their supplemental brief, we did not

consider them in reaching our decisions in these cases.    See

Rules 31(a), 41(a); Krause v. Commissioner, 99 T.C. 132, 177

(1992), affd. sub nom. Hildebrand v. Commissioner, 28 F.3d 1024

(10th Cir. 1994); DiLeo v. Commissioner, 96 T.C. 858, 891 (1991),

affd. 959 F.2d 16 (2d Cir. 1992); Foil v. Commissioner, 92 T.C.

376, 418 (1989), affd. 920 F.2d 1196 (5th Cir. 1990);

Markwardt v. Commissioner, 64 T.C. 989, 997 (1975).
                                - 128 -

     In respondent’s supplemental brief, filed August 12, 2004,

respondent attempted to amend respondent’s determination to

include the $25,955 of constructive dividends in the Roses’ basis

in their Zephyr interest and thus increase the deficiency

determined against the Roses.    Respondent did not seek to raise

this new position at or before trial of these cases.

Furthermore, respondent had not argued that respondent’s

determination to treat a portion of the transfers from PK

Ventures, TBPC, and TPTC to Zephyr as a constructive dividend to

the Roses was incorrect.

     In their memorandum in support of their motion for

reconsideration of findings and opinion, filed 2 months after

release of our now-withdrawn opinion, petitioners contended for

the first time that the statutory notice of deficiency sent to

the Roses--

     is invalid to the extent it excludes from the Roses’
     basis in Zephyr a proportionate share of Zephyr’s
     excluded COD income. Moreover, since respondent failed
     to adjust Zephyr’s excluded COD income in a FSAA issued
     to Zephyr, this Court did not have jurisdiction to
     sustain respondent’s adjustment. To be clear,
     petitioners do not argue that the Court is without
     jurisdiction to determine the Roses’ outside basis in
     Zephyr. Rather, petitioners argue only that the Court
     did not have jurisdiction to determine the Roses’ (or
     any other shareholder’s) share of Zephyr’s excluded COD
     income in a shareholder level proceeding.

At the time of hearing on petitioners’ motion for

reconsideration, the parties agreed that the Court lacked

jurisdiction to redetermine the Roses’ basis in their Zephyr
                               - 129 -

interest.   Petitioners argued, for the first time, that “We

really think that the issue here is the 1990 return, not the 1989

return.”    Petitioners then proceeded to argue that the Schedule L

to Zephyr’s Form 1120S for 1990 reflected COD income, which was

not required to be “reported” because of section 108.

Petitioners now argue that such COD income must be reflected in

the calculation of the Roses’ basis in Zephyr.

     As detailed in our findings of fact, supra pp. 30-33, no

direct references were made and no explanations were provided in

Zephyr’s Forms 1120S as to the amounts that Zephyr received from

PK Ventures and its subsidiaries for years prior to 1990.    On its

Form 1120S for 1990, Zephyr represented that “No income or

expense items where [sic] reported on the tax return due to the

fact that the corporation was not solvent after the completion of

the bankruptcy.”   Petitioners now argue that COD income was

reflected on Zephyr’s return in an attachment, although not on

the face of the return, because (1) Zephyr’s net loss from

operations was eliminated by the amount of excluded COD income

and (2) in Schedule L to the Form 1120 for 1990, assets and

liabilities were eliminated and retained earnings were increased

to reflect COD income of $7,144,750 that was excluded under

section 108.

     Respondent argues that the Court lacks jurisdiction to

increase the basis of the Roses in Zephyr as belatedly sought by
                              - 130 -

petitioners.   Respondent contends that the Court had no

jurisdiction to determine basis in excess of the amounts

determined in the statutory notice, which did not depend on

recharacterization or any other determination that would cause

the Roses’ basis in Zephyr to become a partnership item.

Respondent notes that the Roses did not report any COD income

from Zephyr for 1989 or 1990 and disputes petitioners’ contention

with respect to the effect of the Schedule L to the 1990 return.

Respondent also contends that the Court lacks jurisdiction to

increase the Roses’ basis in Zephyr in accordance with

respondent’s concession.

     In view of the extended history of these cases, we believe

that the interests of justice are best served, and jurisdiction

is not implicated, by accepting the Roses’ concession in their

petition of the correctness of respondent’s determination of

basis, as supplemented by respondent’s concession of increased

basis.   We do not believe that we are required to increase basis

in accordance with Zephyr’s 1990 return consistent with a claim

made for the first time in a motion for reconsideration and based

on an analysis different from and inconsistent with the claim

made prior to and during trial and in posttrial briefs

specifically addressed to that issue.   The notice of deficiency

that was sent to the Roses does not purport to redetermine COD

income or any other entity-level item, so cases holding notices
                                - 131 -

of deficiency invalid as to items where there has not been a

prior entity-level proceeding are not in point.     See Roberts v.

Commissioner, 94 T.C. 853, 860-861 (1990).     As detailed in our

findings of fact, no direct references were made and no

explanations were provided in Zephyr’s Forms 1120S as to the

amounts that Zephyr received from PK Ventures and its

subsidiaries for years prior to 1990.     On its Form 1120S for

1990, Zephyr represented that “No income or expense items where

[sic] reported on the tax return due to the fact that the

corporation was not solvent after the completion of the

bankruptcy.”   Petitioners now argue that cancellation of

indebtedness income was reflected on Zephyr’s return in an

attachment, although not on the face of the return, because

(1) Zephyr’s net loss from operations was eliminated by the

amount of excluded COD income and (2) in Schedule L to the

Form 1120 for 1990, assets and liabilities were eliminated and

retained earnings were increased to reflect COD income of

$7,144,750 that was excluded under section 108.

     Petitioners would have the notice of deficiency make an

affirmative adjustment in the absence of an entity-level

proceeding reflected in an FSAA.    Respondent contends that the

claim of increased basis could have been raised by the Roses in

an administrative adjustment request under section 6227 but that

such a request is now barred.    We conclude, however, that the
                              - 132 -

burden of timely pleading and proving an increase in basis was on

petitioners here, and they did not do so in a timely manner.

Thus, the starting point for calculation of the Roses’ basis will

be the notice of deficiency, and the only adjustments to that

amount will be for items conceded by respondent or determined

within the scope of our jurisdiction in these cases.

Issue #7--The Roses’ Basis in Their SLPC Interest

     Petitioners contend that the Roses’ basis in their SLPC

interest should be increased as a result of the $350,000

transaction that occurred between SLPC, TPC, and Rose during 1994

and the $800,000 transaction that occurred between SLPC, TPC, and

Rose during 1995.   In support of this contention, petitioners

argue that respondent has conceded the bona fides of the

transactions between SLPC, TPC, and Rose during 1994 and 1995

through the following stipulation:

          At December 31, 1994, Mr. Rose paid $350,000 of
     the amount which St. Louis owed Tampa Pipeline
     Corporation by reducing the amount which Tampa Pipeline
     Corporation owed him.

          The transaction was recorded on Tampa Pipeline
     Corporation’s books by a journal entry reducing the
     amount which it owed Rose by $350,000 and reducing the
     amount which St. Louis Pipeline owed it by $350,000.
     The transaction was recorded in the audited financial
     statements and tax returns for 1994.

          The transaction was reflected on the books of
     St. Louis Pipeline by a journal entry reflecting a
     $350,000 reduction it owed Tampa Pipeline Company and
     an increase of $350,000 in the amount it owed Rose.
     During 1995, Rose paid an additional $800,000 of
                               - 133 -

     St. Louis Pipeline’s debt to Tampa Pipeline Company
     * * * [by] reducing the amount Tampa Pipeline owed him.

          Tampa Pipeline recorded the 1995 transaction by a
     journal entry reducing by $800,000 the amount which it
     owed Rose and the amount which St. Louis Pipeline owed
     Tampa Pipeline. St. Louis Pipeline also recorded the
     transaction in a journal entry, reducing its
     indebtedness to Tampa Pipeline by $800,000, and
     increasing its indebtedness to Rose by $800,000.

          The transaction was recorded in the audited
     financial statements and the tax returns for 1995.

In further support of this contention, petitioners argue that the

transactions between SLPC, TPC, and Rose were more than mere book

entries and “that a change in Rose’s rights to repayment has, in

fact, occurred”.    Petitioners cite only Rev. Rul. 75-144, 1975-1

C.B. 277, in support of their contention.    Conversely, respondent

contends that the Roses’ basis in their SLPC interest should not

be increased as a result of the $350,000 transaction that

occurred between SLPC, TPC, and Rose during 1994 and the $800,000

transaction that occurred between SLPC, TPC, and Rose during

1995.    In support of this contention, respondent argues that the

transactions between SLPC, TPC, and Rose during 1994 and 1995

“were merely book entries, lacking economic substance of any

sort.”    As discussed below, we agree with respondent.

     We are unpersuaded that the quoted stipulation is any kind

of concession on the part of respondent.    The stipulation merely

outlines the manner in which the transactions between SLPC, TPC,

and Rose during 1994 and 1995 were recorded on the books of SLPC
                               - 134 -

and TPC.    The stipulation neither establishes that these

transactions had economic substance nor that these transactions

gave rise to a bona fide debt between SLPC and Rose.

     An S corporation shareholder must make an actual economic

outlay to the S corporation in order to increase the basis of his

or her interest in the S corporation.    Bergman v. United States,

174 F.3d 928, 932 (8th Cir. 1999); see also Selfe v. United

States, 778 F.2d 769, 772 (11th Cir. 1985); Underwood v.

Commissioner, 535 F.2d 309, 311-313 (5th Cir. 1976), affg. 63

T.C. 468 (1975); Hitchins v. Commissioner, 103 T.C. 711, 715

(1994).    A shareholder makes an actual economic outlay to an

S corporation by engaging in a transaction that leaves “‘the

taxpayer poorer in a material sense’” when fully consummated.

Perry v. Commissioner, 54 T.C. 1293, 1296 (1970) (quoting

Horne v. Commissioner, 5 T.C. 250, 254 (1945)), affd. 27 AFTR 2d

71-1464, 71-2 USTC par. 9502 (8th Cir. 1971).

     Petitioners have failed to address the myriad cases

involving transactions factually similar to or indistinguishable

from the transactions between SLPC, TPC, and the Roses during

1994 and 1995.    See, e.g., Underwood v. Commissioner, supra;

Bhatia v. Commissioner, T.C. Memo. 1996-429; Wilson v.

Commissioner, T.C. Memo. 1991-544; Griffith v. Commissioner, T.C.

Memo. 1988-445; Shebester v. Commissioner, T.C. Memo. 1987-246.

For example, in Underwood v. Commissioner, supra, the taxpayers
                               - 135 -

were the sole shareholders of two corporations engaged in the

retail barbecue business.    One of the corporations, an

S corporation, was consistently unprofitable.    The other

corporation, a C corporation, was consistently profitable.    Over

the course of approximately 22 months, the C corporation had made

loans totaling $110,000 to the S corporation, which were

memorialized by a series of promissory notes.    The taxpayers’

accountant informed the taxpayers that their losses from the

S corporation would exceed their adjusted basis in the

S corporation and advised them to increase their basis in the

S corporation so they could utilize the losses.    In an

arrangement, not unlike the one herein, the C corporation

surrendered the notes of the S corporation to the S corporation,

the taxpayers substituted their personal note to the

C corporation, and the S corporation gave its demand note to the

taxpayers.   The Court of Appeals for the Fifth Circuit, affirming

the decision of this Court, determined that the taxpayers were

not entitled to increase their basis in the S corporation as a

result of the arrangement.

     In reaching its decision, the Court of Appeals for the Fifth

Circuit discussed the focus of Congress at the time section

1374(c)(2)(B), the predecessor to section 1366(d)(1), was

enacted, referring initially to the following statement in the

legislative history:
                              - 136 -

          The amount of the net operating loss apportioned
     to any shareholder pursuant to the above rule is
     limited under section 1374(c)(2) to the adjusted basis
     of the shareholder’s investment in the corporation;
     that is, to the adjusted basis of the stock in the
     corporation owned by the shareholder and the adjusted
     basis of any indebtedness of the corporation to the
     shareholder. * * * [S. Rept. 1983, 85th Cong., 2d
     Sess. (1958), 1958-3 C.B. 922, 1141.]

The Court of Appeals then went on to conclude:

          In the transaction at issue in this case, the
     taxpayers in 1967 merely exchanged demand notes between
     themselves and their wholly owned corporations; they
     advanced no funds to either Lubbock or Albuquerque.
     Neither at the time of the transaction, nor at any
     other time prior to or during 1969 was it clear that
     the taxpayers would ever make a demand upon themselves,
     through Lubbock, for payment of their note. Hence, as
     in the guaranty situation, until they actually paid
     their debt to Lubbock in 1970 the taxpayers had made no
     additional investment in Albuquerque that would
     increase their adjusted basis in an indebtedness of
     Albuquerque to them within the meaning of section
     1374(c)(2)(B). * * * [Underwood v. Commissioner, supra
     at 312; fn. refs. omitted.]

     In Shebester v. Commissioner, supra, the taxpayer was a

majority shareholder in two S corporations, A & L and Hennessey.

In late 1979, the taxpayer assumed the liability of A & L to

Hennessey.   A & L’s books were adjusted with a debit to accounts

payable and a credit to notes payable.   Hennessey’s books were

adjusted with a debit to the taxpayer’s drawing account and a

credit to accounts receivable.   At the end of the year, the

taxpayer’s drawing account was closed by debiting the taxpayer’s

undistributed taxable income account in an amount including the

amount of the debt assumed.   We concluded that the charge to the
                             - 137 -

taxpayer’s drawing account was not an actual economic outlay

stating:

     [The taxpayer’s] bookkeeping maneuvers merely shifted,
     on paper, the liability for prior loans. Hennessey’s
     debit to * * * [the taxpayer’s] drawing account, and
     its subsequent credit to that account and debit to
     * * * [the taxpayer’s] undistributed taxable income
     account, do not reflect a current economic outlay
     entitling * * * [the taxpayer] to increase his basis in
     A & L. Although the entries in Hennessey’s books
     technically reduced * * * [the taxpayer’s] book equity,
     such entries could not, absent liquidation of
     Hennessey, leave * * * [the taxpayer] “poorer in a
     material sense.” * * * [Shebester v. Commissioner,
     supra; citation omitted.]

     Furthermore, petitioners’ reliance on Rev. Rul. 75-144,

1975-1 C.B. 277, is misplaced.   The Court of Appeals in

Underwood v. Commissioner, 535 F.2d 309 (5th Cir. 1976), noted

the ruling as applied to situations such as is involved here,

stating:

     In the ruling [Rev. Rul. 75-144] the obligee on the
     shareholder’s note was an outsider, a bank, which stood
     ready to enforce the obligation. Hence it was clear at
     the time the substitution occurred that at some future
     date payment would be required. Here, by contrast, the
     obligee on the taxpayers’ demand note was their own
     wholly-owned corporation. * * * [Underwood v.
     Commissioner, supra at 312 n.2.]

     After considering the reasoning set forth in the cases

discussed above and the dearth of evidence establishing the

substance of the transactions between SLPC, TPC, and Rose, we

conclude that the only intended economic effect of these

transactions was to enable the Roses to deduct losses from SLPC

on their joint income tax returns for 1994 and 1995 that they
                               - 138 -

would not have otherwise been able to deduct.   At the time that

these transactions were consummated, no party either advanced or

received any funds.   Rather, the transactions occurred through

offsetting book entries.   Furthermore, there is no evidence that

indicates whether a bona fide debt existed between TPC and Rose

prior to the occurrence of these transactions or whether TPC had

paid Rose any of the amounts that it owed to him, and we are

unpersuaded that the evidence establishes that SLPC paid Rose any

of the amounts that it owed to him after these transactions

occurred.   Because these transactions did not leave Rose poorer

in a material sense when fully consummated, we conclude that Rose

did not make an actual economic outlay by engaging in them.

Accordingly, we sustain respondent’s determination that the Roses

had an insufficient basis in their SLPC interest during 1994 and

1995 to deduct the losses that they claimed from that

S corporation on their joint income tax returns for those years.

Issue #8–-Reasonable Compensation

     Section 162(a)(1) allows as a deduction “a reasonable

allowance for salaries or other compensation for personal

services actually rendered”.   The test for deductibility in the

case of compensation payments is whether they are reasonable and

are in fact payments purely for services.   Sec. 1.162-7(a),

Income Tax Regs.   In any event, the allowance for the

compensation paid may not exceed what is reasonable under all the
                               - 139 -

circumstances.    Sec. 1.162-7(b)(3), Income Tax Regs.   Reasonable

and true compensation is only such amount as would ordinarily be

paid for like services by like enterprises under like

circumstances.    Id.

     Whether an expense that is claimed pursuant to section

162(a)(1) is reasonable compensation for services rendered is a

question of fact that must be decided on the basis of the

particular facts and circumstances.      Paula Constr. Co. v.

Commissioner, 58 T.C. 1055, 1058-1059 (1972), affd. without

published opinion 474 F.2d 1345 (5th Cir. 1973); see also Pepsi-

Cola Bottling Co. of Salina, Inc. v. Commissioner, 528 F.2d 176,

179 (10th Cir. 1975), affg. 61 T.C. 564 (1974); Pac. Grains, Inc.

v. Commissioner, 399 F.2d 603, 605 (9th Cir. 1968), affg. T.C.

Memo. 1967-7.    There are no fixed rules or exact standards for

determining what constitutes reasonable compensation.      Golden

Constr. Co. v. Commissioner, 228 F.2d 637, 638 (10th Cir. 1955),

affg. T.C. Memo. 1954-221.    When the case involves a closely held

corporation with the controlling shareholders setting their own

level of compensation as employees, the reasonableness of the

compensation is subject to close scrutiny.      Owensby & Kritikos,

Inc. v. Commissioner, 819 F.2d 1315, 1324 (5th Cir. 1987), affg.

T.C. Memo. 1985-267; see also Tulia Feedlot, Inc. v. United

States, 513 F.2d at 805; Golden Constr. Co. v. Commissioner,

supra at 638.
                             - 140 -

     In these cases, the parties dispute the reasonableness of

the total compensation paid to Rose by PK Ventures and its

subsidiaries during 1992 and 1993 and deducted by PKV&S on its

consolidated income tax returns for those years.   Petitioners

contend that the amounts that PKV&S deducted as compensation paid

to Rose in 1992 and 1993 were reasonable because (1) a

significant portion of these amounts was intended to be

deductible as compensation for services that Rose performed for

PK Ventures and its subsidiaries during 1986 through 1991 and

(2) an analysis of the facts and circumstances of these cases

establish that these amounts were reasonable.   Conversely,

respondent contends that the amounts that PKV&S deducted as

compensation paid to Rose in 1992 and 1993 were not reasonable

because (1) petitioners have failed to establish that a

significant portion of these amounts was intended to be

deductible as compensation for services that Rose performed for

PK Ventures and its subsidiaries during 1986 through 1991 and

(2) the testimony provided by petitioners’ expert witness

establishes that these amounts were not reasonable.   We address

the parties’ contentions below.

     Petitioners contend that a significant portion of the

compensation that Rose received from PK Ventures and its

subsidiaries during 1992 and 1993 was intended to be deductible

as compensation for services that Rose performed for those
                              - 141 -

corporations during 1986 through 1991.   In support of this

contention, petitioners argue that (1) respondent’s determination

in the PKV&S notice of deficiency and paragraph 51 of the

Stipulation of Facts establish that a portion of the compensation

deducted by PKV&S on its consolidated income tax returns for 1992

and 1993 is attributable to deferred compensation that was paid

to Rose during those years and (2) Rose was insufficiently

compensated for his services to PK Ventures and its subsidiaries

during 1986 through 1991.   As discussed below, petitioners’

arguments are unpersuasive.

     Paragraph 51 of the Stipulation of Facts recites the

following:

          51. As is reflected in the notice of deficiency,
     the respondent determined that PK Ventures is entitled
     to a 1992 deduction for compensation for Rose in the
     amount of $438,055, which consists of $143,317 of
     then-current compensation and $294,738 of deferred
     compensation. The notice of deficiency also reflects
     the determination of the respondent that PK Ventures is
     entitled to a 1993 deduction for compensation for Rose
     in the amount of $139,141, all of which is then-current
     compensation.

Paragraph 51 of the Stipulation of Facts does not add anything to

respondent’s determination, and it does not establish that

respondent’s determination is correct.   Because our conclusions

as to deductible amounts are based on the evidence and not on any

alleged concession as to deferred compensation, petitioners’

argument as to the effect of this stipulation and of respondent’s

determination in the PKV&S notice of deficiency is unpersuasive.
                               - 142 -

Notwithstanding this conclusion, we do not allow respondent to

disavow the amount allowed in the PKV&S notice of deficiency for

“deferred compensation” paid to Rose in 1992 (as respondent

attempts to do on brief) because to do so would be to permit

respondent to increase the related deficiency without making a

timely claim for it.    See sec. 6214(a); Estate of Petschek v.

Commissioner, 81 T.C. 260, 271-272 (1983); see also Koufman v.

Commissioner, 69 T.C. 473, 475-476 (1977).

     Under certain circumstances, prior services may be

compensated in a later year.    Lucas v. Ox Fibre Brush Co., 281

U.S. 115, 119 (1930).    In such instances, however, the taxpayer

must establish that there was not sufficient compensation in

prior periods and that, in fact, the current year’s compensation

was to compensate for that underpayment.     Estate of Wallace v.

Commissioner, 95 T.C. 525, 553-554 (1990), affd. on another

ground 965 F.2d 1038 (11th Cir. 1992); see also Pac. Grains,

Inc. v. Commissioner, supra at 606.

     In support of their argument that Rose was insufficiently

compensated for his services to PK Ventures and its subsidiaries

during 1986 through 1991, petitioners claim that a deferred

compensation agreement existed between Rose and those

corporations during those years and that the “going concern”

notes included in the notes to the audited financial statements

for the year ended December 31, 1989, for PK Ventures, SLPC,
                              - 143 -

TBPC, and TPTC establish the existence of this deferred

compensation agreement.   These notes state that each

corporation’s “management extended payment terms related to

certain accrued payables such as officer’s salaries,

indefinitely, subject to cash availability.”   There is no

indication in these notes as to the period of time, other than

1989, to which these extended payment terms relate or to the

amount or percentage of compensation that was not paid to Rose.

Moreover, there is no evidence of corporate resolutions and/or

other agreements by PK Ventures, SLPC, TBPC, or TPTC that set

forth the terms of these extended payment arrangements.   In

addition, PKV&S’s audited consolidated financial statements for

the years ended December 31, 1990, through December 31, 1993,

made no reference to any extended payment arrangements or to any

deferred compensation arrangement with Rose, and there was no

liability for deferred compensation reported on the Schedules L

attached to PKV&S’s consolidated income tax returns for 1992 and

1993.

     When questioned on cross-examination about the existence of

a deferred compensation agreement, Rose testified as follows:

          Q [By respondent’s counsel] Did you have an
     agreement as of the end of 1991 between yourself and
     PK Ventures to defer your compensation for 1991 and
     prior years?

          A [By Rose] Being a small company, conceptually,
     what we did was the real deal. And the real deal was–-
     is I did not pay myself, so I deferred it.
                                - 144 -

            Q   Did you have an agreement–-

            A   Well, an agreement as a written agreement?   No,
     sir.

          Q Did you have an understanding, sir, that you
     were entitled to compensation in 1991 and that you, as
     PK Ventures, were going to defer that amount into the
     next or subsequent years?

          A I don’t believe I had an agreement.      I knew I
     wanted to be paid.

The lack of documentation in the corporate records of PK Ventures

and its subsidiaries and Rose’s testimony at trial significantly

undermine the inference that petitioners wish for us to draw from

these “going concern” notes.     Consequently, we conclude that

these notes do not establish the existence of a deferred

compensation agreement between Rose and PK Ventures and its

subsidiaries during 1986 through 1991.     After considering the

testimony and lack of evidence supporting petitioners’ position,

we conclude that no deferred compensation agreement existed

between Rose and PK Ventures and its subsidiaries during those

years.

     As additional support for their argument that Rose was

insufficiently compensated for his services to PK Ventures and

its subsidiaries during 1986 through 1991, petitioners claim:

“Rose did not receive any compensation from Ventures and its

subsidiaries for 1986, 1987, and 1988.     In 1989, Ventures paid

Rose $170,000, and in 1990, Rose was paid $50,068.     In 1991,

Ventures paid Rose $140,469.”     In sum, petitioners claim that
                              - 145 -

Rose was paid $360,537 for his services to PK Ventures and its

subsidiaries during 1986 through 1991.   The record establishes,

however, that Rose received $740,537 for his services to

PK Ventures and its subsidiaries during 1986 through 1991.    In

addition, PK Ventures provided health insurance to Rose and his

family during those years, PK Ventures provided Rose with a

company car beginning in 1991, and Rose received equity interests

in both PK Ventures and PKVI LP as part of his compensation for

organizing those investment opportunities for Printon Kane.

Accordingly, petitioners’ assertion is incomplete and inaccurate.

     Petitioners also claim that the amounts of deferred

compensation listed in PK Ventures’ general ledger for 1992

establish that Rose was not sufficiently compensated for the

services that he performed for PK Ventures and its subsidiaries

during 1986 through 1991.   After considering, inter alia, Rose’s

testimony as to the manner in which he “calculated” the deferred

compensation amounts listed in PK Ventures’ general ledger for

1992, the lack of any contemporaneous accounting for these

amounts prior to 1992, and the failure to list these amounts as

liabilities in both PKV&S’s consolidated financial statements and

consolidated income tax returns, we are not persuaded that these

amounts represented compensation that Rose was owed for his

services to PK Ventures and its subsidiaries during 1986 through

1991.   Rather, we conclude that the health insurance, company
                              - 146 -

car, and $740,537 that Rose received from PK Ventures and its

subsidiaries, along with the equity interests that Rose received

in PK Ventures and PKVI LP, were sufficient compensation for his

services to PK Ventures and its subsidiaries during 1986 through

1991.

     We conclude that no portion of the amounts that PKV&S

deducted as officer compensation on its consolidated income tax

returns for 1992 and 1993 is attributable to deferred

compensation.   Therefore, we must decide whether the $1,646,948

that PKV&S deducted in 1992 and the $2,031,933 that PKV&S

deducted in 1993 were reasonable amounts of compensation for the

services that Rose performed for PK Ventures and its subsidiaries

during those years.

     The cases contain a lengthy list of factors that are

relevant when considering the reasonableness of the compensation

deductions claimed by a business, including:   (1) The employee’s

qualifications; (2) the nature, extent, and scope of the

employee’s work; (3) the size and complexities of the business;

(4) a comparison of salaries paid with gross income and net

income; (5) the prevailing general economic conditions; (6) a

comparison of salaries with distributions to stockholders;

(7) the prevailing rates of compensation for comparable positions

in comparable concerns; (8) the salary policy of the taxpayer as

to all employees; and (9) the amount of compensation paid to the
                               - 147 -

particular employee in previous years.    Home Interiors & Gifts,

Inc. v. Commissioner, 73 T.C. 1142, 1156 (1980); see also Owensby

& Kritikos, Inc. v. Commissioner, 819 F.2d at 1323; Pepsi-Cola

Bottling Co. of Salina, Inc. v. Commissioner, 528 F.2d at 179;

Commercial Iron Works v. Commissioner, 166 F.2d 221, 224 (5th

Cir. 1948), affg. a Memorandum Opinion of this Court.    No single

factor is determinative.    Home Interiors & Gifts, Inc. v.

Commissioner, supra at 1156; see also Owensby & Kritikos, Inc. v.

Commissioner, supra at 1323; Pepsi-Cola Bottling Co. of Salina,

Inc. v. Commissioner, supra at 179.

       Each party presented expert testimony in support of its

positions on reasonable compensation levels.    We are not bound by

the opinion of any expert when the opinion is contrary to our own

judgment.    Bausch & Lomb, Inc. v. Commissioner, 92 T.C. 525, 597

(1989), affd. 933 F.2d 1084 (2d Cir. 1991); see also Estate of

Hall v. Commissioner, 92 T.C. 312, 338 (1989); Chiu v.

Commissioner, 84 T.C. 722, 734 (1985).    We may embrace or reject

expert testimony, whichever in our judgment is most appropriate.

Helvering v. Natl. Grocery Co., 304 U.S. 282, 295 (1938).     Thus,

we are not restricted to choosing the opinion of one expert over

another but may extract relevant findings from each in drawing

our own conclusions.    Estate of Hall v. Commissioner, supra at

338.    Here, the experts’ usefulness is primarily in the data that

they collected and analyzed.
                              - 148 -

     Petitioners’ expert, Dr. Keith R. Ugone (Ugone), performed

an analysis that focused on determining an amount of total

compensation that was reasonable for the services that Rose

performed for PK Ventures and its subsidiaries during 1987

through 1993.   In so doing, Ugone assumed that a deferred

compensation agreement existed between Rose and PK Ventures and

its subsidiaries during those years.    As discussed above, that

assumption was unwarranted.   As part of this analysis, however,

Ugone determined amounts of “reasonable compensation based upon

market data” for the services that Rose performed for PK Ventures

and its subsidiaries during 1992 and 1993.

     In determining the amounts of “reasonable compensation based

upon market data”, Ugone identified public companies that were

similarly situated to PK Ventures during those years.    Ugone

identified 10 companies for purposes of his analysis for 1992 and

1993.   Ugone also considered data published in several different

executive compensation surveys in his analysis.    Based upon the

entirety of his analysis, Ugone concluded that reasonable

compensation amounts for the services that Rose performed for

PK Ventures and its subsidiaries during 1992 and 1993 were

$360,067 and $366,391, respectively.

     Respondent’s expert, Paul R. Dorf (Dorf), identified a “peer

group” of public companies that were similarly situated to

PK Ventures and whose top executives performed duties similar to
                               - 149 -

those performed by Rose.    Dorf identified eight companies for

purposes of his analysis.    In his analysis, Dorf also considered

data published in at least five different executive compensation

surveys.   Based upon the entirety of his analysis, Dorf concluded

that reasonable compensation amounts for the services that Rose

performed for PK Ventures and its subsidiaries during 1992 and

1993 were $383,104 and $362,356, respectively.

     Petitioners contend that the compensation that Rose received

from PK Ventures and its subsidiaries during 1992 and 1993 was

reasonable based on an analysis of the following factors:

(1) Dividend history; (2) past and present financial conditions;

(3) nature, extent, and scope of employee’s work; (4) complexity

of employer’s business; (5) risk assumed by the employee; and

(6) employee’s qualifications and training.    Petitioners attempt

to discount the determinations of reasonable compensation made by

their own expert by arguing that his determinations reflect a

conservative approach.   Petitioners also attempt to discredit the

determinations of reasonable compensation made by respondent’s

expert by calling his determinations “facially suspect”.

Furthermore, petitioners argue that there is no consensus in the

determinations made by Ugone and Dorf.    Conversely, respondent

contends that “there is an expert consensus as to reasonable

compensation for the duties that Rose performed on behalf of

PK Ventures during 1992 and 1993.”    Respondent concludes that
                              - 150 -

PKV&S should be limited to deducting the reasonable compensation

amounts determined by Ugone for 1992 and 1993.   We consider these

contentions below.

     We agree with petitioners that a number of factors must be

considered when deciding whether compensation is reasonable in

situations such as the one presented here.   With respect to the

factors cited by petitioners, our review of both experts’ reports

leads us to the conclusion that they considered many of these

factors as well as others in making their determinations as to

reasonable compensation amounts for 1992 and 1993.    In

particular, we note the following excerpt from Dorf’s report:

     In gathering relevant company data, identifying market
     data, conducting our analyses, and ultimately rendering
     our expert opinion, we considered the following issues:

          1.   What were Mr. Rose’s qualifications?

          2. What were Mr. Rose’s duties and
          responsibilities at PKV?

          3. What was the financial performance of PKV
          during the period 1987 through 1991?

          4. What was Mr. Rose’s compensation during the
          period 1987 through 1993?

          5.   How was Mr. Rose’s compensation determined?

          6. What was the market value of Mr. Rose’s
          position during 1987 through 1993?

          7. How did Mr. Rose’s compensation compare to the
          market value of similar position(s)?

          8. Was there a deferred compensation plan in
          place at PKV?
                              - 151 -

Accordingly, we are unpersuaded that we should deviate from the

reasonable compensation amounts determined by the experts in

these cases.   Rather, we conclude that these expert reports

establish a consensus as to the amounts of compensation that were

reasonable for the services that Rose performed for PK Ventures

and its subsidiaries during 1992 and 1993.   Because the experts’

calculations lead to approximations, in any event, and because

Rose’s services to PK Ventures and its subsidiaries were

obviously substantial, we give him the benefit of the higher of

the amounts determined by the experts.

     Using our best judgment on the entire record, we conclude

that, for 1992 and 1993, reasonable compensation for Rose is

$383,104 and $366,391, respectively.    Therefore, for 1992, PKV&S

is limited to deducting $383,104 for compensation paid to Rose

plus an additional $294,738 to reflect the amount allowed by

respondent in the PKV&S notice of deficiency for “deferred

compensation”.   For 1993, PKV&S is limited to deducting $366,391

for compensation paid to Rose.

Issue #9–-Penalties

     Respondent determined accuracy-related penalties with

respect to the Roses under section 6662(a) for substantial

understatements of income tax on their joint income tax returns

for 1990 through 1993.   Under section 6662(a), a taxpayer may be

liable for a penalty of 20 percent on the portion of an
                                - 152 -

underpayment of tax due to, inter alia, any substantial

understatement of income tax.    Sec. 6662(b)(2).   An

understatement of income tax is “substantial” if it exceeds the

greater of 10 percent of the tax required to be shown on the

return or $5,000.   Sec. 6662(d)(1)(A).   An “understatement” is

defined as the excess of the tax required to be shown on the

return over the tax actually shown on the return, less any

rebate.   Sec. 6662(d)(2)(A).

     The section 6662(a) penalty will not be imposed with respect

to any portion of the underpayment as to which the taxpayer acted

with reasonable cause and in good faith.    Sec. 6664(c)(1); see

also Higbee v. Commissioner, 116 T.C. 438, 448 (2001).     The

decision as to whether a taxpayer acted with reasonable cause and

in good faith is made by taking into account all of the pertinent

facts and circumstances.   Sec. 1.6664-4(b)(1), Income Tax Regs.

Relevant factors include the taxpayer’s efforts to assess his or

her proper tax liability, including the taxpayer’s reasonable and

good faith reliance on the advice of a tax professional.    See id.

     Petitioners argue that the accuracy-related penalties should

not be imposed against the Roses because “respondent is unable to

carry his burden of production as to the penalty pursuant to the

requirements of IRS sec. 7491(c).”    Petitioners further argue

that “respondent has failed to adequately consider the reasonable

cause prong of the penalty provision” because “Rose relied on the
                                - 153 -

information returns furnished by Ventures and Limited and filed

his returns consistent with the information returns received from

those entities.”   As discussed below, petitioners’ arguments are

unpersuasive.

     Section 7491 applies to court proceedings arising in

connection with examinations commencing after July 22, 1998.

Internal Revenue Service Restructuring and Reform Act of 1998,

Pub. L. 105-206, sec. 3001(c)(1), 112 Stat. 727.   The record in

these cases establishes that respondent’s examination of the

Roses’ joint income tax returns began before July 22, 1998.

Furthermore, the record in these cases negates reasonable cause.

The Roses conceded that they failed to report a number of items

of income on their joint income tax returns for 1990 through

1993.   Contrary to petitioners’ argument, the evidence does not

establish that the Roses’ failure to report these items of income

was the result of Rose’s reliance on the tax professionals that

prepared the returns for PKV&S, PKVI LP, or Zephyr.   In addition,

the evidence establishes that the Roses’ inability to calculate

the bases of their interests in PKVI LP and Zephyr and to claim

losses from those entities in the correct amounts and in the

correct years did not result from the Roses’ reliance on the

information that was reported on the Schedules K-1 that they

received from those entities.    The evidence also establishes that

Rose was well versed in corporate finance and that he made the
                              - 154 -

decisions regarding the terms and structure of the cash transfers

involving PK Ventures and its subsidiaries, PKVI LP, Zephyr, and

the Zephyr purchasers.   Consequently, any argument as to Rose’s

reliance on the advice of tax professionals for the treatment of

these cash transfers as debt rather than equity contributions or

distributions is unconvincing.

     Based upon our analysis of the relevant facts and

circumstances of these cases, we conclude that respondent’s

imposition of accuracy-related penalties against the Roses must

be sustained if the recalculation of the Roses’ income tax

liabilities for 1990 through 1993 gives rise to substantial

understatements of income tax for those years.

     We have considered the arguments of the parties that were

not specifically addressed in this opinion.   Those arguments are

either without merit or irrelevant to our decision.

     To reflect the foregoing and the concessions of the parties,


                                         Decisions will be entered

                                    under Rule 155.
