                        T.C. Memo. 2003-327



                      UNITED STATES TAX COURT



              WATERFALL FARMS, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent

         RODNEY F. HUBER AND POLLY HUBER, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 5363-01, 5365-01.       Filed November 25, 2003.



     Douglas Bleeker, for petitioners.

     Douglas Polsky and Charles Berlau, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     JACOBS, Judge:   These cases have been consolidated for

trial, briefing, and opinion.   In separate notices of deficiency,

respondent determined deficiencies in petitioners’ Federal income
                                 - 2 -

tax and accuracy-related penalties under section 66621 for 1995,

1996, and 1997 as follows:

Waterfall Farms, Inc., Docket No. 5363-01:

                                           Penalty
          Year      Deficiency           Sec. 6662(a)

          1995         $184                  $37
          1996          195                   39
          1997        2,507                  501

Rodney F. and Polly Huber, Docket No. 5365-01:

                                           Penalty
          Year      Deficiency           Sec. 6662(a)

          1995        $1,706                 --
          1996           855                 --
          1997         2,505                 --

     The issues for decision are:

     (1) Whether amounts paid by Waterfall Farms, Inc. (Waterfall

Farms or the corporation), to provide medical care, food, and

lodging to its shareholders, Rodney F. Huber (Mr. Huber) and

Polly Huber (Mrs. Huber) (collectively the Hubers), and their

daughter are (a) constructive dividends, as respondent maintains,

or (b) employee medical care expenses and/or reimbursed employee

expenses that are excluded from the Hubers’ gross income and

deductible by Waterfall Farms as ordinary and necessary business

expenses, as petitioners maintain; and




     1
      All section references are to the Internal Revenue Code in
effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
                               - 3 -

     (2) whether Waterfall Farms is liable for the accuracy-

related penalty under section 6662(a) for the taxable years ended

November 30, 1995, 1996, and 1997.

                         FINDINGS OF FACT

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

The stipulation of facts and the attached exhibits are

incorporated herein by this reference.

     When the petitions were filed in these cases, the residence

of the Hubers, as well as the principal place of business of

Waterfall Farms, was in Fulton, South Dakota.

A.   The Hubers

     The Hubers are husband and wife; they have three daughters.

The Hubers live in a house (the farmhouse) on 6 acres (the

homestead) that, until 1997, they leased from Emma Rose (Ms.

Rose).   Between November 1989 and August 1992, the Hubers

acquired four contiguous lots totaling 330 acres (the Huber

farm).   The Huber farm consists of farmland and pasture on which

the Hubers raise corn and livestock.   There are no houses on the

Huber farm.

B.   Waterfall Farms

     The Hubers executed articles of incorporation for Waterfall

Farms on March 11, 1994.2   The articles were filed with the


     2
      Douglas Bleeker, counsel for petitioners, prepared the
articles of incorporation, minutes of meetings, and other
                                                   (continued...)
                               - 4 -

secretary of state of South Dakota on March 22, 1994.   The Hubers

conveyed the Huber farm to Waterfall Farms by deed, dated March

10, 1994, that was filed in the Hanson County register of deeds

on March 28, 1994.

     The Hubers have been the sole shareholders, officers, and

directors of Waterfall Farms since its incorporation.   Mr. Huber

has been president, treasurer, and a director, and Mrs. Huber has

been vice president, secretary, and a director, of Waterfall

Farms.

     Article IV, section 10, of the bylaws of Waterfall Farms

provides:

          SECTION 10. Repayment of Disallowed Expenses.
     Any expense paid by the Corporation which is finally
     determined as a personal expense of any officer or
     employee and disallowed as Corporation expense shall be
     repaid by the officer or employee to the Corporation
     within Twenty-four (24) months of the final
     determination by the Internal Revenue Service with
     interest at Three (3%) below the New York Prime Rate on
     the date of final determination.

     The first meeting of the board of directors of Waterfall

Farms was held on March 18, 1994.   At that meeting, the directors

adopted a medical reimbursement plan covering all “employees and

officers executing management responsibilities” and their spouses

and dependents.   The medical reimbursement plan provides for the

payment of all medical care costs that would be “deductible on


     2
      (...continued)
corporate documents for Waterfall Farms.
                               - 5 -

Form 1040” (before considering limitations).   Under the plan,

each participant is entitled to a maximum reimbursement of

$10,000 per year.

     At a special meeting of the directors held on November 1,

1994, the board of directors of Waterfall Farms adopted a

resolution setting forth a repayment obligation similar to that

set forth in the bylaws.   At that meeting, the directors also

adopted the following resolution:

          RESOLVED that the Corporation’s officers and
     employees shall be required to live at the worksite of
     the Corporation to ensure security for the Corporation
     property and operations. The officers and employees
     shall be required to live on the worksite to supervise
     the care and feeding of the livestock of the
     corporation. The Corporation shall supply said
     officers and employees all of their food and lodging
     while living at said worksite. That all of the
     officers and employees shall be considered “on duty”
     when at the worksite and therefore entitled to such
     benefits.

C.   Farm Lease

     During the years at issue, Waterfall Farms leased the Huber

farm to Mr. Huber under a “share-crop” arrangement.   Under a

written agreement titled “Farm Lease”, dated December 1, 1994

(the 1995 lease), effective for 1 year (to November 30, 1995),

Mr. Huber agreed to pay Waterfall Farms $15,000 plus one-third of

the proceeds from the sale of all crops grown on the farm.    Mr.

Huber was to receive the other two-thirds of the proceeds from

the sale of the crops, as well as all payments received under
                                - 6 -

Federal conservation programs (or any other Federal, State, or

local governmental programs).

     Mr. Huber agreed (1) to farm the land; (2) to provide all

labor and other items required in producing, harvesting, and

marketing the crops; (3) to furnish all tools, farm implements,

machinery, hired help, fertilizer, chemicals, and seed necessary

to cultivate and manage the farm; (4) to protect the crops from

injury and waste; (5) to till the land after harvesting the

crops; and (6) to rotate the crops from year to year.    Waterfall

Farms agreed to furnish all necessary materials, and Mr. Huber

agreed to supply all necessary labor, to maintain all fences and

other improvements.

     Mr. Huber and Waterfall Farms entered into a second 1-year

farm lease (the 1996 lease), dated December 1, 1995 (ending

November 30, 1996).   The provisions of the 1996 lease were

identical to those contained in the 1995 lease except that Mr.

Huber was not required to pay any amount to Waterfall Farms and

the proceeds from the sale of the crops were to be divided three-

fifths to Mr. Huber and two-fifths to Waterfall Farms.

     Mr. Huber entered into a third farm lease with Waterfall

Farms, dated December 1, 1996 (the 1997 lease).   The 1997 lease

was identical to the 1995 lease except that Mr. Huber agreed to

pay $5,000 to Waterfall Farms plus one-fourth of the proceeds

from the sale of all crops grown on the farm.   The term of the
                                - 7 -

1997 lease was 1 year; it continued in effect year to year until

otherwise canceled.

       In 1996, Waterfall Farms acquired 10 cows in order to start

a herd.    Mr. Huber, as an employee of Waterfall Farms, was

responsible for the care of the corporation’s livestock.

D.     Mr. Huber’s Separate Business Activity

       During the years at issue, Mr. Huber (as a self-employed

farmer) farmed properties that were not owned by Waterfall Farms.

These other farms were located 2 to 20 miles from the homestead.

In addition, Mr. Huber worked part time for other employers.

Specifically, he worked for Alexandria Grain and Oil in 1996 and

for Spencer Quarries, Inc., in 1997.

       In 1997, Mr. Huber purchased a one-half interest in a race

car.    He attended races most Saturday and Sunday nights.

       In 1995 and 1996, Mrs. Huber worked full time as a secretary

for the police department of the City of Mitchell, South Dakota,

and part time for Davison County.    The Hubers were covered by a

health insurance policy that was obtained through Mrs. Huber’s

employment with the police department.    The insurance premium was

paid partly by Mrs. Huber and partly by her employer.

Waterfall Farms reimbursed the Hubers for Mrs. Huber’s share of

the insurance premium.
                                 - 8 -

E.   Compensation and Payment of Food, Lodging, and Medical
     Expenses

     Mr. Huber was the sole employee of Waterfall Farms.      He kept

the corporate books and paid its bills.    For his services, Mr.

Huber received $1,000 in 1995, $600 in 1996, and $1,000 in 1997.

In addition, Waterfall Farms paid all of the Hubers’ medical care

expenses.

     In 1997, Waterfall Farms leased the homestead from Ms. Rose;

the rent was $7,500 per annum.    The original term of the lease

was 1 year beginning January 1, 1997, and ending December 31,

1997; the agreement continued in effect year to year until

otherwise canceled.   The Hubers (and one of their daughters)

continued to use the homestead as their residence     after

Waterfall Farms leased the homestead from Ms. Rose.    In addition

to the rent for the homestead, Waterfall Farms paid for

the food consumed by the Hubers and their daughter.

     Waterfall Farms did not pay dividends for fiscal years ended

November 30, 1995, 1996, and 1997.
                                  - 9 -

     F.    Income Tax Returns

     Mr. Bleeker (petitioners’ counsel) prepared the Hubers’

joint Forms 1040, U.S. Individual Income Tax Return, and

Waterfall Farms’ Forms 1120, U.S. Corporation Income Tax Return,

for the years at issue.

     1.    Waterfall Farms

     Waterfall Farms filed timely its Forms 1120 for the taxable

years ended November 30, 1995, 1996, and 1997.             On these returns,

Waterfall Farms reported total income and total deductions as

follows:

                             11/30/95            11/30/96         11/30/97

     Total income         $27,500                $20,172         $30,132
     Total deductions      24,769                 18,404          29,699
      Taxable income        2,731                  1,768             433

     Included in the total expenses deducted by Waterfall Farms

were the following items for food, lodging, and medical expenses

provided to the Hubers:

                                    11/30/95        11/30/96    11/30/97
  Food & lodging
   Food for employees                   $4,290       $4,395      $4,709
   Rent                                    –-           –-        7,500
    Food & lodging expenses              4,290        4,395      12,209
  Medical
   Medical insurance                    $1,224       $1,297      $3,048
   Medical expenses                       --           –-         1,456
    Total medical                        1,224        1,297       4,504

     Waterfall Farms filed Forms 1120X, Amended U.S. Corporation

Income Tax Return, for its fiscal years ended November 30, 1995

and 1996, that were received by the Internal Revenue Service in
                               - 10 -

March 1998.    In the amended returns, Waterfall Farms eliminated

the deduction for food for employees.    As a result, the

corporation reported taxable income of $7,021 for 1995 and $6,163

for 1996.

     2.     The Hubers

     The Hubers timely filed their joint income tax returns for

1995, 1996, and 1997.    On these returns, the Hubers reported Mr.

Huber’s wages from Waterfall Farms.     They reported farming income

(including Mr. Huber’s share of the proceeds from the sale of

crops grown on the Huber farm) as self-employment income.    They

did not report any income attributable to their food, lodging-

related, and medical expenses paid by Waterfall Farms.

   The Hubers filed a Form 1040X, Amended U.S. Individual Income

Tax Return, for 1995.    On the amended return, the Hubers elected

to defer crop insurance proceeds.   The amended return did not

include the $4,290 paid by Waterfall Farms for the Hubers’ food

in 1995.    The Hubers did not amend their 1996 return to include

the $4,395 paid by Waterfall Farms for their food in 1996.

     On Schedule F, Profit or Loss from Farming, Mr. Huber

reported gross income, total expenses, and net profit or loss

from his separate farming activities for 1995, 1996, and 1997 as

follows:
                                 - 11 -

                              19951         1996       1997

     Gross income           $85,151       $112,626   $126,764
     Total expenses          96,344        112,589    128,520
       Net profit/loss      (11,193)            37     (1,756)
     1
         As amended.

G.   Notices of Deficiency

     On January 31, 2001, respondent timely mailed to the Hubers

a statutory notice of deficiency for 1995, 1996, and 1997 (the

Huber notice of deficiency).      Also on January 31, 2001,

respondent timely mailed to Waterfall Farms a statutory notice of

deficiency for its fiscal years ended November 30, 1995, 1996,

and 1997 (the Waterfall Farms notice of deficiency).

     In the Waterfall Farms notice of deficiency, respondent

disallowed the food, lodging, and medical expenses deducted by

Waterfall Farms, totaling $1,224 for 1995, $1,297 for 1996, and

$16,713 for 1997.      Respondent determined that (1) Waterfall Farms

failed to establish that the food and lodging expenses were

ordinary and necessary business expenses under section 162 and

(2) those items are the Hubers’ personal expenses.      Respondent

further determined that Waterfall Farms was liable for the

accuracy-related penalty under section 6662(a).

     In the Huber notice of deficiency, respondent determined

that payments by Waterfall Farms of the Hubers’ food, lodging,

and medical expenses resulted in constructive dividends as

follows:
                              - 12 -

                                 11/30/95      11/30/96   11/30/97

     Food & lodging               $4,290        $4,395    $12,209
     Medical                       1,224         1,297      4,504
      Total dividends              5,514         5,692     16,713

                              OPINION

Issue 1.   Expenses Incurred by Waterfall Farms To Provide Medical
           Benefits, Food, and Housing to the Hubers in 1995,
           1996, and 1997

A.   Positions of the Parties3

     Respondent disallowed deductions taken by Waterfall Farms

for medical costs (health insurance premiums and other medical

care expenses), food, and lodging (rent for the homestead).

Respondent asserts that the medical costs, food, and lodging

expenses are the Hubers’ personal, family, and living expenses

and that payments of these expenses by Waterfall Farms constitute

constructive dividends to the Hubers.       On the other hand,

petitioners assert that all the expenditures are reasonable and




     3
      Under certain circumstances, sec. 7491 places the burden of
proof or production on the Commissioner. Sec. 7491 applies to
court proceedings arising in connection with tax examinations
beginning after July 22, 1998. Internal Revenue Service
Restructuring and Reform Act of 1998, Pub. L. 105-206, sec.
3001(a), 112 Stat. 726. Petitioners timely filed their returns
for the years at issue. Hence, all of the returns were filed on
or before Apr. 15, 1998. The record does not disclose when the
examination of petitioners’ tax returns began, and it is possible
that the examination began before July 23, 1998. Petitioners do
not contend that sec. 7491 applies in these cases, and they have
not otherwise asserted that respondent has the burden of proof or
production with respect to any issue presented in these cases.
We therefore conclude that sec. 7491 does not apply, and
petitioners have the burden of proof and production.
                             - 13 -

necessary business expenses, deductible by Waterfall Farms and

excluded from the Hubers’ income.

     Petitioners contend that the medical costs are employee

benefits, deductible by the employer and excludable from the

employee’s income under sections 105 and/or 106.   Petitioners

further maintain that Waterfall Farms provided food and lodging

to Mr. Huber in his capacity as an employee and that such was

done for the convenience of Waterfall Farms.   Consequently,

petitioners assert that the food and lodging expenses are

employer-provided “meals and lodging”, the costs for which are

excluded from the Hubers’ income under section 119 and deductible

by Waterfall Farms.

B.   Medical Expenses

     We first shall decide whether the payments by Waterfall

Farms of the medical expenses are excludable from the Hubers’

gross income under sections 105 and 106 and deductible by the

corporation as ordinary and necessary business expenses under

section 162(a).

     Under section 106, “an employee’s gross income does not

include employer-provided coverage (e.g., accident and health

insurance premiums) under an accident and health plan.”     Rugby

Prods. Ltd. v. Commissioner, 100 T.C. 531, 535 (1993).    The

employer may provide coverage under an accident or health plan by

paying the premium (or a portion of the premium) on an accident
                              - 14 -

or health insurance policy covering one or more employees or by

contributing to a separate trust or fund.   Sec. 1.106-1, Income

Tax Regs.

     Under the general rule of section 105(a), amounts received

by an employee through accident and health insurance for personal

injury or sickness, to the extent attributable to nontaxed

employer contributions, are includable in the employee’s gross

income.   Amounts received under an accident or health plan for

employees are treated as amounts received through accident or

health insurance.   Sec. 105(e).   An exception to the general rule

allows an employee to exclude from gross income amounts received

to reimburse the employee for expenses incurred by the employee

for the medical care (as defined in section 213(d)) of the

employee and the employee’s spouse and dependents.   Sec. 105(b).

     For the reasons set forth below, we agree with petitioners

that pursuant to sections 105 and/or 106 payments by Waterfall

Farms for reimbursement of medical care costs (including

reimbursement for the health insurance premiums) need not be

included in the Hubers’ income for 1995, 1996, and 1997.

     Section 105(e) requires first, that the benefits be received

under a “plan”, and second, that the plan be “for employees”,

rather than for some other class of persons such as shareholders

and their relatives.   Larkin v. Commissioner, 48 T.C. 629, 635

(1967), affd. 394 F.2d 494 (1st Cir. 1968).   After giving due
                              - 15 -

consideration to the record before us, we conclude that Waterfall

Farms’ medical reimbursement plan satisfies both the “plan” and

“for employees” requirements of section 105(e).

     Section 1.105-5(a), Income Tax Regs., provides guidelines as

to what constitutes an accident or health plan.   A plan may cover

one or more employees, and different plans may be established for

different employees or classes of employees.    Id.   Income Tax

Regs.   The regulations do not require that there be a written

plan or that there be enforceable employee rights under the plan,

so long as the participant has notice or knowledge of the plan.

Wigutow v. Commissioner, T.C. Memo. 1983-620.

     In the instant case, a plan (as defined in section

1.105-5(a), Income Tax Regs.) existed.   Waterfall Farms adopted a

written medical reimbursement plan identifying who was eligible

to participate, what expenses would be reimbursed, and how

participants were to make claims for reimbursement.    The plan was

adopted at the first meeting of the board of directors.

     Mr. Huber had knowledge of the medical reimbursement plan.

Moreover, the medical reimbursements provided under the written

plan included reimbursement for all “medical care” costs

deductible on Form 1040, which includes health insurance costs.

Sec. 213(d)(1)(D).   And finally, we are satisfied that the

corporation’s medical plan was for Mr. Huber as an employee of
                              - 16 -

Waterfall Farms, and not for his benefit as one of the

corporation’s shareholders.

     Plans limited to employees who are also shareholders are not

per se disqualified under section 105(b).     Larkin v.

Commissioner, supra at 635 n.5.    In this regard, we have

sustained plans for corporate officers who were also shareholders

because those officers had central management roles in conducting

the business of the corporation.    Wigutow v. Commissioner, supra;

Epstein v. Commissioner, T.C. Memo. 1972-53; Seidel v.

Commissioner, T.C. Memo. 1971-238; Smith v. Commissioner, T.C.

Memo. 1970-243; Bogene, Inc. v. Commissioner, T.C. Memo.

1968-147.

     Respondent has stipulated that during the years at issue Mr.

Huber was an employee of Waterfall Farms.   Indeed, Mr. Huber was

the corporation’s only employee.   And without Mr. Huber’s

involvement, Waterfall Farms could not have conducted its farming

operations.

     Mr. Huber’s compensation for services rendered to Waterfall

Farms was his salary and employee benefits.    Respondent does not

contend that Mr. Huber received excessive compensation.      Indeed,

respondent contends that Mr. Huber was undercompensated for his

services.

     Although Mrs. Huber did not work for Waterfall Farms,

payment of her medical expenses was based on her status as Mr.
                              - 17 -

Huber’s spouse.   Likewise, payment of the medical expenses for

the Hubers’ daughter was based on her status as Mr. Huber’s

dependent.   The derivative participation of Mr. Huber’s spouse

and dependent is plainly contemplated both by the medical plan

and by section 105(b).

     On the basis of the record before us, we conclude that

medical payments made for the benefit of the Hubers and/or their

daughter were made under a plan for employees and not for

shareholders.   Accordingly, during the years at issue, the

medical payments made by Waterfall Farms pursuant to its medical

plan (the insurance premiums and other medical care expenditures)

are excludable from the Hubers’ gross income under section

105(b).

     Section 162(a) permits a taxpayer to deduct all ordinary and

necessary expenses incurred during the taxable year in carrying

on a taxpayer’s trade or business.     An expense is ordinary if it

is customary or usual within a particular trade, business, or

industry or relates to a transaction “of common or frequent

occurrence in the type of business involved.”     Deputy v. du Pont,

308 U.S. 488, 495 (1940).   An expense is necessary if it is

appropriate and helpful for the development of the business.    See

Commissioner v. Heininger, 320 U.S. 467, 471 (1943).

     When payments for medical care are properly excludable from

an employee’s income because they are made under a “plan for
                                - 18 -

employees,” they are deductible by the employer as ordinary and

necessary business expenses under section 162(a).    Sec.

1.162-10(a), Income Tax Regs.    Consequently, Waterfall Farms is

entitled to deduct the insurance premiums and medical

reimbursement payments under section 162(a).

C.   Food and Rent

     1.   Section 119: Employer-Provided Meals and Lodging

     We next decide whether the food and rent are employer-

provided meals and lodging expenses, excludable from the Hubers’

income under section 119 and deductible by Waterfall Farms under

section 162.

     Meals and lodging furnished to an employee by his employer

are excluded from the employee’s gross income under section 119

if the meals and lodging are provided for the convenience of the

employer on the premises of the employer.   In the case of

lodging, the employee must be required to accept the lodging on

the business premises of his employer as a condition of

employment.

     The term “‘business premises of the employer’ generally

means the place of employment of the employee.”    Sec.

1.119-1(c)(1), Income Tax Regs.    They are the premises where the

employee performs a significant portion of his duties or where

the employer conducts a significant portion of its business.

McDonald v. Commissioner, 66 T.C. 223 (1976).     The extent or
                              - 19 -

boundaries of the business premises is a factual question that

considers the employee’s duties as well as the nature of the

employer’s business.   Lindeman v. Commissioner, 60 T.C. 609, 615

(1973).

     During the years at issue, Waterfall Farms paid for the

Hubers’ food (which they consumed on the homestead) and deducted

the cost of the food on the corporation’s Forms 1120 filed for

fiscal years ending November 30, 1995, 1996, and 1997.     In 1995

and 1996, the Hubers rented the homestead from Ms. Rose.

Waterfall Farms filed amended returns for 1995 and 1996

eliminating the deduction for the food because the homestead was

not its business property.   In 1997, Waterfall Farms rented the

homestead from Ms. Rose.   Although Waterfall Farms rented the

homestead, there is no evidence that any business activity (aside

from record keeping) took place on the homestead.     Thus, the food

and lodging were not provided on the business premises of

Waterfall Farms.

     Moreover, section 119 requires that meals and lodging be

furnished for the “convenience of the employer”.     Meals and

lodging are furnished for the “convenience of the employer” if

there is a direct nexus between the meals and lodging furnished

and the asserted business interests of the employer served

thereby.   McDonald v. Commissioner, supra at 230.    Petitioners
                               - 20 -

assert that Mr. Huber, as the corporation’s sole employee, was

required to be available for duty 24 hours a day.

     Waterfall Farms leased the Huber farm to Mr. Huber.

Waterfall Farms contracted with Mr. Huber as a tenant, not as its

employee, to perform all necessary work on the Huber farm.

     It is well settled that “Ordinarily, taxpayers are bound by

the form of the transaction they have chosen; taxpayers may not

in hindsight recast the transaction as one that they might have

made in order to obtain tax advantages.”    Framatome Connectors

USA Inc. v. Commissioner, 118 T.C. 32, 70 (2002) (citing Estate

of Leavitt v. Commissioner, 875 F.2d 420, 423 (4th Cir. 1989),

affg. 90 T.C. 206 (1988), and Grojean v. Commissioner, 248 F.3d

572, 576 (7th Cir. 2001), affg. T.C. Memo. 1999-425).    Here,

inasmuch as Mr. Huber farmed the Huber farm as a tenant, and not

as an employee of Waterfall Farms, the food and lodging in

question were not furnished to Mr. Huber as a corporate employee

for the convenience of his employer.    Thus, the food and rent at

issue are not section 119(a) meal and lodging expenses.

     2.     Inclusion of Payments in the Hubers’ Gross Income

     When a corporation makes an expenditure that primarily

benefits the corporation’s shareholders, the amount of the

expenditure may be taxed to the shareholder as a constructive

dividend.   Hood v. Commissioner, 115 T.C. 172 (2000); Magnon v.

Commissioner, 73 T.C. 980, 993-994 (1980); Am. Insulation Corp.
                              - 21 -

v. Commissioner, T.C. Memo. 1985-436.     We have found that

expenses for food and rent paid by Waterfall Farms are the

Hubers’ expenses.   Petitioners contend that the payments are not

constructive dividends because Mr. Huber was required to repay

any amounts that Waterfall Farms could not deduct for Federal

income tax purposes.   Petitioners cite Cepeda v. Commissioner,

T.C. Memo. 1993-477, to support their position.     Cepeda, however,

is inapposite.   In that case, the taxpayers claimed that advances

made by the corporation were loans rather than employee

compensation or constructive dividends.    Here, petitioners do not

contend that the corporate payments of the Hubers’ expenses were

loans.

     For Federal income tax purposes, a transaction will be

characterized as a loan if there was “an unconditional obligation

on the part of the transferee to repay the money, and an

unconditional intention on the part of the transferor to secure

repayment.”   Haag v. Commissioner, 88 T.C. 604, 616 (1987), affd.

without published opinion 855 F.2d 855 (8th Cir. 1988).     In the

instant case, when the payments were made there was no

unconditional obligation on the part of the Hubers to repay a

specific dollar amount to the corporation.     Their obligation to

repay any of the payments was in general terms.     The amount of

repayment could not be determined when the payments were made.

Any obligation to repay any amount could not arise before
                                - 22 -

respondent disallowed the deduction for the expenses; i.e, when

the Waterfall Farms notice of deficiency was issued in January

2001.     Thus, the payments were not loans.   Since the payments

when made by Waterfall Farms did not constitute business expenses

of the corporation or loans to the Hubers, the conclusion is

inescapable that the payments constituted distributions by

Waterfall Farms to the Hubers.

     In N. Am. Oil Consol. v. Burnett, 286 U.S. 417, 424 (1932),

the Supreme Court stated:

        If a taxpayer receives earnings under a claim of right
        and without restriction as to its disposition, he has
        received income which he is required to return, even
        though it may still be claimed that he is not entitled
        to retain the money, and even though he may still be
        adjudged liable to restore its equivalent. * * *

It is clear, therefore, under the claim of right doctrine, the

amounts paid by Waterfall Farms in 1995, 1996, and 1997 were

taxable to the Hubers in those years.     See Pahl v. Commissioner,

67 T.C. 286, 289 (1976).

        If a taxpayer is required to repay income recognized under

the claim of right doctrine in an earlier tax year, section 1341

permits the taxpayer, in effect, to elect to compute his taxes

for the year of repayment in a manner that gives the taxpayer the

equivalent of a refund (without interest) of tax for the earlier

year.     Specifically, section 1341(a)(5) permits the tax for the

year of repayment to be reduced by the amount of the tax paid for

the year of receipt that was attributable to the inclusion of the
                              - 23 -

repaid amount of that year’s gross income.    United States v.

Skelly Oil Co., 394 U.S. 678, 682 (1969).    Section 1341, however,

requires actual repayment, restoration, or restitution.     Chernin

v. United States, 149 F.3d 805, 816 (8th Cir. 1998); Kappel v.

United States, 437 F.2d 1222, 1226 (3d Cir. 1971); Estate of

Smith v. Commissioner, 110 T.C. 12 (1998).

     Although the bylaws of Waterfall Farms require the Hubers to

repay amounts for which the corporation is disallowed a

deduction, the Hubers do not claim that they have repaid the

disallowed amounts.   Indeed, there is no evidence in the record

to show that they did.   Therefore, section 1341 does not apply.

We hold that Waterfall Farms’ payment of the Hubers’ food and

rent constitutes income to the Hubers.

     Petitioners argue that the expenses are meals and lodging

expenses excludable under section 119.   We have found to the

contrary.

     Personal, family, or living expenses are not deductible

except as otherwise expressly permitted.    Sec. 262.   A taxpayer’s

expenses for his or her own meals and lodging are personal

because they would have been incurred whether or not the taxpayer

had engaged in any business activity.    Christey v. United States,

841 F.2d 809, 814 (8th Cir. 1988); Moss v. Commissioner, 80 T.C.

1073, 1078 (1983), affd. 758 F.2d 211 (7th Cir. 1985).    In order

for personal living expenses to qualify as a deductible business
                              - 24 -

expense under section 162(a), the taxpayer must demonstrate that

the expenses were different from, or in excess of, what he would

have spent for personal purposes.   Sutter v. Commissioner, 21

T.C. 170, 173 (1953).   Petitioners did not produce any evidence

that the food and the rent for the homestead were other than

ordinary living expenses.   Thus, petitioners have failed to

establish that the Hubers are entitled to a deduction for any

portion of the expenses under section 162.4

Issue 2.   Accuracy-Related Penalty Under Section 6662(a)

     Respondent determined that Waterfall Farms is liable for the

accuracy-related penalty under section 6662(a).   As pertinent

here, section 6662(a) imposes a 20-percent penalty on the portion

of an underpayment attributable to negligence or disregard of

rules or regulations.   Sec. 6662(b)(1).   Negligence includes any

failure to make a reasonable attempt to comply with the

provisions of the Internal Revenue Code.   Sec. 6662(c); sec.

1.6662-3(b)(1), Income Tax Regs.



     4
      Except as otherwise provided, an individual is not allowed
a deduction with respect to the use of a dwelling unit that is
used by the individual as a residence. Sec. 280A(a). The
individual, however, may deduct expenses allocable to portions of
the dwelling that are exclusively used for business purposes.
Sec. 280A(c). In the case at bar, the Hubers did not argue that
their housing expenses are deductible under sec. 280A.
Therefore, we do not address the question of whether certain
portions of their expenses may be deductible under that section.
We note, however, that the Hubers have made no showing that the
farmhouse, or any portion thereof, was used exclusively for
business purposes.
                              - 25 -

     The penalty under section 6662(a) does not apply to any

portion of an understatement of tax if it is shown that there was

reasonable cause for the taxpayer’s position and that the

taxpayer acted in good faith with respect to that portion.     Sec.

6664(c)(1).   The determination of whether a taxpayer acted with

reasonable cause and in good faith is made on a case-by-case

basis, taking into account all the pertinent facts and

circumstances.   Sec. 1.6664-4(b)(1), Income Tax Regs.   The most

important factor is the extent of the taxpayer’s effort to assess

his/her proper tax liability for the year.   Id.   The good faith

reliance on the advice of an independent, competent professional

as to the tax treatment of an item may meet this requirement.

Sec. 1.6664-4(b), Income Tax Regs.

     Despite the fact that petitioners have the burden of proof,

see supra note 3, petitioners have made no showing that they made

an attempt to comply with the tax rules and regulations with

regard to those deductions taken by Waterfall Farms for the years

at issue which have been disallowed.   Hence, with respect to

those deductions, petitioners have failed to show that Waterfall

Farms was not negligent.   Nor have petitioners showed that they

acted in good faith with respect to, or that there was reasonable

cause for, the position they took.

     Further, petitioners do not claim that they relied on Mr.

Bleeker or any other professional as to the tax treatment of the
                              - 26 -

expenses for food and lodging.5   Petitioners simply assert that

the accuracy-related penalty does not apply because Waterfall

Farms properly claimed the deductions under section 162(a) and

the Hubers properly excluded the payments under section 119.    We

have found to the contrary.

     Under these circumstances, we are compelled to hold that

Waterfall Farms is liable for the accuracy-related penalty for

the years at issue.

     To reflect the foregoing,

                                              Decisions will be

                                         entered for respondent.




     5
      Before the trial in these cases, respondent filed a motion
to disqualify Mr. Bleeker from his representation of petitioners.
Respondent’s motion was based, in part, on the premise that, if
petitioners contend that they reasonably relied on Mr. Bleeker’s
advice with respect to the proper tax treatment of the payments
at issue, then Mr. Bleeker would be required to testify as a
witness in the trial of these cases. The Court held a telephone
conference call with Mr. Bleeker and counsel for respondent to
discuss respondent’s motion. During that call, Mr. Bleeker
informed the Court that petitioners did not intend to raise
reasonable reliance on a tax professional as a defense to the
accuracy-related penalties.
