                     T.C. Memo. 1996-168



                   UNITED STATES TAX COURT



    NORTHWESTERN INDIANA TELEPHONE COMPANY, Petitioner v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent

    ROBERT G. MUSSMAN AND MYRTIS MUSSMAN, Petitioners v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent1



Docket Nos. 7970-91, 7971-91.       Filed April 2, 1996.



     R determined that NITCO, a local telephone
company, unreasonably accumulated its earnings and
profits and, therefore, was subject to accumulated
earnings tax. R further disallowed business deductions
NITCO claimed for legal expenses and determined that
NITCO was liable for certain additions to tax.

     R determined that M, NITCO’s president and major
shareholder, had constructive dividend income and that
M and M’s wife were liable for certain additions to
tax.

     1. Held: NITCO is liable for accumulated
earnings tax because its accumulated earnings exceeded
its reasonable business needs and NITCO was availed of

1
 This Court granted petitioners' motion to consolidate.
                                         - 2 -

         to avoid income tax with respect to its shareholders.

              2. Held, further, most of the legal expenses in
         issue are not deductible under sec. 162, I.R.C.

              3.     Held, further, M had constructive dividend
         income.

              4. Held, further, NITCO is liable for the
         additions to tax.

              5. Held, further, M and M’s wife are liable for
         the additions to tax.


         David J. Duez, Gail H. Morse, and Roger W. Wenthe, for

    petitioners.

         Marjory A. Gilbert, Linda Grobe, and Claire McKenzie, for

    respondent.


                     MEMORANDUM FINDINGS OF FACT AND OPINION


         RUWE, Judge:      Respondent determined deficiencies in

    petitioners' Federal income taxes and additions to tax as

    follows:

                          Northwestern Indiana Telephone Co.
                                  docket No. 7970-91


                                            Additions to Tax
                          Sec.           Sec.           Sec.       Sec.
Year   Deficiency    6653(a)(1)(A)   6653(a)(1)(B)      6661       6662
                                          1
1987   $786,115.00    $39,305.75                    $182,675.75       --
1988    429,006.00     21,450.30          --         101,935.50       --
1989    329,369.00        --              --             --       $23,509.40
1
 50 percent of the interest due on $55,412.
                                   - 3 -
                         Robert G. and Myrtis Mussman
                              docket No. 7971-91


                                         Additions to Tax
                                Sec.           Sec.           Sec.
     Year   Deficiency      6653(a)(1)         6661           6662

     1988   $74,850.00      $3,742.50      $18,712.50           --
     1989   127,004.00         --              --           $25,400.80


     After concessions, the issues we must decide are:                   (1)

Whether petitioner Northwestern Indiana Telephone Co. (NITCO)

permitted its earnings to accumulate beyond the reasonable needs

of the business during the years 1987, 1988, and 1989; (2)

whether NITCO was availed of for the proscribed purpose of

avoiding income tax with respect to its shareholders and is

liable for the accumulated earnings tax under section 531,2 for

1987, 1988, and 1989; (3) whether NITCO, for 1987, 1988, and

1989, is entitled to business deductions for certain legal

expenses it incurred and/or paid; (4) whether petitioner Robert

G. Mussman received constructive dividend income in the years

1988 and 1989; and (5) whether petitioners are liable for

additions to tax.

                             FINDINGS OF FACT


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

The stipulation of facts, first and second supplemental


     2
      Unless otherwise indicated, all section references are to
the Internal Revenue Code as in effect for the years in issue,
and all Rule references are to the Tax Court Rules of Practice
and Procedure.
                                - 4 -

stipulations of fact, and attached exhibits are incorporated

herein by this reference.

     At the time their petitions were filed, NITCO maintained its

principal office in Hebron, Indiana, and petitioners Robert G.

and Myrtis Mussman resided in Hebron, Indiana.   Mr. and Mrs.

Mussman filed joint individual income tax returns for 1988 and

1989.


         A.   Background on NITCO and the Mussman Family


     NITCO, an Indiana corporation, is an independent telephone

company that provides local wire-based telephone services in the

five following rural areas located in northwestern Indiana:     (1)

Roselawn, (2) Mt. Ayr, (3) Demotte, (4) Lakes of the Four

Seasons, and (5) Hebron.    It operates a local telephone company

office or exchange in each of these areas.   In each of the years

1987, 1988, and 1989, NITCO had a total of 7,238, 8,099, and

8,634 access lines, respectively.   Most of these access lines

were for residential customers.   NITCO had relatively few

multiline business customers.   As of 1989, NITCO had 16 multiline

business customers, none of whom had lines in excess of 10.

     Since 1982, petitioner Robert G. Mussman (Mr. Mussman) has

been NITCO's president and chief executive officer.   He has owned

approximately 95 percent of NITCO's outstanding shares of stock

since at least 1982.   The balance of NITCO's outstanding shares

has been owned by Mr. Mussman's brother, Gerald Mussman.     Since
                                - 5 -

1982, Gerald Mussman served as NITCO's vice president, and

petitioner Myrtis Mussman (Mrs. Mussman) served as its secretary-

treasurer.   During the years in issue, Mr. and Mrs. Mussman and

Gerald Mussman were NITCO's only directors and officers.

     During 1987 through 1989 and in prior and subsequent years

relevant to these instant cases, Mr. Mussman was the primary

decision maker at NITCO.    He made all final major decisions

concerning NITCO's operation and how its earnings were spent.

     Mr. and Mrs. Mussman have two sons, Rhys Mussman (Rhys) and

Kyle Mussman (Kyle).    Rhys was born in 1956 or 1957; Kyle was

born in 1965 or 1966.    Each son, at various times pertinent to

the instant cases, worked as a full-time employee of NITCO.       They

also, at various times pertinent to the instant cases, left

NITCO's employ to pursue other business ventures for their own

accounts, including a cable television company business and

various cellular telephone company businesses.

     NITCO's local telephone business has been a family-owned

and-operated business.    The business was originally owned and

operated by Mr. Mussman's father.    Mr. Mussman began working in

the business as a teenager in 1938.     From about 1947 through the

time of the trial in the instant cases, Mr. Mussman worked as a

full-time employee in the business.     Gerald Mussman left the

family business in 1947 when he took a job with AT&T.

     When Mr. Mussman's father died in 1954, Mr. Mussman

inherited his father's NITCO shares.     At various times since
                                - 6 -

1954, NITCO offered additional shares of its stock to Mr. Mussman

and his brother, Gerald Mussman.   Mr. Mussman purchased the

shares offered to him, but his brother declined to purchase

additional shares.

     Throughout the 1950's, NITCO's earnings were fairly

moderate.   In 1951, NITCO's annual net income was about $9,800.

By 1987, however, NITCO's annual revenue exceeded $5 million.

     In the early 1960's, Interstate Highway 65 was constructed

through NITCO's service area.   The completion of the highway

spurred development and economic growth in NITCO's service area,

which resulted in increased annual revenue for NITCO.   New

subdivisions of homes were built, and portions of NITCO's service

area eventually included bedroom communities composed of

individuals who worked in the Gary, Indiana, area, and in the

Chicago, Illinois, area.

     NITCO's annual revenue and profits began to increase

significantly in late 1985, as a result of the breakup of the

Bell system and the entry of other companies into the long-

distance telephone service market in competition with AT&T.

Generally, when a long-distance telephone service company, like

AT&T, originates or places a long-distance call into or from an

area serviced by a local telephone company, it pays the local

telephone company an access charge for the use of its lines.

Prior to the breakup of the Bell system, AT&T alone established

and prescribed the access charges it paid to local telephone
                                - 7 -

companies.    Following the breakup of the Bell system, an

independent entity, the National Exchange Carriers Association,

was established and given responsibility over deciding how long-

distance call revenues were divided among all telephone service

providers.


     B.     NITCO's Principal Business Office and Headquarters


     From about 1980 through the time of the trial, NITCO

maintained its principal business office and headquarters in an

office building at 205 North Washington Street, Hebron, Indiana.

NITCO leased the office building from Mr. Mussman, who owned the

building and the parcel of land on which the building is

situated.

     Mr. Mussman also owned another smaller office building

situated on the same parcel of land, with the address 301 North

Washington Street, Hebron, Indiana.     Prior to its moving into and

occupying the newer and larger building at 205 North Washington

Street, NITCO maintained its principal business office at the 301

North Washington Street building, which it leased from Mr.

Mussman.    From 1980 through 1993, NITCO continued to lease the

301 North Washington Street building from Mr. Mussman.    From 1983

until about July 1989, NITCO subleased the 301 North Washington

Street office building to Rhys' cable television company.    After

Rhys' cable television company vacated the premises in July 1989,

NITCO used the 301 North Washington Street building for storage
                                - 8 -

and later, in the fall of 1993, moved some of its marketing

division employees into the building.

     From 1987 through 1989, NITCO had no plans to build other

principal office facilities for itself or to expand and enlarge

its offices at 205 North Washington Street.    In securing office

facilities for NITCO, Mr. Mussman's longstanding practice was to

own individually the office building and lease it to NITCO.    As

the building's owner, Mr. Mussman, rather than NITCO, financed

and constructed the building.    NITCO's respective lease

agreements with Mr. Mussman on the 205 and 301 North Washington

Street buildings were entered into prior to each building's

construction, so that Mr. Mussman could use the executed lease

agreement to secure financing from a lender to construct the

building.    Mr. Mussman experienced no difficulty in obtaining

loans to construct the 205 and 301 North Washington Street

buildings.    The lease agreements and the mortgages on the

buildings served as the security for the lender's loans to Mr.

Mussman.

     No enlargement of NITCO's offices at 205 North Washington

Street occurred from 1987 through 1994.


        C.   NITCO's Alcatel Telephone Switching Equipment


     During 1985 through 1987, NITCO replaced the old switching

systems at its five exchanges with new digital switching

equipment it purchased from Alcatel, a French manufacturer of
                                 - 9 -

telephone switching equipment.    After it replaced the old

switching equipment at its exchanges with the new Alcatel

switching equipment, NITCO paid off the remaining purchase money

debt of $669,530 that it owed on the old equipment to the old

equipment's manufacturer.

     When NITCO ordered the Alcatel E10-5 switching equipment for

its five exchanges in 1985, Alcatel had represented to NITCO that

Alcatel would continue to engage in research and development

efforts that would allow the Alcatel equipment that was purchased

to be upgraded in future years so as to offer enhanced and

improved telephone services.   In 1988, NITCO purchased and

installed another piece of Alcatel switching equipment, an

Alcatel 1210 access tandem toll switch, at its central office.

The Alcatel E10-5 switching equipment installed in NITCO's five

exchanges performs switching functions in each exchange and is

connected to the Alcatel 1210 tandem toll switch, which provides

access to long-distance telephone service carriers, equal access,

and 800 call capability to all of NITCO's exchanges.    With the

E10-5 switches and the 1210 switch, NITCO can provide equal

access, touch-tone services, direct long-distance dialing, call

forwarding, call waiting, three-way calling, speed dialing,

foreign exchange lines, pbx services, call tracing, and 911

services to all its exchanges.

     In various 1990 NITCO publications circulated to NITCO's

customers and employees, NITCO stated that the Alcatel switching
                                 - 10 -

equipment it had installed within the past 5 years was state of

the art equipment that offered the latest calling features.

NITCO's operating experience with its Alcatel equipment has been

good.

     In an August 17, 1990, response that was submitted by NITCO

to a service audit report issued by the engineering staff of the

Indiana Utility Regulatory Commission (IURC), NITCO indicated

that Alcatel was continuing future research and development

efforts with respect to NITCO's Alcatel equipment.     To support

this representation, NITCO attached to its response a copy of a

letter dated August 14, 1990, from Mr. James V. Parish, national

sales account manager--ITT-Alcatel--stating that Alcatel was not

withdrawing from the North American switching market, had no

plans to do so, and was providing a complete line of support for

its switching systems equipment.

     From 1987 through sometime in 1992, NITCO did not obtain any

bids on new switching equipment to replace its Alcatel switching

equipment.     In 1992, NITCO for the first time obtained a firm

quotation on the price of possible replacement equipment.     As of

the time of trial, however, NITCO has not purchased new switching

equipment to replace its Alcatel switching equipment.


             D.   NITCO's Installation of Fiber Optic Cable


        Although it is more costly than the traditional copper cable

still extensively used by local telephone companies, fiber optic
                               - 11 -

cable has certain definite advantages over copper cable.    The

fiber optic cable is much smaller in size and has a greater

transmission capacity than copper cable.    It further allows

higher speed transmissions and requires less maintenance than

copper cable.

     However, from 1987 through the time of trial, it was not

economically feasible for NITCO to install fiber optic cable in

the homes or business premises of its customers.    From 1986 until

sometime in 1987 or 1988, Kyle was NITCO's fiber optic cable

specialist.   During 1989, while he was employed as NITCO's

general manager, Kyle authored and published a white paper for

the independent telephone industry stating that, at that time and

for the immediate future, installation of fiber optic cable by

local telephone companies in residences was not economically

feasible.   In the paper, Kyle expressed the opinion that there

was then no economic justification for local telephone companies

to incur the high cost of installing the fiber optic cable in

residences, because no significant additional revenues would yet

be produced for them from their installation of the cable in

residences.

     From 1987 through the time of trial, NITCO has not installed

fiber optic cable in residences or in the business premises of

its customers.    However, NITCO has installed and utilized fiber

optic cable in connection with other parts of its telephone

service system.   Its employees have laid and installed the fiber
                                 - 12 -

optic cable.    During 1987 through 1989, NITCO was installing

fiber optic cable to connect its five exchanges.     Most of this

work to connect its exchanges was completed in 1987 and 1988.       In

1989, NITCO installed fiber optic cable to a point in its service

area where it located a switching device to handle calls to homes

using traditional copper cables.     Since 1990, NITCO has installed

fiber optic cables in a few new subdivision areas to service

homes in the subdivisions that had copper cables.     In addition to

the fiber optic cable's better performance and reliability and

its potential future capacity for offering other new or enhanced

services that might become available, the fiber optic cable was

cheaper to install in these subdivision areas because of its

smaller size.


               E.   NITCO's Billing and Collections Work


     Prior to 1986, in addition to billing and collecting

payments for its own local telephone services, NITCO billed and

collected payments for long-distance calls from customers in its

service area who utilized AT&T's long-distance telephone

services.   With respect to the long-distance payments it

collected on behalf of AT&T, NITCO subtracted the access charges

due to it, as well as an administrative and collection fee, and

then was required to remit the balance of the long-distance

payments to AT&T.
                              - 13 -

     NITCO owned an IBM computer, which it used to help perform

its billing and collections work.   In late 1986, AT&T took back

the long-distance billing and collections function that NITCO

previously performed for AT&T with respect to long-distance

calls.

     In October 1989, NITCO and Bank of Illinois entered into a

3-year contract under which Bank of Illinois agreed to perform

NITCO's billing and collections work.   In a November 1989 NITCO

publication circulated to its employees, NITCO announced that the

new NITCO billing system to be operated by Bank of Illinois would

help to (1) improve service to NITCO's customers, and (2)

increase the productivity of NITCO's employees.   Another reason

why NITCO entered into the contract was because the IBM computer

that NITCO owned could not provide all the information on long-

distance calls that NITCO was required to furnish to AT&T.    The

contract was subsequently taken over from Bank of Illinois by

another company, Communications Data Group (CDG).

     As of September 1991, although it had experienced some

problems with the billing and collections work done, NITCO was

still utilizing CDG's billing and collections services.   At a

meeting on October 25, 1991, attended by NITCO personnel and CDG

personnel at the offices of NITCO's attorneys, NITCO and CDG

agreed that NITCO would continue to utilize CDG's billing and

collections services.   However, the problems with the billing and

collections work done for NITCO persisted.
                                - 14 -

     In 1992, NITCO purchased and paid approximately $781,000 for

a new computer to perform its own billing and collections work.

NITCO also hired additional employees to operate the new computer

and to perform this work.     Thereafter, employees of NITCO

utilized this computer to perform NITCO's billing and collections

work.

     During 1987 through 1989, NITCO had no specific and definite

plans to buy a computer to perform its billing and collections

work.


          F. Long Range Planning and Discussions Concerning
          a Proposed Airport in or Near NITCO's Service Area


        At various times during 1987 through 1989, long-range

planning and discussions were taking place concerning a proposed

new airport in Indiana to service the Chicago, Illinois, area.

Proponents of the airport project anticipated that the proposed

airport eventually would be needed, because Chicago's O'Hare

airport was already being heavily used.     The proponents believed

that, as O'Hare airport's maximum air traffic capacity was

reached (which some of them predicted could occur as early as

2010 through 2020), much of the increased air traffic to the

Chicago area would have to be accommodated at a new Indiana

airport.

        During the years in issue, 4 of the 15 possible sites in

Indiana discussed for the proposed airport were either in or near

NITCO's service area.     However, a final decision concerning the
                                - 15 -

building of the airport and the selection of its site was not

likely to be made for a number of years.    As of the time of

trial, no decision had yet been made concerning the building or

site of the proposed airport, and there were no current plans to

build the airport in or near NITCO's service area.


          G. Cellular Telephone and Long-Distance Telephone
          Service License Applications Filed by Mr. Mussman,
           NITCO, and Another Company Mr. Mussman Controlled


     In order to offer cellular telephone or long-distance

telephone services in a specific area, the potential service

provider must first apply for and obtain authorization from

either the Federal Communications Commission (FCC) or an

appropriate State regulatory agency.

     During the 1980's, the FCC held lotteries to select the

applicants to whom it would issue licenses to build and operate

cellular telephone systems serving various areas of the United

States.    The FCC issued two types of cellular telephone licenses:

(1) On frequency B, only to local wire-line telephone companies,

their owners, and affiliates who were under the common control of

local telephone companies and/or their owners; and (2) on

frequency A, to anyone else other than local telephone companies,

owners of local telephone companies, and their affiliates.      If a

cellular telephone licensee failed to provide the required level

of cellular telephone service to the entire area covered under

the license issued to it within a 5-year period, then the FCC
                                - 16 -

could take back the license to the unserviced portion of the

licensee's service area and issue a new license to another

qualified applicant to provide cellular telephone service to the

unserviced portion of the area.

     In 1988, Lukas, McGowan, Nace & Gutierrez (LMN&G), a

Washington, D.C., law firm that specializes in communications

law, prepared and filed with the FCC at least 78 cellular

telephone license applications on behalf of either Mr. Mussman,

Kyle, or Rhys.   Previously, in 1986, Rhys applied for and was

tentatively selected to be awarded two licenses to furnish

cellular telephone services in Enid, Oklahoma, and in Asheville,

North Carolina, respectively.    Rhys' Enid, Oklahoma, and

Asheville, North Carolina, cellular telephone business activities

were conducted by him through Dial One Mobile, a company Rhys

solely owned.    Almost all the 78 applications LMN&G filed in 1988

were for Kyle and Rhys.   During 1988, NITCO paid the filing fees

with respect to the 78 license applications and deducted the

payments.   Petitioners have conceded that NITCO should not have

deducted these payments of Mr. Mussman's, Kyle's, and Rhys'

license application filing fees.

     LMN&G also performed a substantial amount of other legal

work for NITCO and the Mussman family during the years in issue.
                              - 17 -

Mr. Mussman's Hagerstown, Maryland, and Cumberland, Maryland-West
Virginia Cellular Telephone License Applications


     On or about January 6, 1988, Mr. Mussman filed with the FCC

two cellular telephone license applications to provide cellular

telephone services in the Hagerstown, Maryland, and the

Cumberland, Maryland-West Virginia, areas, respectively.   An

LMN&G attorney prepared the two applications.

     NITCO had no interest in the above license applications.

The applications stated that Mr. Mussman was the applicant and

that NITCO had no interest in the licenses being sought.


NITCO's Indiana Rural Statistical Area Number One Cellular
Telephone License Application and Serv-U-Cellular, Inc.


     In 1988, NITCO, certain other local wire-line telephone

companies, and/or affiliates of other local wire-line telephone

companies, filed competing applications with the FCC for a

license to provide cellular telephone service in the rural

statistical number one area in Indiana.   Mr. Mussman's intention

and plan was to transfer the cellular telephone license rights

that NITCO obtained to Serv-U-Cellular, Inc. (Serv-U-Cellular), a

corporation that he and one or more of his sons, individually,

would own.   At that time, when competing cellular telephone

license applications were filed by local wire-line telephone

companies and/or their affiliates, it was a common occurrence for

some license applicants to join subsequently in a partnership to
                               - 18 -

build and operate the cellular telephone system that serviced the

area.

     As a result of an agreement among various applicants who

sought the rural statistical number one area cellular telephone

license, they agreed to withdraw their license applications to

service the area as follows:   (1) All the applicants except a

company called Ameritech would withdraw their applications to

service the area's northern portion; and (2) all the applicants

would either withdraw or amend their applications so that NITCO

and certain of the other applicants could form and participate in

a partnership to service the area's southern portion.

Subsequently, RSA #1, a limited partnership, was formed for this

purpose.   Ameritech further agreed to pay the other applicants

$750,000 each for their agreement to cede the northern portion of

the rural statistical number one area to Ameritech.

     On or about September 24, 1990, an LMN&G attorney sent

letters advising the other participants in RSA #1 that Serv-U-

Cellular, rather than NITCO, would be a limited partner in the

RSA #1 limited partnership.    The attorney's letter to them stated

that Serv-U-Cellular was a newly formed “subchapter S

corporation” whose shares of stock were owned by individual

members of the Mussman family and that Mr. Mussman would own and

vote 51 percent of Serv-U-Cellular's shares.

     By October 9, 1990, the RSA #1 partnership agreement was

amended to reflect Serv-U-Cellular's substitution in place of
                               - 19 -

NITCO as a limited partner in the RSA #1 limited partnership.

Under the original RSA #1 partnership agreement entered in mid-

1989, NITCO and the other partners had agreed that subsidiaries

or affiliates of a partner would be allowed to assume the

partner’s rights and obligations in and to the partnership.

     In 1990, Serv-U-Cellular received $750,000 as a result of

the agreement to cede the northern portion of the rural

statistical number one area to Ameritech.     NITCO received the

$750,000 from Ameritech and paid it to Serv-U-Cellular.

     Pursuant to Mr. Mussman's plan, Serv-U-Cellular was to be

owned individually by him and Rhys.     Mr. Mussman was to own 6

percent and Rhys was to own 94 percent of Serv-U-Cellular's

outstanding shares of stock.

     Mr. Mussman subsequently decided to abandon his plan that he

and Rhys individually own Serv-U-Cellular, as a result of the

Internal Revenue Service’s (IRS) commencement of the examinations

that led to the instant proceedings.     On its 1990 return dated

September 12, 1991, NITCO reported in its income $696,772 of the

$750,000 payment that Serv-U-Cellular had received from

Ameritech.   Attached to its Form 1120 for the tax year 1991,

Serv-U-Cellular notified the IRS of the termination of Serv-U-

Cellular's S corporation status as a result of the transfer of

all its shares to NITCO on January 1, 1991.     However, on its

annual reports for 1990, 1991, and 1992, to the FCC and the

Indiana Utility Regulatory Commissioner (IURC), NITCO did not

report that it had any subsidiaries.
                             - 20 -

Dial One USA, Inc.


     Dial One USA, Inc. (Dial One USA), was a wholly owned

subsidiary of Intelcom, Inc. (Intelcom).    Mr. Mussman was the

principal stockholder of Intelcom.

     In 1989, Dial One USA petitioned the IURC for a certificate

of territorial authority for authorization to be a reseller of

long-distance telephone services.    In connection with the

petition, Mr. Mussman essentially acknowledged that he owned Dial

One USA through Intelcom but stated that there was no affiliation

between NITCO and Dial One USA.   At that time, the IURC had

certain concerns with respect to a local telephone company's

having a long-distance telephone service affiliate.

     After reviewing Dial One USA's application, the IURC staff

requested further information concerning the allocation of Dial

One USA's expenses between it and NITCO.    In September 1989, Dial

One USA moved to dismiss its application and did not provide the

information the IURC staff requested.    NITCO had paid certain

legal and other expenses of Dial One USA and had paid certain

legal expenses attendant to the incorporation of Dial One USA's

parent, Intelcom.


             H. Possible Acquisition of Other Local
       Telephone Companies by NITCO or the Mussman Family


     During the years in issue, Mr. Mussman, on several

occasions, had asked certain individuals with whom he was
                             - 21 -

acquainted, including an accountant, an attorney, and a

communications consultant, to apprise Mr. Mussman of potential

opportunities to acquire other local telephone companies.    On the

record presented in the instant cases, it is not clear whether

Mr. Mussman intended and planned to have NITCO or individual

members of the Mussman family ultimately acquire other telephone

companies.

     In 1990, NITCO contacted two local telephone companies about

the possibility of acquiring them.    One telephone company replied

that it was not for sale; the other company never responded to

NITCO's inquiry.

     Additionally, in 1990, Rhys visited another local telephone

company located in Tennessee to examine its operations and to

discuss its possible purchase.   Rhys' trip took place after the

IRS’ commencement of the examinations that resulted in the

instant cases.

     From 1987 through the time of trial, NITCO did not enter

into a contract to purchase another local telephone company.


         I. NITCO's Provision of Financial Assistance to
     Mr. Mussman's Sons and Various Companies the Sons Owned


Rhys and Northwestern Indiana CATV, Inc.


     Prior to 1983, Northwestern Indiana CATV, Inc. (NICATV), a

corporation that Rhys owned, applied for and was issued a license

by the FCC to offer cable television services in certain areas in
                               - 22 -

Indiana.    NITCO provided local telephone services in these same

areas.   To help Rhys and NICATV obtain the financing needed to

build NICATV's cable television system, Mr. Mussman personally

guaranteed the bank loan to NICATV.

     From 1983 through 1988, NITCO's employees helped construct

NICATV's cable television system.    From 1983 through about July

1989, NICATV maintained its offices at the 301 North Washington

Street building that it subleased from NITCO.    It further leased

or subleased from NITCO a small area of cleared land located

behind NITCO's office building at 205 North Washington Street and

telephone pole space for cable television attachments.   In 1988

and 1989, NITCO paid a total of at least $6,119.95 and $3,263.51,

respectively, in utility bills at the 301 North Washington Street

building.

     NITCO had no ownership interest in NICATV or in NICATV's

cable television facilities.

     In 1983, Rhys, NICATV, and NITCO became involved in a

dispute before the FCC concerning whether NICATV was an affiliate

of NITCO.   The FCC later took the position that NICATV was a

NITCO affiliate, in large part because of the extensive financial

support and other assistance NICATV and Rhys received from Mr.

Mussman and NITCO.    This dispute continued for a number of years

and was not resolved until after Rhys sold NICATV to an unrelated

party in July 1989.   The FCC proceedings and other related legal

proceedings that arose from this dispute are discussed more fully
                               - 23 -

infra.

     The cable television system construction work and other

various activities NITCO engaged in, from 1983 to 1989, with

respect to NICATV were not undertaken by NITCO with a profit

motive.   As of about 1989, NITCO's books reflected that Rhys and

NICATV owed NITCO in excess of $122,000.   In July 1989, Rhys sold

NICATV for about $4 million.   Although Rhys received sufficient

cash from his sale of NICATV to discharge this $122,000 "debt" to

NITCO, the "debt" owed to NITCO remained unpaid.   On the 1989

annual report it filed with the IURC in May 1990, NITCO indicated

that it had written off as uncollectible its $122,000

"receivable" with respect to Rhys and NICATV and stated that this

was a "Non-deductible write-off" for tax purposes.

NITCO's 1988 Payment to Rhys and its 1989 Purchase of a Country
Club Membership for Rhys


     Rhys left NITCO's employ and was no longer an employee of

NITCO after December 31, 1983.   However, during 1984, NITCO

continued to pay Rhys a "salary", provided him with health

insurance coverage, and allowed him to participate in NITCO's

retirement plan.   As a result of the FCC's taking issue with

these payments and benefits that NITCO provided to Rhys, on or

about May 31, 1985, an attorney representing NITCO advised the

FCC that Rhys would no longer serve as a "consultant" to NITCO

and indicated that NITCO's provision of such money and benefits

to Rhys would cease.   As indicated above, the dispute between
                              - 24 -

NICATV, NITCO, and the FCC continued for some time and was not

resolved until after Rhys' July 1989 sale of NICATV.

Additionally, in the March 24, 1988, complaint NITCO and Rhys

filed in the constitutional challenge action discussed infra,

NITCO alleged that Rhys did not receive compensation from NITCO

and had no formal responsibilities at NITCO.

     On December 20, 1988, NITCO paid $22,646 to Rhys.    In early

1989, NITCO purchased individual memberships at a local country

club on behalf of several of its employees and on behalf of Rhys.

NITCO paid an $1,800 initiation fee to obtain Rhys' club

membership.   At this point, Rhys had not yet sold NICATV and was

not an employee of NITCO.

Blue Mountain Cellular Telephone, Inc., FiberComm, Inc., and
BMCT, L.P.


     In 1988, FiberComm, Inc. (FiberComm), a corporation solely

owned by Kyle, applied to the FCC for a license to provide

cellular telephone services in the rural statistical number three

area in Oregon.   On October 20, 1989, the FCC issued FiberComm a

cellular telephone license to the area.   FiberComm previously had

obtained a financing commitment from an unrelated party to help

it construct its Oregon cellular telephone system.    Although

FiberComm's cellular telephone system began operating in January

1991, and as of March 31, 1991, FiberComm had 105 subscribers to

the system's cellular telephone services, further construction

work with respect to the system was needed.    In April 1991,
                              - 25 -

FiberComm assigned its Oregon rural statistical area number three

cellular telephone license to Blue Mountain Cellular Telephone,

Inc. (BMCT), another corporation solely owned by Kyle.

     BMCT was formed in October 1990.   In late 1990, BMCT entered

into an agreement to purchase for $3,615,771 a cellular telephone

license and other assets from WKBN Broadcasting Corp. (WKBN).

BMCT and WKBN were unrelated parties.   During its negotiations

with BMCT, WKBN was advised and represented by a large nationally

known law firm.

     The above purchase of the cellular telephone license and

other assets would allow BMCT to operate a cellular telephone

system in the rural statistical number eight area of Washington

State.   Although WKBN's cellular telephone system for the area

began operating in January 1991, and as of March 31, 1991, there

were 85 subscribers to the system's cellular telephone services,

further extensive construction work with respect to the system

was needed.

     To help effectuate its purchase of the Washington rural

statistical area number eight cellular telephone license and

other assets, in late 1990, BMCT applied to a local Indiana bank

for a letter of credit for approximately $2.99 million.   The bank

issued the letter of credit after Mr. Mussman executed an

agreement pledging certain of NITCO's assets, including certain

certificates of deposit and interests in various governmental

securities, to cover the bank's potential liability under the
                              - 26 -

letter of credit.   In addition, in 1990, NITCO loaned BMCT

$500,000 to use as a downpayment on BMCT's purchase of the

cellular telephone license and other assets.

     On or about April 22, 1991, NITCO loaned BMCT another $3.1

million, so that the principal amount of NITCO's outstanding

loans to BMCT totaled in excess of $3.6 million.      With this

additional $3.1 million loan from NITCO, BMCT was then able to

conclude its purchase of the cable telephone license and other

assets from WKBN on April 22, 1991.3    As a result, the above

letter of credit issued by the local Indiana bank was canceled.

     At about the time of its April 22, 1991, acquisition of the

Washington rural statistical area number eight cellular telephone

business, BMCT arranged to borrow another $2.8 million from an

unrelated third party, to finance further construction of the

Washington cellular telephone system.    To help BMCT obtain the

$2.8 million loan from this third party, NITCO agreed to

subordinate its prior loans to BMCT to the third party's loan.

     3
      An explanatory note to the Dec. 31, 1991, financial
statements of BMCT, L.P., the limited partnership that BMCT,
FiberComm, and NITCO subsequently formed, reflects that the
$3,615,771 purchase price paid by BMCT was allocated to the
license and other assets that were acquired as follows:


          Land and buildings               $151,143
          Cellular license                2,217,265
          Equipment                         147,363
          Warranties                        500,000
          Consulting agreement              100,000
          Noncompete agreement              500,000

            Total                        $3,615,771
                              - 27 -

Thus, the third party generally would enjoy priority over NITCO

with respect to having the third party's $2.8 million loan repaid

by BMCT.

     Kyle ceased being an employee of NITCO around the middle of

1990.   He then moved to the Pacific Northwest and resided there

in 1991 and 1992 in order to conduct BMCT's and FiberComm's

respective operations.   In 1991 and 1992, NITCO paid Kyle an

annual "salary" of $73,292 and $77,283, respectively.

Additionally, from the middle of 1990 through February 1993, Kyle

continued to be covered under NITCO's retirement plan and

continued to receive coverage under NITCO's dental and health

insurance plans.

     During 1991 and 1992, BMCT made no interest and principal

payments on the loans it received from NITCO.

     During the latter part of 1991, Mr. Mussman proposed to Kyle

that BMCT, FiberComm, and NITCO form a limited partnership that

would undertake to build and operate the Oregon rural statistical

area number three and Washington rural statistical area number

eight cellular telephone systems.   Mr. Mussman told Kyle that he

just wanted NITCO to have a short-term investment that paid a

guaranteed annual return.

     In late 1991, Kyle sold to Rhys:   (1) A 46-percent stock

interest in BMCT for $61,000, and (2) a 46-percent stock interest

in FiberComm for $61,000.   By the end of 1991, BMCT owed a total

of approximately $3.8 million in principal and interest on the
                              - 28 -

loan it received from the unrelated third party, in addition to

the $3.6 million it owed to NITCO.

     By about April 1992, BMCT, FiberComm, and NITCO had formed

BMCT, L.P. (the BMCT limited partnership).   Although the BMCT

limited partnership's formation was actually concluded and

finalized by them in April 1992, the BMCT limited partnership's

written partnership agreement stated that the partnership

agreement was made and entered into by them as of November 30,

1991.   The partnership agreement provided that BMCT and FiberComm

would serve as the general partners and that NITCO would be a

limited partner in the BMCT limited partnership.    There were no

other partners in the BMCT limited partnership.

     BMCT and FiberComm contributed all their assets, subject to

all their liabilities, to the BMCT limited partnership.    NITCO

contributed to the BMCT limited partnership the loans it had

previously made to BMCT, interest that had accrued with respect

to the loans, and certain equipment.

     The formation of the partnership was not an arm's-length

transaction among BMCT, FiberComm, and NITCO.    The respective

partnership interests that BMCT, FiberComm, and NITCO received in

the BMCT limited partnership were not commensurate with and bore

no reasonable relationship to their relative capital

contributions to the BMCT limited partnership.    Considering the

relative amount of NITCO's capital contribution, NITCO's limited

partnership interest was a substantially lesser interest than
                               - 29 -

what NITCO should have obtained had it been dealing at arm's

length with the other two partners, BMCT and FiberComm.    In

addition, to NITCO's detriment, the partnership agreement greatly

overvalued BMCT’s and FiberComm's capital contributions to the

BMCT limited partnership.

     The partnership agreement provided that NITCO would receive

annual guaranteed payments from the limited partnership equal to

10 percent of NITCO's capital contribution.    The partnership

agreement also provided that any remaining cash flow and

operating profits would be allocated 99 percent to BMCT and

FiberComm, the general partners, and 1 percent to NITCO, the only

limited partner.    In the event that the BMCT limited partnership

was liquidated, the proceeds were to be distributed to the extent

of and in proportion to the positive balances in the partners'

capital accounts.

     Prior to the latter part of 1991, Mr. Mussman and NITCO had

not engaged in any discussions with Kyle about the formation of a

cellular telephone partnership between BMCT and NITCO.    In April

1991, the IRS issued the respective notices of deficiency to

petitioners that are the subject of the instant cases.    As a

result of certain legal advice he and NITCO received from

attorneys with the law firm of McDermott, Will & Emery (MW&E),

Mr. Mussman decided to have NITCO's loans to BMCT converted to a

limited partnership interest in a partnership to be formed among

BMCT, FiberComm, and NITCO.    A MW&E attorney previously had
                                - 30 -

represented Mr. Mussman and NITCO during the examinations that

led to the IRS’ issuances of the notices of deficiency in the

instant cases.   MW&E attorneys also represented NITCO in the

formation of the limited partnership.

     Pursuant to their partnership agreement, the partners valued

their respective capital contributions to the BMCT limited

partnership as follows:


  General Partner           Description                  Value

    BMCT               All assets subject to all          $-0-
                         liabilities

    FiberComm          All assets subject to all        6,507,353
                         liabilities

  Limited Partner           Description                  Value

    NITCO              Subordinated promissory note    $3,972,553
                         dated Apr. 22, 1991, from
                         BMCT, in the principal amount
                         of $3,615,771, together with
                         interest accrued thereon of
                         $210,920 and the contribution
                         of equipment worth $145,862


     On the BMCT limited partnership's December 31, 1991,

financial statements, the partners' formation of the partnership

was not treated as being an arm's-length transaction among the

partners.   Certain notes to the BMCT limited partnership's

December 31, 1991, financial statements concerning the relative

capital contributions made by BMCT, FiberComm, and NITCO,

explained, in pertinent part:
                             - 31 -

     The shareholders of * * * [BMCT] and FiberComm are also
     related to the majority shareholder of NITCO. Because
     the partners are all related entities, the assets
     contributed to the partnership were recorded at book
     value for financial reporting purposes.

     Contributed assets and liabilities at book value are
     summarized as follows:

                                 BMCT    FiberComm       NITCO

     Cash                      $(834)        $25      $3,615,771
     Other current assets    402,145         --           --
     Cellular communica-   2,591,958       4,075          --
       tions assets
     Licenses &            3,099,068      43,331            --
       intangibles
     Current liabilities    (510,420)        --           --
     Long-term debt       (6,382,521)    (12,093)        210,920
     Net capital            (800,604)     35,338       3,826,691
       contributions

                         * * * * * * *

     The limited partner has contributed certain equipment
     for use by * * * [the BMCT limited partnership], the
     value of which has not been reflected in the assets or
     capital accounts. In addition, interest of $210,920
     was accrued on the note to the limited partner prior to
     its conversion to a capital contribution.


     On June 9, 1994, shortly before the trial in the instant

cases, NITCO's interest in the BMCT limited partnership was

redeemed for about $3.6 million.

     Although petitioners offered expert witness testimony at

trial as to the value of the Oregon rural statistical area number

three and Washington rural statistical area number eight cellular

telephone businesses, as of March 31, 1991, their experts’

appraisal reports grossly inflated the actual value of these

cellular telephone businesses.   One appraisal report concluded
                               - 32 -

that FiberComm's Oregon rural statistical area number three

cellular telephone business, "free and clear of any

encumbrances", was worth $12,039,000, as of March 31, 1991.    The

other appraisal report concluded that the Washington rural

statistical area number eight cellular telephone business, "free

and clear of any encumbrances", was worth $8,253,000, as of March

31, 1991.

     These inflated valuations were based on revenue projections

of the mean annual revenue produced by certain other cellular

telephone businesses and were not based on revenue projections of

the subject cellular telephone businesses' expected future

financial operating results.   The appraisal reports failed to

elaborate specifically with respect to exactly how comparable

these other cellular telephone businesses were to the subject

businesses.4   As indicated above, the subject businesses'

cellular telephone systems still required further extensive



     4
      Each of the appraisal reports stated, in pertinent part:


          The subscriber and financial projections presented
     in this report and used to value * * * [the subject
     cellular telephone business] are intended to reflect
     mean expectations in the marketplace. These
     projections are based on information contained in
     financial analyses of the industry and the expectations
     implied by recent comparable sales. These assumptions
     may differ from projections made for operational
     purposes. The projections presented in this report
     therefore include both the current industry results and
     the significant upside potential of the industry.
                               - 33 -

construction work.5   Moreover, while the Washington cellular

telephone business was appraised to be worth in excess of $8.25

million, BMCT, in late 1990, had contracted to purchase this

business for approximately $3.6 million following arm's-length

negotiations between BMCT and the seller, an unrelated party.

See note 3, supra p. 26.    The record does not show that the

Washington cellular telephone business appreciated greatly in

value shortly after BMCT purchased it in late 1990.

Additionally, as indicated above, Kyle sold 46-percent stock

interests in BMCT and FiberComm, the two corporations that owned

the two businesses, to Rhys for $61,000 apiece in late December

1991.    Kyle testified that the price paid to him by Rhys for the

FiberComm shares represented "what a willing buyer would have

paid a willing seller".


     5
      An explanatory note to the Dec. 31, 1991, financial
statements of BMCT, L.P., stated, in pertinent part:


     Operations
     BMCT, L.P. is principally engaged in the ownership and
     operation of cellular telephone systems. The Company
     has been in a start-up phase in which its activities
     have primarily concentrated on the acquisition of
     cellular licenses and the construction and initial
     operation of cellular systems. As a result, the
     Company has experienced substantial net losses and has
     had insufficient internally generated funds to cover
     capital and operating expenditures and debt service.
     Management anticipates that it will continue to incur
     substantial losses and will not be able to generate
     sufficient cash from operations to meet expenditure
     requirements over the next few years.
                              - 34 -

           J.   Certain Legal Expenses Which NITCO Paid


     During the years in issue, NITCO paid substantial fees to

various attorneys and law firms in connection with certain legal

proceedings and other legal matters.   Most of the legal expenses

that are in dispute between the parties are attributable to

proceedings that were commenced before the FCC in 1983,

concerning whether NICATV (the cable television company Rhys

owned) was an affiliate of NITCO or are attributable to

subsequent related legal proceedings that were brought as a

result of the FCC proceedings.


Divestiture Action


     On October 13, 1983, another cable television company that

was a competitor of NICATV filed a complaint with the FCC against

Rhys Mussman d/b/a NICATV and NITCO.   The complaint alleged that

NICATV and NITCO were affiliated companies engaged in

discriminatory and anticompetitive conduct in violation of the

Communications Act and the FCC's telephone company/cable

television company cross-ownership rules.6   In its complaint, the

other cable television company sought damages and a cease and



     6
      The FCC’s cross-ownership rules generally prohibited a
local telephone company from offering cable television services
to the viewing public within its telephone service area, either
directly or indirectly through an affiliated company. The FCC’s
rules broadly defined affiliation to include any financial or
business relationship between the telephone company and the cable
television company, except the common carrier-user relationship.
                               - 35 -

desist order against NICATV and NITCO.

     On March 18, 1985, the FCC, after concluding that NICATV and

NITCO were affiliated companies and that they had violated the

FCC's cross-ownership rules, ordered NICATV and NITCO to:    (1)

Divest all cable television facilities constructed in violation

of the FCC's rules and terminate all improper affiliations

between NICATV and NITCO, and (2) undertake to negotiate a good

faith settlement of the cable television company-complainant's

claim for damages.    The FCC further proposed to impose a $20,000

fine against NITCO.   On August 13, 1985, the FCC denied NITCO's

motion for reconsideration and reaffirmed its prior March 12,

1985, order.

     In November 1985, NICATV and NITCO concluded a settlement

with the cable television company-complainant that disposed of

the complainant's claim against them.    The FCC, however, declined

to terminate the proceedings and rescind its prior orders

requiring NICATV and NITCO to divest themselves of the cable

television facilities.

     Until about 1990, NITCO and NICATV continued to dispute the

validity of the FCC orders requiring a divestiture of the cable

television facilities.   At various times during the period from

August 1985 through 1990, they sought to have the FCC's actions

reviewed and invalidated by the United States Court of Appeals

for the District of Columbia Circuit and the United States

Supreme Court.   Ultimately, the Court of Appeals upheld the FCC's
                              - 36 -

actions, and the Supreme Court denied NITCO and NICATV's petition

for a writ of certiorari.   See Northwestern Ind. Tel. Co. v. FCC,

872 F.2d 465 (D.C. Cir. 1989), cert. denied 493 U.S. 1035-1036

(1990).   These proceedings involving NICATV and NITCO before the

FCC, the Court of Appeals for the District of Columbia Circuit,

and the Supreme Court, are collectively referred to for

convenience as the divestiture action.


Enforcement Action


     During 1985 and 1986, after learning that NICATV and NITCO

were commencing appellate proceedings to have the FCC's 1985

orders reviewed by the Court of Appeals for the District of

Columbia Circuit, the FCC offered to them the option of placing

the alleged unlawfully constructed cable television facilities in

trust, pending the outcome of the appellate proceedings.   NICATV

and NITCO, however, were unable to reach an agreement with the

FCC concerning such a trust, as the FCC, among other things,

proposed that any appreciation in the cable television

facilities, during the period that the facilities were held in

the trust, be contributed to charity if the FCC's position were

sustained.   The Court of Appeals for the District of Columbia

Circuit subsequently declined NICATV and NITCO's request to have

the FCC orders stayed.   When NICATV and NITCO further declined to

divest themselves of the cable television facilities, the FCC

referred the matter to the Department of Justice for purposes of
                              - 37 -

enforcing the FCC's divestiture orders against NICATV and NITCO.

     In early 1987, the United States brought suit against NICATV

and NITCO in the United States District Court for the Northern

District of Indiana for enforcement of the FCC's divestiture

orders.   These proceedings before the District Court are referred

to for convenience as the enforcement action.


Constitutional Challenge Action


     During the course of the above divestiture action, NICATV

and NITCO later tried to raise certain issues with respect to the

constitutionality of the Communications Act and the FCC's cross-

ownership rules.   The FCC and the Court of Appeals for the

District of Columbia Circuit, however, essentially held that

these constitutional issues were not properly before them.

Northwestern Ind. Tel. Co. v. FCC, 872 F.2d at 471-472.

     On March 24, 1988, Rhys and NITCO filed a declaratory

judgment action against the FCC in the United States District

Court for the Northern District of Indiana, requesting that the

District Court declare unconstitutional an FCC cross-ownership

rule imposed against Rhys.   In the complaint, it was alleged that

Rhys wished to buy shares of stock in NITCO from Mr. Mussman, but

was unable to do so under the FCC’s cross-ownership rules, in

light of his ownership of NICATV.   These proceedings before the

District Court are referred to for convenience as the

constitutional challenge action.
                                 - 38 -

Attribution of Legal Expenses NITCO Incurred and/or Paid to
Various Legal Proceedings and Other Legal Matters


     During 1987 and 1988, the attorney’s fees in issue, that

NITCO incurred and/or paid to the law firm of Baker & Hostetler

(B&H), were attributable to the following legal proceedings and

other legal matters:


            Year       Amount         Proceeding or Matter

            1987     $2,762.65        AT&T negotiations
                      1,500.00        Constitutional challenge
                                        action
                      4,337.50        Dial One Mobile
                        130.00        Divestiture action
                    172,756.85        Enforcement action
                      1,000.00        NITCO business plan

            1988      2,500.00        AT&T negotiations
                     15,959.48        Constitutional challenge
                                        and divestiture action
                      3,022.96        Dial One Mobile
                      7,009.89        RSA #1

            1989     10,117.80        Postal Service Investigation
                      1,365.44        Unknown


Respondent concedes that the above fees paid to B&H for AT&T

negotiations and the NITCO business plan are deductible by NITCO.

The Dial One Mobile matters concerned the company that Rhys

owned, which was engaged in activities with respect to cellular

telephone systems in Asheville, North Carolina, and Enid,

Oklahoma.    NITCO had no interest in Dial One Mobile.   The Postal

Service investigation involved a matter in which certain

documents and records of NICATV's were seized from NICATV's

business offices.
                                   - 39 -

     During 1987, 1988, and 1989, the attorney’s fees in issue,

that NITCO incurred and/or paid to the law firm of LMN&G, were

attributable to the following legal proceedings and other legal

matters:


           Year         Amount          Proceeding or Matter

           1987     $169,686.00         Constitutional challenge,
                                          divestiture, and
                                          enforcement actions
                       5,000.00         Unknown

           1988       98,212.00         Constitutional challenge,
                                          divestiture, and
                                          enforcement actions
                       1,000.00         Dial One USA trademark
                      38,020.00         RSA #1
                       1,400.00         Unknown

           1989      214,201.00         Constitutional challenge,
                                          divestiture, and
                                          enforcement actions
                       5,393.00         Dial One USA
                      31,249.00         RSA #1
                      32,240.00         Sprint contract
                      14,650.00         Unknown


The Sprint work referred to above concerned the negotiation of a

contract between Dial One USA and Sprint.

     During 1988 and 1989, NITCO incurred and/or paid to the law

firm of Williams & Connolly (W&C) attorney’s fees that were

attributable to the following legal proceedings and other legal

matters:


             Year         Amount            Proceeding or Matter

             1988       $32,144.50          Constitutional challenge
                                              action
                              - 40 -

             1989     13,742.45        Constitutional challenge
                                         action
                       2,239.85        Dial One Mobile


The Dial One Mobile work listed above was billed by W&C to Rhys,

not to NITCO.   Petitioners concede that the $2,239.85 is not

deductible by NITCO and represents constructive dividend income

to Mr. Mussman.

     During 1989, NITCO made certain legal expenditures totaling

$88,484, for which it claimed no deduction.    A portion of these

expenditures in the amount of $75,342 was recorded by NITCO in an

account called "Cellular Telephone Investment".       The remaining

$13,052 of the expenditures was recorded by NITCO in an account

called "Other Investments".   The $88,484 in legal expenditures

was attributable to the following matters:


     Payee                Amount             Matter

  Andrew & Kurth         $1,166.59       Dial One Mobile
  B&H                    32,363.64       Dial One Mobile
  EMCI                    3,327.50       Purchase of cellular
                                           telephone publications
  Handlon & Handlon      1,525.81        Work for Dial One USA and
                                         Intelcom
                           132.00        Work for FiberComm
                           229.00        Unknown
                           234.00        Incorporation of
                                           Northwestern
                                         Indiana Cellular
  LMN&G                  2,982.58        Work for Rhys
                         2,564.05        Indiana RSA #1 venture
                         4,400.00        Conceded by petitioners to
                                           be constructive dividend
                                           to Mr. Mussman
  Unknown               39,968.83        Unknown


On the record presented in the instant cases, it is not clear
                               - 41 -

whether the purchase of cellular publications referred to above

furthered NITCO's interests and was of direct and substantial

benefit to NITCO or, instead, was primarily of benefit to

individual members of the Mussman family.     The Northwestern

Indiana Cellular matter referred to above concerned a corporation

that was originally formed to hold cellular telephone interests,

but which subsequently was abandoned.   It is not clear whether

Mr. Mussman planned to have NITCO, rather than the individual

members of the Mussman family, own Northwestern Indiana Cellular,

and whether Mr. Mussman planned to have it hold cellular

telephone interests that NITCO, rather than individual members of

the Mussman family, owned.


        K. NITCO's Earnings and Dividend Payment History,
    Current Liquid Assets, Working Capital Needs, and Records
    Documenting Its Specific Future Business Needs and Plans


     NITCO maintained its books and filed its income tax returns

on a calendar year basis, utilizing an accrual method of

accounting.   During 1982 through 1993, NITCO's gross receipts and

its accumulated earnings and profits (Accum. E&P) were as

follows:

                                                 Yearly Increase
    Year      Gross Receipts    Accum. E&P        In Accum. E&P

    1982       $3,172,182        $3,176,521              --
    1983        3,684,425         3,929,694           $753,173
    1984        4,247,606         4,895,862            966,168
    1985        4,019,355         5,406,973            511,111
    1986        4,575,760         6,240,031            833,058
    1987        5,754,822         7,807,835          1,567,804
    1988        6,134,837         9,226,900          1,419,065
                              - 42 -

    1989        5,281,159        9,939,632             712,732
    1990        6,305,070       11,675,809           1,736,177
    1991        6,860,118       12,688,043           1,012,234
    1992        7,780,380       14,544,105           1,856,062
    1993        8,726,683       15,250,005             705,900


     During 1987 through 1989, NITCO's current assets consisted

mostly of cash or other liquid assets.     Its customer accounts

receivable and National Exchange Carriers Association accounts

receivable (i.e., long-distance call access charges) were billed

monthly.

     During 1987 through 1989, NITCO's net current liquid assets,

as adjusted by two loans it made, respectively, to a local

Indiana bank's employee stock option plan and to the bank's

president,7 and if not depleted by certain payments it made to

support the individual Mussman family members during these years,

would have been as follows:

                 Year         Net Current Liquid Assets

                 1987                  $5,183,131
                 1988                   4,726,973
                 1989                   4,455,217


     NITCO's working capital requirements for 1987, 1988, and

1989, were $75,569, $278,646, and $190,312, respectively.



     7
      After its renegotiation in August 1987, the ESOP loan
essentially was required to be repaid to NITCO on NITCO's demand.
The $400,000 loan to the bank president occurred on June 15,
1987, and was made out of a loan repayment NITCO received from
the ESOP. Although a promissory note bearing a December 1988
execution date was later issued by the bank president, the note
obligated the bank president to repay the $400,000 loan to Mr.
Mussman, rather than to NITCO, in 4 years.
                               - 43 -

     From 1980 through 1989, NITCO maintained no written records

documenting its specific future business needs and plans.

     From 1954 through 1994, NITCO did not declare and pay any

formal dividends to its shareholders.


 L. Examinations Conducted of Petitioners' Returns, Notices of
 Deficiency, NITCO's Petition, and Subsequent Formal Discovery
          Conducted by Respondent in the Instant Cases


     On or about August 3, 1990, a revenue agent contacted and

apprised Mr. Mussman and NITCO that the agent would be conducting

an examination.   In an Information Document Request dated October

31, 1990, to NITCO, the revenue agent, among other things, asked

NITCO to elaborate with respect to its plans concerning the use

of its accumulated earnings.   The agent's request, in pertinent

part, stated:


     1. During my first visit, you enumerated the following
     potential uses of the company's retained earnings:

     At the present time, the Company is involved in
     expansion:

     (1) The Company has a plan to introduce fiberoptics to
     its system. Engineering estimates have not been made
     for the system.

     (2) The Company is developing a cellular telephone
     capability for the area. This area is a RSA, Rural
     Statistical Area. This development is being shared
     with two other companies, Monan and Pulaski-White.
     However, the family members, not the Company, made the
     investment.

     (3) The Company would like to acquire the Monan
     telephone exchange. There have been negotiations but
     nothing has been put in writing about this. The
     Company is closely held. As a result, there are no
                              - 44 -

     formal annual meetings or minutes.

     Are there any other planned uses of these funds?


     On or about December 12, 1990, two MW&E attorneys advised

the revenue agent that they would be representing NITCO during

the examination.   By letter dated December 17, 1990, one of the

MW&E attorneys further advised the revenue agent, among other

things:   (1) NITCO had not yet completed its review of the

planned uses for its accumulated earnings, and (2) NITCO was not

willing to consent to an extension of the period of limitations

on assessment and collection of its tax liability with respect to

1987.   The MW&E attorney's December 17, 1990, letter, in

pertinent part, stated:


          You have also asked the company to identify the
     potential uses of net liquid assets [and accumulated
     earnings]. We have recently been retained by the
     company for purposes of this representation and are in
     the process of reviewing the corporate documentation
     and interviewing the officers. When that process has
     been completed, we will provide you with a full
     statement concerning the historic purposes for
     accumulating net liquid assets [and earnings].
     Although the process is far from complete, the list
     included in your [October 31, 1990] document request
     overlooks the largest and most obvious need for net
     liquid assets. That is, the preservation of financial
     strength to cope with the uncertainty present in the
     telecommunications industry during the period under
     audit. Those uncertainties concern technical
     developments and regulatory governance and management
     succession.

          As counsel to the company, we have advised them
     not to extend the statute of limitation for the year
     1987 for purposes of audit. While we generally
     recommend extensions of the statute for purposes of
     appellate review of a case, we do not recommend
                             - 45 -

     extension of the statute for purposes of audit. In our
     view, the time pressure you face for the year 1987 is
     the product of your (or your supervisor's) decision to
     open 1987 with so little time remaining on the statute.


     Respondent subsequently notified NITCO of the proposed

determination against NITCO with respect to accumulated earnings

tax liability for 1987, 1988, and 1989.   NITCO chose not to

respond and did not file a statement concerning the grounds on

which it relied to establish that its earnings were accumulated

to meet its reasonable business needs.8

     In April 1991, respondent issued respective notices of

deficiency to Mr. and Mrs. Mussman for 1988 and 1989, and to

NITCO for 1987, 1988, and 1989.   With respect to the accumulated

earnings tax liability asserted against NITCO, the notice of

deficiency issued to NITCO stated, in pertinent part:


     10(b.) Section 531 Tax
     It is determined that you were availed of for the
     purpose of avoiding the income tax with respect to your
     shareholders by permitting earnings and profits to
     accumulate instead of being divided or distributed
     during the taxable years 1987, 1988, and 1989.
     Accordingly, the accumulated earnings tax provided by
     Section 531 of the Internal Revenue Code is being
     asserted for 1987, 1988, and 1989. In determining your
     accumulated earnings credit under the provisions of
     section 535 of the Internal Revenue Code, your failure
     or refusal to respond to the notification sent to you
     by certified mail on January 15, 1991 pursuant to
     [section] 534(b) explaining the capital needs of your
     business has been considered. Therefore, accumulated


     8
      As a result, in the instant cases, NITCO has the burden of
proof in establishing that it is not liable for the accumulated
earnings tax liabilities determined against it by respondent in
the notice of deficiency. See sec. 534(a)(2).
                                    - 46 -

     earnings tax is increased $540,044.00, $322,147.00, and
     $195,917.00, respectively for the tax years ended
     December 31, 1987, December 31, 1988, and December 31,
     1989. * * *


The notice of deficiency indicated that respondent computed

NITCO's above 1987, 1988, and 1989 accumulated earnings tax

liabilities as follows:

                             1987             1988         1989

Taxable income           $1,431,283.00   $1,150,524.00     $699,703.00
  as adjusted

Less dividends                    0.00              0.00          0.00

Current earning          1,431,283.00    1,150,524.00      699,703.00
  and profits retained

Accumulated earnings
  Credit
   1. Minimum              250,000.00          --          250,000.00
        accumulated
        earnings allowed
   2. Less              (6,240,031.45)   (7,800,101.00) (9,266,900.00)
        accumulated
        earnings as of the
        close of the preceding
        taxable year
   3. Reduced by dividends       0.00               0.00          0.00
       considered paid during
       preceding taxable year
   4. Allowable credit           0.00               0.00          0.00
   5. Current earnings and       0.00               0.00          0.00
       profits determined to be
       retained for reasonable
       needs of the business
   6. Less: deduction for        0.00                --           --
       long-term capital gains
   7. Allowable credit under     0.00               0.00          0.00
       IRC sec. 535(c)(1)

Accumulated earnings credit       0.00              0.00          0.00
  (greater of item 4 or item 7)

Accumulated taxable      $1,431,283.00   $1,150,524.00     $699,703.00
 income subject to tax

Tax on accumulated         540,044.00        322,147.00    195,916.84
  earnings
                                - 47 -

     Petitioners subsequently filed their respective petitions

commencing the instant cases.    In its petition, NITCO did not

allege any specific business needs for which it was accumulating

its earnings.

     During pretrial discovery, on March 4, 1992, respondent

propounded certain interrogatories to NITCO asking it to

elaborate fully with respect to the alleged specific business

needs for which NITCO contended it was accumulating its earnings

during 1987 through 1989.   In its April 17, 1992, response to the

interrogatories, NITCO generally objected to having to answer the

interrogatories and declined to provide the information

respondent sought, except that in partial response to some of the

interrogatories, NITCO referred to an April 8, 1992, memorandum

concerning NITCO's reasonable business needs that had been

prepared by NITCO's counsel and that recently had been furnished

by NITCO's counsel to respondent's Appeals officer.    The April 8,

1992, memorandum provided to the Appeals officer stated:


     This is a summary of the items we intend to rely on as
     justification of * * * NITCO's accumulation of working
     capital [and earnings] for years 1987 through 1989. It
     is based upon documents we have reviewed and
     discussions we have had to date with NITCO personnel
     and outside advisors (including NITCO's accountant,
     outside counsels [sic] and independent telephone
     industry consultants).


The memorandum did not indicate that NITCO, during the years in

issue, planned to:   (1) Replace its Alcatel switches, (2) acquire
                                - 48 -

SS7 signaling technology,9 (3) offer CLASS services,10 (4) save in

order to provide increased local telephone services in the event

the proposed Indiana airport was built in or near NITCO's service

area, (5) save for expansion of NITCO's principal office

facilities, or (6) purchase a computer to meet its alleged office

equipment needs.     Subsequently, on August 4, 1992, the Court

granted respondent's motion to compel NITCO to answer the

interrogatories and issued an order requiring NITCO to answer the

interrogatories on or before September 4, 1992.

         It was not until about December 1992 that NITCO first

advised respondent of its alleged plans, during the years in

issue, to:     (1) Save in order to provide increased telephone

services in the event the proposed Indiana airport was built, and

(2) save for an expansion of its principal office facilities.

Similarly, it was not until November 1993 that NITCO first

advised respondent that its alleged office equipment needs during

the years in issue included a billing and collections computer.




     9
      SS7 signaling technology uses a data network separate from
the voice network to carry information about telephone call setup
and accounting.
     10
      CLASS services are a group of telecommunication services
consisting of selective call forwarding, selective call
rejection, distinctive ringing, customer originated trace,
automatic callback, automatic recall, and calling number delivery
and calling number delivery blocking.
                               - 49 -

                              OPINION


     Petitioners bear the burden of proof and must establish that

the determinations made in respondent's notices of deficiency are

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


                   I.   Accumulated Earnings Tax


     Section 532(a) provides that every corporation formed or

availed of for purposes of avoiding the income tax with respect

to its shareholders, by permitting earnings and profits to

accumulate instead of being divided or distributed, shall be

subject to the accumulated earnings tax imposed by section 531.

The accumulated earnings tax is a way of discouraging

corporations from accumulating earnings not needed in conducting

the business.   Snow Manufacturing Co. v. Commissioner, 86 T.C.

260, 268 (1986).   The tax is considered to be a penalty and,

therefore, is to be strictly construed.   Ivan Allen Co. v. United

States, 422 U.S. 617, 626 (1975); see generally Technalysis Corp.

v. Commissioner, 101 T.C. 397, 402-403 (1993).

     The most important factor in deciding if the accumulated

earnings tax applies is whether a corporation accumulates

earnings and profits beyond the reasonable needs of the business.

United States v. Donruss Co., 393 U.S. 297, 307 (1969).     Section

533(a) establishes a presumption that a corporation that permits

earnings and profits to accumulate beyond the reasonable needs of
                               - 50 -

the business does so with the purpose of avoiding income tax with

respect to its shareholders.

     The presumption can be rebutted by a preponderance of

evidence to the contrary.   Sec. 533(a); Snow Manufacturing Co. v.

Commissioner, supra at 269.    Therefore, the accumulated earnings

tax does not apply if a corporation has allowed an unreasonable

accumulation but lacks the proscribed purpose or intent.

Technalysis Corp. v. Commissioner, supra at 403; Pelton Steel

Casting Co. v. Commissioner, 28 T.C. 153, 173 (1957), affd. 251

F.2d 278 (7th Cir. 1958).   However, it has been recognized that

without the presumption provided in section 533(a), the

accumulated earnings tax would largely, as a practical matter, be

unenforceable.   Ivan Allen Co. v. United States, supra at 628.

     Section 1.533-1(a)(2), Income Tax Regs., sets forth factors

to be considered in determining whether a corporation had the

proscribed purpose.   Some of the relevant factors are:   (1)

Dealings between the corporation and its shareholders for the

personal benefit of the shareholders; for example, personal

loans; (2) corporate investment of undistributed assets in

unrelated businesses or investments; and (3) the corporation's

dividend history.

     Section 535(a) defines "accumulated taxable income" (the

recomputed taxable income of the corporation against which tax

under section 531 is imposed) as the taxable income of the

corporation, as adjusted in section 535(b), less the dividend-
                             - 51 -

paid deduction (as defined in section 561) and the accumulated

earnings credit (as defined in section 535(c)).   Insofar as

relevant to the instant cases, this accumulated earnings credit

is the amount of the corporation's earnings and profits that are

retained for the reasonable needs of the business.   Where a

taxpayer can show that all its current earnings were accumulated

for the reasonable needs of the business, there is no accumulated

earnings tax since the accumulated earnings credit eliminates the

amount against which the tax is imposed.   E.g., Magic Mart, Inc.

v. Commissioner, 51 T.C. 775, 799 (1969); Faber Cement Block Co.

v. Commissioner, 50 T.C. 317, 336 (1968); John P. Scripps

Newspapers v. Commissioner, 44 T.C. 453, 474 (1965).

     Whether a taxpayer's accumulation of earnings and profits is

in excess of its reasonable business needs is a factual question.

Helvering v. National Grocery Co., 304 U.S. 282 (1938).    The

"reasonable needs of the business" includes the reasonably

anticipated needs of the business.    Sec. 537(a)(1); sec. 1.537-

1(a), Income Tax Regs.

     With respect to a corporation's reasonably anticipated

future business needs, section 1.537-1(b), Income Tax Regs,

provides:


          (b) Reasonably anticipated needs. (1) In order for
     a corporation to justify an accumulation of earnings
     and profits for reasonably anticipated future needs,
     there must be an indication that the future needs of
     the business require such accumulation, and the
     corporation must have specific, definite, and feasible
                             - 52 -

     plans for the use of such accumulation. Such an
     accumulation need not be used immediately, nor must the
     plans for its use be consummated within a short period
     after the close of the taxable year, provided that such
     accumulation will be used within a reasonable time
     depending upon all the facts and circumstances relating
     to the future needs of the business. Where the future
     needs of the business are uncertain or vague, where the
     plans for the future use of an accumulation are not
     specific, definite, and feasible, or where the
     execution of such a plan is postponed indefinitely, an
     accumulation cannot be justified on the grounds of
     reasonably anticipated needs of the business.

          (2) Consideration shall be given to reasonably
     anticipated needs as they exist on the basis of the
     facts at the close of the taxable year. Thus,
     subsequent events shall not be used for the purpose of
     showing that the retention of earnings or profits was
     unreasonable at the close of the taxable year if all
     the elements of reasonable anticipation are present at
     the close of such taxable year. However, subsequent
     events may be considered to determine whether the
     taxpayer actually intended to consummate or has
     actually consummated the plans for which the earnings
     and profits were accumulated. * * *


     Upon determining the amount necessary to satisfy the

"reasonable needs of the business", we shall not simply compare

this amount with the corporation's total accumulated earnings and

profits, but shall examine the amount of accumulated earnings and

profits that is reflected in business-related assets or in idle

net liquid assets of the corporation.   Ivan Allen Co. v. United

States, supra at 628; Smoot Sand & Gravel Corp. v. Commissioner,

274 F.2d 495, 501 (4th Cir. 1960), affg. T.C. Memo. 1958-221.   In

other words, we must consider whether the corporation's

accumulated earnings and profits have been translated into assets

related to the business, so as to have been employed to meet the
                               - 53 -

corporation's reasonable business needs.    In Smoot Sand & Gravel

Corp. v. Commissioner, 274 F.2d at 500-501, the Court of Appeals

for the Fourth Circuit explained:


     the size of the accumulated earnings and profits or
     surplus is not the crucial factor; rather, it is the
     reasonableness and nature of the surplus. * * *
     Again, to the extent the surplus has been translated
     into plant expansion, increased receivables, enlarged
     inventories, or other assets related to its business,
     the corporation may accumulate surplus with impunity.
     * * *


     In Ivan Allen Co. v. United States, supra, the taxpayer had

substantial accumulated earnings and profits and owned certain

readily marketable securities that had considerably appreciated

in value.    The issue presented to the Supreme Court was whether

in determining the applicability of the rebuttable presumption

provided in section 533(a) (i.e., whether the taxpayer's earnings

had accumulated beyond the reasonable needs of the business so

that the taxpayer should be presumed to have the purpose to avoid

income with respect its shareholders), the taxpayer's securities

were to be taken into account at their cost to the corporation or

at their net liquidation value.     Id. at 619.

     In holding that the securities were to be taken into account

at their net liquidation value, rather than cost, the Supreme

Court recognized that a comparison of the taxpayer's liquidity to

its business needs was highly significant in deciding the

reasonableness of the taxpayer's accumulation of earnings.   It

explained:
                             - 54 -



          It is important to emphasize that we are concerned
     here with a tax on "accumulated taxable income," § 531,
     and that the tax attaches only when a corporation has
     permitted "earnings and profits to accumulate instead
     of being divided or distributed," § 532(a). What is
     essential is that there be "income" and "earnings and
     profits." This at once eliminates, from the measure of
     the tax itself, any unrealized appreciation in the
     value of the taxpayer's portfolio securities over cost,
     for any such unrealized appreciation does not enter
     into the computation of the corporation's "income" and
     "earnings and profits."

          The corporation's readily marketable portfolio
     securities and their unrealized appreciation,
     nonetheless, are of profound importance in making the
     entirely discrete determination whether the corporation
     has permitted, what, concededly, are earnings and
     profits to accumulate beyond its reasonable business
     needs. If the securities, as here, are readily
     available as liquid assets, then the recognized
     earnings and profits that have been accumulated may
     well have been unnecessarily accumulated, so far as the
     reasonable needs of the business are concerned. * * *
     Upon this analysis, not only is such accumulation as
     has taken place important, but the liquidity otherwise
     available to the corporation is highly significant. In
     any event--and we repeat--the tax is directed at the
     accumulated taxable income and at earnings and profits.
     The tax itself is not directed at the unrealized
     appreciation of the liquid assets in the securities
     portfolio. The latter becomes important only in
     measuring reasonableness of accumulation of the
     earnings and profits that otherwise independently
     exist. What we look at, then, in order to determine
     its reasonableness or unreasonableness, in the light of
     the needs of the business, is any failure on the part
     of the corporation to distribute the earnings and
     profits it has.


Ivan Allen Co. v. United States, 422 U.S. at 627-628.


     What is required, then, is a comparison of accumulated
     earnings and profits with "the reasonable needs of the
     business." Business needs are critical. And need,
                             - 55 -

     plainly, to use mathematical terminology, is a function
     of a corporation's liquidity, that is, the amount of
     idle current assets at its disposal. The question,
     therefore, is not how much capital of all sorts, but
     how much in the way of quick or liquid assets, it is
     reasonable to keep on hand for the business. * * *

          The taxpayer itself recognizes, and accepts, the
     liquidity concept as a basic factor, for it "has agreed
     that the full amount of its realized earnings invested
     in its liquid assets--their cost--should be taken into
     account in determining the applicability of Section
     533(a)." * * * It concedes that if this were not so,
     "the tax could be avoided by any form of investment of
     earnings and profits." * * * But the taxpayer would
     stop at the point of cost and, when it does so, is
     compelled to compare earnings and profits--not the
     amount of readily available liquid assets, net--with
     reasonable business needs.

          We disagree with the taxpayer and conclude that
     cost is not the stopping point; that the application of
     the accumulated earnings tax, in a given case, may well
     depend on whether the corporation has available readily
     marketable portfolio securities; and that the proper
     measure of those securities, for purposes of the tax,
     is their net realizable value. Cost of the marketable
     securities on the assets side of the corporation's
     balance sheet would appear to be largely an irrelevant
     gauge of the taxpayer's true financial condition.
     Certainly, a lender would not evaluate a potential
     borrower's marketable securities at cost. Realistic
     financial condition is the focus of the lender's
     inquiry. It also must be the focus of the
     Commissioner's inquiry in determining the applicability
     of the accumulated earnings tax.

          This taxpayer's securities, being liquid and
     readily marketable, clearly were available for the
     business needs of the corporation, and their fair
     market value, net, was such that, according to the
     stipulation, the taxpayer's undistributed earnings and
     profits for the two fiscal years in question were
     permitted to accumulate beyond the reasonable and
     reasonably anticipated needs of the business.


Ivan Allen Co. v. United States, 422 U.S. at 629-630 (fn. refs.

omitted.)
                               - 56 -

NITCO's Net Liquid Assets


     Petitioners contend that NITCO's accumulated earnings and

profits are "irrelevant" and that only NITCO's net liquid assets

should be considered in connection with NITCO's reasonable

business needs and its liability for accumulated earnings tax

during the years in issue.    They argue that the accumulated

earnings tax is directed at "economic reality" and that this

relevant economic reality (NITCO's dividend-paying capacity) is

to be determined solely by examining NITCO's available net liquid

assets.

     Respondent, on the other hand, asserts that NITCO's true

dividend-paying capacity is not accurately reflected by NITCO's

remaining net liquid assets, because of NITCO's substantial

expenditures, during 1987 through 1989, for the personal benefit

of Mr. Mussman's family.    We agree with respondent.

     We have no quarrel with, and the case law completely

supports, the proposition that where a corporation's net liquid

assets have been invested in nonliquid, business-related assets,

the corporation has appropriately diminished its dividend-paying

capacity for accumulated earnings tax purposes.    In such

instances, the corporation's accumulated earnings have been

applied to meet its reasonable business needs.    However, this is

not the same situation that we are presented with in the instant

cases.
                               - 57 -

     In our findings, we have made certain adjustments to reflect

what NITCO's net liquid assets would have been (i.e., its true

dividend-paying capacity), during the years in issue, if NITCO

had not made certain nonbusiness-related payments to benefit the

individual Mussman family members.11    These expenditures did not

further NITCO's business interests and were not of substantial

and direct benefit to NITCO.

     Petitioners' arguments in this connection misapply and

misinterpret the pertinent case law.    NITCO's remaining net

liquid assets do not reflect its true dividend-paying capacity

because of substantial nonbusiness-related expenditures it made.

Indeed, many of these expenditures may have been constructive

dividends to Mr. Mussman.   These expenditures do not represent

translations of NITCO's accumulated earnings into assets related

to the conduct of NITCO's business.     Cf. Smoot Sand & Gravel



     11
      Petitioners, on the other hand, contend that for 1987,
1988, and 1989, NITCO's net liquid assets were as follows:

                    Year       Net Liquid Assets

                    1987          $3,190,325
                    1988           4,251,470
                    1989           3,991,669

We note that even these respective amounts of net liquid assets
well exceed the current earnings that NITCO accumulated during
each of these years. We are further aware that to the extent we
sustain respondent's determinations with respect to the Mussmans'
having constructive dividend income for the years in issue, there
will be a resulting decrease in NITCO's accumulated taxable
income and current earnings. See secs. 535(a), (c)(1);
301(c)(1); 316(a).
                               - 58 -

Corp. v. Commissioner, 274 F.2d at 501.     In other words, rather

than being positive evidence demonstrating that NITCO's earnings

were, in fact, accumulated to meet its reasonable business needs,

these expenditures indicate NITCO's earnings were accumulated for

the proscribed purpose of avoiding income tax with respect to its

shareholders.    See sec. 1.533-1(a)(2), Income Tax Regs.    To

accept petitioners' contention would be tantamount to holding

that the accumulated earnings tax could be avoided by making

nonbusiness expenditures to benefit a shareholder or

shareholder's family.


NITCO's Reasonable Business Needs


     The parties have stipulated, and we have so found, what

NITCO's working capital requirements were during the years in

issue.    In addition to these working capital requirements,

petitioners contend that a number of other reasonably anticipated

business needs of NITCO justified NITCO's accumulation of

earnings during the years in issue.12


     12
      Petitioners contend that NITCO's "reasonably anticipated
business needs" during the years in issue were as follows:


     Business Need                1987          1988        1989

   Working capital                $75,569    $278,646     $190,312
   Retirement of long-            557,505     170,760        -0-
     term debt
   Plant modernization:
     Fiber to the exchange      1,000,000      same          same
                                                        (continued...)
                              - 59 -

     Respondent generally disputes that NITCO, during 1987

through 1989, had the reasonable business needs that petitioners

allege.   Respondent agrees with the working capital requirements

and agrees that, for 1987, NITCO needed $669,530 to retire its

long-term debt on the old switching equipment it replaced.

Respondent further agrees that NITCO's reasonable business needs

required the accumulation of some earnings to install fiber optic

cable between its exchanges, but contends that petitioners have

failed to offer convincing evidence establishing the precise

amount.   Respondent contends that NITCO, during the years in

issue, had no actual definite plans with respect to meeting the

other alleged business needs and that those alleged needs were

not reasonably anticipated business needs of NITCO.   We generally

agree with respondent.


     12
      (...continued)
     Fiber optic cable to        500,000      same       same
       support broadband       1,000,000      same       same
     Switches for              6,000,000-     same       same
       SS7/Class              10,000,000
     Broadband switch          8,000,000-     same       same
                              20,000,000
   Telephone acquisition       1,000,000-     same       same
                               5,000,000
   Airport risk:
     In NITCO's exchange     300,000,000      same       same
     Near NITCO's             25,000,000-     same       same
       exchanges              50,000,000
   Cellular                    2,000,000-     same       same
       diversification         2,500,000
   Billings & collections        850,000-     same       same
     computer                  1,000,000
   Building expansion;         2,000,000-     same       same
     furnished                 2,500,000
                              - 60 -

     In evaluating what NITCO's reasonable business needs were

during the years in issue, we have been faced with a lack of

forthrightness on petitioners' part.   For instance, Mr. Mussman

testified that, during 1987 through 1989, NITCO planned to

replace its Alcatel switches, because the French manufacturer had

decided to abandon the U.S. market and stop conducting future

research and development efforts with respect to upgrading the

switches.   He claimed that NITCO learned of the French

manufacturer's decision shortly after NITCO had purchased and

installed its Alcatel switches.   Yet, when questioned by

respondent's counsel on cross-examination about NITCO's contrary

representations concerning the switches to the IURC's engineering

staff in late 1990, Mr. Mussman maintained that the statements in

the August 1990 letter issued to NITCO by Alcatel's U.S.

representative were untrue.   Mr. Mussman, however, offered no

convincing explanation why, if NITCO knew the statements made

were untrue, NITCO then had provided a copy of the letter to the

IURC's staff.13

     On the record presented, it is questionable whether during


     13
      In another instance, Mr. Mussman testified that
architectural plans of new principal office facilities for NITCO
were drawn up in 1989. On cross-examination, however, he claimed
that the plans were not provided to respondent during pretrial
discovery, because the plans were his personal property and did
not belong to NITCO. He further offered no convincing
explanation with respect to why petitioners had failed to produce
the alleged plans and information concerning the alleged
architect who drew them in response to respondent's pretrial
discovery requests.
                              - 61 -

the years in issue, NITCO had actual plans concerning many of the

purported business needs petitioners have alleged.   NITCO

produced practically nothing in terms of documents that were

prepared during the years in issue that reflect its alleged plans

and future needs.   Indeed, we view these claimed future needs to

be largely afterthoughts advanced by petitioners to avoid the

imposition of accumulated earnings tax liability against NITCO.

Moreover, almost all the asserted future needs are too vague and

uncertain to be considered reasonably anticipated business needs

of NITCO.

     Additionally, considerably undercutting petitioners'

position that NITCO's earnings were accumulated to meet these

alleged reasonably anticipated business needs of NITCO, is the

fact that, notwithstanding these alleged future needs, NITCO, in

late 1990 and early 1991, loaned approximately $3.6 million to

BMCT, a corporation solely owned by Mr. Mussman's son Kyle, to

enable BMCT to acquire a Washington State cellular telephone

business.   The $3.6 million loaned was an investment unrelated to

NITCO's business and was of dubious economic benefit to NITCO,

considering NITCO's later agreement to subordinate its rights

with respect to BMCT's repayment of the loan in order for BMCT to

borrow an additional $2.8 million from another lender.   Although

NITCO subsequently converted its $3.6 million loan to a limited

partnership interest in the BMCT limited partnership, pursuant to

the advice of its attorneys following the issuances of the
                              - 62 -

notices of deficiency in the instant cases, the limited

partnership's formation was not an arm's-length transaction

between the partners, and the limited partnership interest NITCO

obtained was not commensurate with its relative capital

contribution to the limited partnership.

     With respect to the retirement of NITCO's long-term debt,

petitioners have established that in 1988 and 1989, NITCO made

respective payments of $575,505 and $170,700 to retire the debt.

Although the debt's outstanding principal amount was $669,530,

NITCO was required to pay some additional interest and a

prepayment penalty to retire the debt.

     With respect to NITCO's installation of fiber optic cable to

connect its exchanges, Mr. Mussman testified that NITCO spent

about $1 million to install the fiber optic cable during 1987

through 1989.   On cross-examination, however, he admitted that

his $1 million figure included NITCO's overhead costs, as NITCO's

employees performed the installation work.   Further, most of the

cable to connect the exchanges was installed in 1987 and 1988.

By 1989, NITCO was in the final stages of the connection work,

and only a relatively short segment of cable remained to be

installed once NITCO resolved an easement problem.   We think Mr.

Mussman's $1 million figure is high.   Petitioners offered no

specific additional evidence concerning the actual amounts NITCO

spent to install the fiber optic cable during 1987 through 1989.

Doing the best we can on the record presented, and bearing
                              - 63 -

heavily against petitioners because this inexactitude is of their

own making, we estimate that the accumulation of earnings

justified to meet NITCO's reasonable business need for installing

fiber optic cable to connect its exchanges was $300,000 for 1987

and was $100,000 for each of the years 1988 and 1989.

     With respect to broadband switches and the fiber optic cable

to support broadband switches, petitioners maintain that NITCO

planned to eventually acquire the broadband switches at about the

time it commenced to rewire the homes of its residential

customers with fiber optic cable.14    Yet, in the white paper Kyle


     14
      In a letter dated Sept. 28, 1992, to respondent's counsel
that elaborated on certain of NITCO's alleged business needs,
petitioners' counsel stated:


          During the years in issue * * * [NITCO] also
     determined that ultimately it would be required to
     retrowire individual housing for fiber optic cable and
     to move on to the next generation of digital switching.
     Fiber optic cable coupled with the next generation of
     digital switching will allow NITCO to provide service
     option features to its customers comparable to
     adjoining telephone companies such as Call blocking,
     caller I.D., and call-me-back services. This next
     generation of digital switches is generally described
     as broad-band switches which have the capacity for
     greater programming flexibility in order to provide
     multiple services to each line. While no copper wire
     in existing residential and commercial installation has
     been retrofitted with fiber optic cable to date to
     allow use of the new generation switches, such program
     is anticipated in the near future to enable NITCO to
     remain competitive.


     These broadband switches apparently could also be used to
provide television or video services to customers. On reply
                                                   (continued...)
                              - 64 -

authored and published in 1989 while he was NITCO's general

manager, Kyle was of the view that the installation of fiber

optic cable in residences by local telephone companies was not

then economically feasible.   His paper estimated that using fiber

optic cables to provide "plain old telephone service" to

individual homes, at that time, would cost from $4,000 to $10,000

per residential customer.

     Respondent offered the expert witness report of Dr. Charles

L. Jackson and Dr. Jeffrey H. Rohlfs, each of whom has had

extensive experience in the telecommunications industry.    Dr.

Jackson is an engineer with 25 years of experience in the

computer and telecommunications industry.   He has worked as a

consultant for the past 13 years.   Dr. Rohlfs is an economist

with over 20 years experience in the telecommunications industry.

He worked for 14 years at Bell Labs where he became a department

head for economic modeling research and subsequently has worked

for the last 10 years as a consultant.

     Drs. Jackson and Rohlfs were of the opinion that, as of

1989, vast uncertainty existed about the future cost and

availability of systems that would provide fiber connections to




     14
      (...continued)
brief, petitioners state that they are not contending that "NITCO
* * * sought to provide wideband (video) services in 1987 to
1989, only that it saw a need * * * to provide video services in
the mid to late 1990s to meet the threat of competition from
cable companies."
                                - 65 -

residential customers.15    They further opined that it would be a

number of years before it was economically justifiable for NITCO

even to consider seriously investing in the technology to provide

broadband switch services over fiber lines to its business and

residential customers.     They noted that during 1987 through 1989,

NITCO had few, if any, business customers who would demand such

services.

     Petitioners offered the expert witness opinion of Warren A.

Liss.     Mr. Liss has extensive experience in the

telecommunications industry.     He has held a variety of management

positions involving the design and development of telephone

switching hardware and software, telephone networks, and

telecommunications services.     He worked for over 20 years at Bell

Labs and then was employed as a director of advanced systems

engineering at MCI Telecommunications.     Since 1987, he has worked

as a consultant to various local, long distance, and

international telephone service companies.

     Mr. Liss was of the opinion that the wideband switch

services now currently offered to certain businesses, hospitals,

schools, and other institutions, would inevitably migrate to

residential applications.     He noted that the FCC's recent "Video


     15
      According to Drs. Jackson and Rohlfs, during 1987 through
1989, experts in their field were predicting that, in the
telephone service industry as a whole, by the end of the century
there would be a 10-to-20 percent penetration of fiber optic
technology into the "copper loop" that connects customers to
telephone company networks.
                              - 66 -

Dial Tone" ruling removed certain regulatory restrictions that

prevented telephone companies from entering that business area.

He opined that, although the time frame could not be well

defined, it could take 5 to 10 years for serious penetration of

the residential market for broadband switch services to occur.

     The above expert opinions of Drs. Jackson and Rohlfs and Mr.

Liss, along with the 1989 white paper Kyle authored, reflect

that, during 1987 through 1989, NITCO's rewiring of residences

with fiber optic cable and its purchase of broadband switches,

would only become economically justified following the occurrence

of future commercial, legal, and technological developments that

would permit NITCO to derive substantial additional revenue from

offering new services, such as television services, over fiber

optic lines.   NITCO's plans to employ broadband switches could

hardly be considered to be specific and definite during the years

in issue.   We conclude that NITCO's future needs to install

broadband switches and the fiber optic cable to support such

switches, were too vague and uncertain to be reasonably

anticipated business needs of NITCO during 1987 through 1989.

Sec. 1.537-1(b)(1), Income Tax Regs.

     Similarly, we are not convinced that NITCO, during 1987

through 1989, had any actual plans with respect to SS7/Class

switches, "Airport risk", a billing and collections computer, and

headquarters building expansion.   As indicated above, we think

that these purported business needs are mere afterthoughts on
                               - 67 -

petitioners' part, rather than actual future needs that NITCO

anticipated and planned to meet during 1987 through 1989.      It was

not until late 1992 and 1993 that petitioners first advised

respondent's counsel that these asserted needs were among NITCO's

alleged reasonable business needs.      Moreover, these asserted

future needs were too vague and uncertain to be considered

reasonably anticipated business needs of NITCO during 1987

through 1989.   Sec. 1.537-1(b)(1), Income Tax Regs.

     With respect to possible telephone company acquisition and

cellular telephone diversification, the record is not clear

whether Mr. Mussman intended to have NITCO or individual members

of the Mussman family, undertake and benefit from such activities

or ventures.    Although NITCO applied for a cellular telephone

license with respect to the Indiana RSA #1 area in 1988, the

record reflects that Mr. Mussman's plan and intention was to

transfer the cellular telephone license rights that were obtained

to Serv-U-Cellular, another corporation that he and one or more

of his sons, individually, would own.      Petitioners have failed to

establish that telephone company acquisition and cellular

telephone diversification were reasonable business needs of NITCO

during 1987 through 1989.    Rule 142(a).

     In conclusion, we find that NITCO's reasonable business

needs, during 1987 through 1989, were as follows:
                                - 68 -


        Business Need               1987       1988       1989

    Working capital                $75,569   $278,646   $190,312
     Retirement of long-term       557,505    170,760      --
       debt
    Fiber optic to                 300,000    100,000    100,000
      the exchange


Petitioners have failed to establish that NITCO, during these

years, had reasonable business needs in excess of these amounts.

Rule 142(a).


NITCO's Liability for Accumulated Earnings Tax


     For 1987, 1988, and 1989, NITCO's accumulated earnings and

adjusted net liquid assets exceeded the reasonable needs of the

business.   NITCO is therefore presumed to have accumulated its

earnings with the purpose of avoiding income tax with respect to

its shareholders.   Sec. 533(a).

     NITCO has failed to rebut this presumption of proscribed

purpose.    Sec. 533(a); Technalysis Corp. v. Commissioner, 101

T.C. at 403.   Indeed, the record in the instant cases reflects

the existence of factors that strongly indicate NITCO had this

proscribed purpose.     NITCO engaged in extensive nonbusiness-

related activities to benefit and support Mr. Mussman's two sons.

NITCO made investments that were unrelated to its business.       From

1954 through 1994, NITCO never declared and paid a formal

dividend to its shareholders.     See sec. 1.533-1(a)(2), Income Tax

Regs.   We hold that NITCO, for 1987, 1988, and 1989, is liable

for accumulated earnings tax.
                              - 69 -

              II. NITCO's Deduction of Legal Expenses


     On its 1987, 1988, and 1989 returns, NITCO claimed

substantial business deductions for legal expenses.     To be

deductible by NITCO under section 162, NITCO must establish that

these outlays were ordinary and necessary expenses incurred in

carrying on NITCO's trade or business.   However, before, during,

and after the years in issue, NITCO engaged in extensive

nonbusiness-related activities to benefit and support Mr.

Mussman's sons.

     Whether a taxpayer is engaged in a trade or business is a

question of fact.   Although there are various factors that are

important in making this determination, the most prominent of

these factors are a profit motive and the carrying on of

activities in a businesslike fashion.    See International Trading

Co. v. Commissioner, 275 F.2d 578, 584-585 (7th Cir. 1960), affg.

T.C. Memo. 1958-104.

     In United States v. Gilmore, 372 U.S. 39, 48 (1963), the

Supreme Court held legal expenses to be deductible if the claim

arises in connection with the taxpayer's profit-seeking

activities.   In the words of the Supreme Court in Gilmore, "the

origin and character of the claim with respect to which an

expense was incurred, rather than its potential consequences upon

the fortunes of the taxpayer, is the controlling basic test of

whether the expense was 'business' or 'personal'"; i.e.,

nonbusiness within the meaning of section 162(a).     Id. at 49.   In
                             - 70 -

the instant cases, application of the Gilmore origin-of-the-claim

test is crucial because NITCO, while a corporation, engaged in

various activities, some of which were business activities and

others of which were nonbusiness activities.   See Accardo v.

Commissioner, 942 F.2d 444, 449-451 (7th Cir. 1991), affg. 94

T.C. 96, 99-100 (1990)

     Implicit in the Gilmore test is the further requirement

that, for an expenditure to be deductible under section 162, it

must be an ordinary and necessary expense, directly connected

with or proximately resulting from the taxpayer's business.

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

     Petitioners contend that the disputed legal expenses NITCO

incurred and paid, during the years in issue, are deductible

ordinary and necessary business expenses under section 162.     They

argue that the litigation expenses with respect to the

constitutional challenge, enforcement, and divestiture actions

are deductible, because NITCO was a named party in the proceeding

before the FCC, was the subject of the FCC's divestiture order,

and was faced with the prospect of being fined or otherwise

sanctioned by the FCC.

     Respondent, on the other hand, contends that the disputed

legal expenses are not deductible, because they fail to meet the

Gilmore origin-of-the-claim test.   Respondent maintains that the

claims in the constitutional challenge, divestiture, and

enforcement actions arose from nonbusiness activities that NITCO

engaged in to benefit Mr. Mussman's son, Rhys, by assisting Rhys'
                                - 71 -

cable television company NICATV.    Respondent also asserts that

petitioners have failed to establish that the disputed legal

expenses were directly connected with or proximately resulted

from NITCO's business activities.    We essentially agree with

respondent.

     We think that the mere naming of NITCO as a party in the FCC

proceedings does not suffice to make the legal expenses

deductible.    The Synanon Church v. Commissioner, T.C. Memo. 1989-

270.16    In Gilmore, the Supreme Court noted:



     16
      But cf. Kopp's Co. v. United States, 636 F.2d 59, 61 (4th
Cir. 1980), where the Court of Appeals for the Fourth Circuit
distinguished United States v. Gilmore, 372 U.S. 39 (1963),
reversed the lower court's holding that the legal expense in
dispute failed to meet the origin-of-the-claim test, and allowed
the taxpayer-corporation to deduct certain legal expense. In
Kopp's Co., the corporation incurred the legal expense in
defending itself and a shareholder's son in a tort suit stemming
from an accident involving a company car driven by the son. The
son had not been a corporate employee, nor had he been engaged in
performing corporate business. The court distinguished Gilmore
on the basis that the taxpayer-corporation had been named as a
party defendant and was alleged to have negligently permitted the
son to operate its car. We think that Kopp's Co. v. United
States is inapposite to the instant cases. Unlike the instant
cases, the taxpayer-corporation in Kopp's Co. apparently engaged
only in business activities. The activity giving rise to the
lawsuit, although arguably unrelated to the taxpayer’s business,
was an isolated incident. In contrast, NITCO engaged in
substantial nonbusiness activities before, during, and after the
years in issue. Indeed, the precise activities giving rise to
the proceedings in issue were NITCO’s nonbusiness activities.
For example, the FCC based its conclusion that NITCO and NICATV
were affiliated, inter alia, upon the following nonbusiness
activities: (1) NITCO’s construction and maintenance of signal
distribution facilities for NICATV, (2) Rhys’ responsibility,
while serving as NITCO’s executive vice president, for
negotiating pole attachment agreements with competing cable
companies, (3) the fact that all contractual agreements between
NITCO and NICATV were oral, and (4) Rhys’ oral “consulting
agreement”.
                              - 72 -

          “Legal expenses do not become deductible merely
     because they are paid for services which relieve a
     taxpayer of liability. That argument would carry us
     too far. It would mean that the expense of defending
     almost any claim would be deductible by a taxpayer on
     the ground that such defense was made to help him keep
     clear of liens whatever income-producing property he
     might have. For example, it suggests that the expense
     of defending an action based upon personal injuries
     caused by a taxpayer's negligence while driving an
     automobile for pleasure should be deductible. * * *

                          * * * * * * *

     “It is not a ground for * * * [deduction] that the
     claim, if justified, will consume income-producing
     property of the defendant.” * * * [United States v.
     Gilmore, 372 U.S. at 46-47 (quoting Lykes v. United
     States, 343 U.S. 118, 125-126 (1952)).]


Thus, the fact that NITCO may have been subject to being fined or

otherwise sanctioned by the FCC is not controlling under the

Gilmore origin-of-the-claim test, because those potential actions

by the FCC concern only the attendant consequences of the

litigation.

     We have found that the activities that NITCO engaged in with

respect to NICATV were not undertaken by NITCO with a profit

motive.   Indeed, NITCO's 1989 annual report to the IURC reflects

that NITCO wrote off the approximately $122,000 "debt" that

NICATV "owed" to NITCO.   The purported debt was written off,

despite the fact that Mr. Mussman knew that Rhys had realized

sufficient cash from his sale of NICATV to discharge the "debt".

In addition, in its 1989 annual report to the IURC, NITCO stated
                                - 73 -

that the writeoff was not deductible for tax purposes.17   We

conclude that the activities that NITCO engaged in with respect

to NICATV were nonbusiness activities of NITCO.   See

International Trading Co. v. Commissioner, 275 F.2d at 584-585.

As the claim in the divestiture and enforcement actions arose in

connection with these nonbusiness activities that NITCO engaged

in with respect to NICATV, the legal expenses of the divestiture

and enforcement actions are not deductible by NITCO under section

162.    See United States v. Gilmore, supra; Accardo v.

Commissioner, supra; Dower v. United States, 668 F.2d 264, 266

(7th Cir. 1981); Anchor Coupling Co. v. United States, 427 F.2d

429, 431-433 (7th Cir. 1970).    Petitioners have further failed to

establish that the constitutional challenge action arose in

connection with or proximately resulted from a business activity




       17
      At trial, Mr. Mussman claimed that the writeoff occurred
due to an inadvertent error on the part of NITCO's accountant.
He related that the accountant, unlike Mr. Mussman, did not know
that Rhys had realized sufficient cash from the sale of NICATV to
discharge the "debt". We find Mr. Mussman's tale of mere
inadvertence to be incredible and not worthy of belief. We doubt
that the accountant would write off as uncollectible this large
$122,000 "receivable", without consulting Mr. Mussman and NITCO's
other top management. Moreover, even if the "receivable" were
inadvertently written off on NITCO's books, this still does not
adequately explain why NITCO never took action to collect the
"debt", as Mr. Mussman knew that Rhys possessed sufficient cash
to discharge the "debt". Additionally, we are not convinced that
Mr. Mussman was unaware of the accountant's "error". In signing
NITCO's 1989 annual report to the IURC, Mr. Mussman represented
that the information contained in the report, to the best of his
knowledge, was true and correct under penalty of perjury. We
think that Mr. Mussman all along never intended that NITCO
actually be paid by NICATV and Rhys for much of the work and
other assistance that NITCO provided to NICATV.
                                  - 74 -

of NITCO.18      The legal expenses incurred in the constitutional

challenge action are thus not deductible by NITCO under section

162.        United States v. Gilmore, supra; Kornhauser v. United

States, supra.

       Similarly, petitioners have failed to establish that the RSA

#1, Dial One Mobile, Dial One USA, Sprint contract, and Postal

Service investigation matters arose in connection with or

proximately resulted from a business activity of NITCO.      With

respect to the RSA #1 venture, Mr. Mussman's intention and plan

was to have the cellular license rights that were obtained

transferred to Serv-U-Cellular, a corporation that he and one or

more of his sons, individually, would own.      Much of this plan was

then implemented with Serv-U-Cellular, rather than NITCO,

becoming a partner in the RSA #1 limited partnership.      NITCO

reported on its return substantially all the $750,000 paid to

Serv-U-Cellular only after Mr. Mussman was forced to abandon the

plan as a result of the examinations that resulted in

respondent's issuances of the notices of deficiency in the

instant cases.      With respect to the Dial One Mobile matters, Dial

One Mobile was a company owned by Rhys that was conducting

activities with respect to cellular telephone systems in


       18
      From petitioners' briefs, we gather that they are not
contending that the claim in the constitutional challenge action
arose in connection with Rhys' alleged desire to purchase shares
of NITCO's stock from Mr. Mussman. As we understand their
contentions, the constitutional challenge action was brought by
Rhys and NITCO in order to challenge the constitutionality of the
FCC's cross-ownership rules, as the constitutional issues could
not be litigated in the divestiture action.
                                - 75 -

Asheville, North Carolina, and Enid, Oklahoma.   NITCO had no

interest in Dial One Mobile.    According to the application that

Dial One USA filed with the IURC to sell long-distance services,

NITCO had no interest in Dial One USA.   The Postal Service

investigation matter involved a seizure of NICATV's records from

NICATV's business offices.    Accordingly, the legal expenses that

NITCO incurred in the RSA #1, Dial One Mobile, Dial One USA,

Sprint contract, and Postal Service investigation matters are not

deductible under section 162.    United States v. Gilmore, supra;

Kornhauser v. United States, supra.

     Finally, petitioners have failed to establish that the legal

expenses incurred in certain other unknown matters or proceedings

arose in connection with or were proximately related to a

business activity of NITCO.    Therefore, the legal expenses that

NITCO incurred in these unknown matters or proceedings are not

deductible under section 162.    United States v. Gilmore, supra;

Kornhauser v. United States, supra.

     In conclusion, with respect to the legal expenses for which

NITCO claimed 1987, 1988, and 1989 business deductions, we hold

that only those legal expenses that respondent has conceded are

deductible by NITCO under section 162.


               III.   Constructive Dividend Income


     In the notice of deficiency issued to Mr. and Mrs. Mussman,

respondent determined that certain payments made by NITCO

represented constructive dividend income to Mr. Mussman for 1988
                              - 76 -

and 1989.   It is well established that a payment made to a

shareholder's family member can constitute a section 301

distribution by a corporation with respect to the stock of the

shareholder.   Green v. United States, 460 F.2d 412, 419 (5th Cir.

1972); Epstein v. Commissioner, 53 T.C. 459, 474-475 (1969).

Under proper circumstances, it is appropriate to hold that a

corporate payment made to or on behalf of a shareholder's family

member represents a distribution by the corporation to the

shareholder, because the shareholder enjoys the use of the

property as much as if the corporation had distributed the

property directly to the shareholder.   Epstein v. Commissioner,

supra.   In determining whether an expenditure by a corporation

represents income to the shareholder, it is necessary to decide

whether the expenditure primarily benefited the shareholder

personally rather than furthered the interest of the corporation.

Hagaman v. Commissioner, 958 F.2d 684, 690-691 (6th Cir. 1992),

affg. on this issue T.C. Memo. 1987-549; Ireland v. United

States, 621 F.2d 731, 735 (5th Cir. 1980).


Legal Expenses for which Respondent Disallowed Business
Deductions to NITCO


     In the notice of deficiency issued to the Mussmans,

respondent determined that the legal expenses for which

respondent disallowed business deductions to NITCO for 1988 and

1989 represented constructive dividend income to Mr. Mussman.

Respondent further determined that these legal expenses were
                               - 77 -

unrelated to NITCO's business.

     We previously have held that substantially all these legal

expenses were not deductible under section 162 by NITCO, because

petitioners failed to establish the expenses were deductible

under the Gilmore origin-of-the-claim test.   Most of these legal

expenses were incurred in the constitutional challenge,

divestiture, and enforcement actions discussed supra.

     To the extent a substantive difference exists between the

Gilmore origin-of-the-claim test discussed at pages 67-68, supra,

and the analysis for whether a particular payment should be

treated as constructive dividend income, petitioners in the

instant cases have failed to meet their burden in proving that

NITCO's payment of the legal expenses:   (1) Did not primarily

benefit Mr. Mussman's son Rhys, (2) furthered the interest of

NITCO, and (3) was of direct and substantial economic benefit to

NITCO.    Compare Hagaman v. Commissioner, supra, and   Ireland v.

United States, supra, with Parker v. Commissioner, 365 F.2d 792,

801-802 (8th Cir 1966), affg. in part, revg. in part, and

remanding T.C. Memo. 1965-77.19


     19
      In Parker v. Commissioner, 365 F.2d 792, 801-802 (8th Cir.
1966), affg. in part, revg. in part, and remanding Foundation for
Divine Meditation, Inc. v. Commissioner, T.C. Memo. 1965-77, the
founder and head of a religious organization was prosecuted for
contributing to the delinquency of a minor. Following his
acquittal, he brought an action for slander. The religious
organization paid the expenses of both the criminal and civil
actions. This Court viewed the legal expenses as a personal
expense of the founder and held that their payment by
the organization represented taxable income to the founder. In
reversing, the Court of Appeals for the Eighth Circuit stated
                                                   (continued...)
                              - 78 -

     With respect to the legal expenditures for the

constitutional challenge, divestiture, and enforcement actions,

petitioners contend the expenditures directly benefited NITCO,

because they prevented NITCO from being subjected to a fine and

protected its business reputation with the FCC.

     We consider the hundreds of thousands of dollars in legal

expenditures that NITCO incurred in litigating the constitutional

challenge, divestiture, and enforcement actions, to have been of

dubious benefit to NITCO and its business, particularly since, as

indicated above, the activities that NITCO engaged in with

respect to NICATV were not undertaken by NITCO with a profit

motive.   We are thus not convinced that the litigation of the

constitutional challenge, divestiture, and enforcement actions

furthered NITCO's interest and was of direct and substantial

benefit to NITCO.   Rather, the litigation primarily benefited

Rhys, by giving Rhys' company NICATV the further time it needed

to build up its cable television system business.

     Moreover, we perceive the protracted litigation to have been

actually more harmful to NITCO's good reputation with the FCC,



     19
      (...continued)
that because the reputation and business of the organization were
inextricably bound up with its founder, the payment of the
expenses was of direct and substantial benefit to the
organization. Although the Court of Appeals for the Eighth
Circuit further stated, in dicta, that the expenses would be
deductible by the organization as an ordinary and necessary
business expense, the issue of the expenses' deductibility had
not been raised. Thus, the Court of Appeals for the Eighth
Circuit did not have the deductibility issue before it and did
not address the Gilmore origin-of-the-claim test.
                               - 79 -

rather than helpful.   In view of NICATV's and NITCO's refusal to

comply with the FCC's orders in the divestiture action, the FCC

referred the matter to the Department of Justice for appropriate

enforcement proceedings.    Ultimately, in July 1989, Rhys sold

NICATV.

     With respect to the legal expenses for which we sustained

respondent's disallowance of business deductions by NITCO for

1988 and 1989, we sustain respondent's determination that NITCO's

payment of those legal expenses represented constructive dividend

income to Mr. Mussman for 1988 and 1989.    Petitioners have failed

to establish that NITCO's payment of the expenses did not

primarily benefit the Mussman family, furthered NITCO's interest,

and was of direct and substantial benefit to NITCO.    Rule 142(a).


Amount NITCO Paid to Rhys on December 20, 1988


     In the notice of deficiency issued to the Mussmans,

respondent determined that $22,646, which NITCO paid to Rhys on

December 20, 1988, was constructive dividend income to Mr.

Mussman.   On brief, petitioners have advanced only a vague

argument that Rhys served as a "consultant" to NITCO in 1985 and

in 1989.

     Petitioners have failed to establish that the payment

furthered NITCO's interest and was of direct and substantial

benefit to NITCO.   They have not offered any details or specific

information concerning what, if any, actual "consulting work"

Rhys performed for NITCO.    Indeed, in NITCO and Rhys' March 24,
                               - 80 -

1988, complaint in the constitutional challenge action, they

alleged that Rhys received no compensation from NITCO and had no

formal responsibilities at NITCO.    We hold that the $22,646

payment was constructive dividend income to Mr. Mussman in 1988.

Rule 142(a).


"Open Account Loans"


     NITCO on its books recorded certain payments that it had

made as "open loan account payments" to Mr. Mussman.     In the

notice of deficiency issued to the Mussmans, respondent

determined that $13,814 in "open account loans" that NITCO made

for 1988 and $16,792 in "open account loans" that NITCO made for

1989, represented constructive dividend income to Mr. Mussman.

Respondent has now conceded that certain of the 1988 and 1989

payments NITCO made were not constructive dividend income to Mr.

Mussman.   Petitioners, on the other hand, have conceded that

certain other of the 1988 and 1989 payments NITCO made were

constructive dividend income to Mr. Mussman.    Still at issue

between the parties is whether the remaining $7,058.11 of 1988

"open account loans" and the remaining $3,263.51 of 1989 "open

account loans" were constructive dividend income to Mr. Mussman.

     Of the remaining $7,058.11 in disputed 1988 payments, the

parties agree that at least $6,119.95 of the payments was for

utility bills with respect to the 301 North Washington Street

property that NITCO was subleasing to NICATV, Rhys's cable

television company.    The parties cannot agree on the
                              - 81 -

identification of the balance of the disputed 1988 payments.

Similarly, of the remaining $3,263.51 of disputed 1989 payments,

the parties agree that the entire $3,263.51 was paid by NITCO for

utility bills with respect to the 301 North Washington Street

property that NITCO was subleasing to NICATV.    All the 1989

utility bill expenses covered the period from January 1 through

June 30, 1989, when NICATV occupied the 301 North Washington

Street building.

     We have previously determined that NITCO's activities with

respect to NICATV were not undertaken by NITCO with a profit

motive.   Petitioners, however, contend that NITCO's payments of

the utility bills directly benefited NITCO, because NITCO also

stored certain telephone equipment in the 301 North Washington

Street building.

     Mr. Mussman testified that NITCO paid these utility bills

because it had stored some of its telephone equipment in the 301

North Washington Street building that it was subleasing to

NICATV.   The revenue agent, however, testified that, during his

visit to the building during the fall of 1992, he found only a

few pieces of office furniture stored there.    On brief,

petitioners have tried to explain this conflict by claiming the

agent was only able to observe the space in the building to which

he was given access.   More importantly, however, petitioners have

failed to adequately explain why the utility bill payments were

recorded as "open account loans" to Mr. Mussman if the payments

were, in fact, business expenses of NITCO.
                               - 82 -

     We conclude that petitioners have failed to establish that

these 1988 and 1989 utility bill payments with respect to the 301

Washington Street property furthered NITCO's interest and were of

direct and substantial benefit to NITCO.    The payments primarily

benefited Rhys and NICATV.    On the record presented, we also are

not able to determine the extent of the storage use NITCO made of

the building.   We decline to speculate and allocate a portion of

the utility bill payments to a business use of NITCO.20

Petitioners have further failed to establish that the remaining

balance of the disputed 1988 "open account loans" furthered

NITCO's interest and directly and substantially benefited NITCO.

We hold that Mr. Mussman had constructive dividend income of

$7,058.11 for 1988 and $3,263.51 for 1989, as a result of the

"open account loans".21


Country Club Initiation Fee


     In early 1989, NITCO paid an $1,800 initiation fee on behalf

of Rhys to obtain a country club membership for Rhys.

Petitioners have acknowledged that Rhys was not a NITCO employee

until after July 1, 1989.    However, they argue that the club


     20
      The utility bill payments were for electricity, gas,
sewage, and water services provided to the 301 Washington Street
property. To the extent that NITCO made some incidental use of
the building for storage, it is difficult to quantify the actual
benefit that resulted to NITCO from the payments.
     21
      From petitioners' arguments in their posttrial briefs
concerning this issue, we gather that petitioners are not
contending that NITCO had made a bona fide loan to Mr. Mussman
with respect to these payments.
                              - 83 -

membership was purchased in anticipation of Rhys' returning to

NITCO's employ, because a waiting list existed at the country

club for memberships.   They assert that, following his resumption

of employment with NITCO, the membership would be used by Rhys in

connection with NITCO's business activities.

     In view of the substantial expenditures NITCO made for

NICATV's and Rhys' benefit that we have held to be constructive

dividend income to Mr. Mussman, we are extremely skeptical of

petitioners' claims with respect to NITCO's payment of the club

initiation fee for Rhys.   Petitioners have failed to establish

that the expenditure was a business expenditure of NITCO, rather

than constructive dividend income to Mr. Mussman.   Consequently,

we sustain respondent's determination that the $1,800 expenditure

to obtain a country club membership for Rhys was constructive

dividend income to Mr. Mussman.   Rule 142(a).


Cellular Telephone and Other Investments


     In the notice of deficiency issued to the Mussmans,

respondent determined that $88,484 of legal expenditures that

NITCO made with respect to certain "cellular telephone and other

investments" was constructive dividend income to Mr. Mussman in

1989.   NITCO claimed no deduction for these expenditures.

     Petitioners contend that a substantial portion of the

$88,484 in total expenditures was actually paid by NITCO in 1988,

rather than in 1989, and that these 1988 payments were

erroneously determined by respondent to be constructive dividend
                              - 84 -

income to Mr. Mussman in 1989.   They point out that in the notice

of deficiency issued to the Mussmans, respondent failed to treat

any portion of the $88,484 in payments as dividend income to Mr.

Mussman in 1988.   They assert that the $75,432 of cellular

telephone investment account expenditures NITCO recorded includes

$33,445.68 in payments made by NITCO in 1988.    Similarly, they

assert that the $13,052 of other investment account expenditures

NITCO recorded includes $9,562.42 in payments NITCO made in 1988.

Respondent, on the other hand, disputes that any of the $88,484

in expenditures was made by NITCO during 1988.

     The record does not support petitioners' claim that the

$88,484 in expenditures includes cellular telephone expenditures

that were made by NITCO during 1988, rather than during 1989.      In

the Schedule B-8 to the 1989 annual report it filed with the

IURC, NITCO reported that it had $75,342 of "deferred cellular

charges" and $13,052 of deferred "other" charges.    Yet, in the

Schedule B-8 to the 1988 annual report it filed with the IURC,

NITCO reported that it had $390,000 of "extraordinary

retirements" and $39,599 of deferred "other" charges.      The

Schedule B-8 to the 1988 report reflected no "deferred cellular

charges" for 1988.   We conclude that petitioners have failed to

establish that the $88,484 in expenditures includes payments that

were made by NITCO in 1988.

     At pages 39-40, supra, of our findings, we have attempted to

allocate and attribute the $88,484 of expenditures to specific

matters as best as we can on the record presented.    We
                                - 85 -

essentially have attributed the $88,484 only to those specific

matters the parties agree upon.

     With respect to the $1,166.59 NITCO expended to Andrew &

Kurth for Dial One Mobile, petitioners have conceded that the

payment was constructive dividend income to Mr. Mussman in 1989,

and we so hold.    NITCO also expended $32,363.64 to B&H for Dial

One Mobile work.   Dial One Mobile was a company Rhys owned, which

was conducting activities with respect to cellular telephone

systems in Asheville, North Carolina, and Enid, Oklahoma.     NITCO

had no interest in Dial One Mobile.      Petitioners have failed to

show that the payment was of direct and substantial benefit to

NITCO.    We hold that the $32,363.64 in payments made to B&H was

constructive dividend income to Mr. Mussman for 1989.

     With respect to the $3,327.50 NITCO expended to EMCI for

cellular telephone publications, it is not clear whether the

cellular telephone publications were purchased and used to

benefit NITCO, as opposed to individual members of the Mussman

family.    Petitioners have failed to establish that the

expenditure furthered NITCO's interest and was of direct and

substantial benefit to NITCO.    We hold that the $3,327.50 payment

was constructive dividend income to Mr. Mussman in 1989.     Rule

142(a).

     With respect to the expenditures NITCO made to Handlon &

Handlon for various matters, petitioners concede that a $264

payment was for work performed for Kyle's corporation, FiberComm,

and that such payment was constructive dividend income to Mr.
                              - 86 -

Mussman for 1989.   As to the remaining balance of the

expenditures NITCO made to Handlon & Handlon, petitioners have

failed to establish that these payments furthered NITCO's

interest and were of direct and substantial benefit to NITCO.

     NITCO paid Handlon & Handlon $1,525.81 for work with respect

to Dial One USA and Intelcom, which were corporations that Mr.

Mussman owned.   According to the 1988 application that Dial One

USA filed with the IURC in seeking authorization to sell long-

distance services, NITCO had no affiliation with Dial One USA and

Intelcom.   Although Mr. Mussman, at trial, claimed that he later

planned to have Intelcom become the parent holding company of

Dial One USA and NITCO, we do not find his self-serving testimony

credible, as this testimony is inconsistent with the statements

made on Dial One USA's application to the IURC.

     NITCO also paid Handlon & Handlon $234 for the incorporation

of Northwestern Indiana Cellular, a corporation formed to hold

various cellular telephone interests.   On the record presented,

it is not clear whether Mr. Mussman intended that Northwestern

Indiana Cellular be owned by NITCO or by individual members of

the Mussman family.   It is also not clear whether the cellular

telephone interests Mr. Mussman planned to have held by

Northwestern Indiana Cellular would be cellular telephone

interests that NITCO or individual members of the Mussman family

owned.

     We hold that the entire $2,120.81 in the above payments that

NITCO made to Handlon & Handlon, including the $229 expended for
                                - 87 -

an unknown matter, was constructive dividend income to Mr.

Mussman for 1989.

     With respect to the expenditures NITCO made to LMN&G,

petitioners concede that $4,400 was constructive dividend income

to Mr. Mussman in 1989.    As to the work LMN&G performed in

connection with the Indiana RSA #1 venture and for Rhys,

petitioners have failed to establish that NITCO's payment for the

work furthered NITCO's interest and was of direct and substantial

benefit to NITCO.   As we have found, Mr. Mussman intended and

planned to have the cellular telephone rights held by Serv-U-

Cellular, a corporation that he and one or more of his sons,

individually, would own.    Rhys was not an employee of NITCO until

after July 1, 1989, and the work LMN&G performed for Rhys was

billed before that date.    Consequently, we hold that all the

expenditures that NITCO made to LMN&G were constructive dividend

income to Mr. Mussman for 1989.    Rule 142(a).

     With respect to the balance of NITCO's expenditures that has

not been attributed to specific matters, petitioners have failed

to establish that these payments furthered NITCO's interest and

were of direct and substantial benefit to NITCO.    Consequently,

we hold that these payments were constructive dividend income to

Mr. Mussman for 1989.22    Rule 142(a).




     22
      These constructive dividends to Mr. Mussman, of course,
will increase NITCO’s dividend paid deduction in computing
NITCO’s accumulated earnings tax liability. See sec. 535(a).
                                - 88 -

                         IV. Additions to Tax


Sections 6653(a) and 6662 Additions For Negligence Or Intentional
Disregard of Rules and Regulations


     In the notice of deficiency issued to NITCO, respondent

determined that NITCO was liable for additions to tax for

negligence or intentional disregard of rules or regulations (1)

under section 6653(a), equal to 5 percent of the respective

underpayments for 1987 and 1988, and (2) under section 6662,

equal to 20 percent of a portion of the underpayment for 1989.

Respondent determined that the 20-percent addition under section

6662 should apply with respect to a $117,547 portion of the

underpayment for 1989.    Respondent further determined that NITCO

was liable for an addition to tax under section 6653(a)(1)(B) for

1987.   Under section 6653(a)(1)(B), an addition to tax (equal to

50 percent of the interest payable under section 6601) is imposed

with respect to the portion of the underpayment attributable to

negligence.   Respondent determined that the portion of the 1987

underpayment resulting from NITCO's improper deduction of

$467,673 in legal expenses was attributable to negligence on

NITCO's part.

     In the notice of deficiency issued to the Mussmans,

respondent determined the Mussmans were liable for additions to

tax for negligence or intentional disregard of rules or

regulations (1) under section 6653(a), equal to 5 percent of the

underpayment for 1988, and (2) under section 6662, equal to 20
                               - 89 -

percent of the underpayment for 1989.    Respondent determined that

the 20-percent addition under section 6662 should apply with

respect to the entire underpayment for 1989.

     Negligence has been defined as the failure to exercise the

due care that a reasonable and ordinarily prudent person would do

under the circumstances.    Neely v. Commissioner, 85 T.C. 934, 947

(1985).    Petitioners bear the burden of showing that they are not

negligent.    Rule 142(a); Bixby v. Commissioner, 58 T.C. 757, 791-

792 (1972).

     Petitioners argue that NITCO and the Mussmans are not liable

for additions to tax for negligence.    Their contentions are as

follows:


          Respondent has not rebutted any of the facts
     supporting the reasonableness of NITCO's accumulations.
     Imposition of the * * * [accumulated earnings tax] and
     any additional penalty is therefore unwarranted.
     Similarly, imposing penalties for deducting the
     allegedly nondeductible attorneys' fees and other costs
     attributable to billing errors by outside attorneys or
     oversight by the independent accountant would also be
     improper. None of any underpayment ultimately
     determined is attributable to negligence or intentional
     disregard. * * *


     We have previously held that NITCO is liable for accumulated

earnings tax for 1987, 1988, and 1989, because NITCO accumulated

its earnings beyond the reasonable needs of the business and was

availed of for the purpose of avoiding income tax with respect to

its shareholders.   We further held that, for 1987, 1988, and

1989, substantial business deductions for legal expenses that

NITCO claimed were not allowable to NITCO under section 162,
                              - 90 -

because the expenditures failed to meet the Gilmore origin-of-

the-claim test.   We also held that Mr. Mussman had large amounts

of constructive dividend income for 1988 and 1989, including the

1988 and 1989 legal expenses NITCO had paid in litigating the

constitutional challenge, divestiture, and enforcement actions.

     Petitioners have failed to establish:   (1) NITCO acted

reasonably in claiming deductions for these legal expenses; and

(2) the Mussmans acted reasonably in not reporting NITCO's

payments of the 1988 and 1989 legal expenses as constructive

dividend income to Mr. Mussman.   Petitioners imply that the

attorneys’ fees in the constitutional challenge, divestiture, and

enforcement actions were deducted because the outside law firms

had billed their work to NITCO, rather than to Rhys and NICATV.

We are not convinced that NITCO acted reasonably in deducting the

fees it paid merely because the work had been billed to NITCO.

Indeed, in one instance NITCO still claimed a 1989 deduction with

respect to its payment of $2,239.85 to W&C for certain Dial One

Mobile work, even though W&C billed the legal work to Rhys and

not to NITCO.   Petitioners have now conceded that the $2,239.85

payment is not deductible by NITCO and was constructive dividend

income to Mr. Mussman.

     With respect to the purported advice petitioners received

from the accountant, we are not satisfied that the accountant was

apprised of all the relevant facts, including the fact that the

activities NITCO engaged in with respect to NICATV were not

undertaken by NITCO with a profit motive.    See Collins v.
                             - 91 -

Commissioner, 857 F.2d 1383, 1386 (9th Cir. 1988), affg. Dister

v. Commissioner, T.C. Memo. 1987-217.    The record fails to

disclose what specifically the accountant was told or was not

told by NITCO and Mr. Mussman.

     Although reliance on the advice of qualified professional

advisers may defeat a finding of negligence under certain

circumstances, petitioners have not established that the reliance

in the instant cases was reasonable.    Freytag v. Commissioner, 89

T.C. 849, 888 (1987), affd. 904 F.2d 1011 (5th Cir. 1990), affd.

501 U.S. 868 (1991).

     Petitioners generally have failed to carry their burden in

establishing that all or parts of their respective underpayments

were not attributable to negligence.    Rule 142(a).

     We hold that NITCO is liable for additions to tax for

negligence (1) under section 6653(a)(1)(A) and (B), for 1987 and

1988, and (2) under section 6662 for 1989.    The section 6662

addition applies with respect to that part of the $117,547

portion of the underpayment for 1989 that respondent determined

to be attributable to negligence or intentional disregard of

rules or regulations, which we have sustained.    We further hold

that NITCO will be liable for an addition to tax under section

6653(a)(1)(B) for 1987 with respect to the portion of the

underpayment for 1987 attributable to NITCO's improper deduction

of certain legal expenses.

     Similarly, we hold that the Mussmans are liable for

additions to tax for negligence (1) under section 6653(a) for
                                - 92 -

1988 and (2) under section 6662 for 1989.       The section 6662

addition applies with respect to the entire underpayment for

1989.


Section 6661 Additions for Substantial Understatement


        In the notice of deficiency issued to NITCO, respondent

determined that NITCO was liable for additions to tax for

substantial understatement of income tax liability under section

6661 for 1987 and 1988.     In the notice of deficiency issued to

the Mussmans, respondent determined the Mussmans were liable for

an addition to tax for substantial understatement under section

6661 for 1988.

        Section 6661 provides for an addition to tax for substantial

understatement of income tax equal to 25 percent of the amount of

the underpayment attributable to such understatement for the

taxable year.     To be considered substantial, the understatement

must exceed the greater of $5,000 ($10,000 in the case of a

corporation like NITCO) or 10 percent of the tax required to be

shown on the return.     Sec. 6661(b)(1).    The amount of the

understatement is reduced by the portion of the understatement

attributable to any nontax shelter item for which there is either

substantial authority for the taxpayer's return position or

adequate disclosure on the return.       Sec. 6661(b)(2)(B).

        NITCO understated its tax for 1987 and 1988; the Mussmans

understated their tax for 1988.     These respective understatements

were substantial.     Petitioners have not asserted that the
                              - 93 -

understatements should be reduced under section 6661(b)(2)(B) or

that respondent should have waived all or any part of the

additions to tax under section 6661(c).23   We hold that NITCO is

liable for additions to tax under section 6661 for 1987 and 1988

and that the Mussmans are liable for an addition to tax under

section 6661 for 1988.


                                   Decisions will be entered

                              under Rule 155.




     23
      On brief, petitioners make the vague argument that they
should not be held liable for the sec. 6661 additions to tax,
because "the substantial understatement penalty is computational,
and thus may not apply; if it does, the penalty is inappropriate
because reasonable cause can be found for the understatement."
However, "reasonable cause", standing alone, is not a sufficient
basis for avoiding liability with respect to the sec. 6661
addition. See H. Conf. Rept. 97-760 at 575 (1982), 1982-2 C.B.
600, 650. At any rate, petitioners have failed to establish:
(1) There was substantial authority for their return positions or
reasonable disclosure on their returns; or (2) respondent should
have waived all or part of the additions. Rule 142(a).
