                       T.C. Memo. 2001-176



                     UNITED STATES TAX COURT



              PINE CREEK FARMS, LTD., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 16033-99.                      Filed July 17, 2001.



     Bob A. Goldman, for petitioner.

     James E. Schacht and Christa A. Gruber, for respondent.



                       MEMORANDUM OPINION

     PAJAK, Special Trial Judge:   Respondent determined a

deficiency in petitioner's Federal income tax for the fiscal year

ending February 28, 1995, in the amount of $1,576 and a section

6662(a) penalty in the amount of $315.20.    Unless otherwise

indicated, section references are to the Internal Revenue Code in
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effect for the year in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure.

       This Court must decide: (1) Whether losses incurred by

petitioner on the sale of hog futures are capital losses or

ordinary losses, and (2) whether petitioner is liable for the

accuracy-related penalty under section 6662(a).

       This case was submitted fully stipulated pursuant to Rule

122.    All of the facts stipulated are so found.   Petitioner had

its principal place of business in Lime Springs, Iowa, at the

time the petition was filed.

       Petitioner was incorporated in Iowa on March 1, 1993, and is

engaged in the farming business.    Petitioner raises corn, soy

beans, and cattle.    Petitioner uses its corn and soy bean crops

either to feed its cattle, which it raises and markets, or to

sell to two other corporations, Grow Pork, Inc. (Grow Pork) and

Reis Ag Ltd. (Reis Ag).

       Grow Pork is engaged in the hog farrowing business.   Grow

Pork breeds sows, raises the baby pigs until they weigh

approximately 60 pounds, and then sells them to the entities

controlled by the owners of Grow Pork, including Reis Ag.     Reis

Ag is engaged in the hog finishing business.    Reis Ag obtains

pigs when they weigh approximately 60 pounds, feeds and raises

them, and then sells the hogs.    Petitioner sells the grain to
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Grow Pork and Reis Ag and the grain is fed to the pigs owned by

the latter corporations.

     All three of these corporations have a common shareholder,

John Reis (Reis).   Reis owns 51 percent of the stock of

petitioner, and Kay Reis, his wife, owns the other 49 percent.

Reis owns 50 percent of the stock of Reis Ag, and his brother

owns the other 50 percent.    Reis owns 20 percent of the stock of

Grow Pork, and there are four other 20 percent shareholders.

Each of the three corporations is a C corporation that maintains

separate business operations with separate books, records, and

bank accounts.

     Prior to incorporating petitioner, Reis maintained a

commodities account with Frontier Futures, Inc. (Frontier) which

he used as a hedge account.   When petitioner was incorporated,

Reis' commodities account with Frontier was transferred to

petitioner.   Neither Reis Ag, Grow Pork, Reis, nor Kay Reis

maintains any commodities accounts.      Reis stated that it was

simpler to have petitioner maintain a hedge account because he

and his wife owned petitioner.    He also stated that this made for

more accurate and simpler maintenance of records for all

purposes, including tax reporting, whereas utilizing a hedge

account for the other corporations would have been very difficult

because of the spread of ownership.
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     During the taxable year ended February 28, 1995, petitioner,

through the Frontier commodity account, was involved in numerous

futures transactions for corn, soybeans, cattle, and hogs.     The

net result of these transactions was a loss of $40,934.80.

Petitioner deducted $40,798 for "hedging expense" as an ordinary

loss on its return for the year ending February 28, 1995.     The

reason why approximately $137 of losses was not deducted by

petitioner is unknown to the parties.     Of the total amount of the

losses, $6,441.52 of the losses was generated by transactions in

hog futures.   In the notice of deficiency, respondent disallowed

$6,305 of petitioner's hedging expense deduction (i.e., $6,441.52

of hog future losses less the approximately $137 of losses

petitioner did not deduct), on the ground that petitioner was not

engaged in the production of hogs.     Respondent determined that

the $6,305 loss was a capital loss.

     Respondent contends that because petitioner was not engaged

in the hog business it could not have hedging transactions in

that commodity and its losses incurred from transactions in hog

futures are capital losses in nature, not ordinary losses.

Petitioner contends that its method of involvement with hog

operations is sufficient to allow the losses from the

transactions to be deducted as hedging losses.
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     Section 165(a) generally allows a deduction for any loss

sustained during the taxable year and not compensated for by

insurance or otherwise.    Section 165(f) states that losses from

sales or exchanges of capital assets shall be allowed only to the

extent allowed in section 1211 and 1212, which set forth

limitations on capital losses.    A "capital asset" is defined as

"property held by the taxpayer", but there are several exceptions

to the general rule.   Sec. 1221.   During the year in issue, none

of the exceptions addressed futures contracts.   Sec. 1221.

(Section 1221 was amended by adding subsection 7 which excludes

clearly identified hedging transactions from the definition of

capital asset, effective for any transaction entered into on or

after December 17, 1999.   Ticket to Work and Work Incentives

Improvement Act of 1999, Pub. L. 106-170, sec. 532(a)(3), 113

Stat. 1928).   Because commodity futures contracts were not

specifically excluded, they generally are treated as capital

assets.   See generally Arkansas Best Corp. v. Commissioner, 485

U.S. 212 (1988); Myers v. Commissioner, T.C. Memo. 1986-518.

     Section 1233(a) specifically provides that gain or loss from

short sales of commodity futures shall be treated as gain or loss

from the sale of a capital asset.    However, section 1233(g)

states that section 1233(a) shall not apply in the case of a

hedging transaction in commodity futures.
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     The regulations under section 1221 also contain a provision

which governs the treatment of hedging transactions.    Sec.

1.1221-2, Income Tax Regs.   Under this provision, "the term

capital asset does not include property that is part of a hedging

transaction".   Sec. 1.1221-2(a)(1), Income Tax Regs.

     A hedging transaction is "a transaction that a taxpayer

enters into in the normal course of the taxpayer's trade or

business primarily * * * to reduce risk of price changes or

currency fluctuations with respect to ordinary property * * *

that is held or to be held by the taxpayer".   Sec. 1.1221-

2(b)(1), Income Tax Regs.    Property is "ordinary property" only

if a sale or exchange of the property by the taxpayer could not

produce capital gain or loss regardless of the taxpayer's holding

period when the sale or exchange occurs.   Sec. 1.1221-2(c)(5)(i),

Income Tax Regs.   The regulations under section 1.1221-2 are

intended to provide the only definition of a "hedging

transaction".   Sec. 1.1221-2(a)(3), Income Tax Regs.

     Under the regulations, whether or not a transaction reduces

the risk of price changes or currency fluctuations is determined

"based on all of the facts and circumstances" surrounding the

taxpayer's business and the transaction.   Sec. 1.1221-2(c)(1)(i),

Income Tax Regs.   In applying this concept, we look to case law

to determine whether a transaction reduces a taxpayer's risk.
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     Under case law, a bona fide hedge requires: (1) A risk of

loss by unfavorable changes in the price of something expected to

be used or marketed in the taxpayer's business; (2) a possibility

of shifting the risk to someone else, through the purchase or

sale of futures contracts; and (3) an intention and attempt to so

shift the risk.   FNMA v. Commissioner, 100 T.C. 541, 569 (1993).

In every hedge there must be a direct relationship between the

product that is the basis of the taxpayer's business and the

commodity futures in which the taxpayer deals for protection.

Cullin v. Commissioner, T.C. Memo. 1997-292.    There must also be

a close relationship between the price of the product and the

price of the commodity future.     United States v. Rogers, 286 F.2d

277, 282 (6th Cir. 1961); Hoover Co. v. Commissioner, 72 T.C.

206, 231 (1979); Cullin v. Commissioner, supra.

     In this case, respondent disallowed the ordinary treatment

of losses on hog futures.   Petitioner did not produce hogs.   In

Myers v. Commissioner, supra, we stated that the taxpayer "had

little, if any, reason to hedge" soybean and feeder cattle where

the taxpayer did not produce soybeans or feeder cattle.     We found

that such transactions resulted in capital losses.    Id.

Petitioner argues that although it did not produce hogs, it did

sell corn and soybeans to other corporations which produced hogs.

Petitioner presented no evidence that it could not sell the
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grains to different companies for other purposes.    Petitioner did

not prove a direct relationship between the corn or soybeans

which are the basis of its business and the hog futures in which

it deals.   Moreover, what is also critical is that petitioner did

not establish that there was a close relationship, or any

relationship, between the price of corn or soybeans and the price

of hog futures.   The transactions in hog futures did not reduce

the risk of price changes or currency fluctuations with respect

to petitioner's ordinary property.

     Petitioner also contends that its major stockholder, Reis,

maintains the hedging account to protect his hog and grain prices

and that everything is held in one account to save expenses and

time.   Respondent’s position is that the business of the other

corporations in which Reis is a shareholder may not be attributed

to Reis, and then reattributed from him to petitioner.

     It is well settled that a corporation is an entity distinct

from its shareholders.   Dalton v. Bowers, 287 U.S. 404, 410

(1932).   A corporation's business is not attributable to its

shareholders, absent exceptional circumstances.     Burnet v. Clark,

287 U.S. 410, 415 (1932).   While the regulations under section

1221 provide that the risk of one member of a "consolidated

group" may be treated as the risk of the other members of the

group, there is no evidence that petitioner, Reis Ag, and Grow
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Pork were members of a consolidated group.    Sec. 1.1221-2(d)(1),

Income Tax Regs.    They did not file, nor were they required to

file, consolidated returns for the tax year.    Secs. 1501 and

1502; secs. 1.1221-2(d)(3), 1.1502-1(h), Income Tax Regs.

Therefore, the business transactions of Reis Ag and Grow Pork

cannot be attributed to Reis and from Reis to petitioner.     We

find no exceptional circumstances which would cause us to ignore

the corporate entities and attribute the production of hogs to

petitioner.   While it may have been easier for Reis to maintain

all the hedging transactions in one account under petitioner's

name, the hog futures transactions cannot be treated as hedging

transactions of petitioner.    The disallowed loss of $6,305 is a

capital loss.    Accordingly, we sustain respondent's

determination.

     Section 6662(a) provides for an accuracy-related penalty in

the amount of 20 percent of the portion of an underpayment of tax

attributable to, among other things, negligence or disregard of

rules or regulations.    Sec. 6662(a) and (b)(1).   Section

6664(c)(1) provides that no penalty shall be imposed if it is

shown that there was reasonable cause for the underpayment and

that the taxpayer acted in good faith.    The determination of

whether a taxpayer acted with reasonable cause and in good faith

depends upon the facts and circumstances.    Sec. 1.6664-4(b)(1),
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Income Tax Regs.   Reliance on the advice of an accountant may

demonstrate reasonable cause and good faith.    United States v.

Boyle, 469 U.S. 241, 250-151 (1985); sec. 1.6664-4(b)(1), Income

Tax Regs.

     In this case, the tax consequences regarding the futures

transactions and the ownership of the various corporations were

fairly complex.    Petitioner's tax returns were prepared by its

accountant.   Petitioner relied upon the accountant's advice.    We

find that petitioner had reasonable cause for the underpayment of

tax and acted in good faith.   Accordingly, we hold for petitioner

as to the section 6662(a) penalty.



                                          Decision will be entered

                                     for respondent as to the

                                     deficiency and for petitioner

                                     as to the penalty.
