                        T.C. Memo. 1999-235



                      UNITED STATES TAX COURT



          SIMCO AUTOMOTIVE PUMP CO., INC, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent

                 JOHN R. MACLEAN, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 1730-96, 1731-96.        Filed July 21, 1999.



     Joseph Falcone, for petitioners.

     Brian H. Rolfe, for petitioner in docket No. 1731-96.

     Timothy S. Murphy, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     GALE, Judge:   In these consolidated cases, respondent

determined deficiencies in petitioners’ Federal income taxes and

fraud penalties as follows:
                                  - 2 -


Petitioner Simco Automotive Pump Co., Inc. (Simco):

                                               Fraud penalty
      Fiscal year        Deficiency              sec. 6663

     June 30, 1990         $24,453                $18,340
     June 30, 1991          27,225                 20,419


Petitioner John R. MacLean (John):

                                          Fraud penalty
           Year      Deficiency             sec. 6663

           1989        $2,423                 $4,464
           1990          ---                  16,664
           1991        11,089                 18,332


     Unless otherwise noted, 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.

     We must decide the following issues:

     (1) Whether John had unreported income in the amounts of

$9,905 in 1989 and $34,731 in 1991.        We hold that he did.

     (2) Whether Simco is entitled to deduct, as compensation,

certain income received by John resulting from sales of scrap

metal.   We hold that Simco is not.
                                 - 3 -


        (3) Whether John committed fraud in not reporting income

from scrap metal sales for the years in issue.     We hold that he

did.1

        (4) Whether Simco committed fraud or, in the alternative,

was negligent in not reporting income from scrap metal sales for

the years in issue.     We hold that Simco is not liable for either.

                           FINDINGS OF FACT

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

incorporate by this reference the stipulation of facts,

supplemental stipulation of facts, and attached exhibits.     At the

time of filing the petitions, Simco’s offices were located in

Detroit, Michigan, and John resided in Bloomfield Hills,

Michigan.

Overview

        Simco was a corporation engaged in the reconditioning and

resale of automobile water pumps.     Simco’s taxable year was a

fiscal year ending June 30.     John and his brother Neal MacLean




        1
       John raised as an affirmative defense in his amended
petition, and petitioners argue on brief, that assessment is
barred by the statute of limitations on assessment and collection
in sec. 6501. Because we find that John committed fraud, the
period of limitations remains open, and respondent may assess at
any time. See sec. 6501(c)(1).
                                - 4 -


(Neal) each owned 50 percent of Simco’s stock.   Neal was

president of Simco, and John was vice president.

     The issues in these cases revolve around the proceeds from

John’s sale of scrap metal.    In August or September of 1989, John

began selling scrap metal that belonged to Simco and retaining

the proceeds from the sales.   At the time, John had a problem

with alcohol abuse.   The sales continued through the years in

issue.   Neal did not become aware of the scrap metal sales until

August of 1992.   The scrap metal sales proceeds were not reported

on either Simco’s or John’s tax returns for the years in issue as

originally filed.   However, both Simco and John filed amended

returns for such years in September 1992, on which a substantial

portion of the proceeds was reported.

The Scrap Metal Sales

     Prior to 1989, there were no sales of Simco scrap metal.

Although Simco generated scrap metal from its operations, the

scrap was treated as refuse because the company did not have the

space to sort and store it.    In August or September of 1989, John

first arranged sales of Simco’s scrap metal.   This was shortly

after Simco began using an additional building, which was known

as the Prospect building, giving John the ability to sort and
                                 - 5 -


store scrap metal.2    The sales of scrap metal continued into

1992.

      John sold the scrap metal to Dix Scrap Iron & Metal Co. (Dix

Scrap).     John contacted the president of Dix Scrap, John Brooks,

to arrange the sales of the scrap metal.    In general, when Dix

Scrap bought scrap metal, it would pay by either cash or check,

although use of a check was more convenient for Mr. Brooks.      When

John arranged the sales of scrap metal to Dix Scrap, he

specifically asked Mr. Brooks to pay in cash, and Mr. Brooks did

so.   John was the only individual associated with Simco with whom

Mr. Brooks dealt.

      Dix Scrap hauled the scrap metal from the Simco plant,

weighed it, and wrote out a weight ticket for each load.    Each

weight ticket indicated the date, the type of scrap metal, the

weight, the unit price, and total price.    Every week or two, John

would go to Dix Scrap to collect payment for the scrap metal.      He

would sign the accumulated weight tickets and take the tickets

and the cash.    Dix Scrap did not send copies of weight tickets,

or a statement of the sales, to Simco.    Further, John did not

request such documentation to be sent to Simco, and Mr. Brooks

did not think he was supposed to supply any such documentation.


        2
       Simco’s main building, which was known as the Buchanan
building, contained the main offices and the production
facilities. John worked in the Prospect building. The Prospect
building contained the purchasing and shipping facilities.
                               - 6 -


     During the years in issue, Dix Scrap purchased scrap metal

belonging to Simco as follows, with all payments in cash made

directly to John, which he retained:

     Period relating                        Total number of
     to Simco’s year      Total amount       separate sales

     July 1, 1989 -         $62,699                63
     June 30, 1990

     July 1, 1990 -          80,589               106
     June 30, 1991

     July 1, 1991 -          33,870                60
     Dec. 31, 1991

     Period relating
     to John’s year       Total amount

     July 1, 1989 -         $21,258
     Dec. 31, 1989

     Jan. 1, 1990 -          79,351
     Dec. 31, 1990

     Jan. 1, 1991 -          76,550
     Dec. 31, 1991

Neal’s Discovery of the Scrap Metal Sales

     Simco’s accountant was Wayne Boyer.    Mr. Boyer prepared

Simco’s, as well as John’s and Neal’s, tax returns and kept

Simco’s books.   However, Mr. Boyer was not a certified public

accountant.   Thus, once a year, Mr. Boyer would ask another

accounting firm to do a review and compilation of Simco’s books.3

     3
       A compilation involves putting a business’ financial
information into a financial statement format. A review involves
analytical procedures, such as comparisons of financial ratios,
                                                   (continued...)
                                - 7 -


For Simco’s June 30, 1991 fiscal year, the review and compilation

was prepared by Judy Zaremba and Jane Brodsky.    Ms. Brodsky

discussed the review and compilation with Mr. Boyer.    In

addition, because she was aware that firms with operations

similar to Simco’s commonly have scrap metal sales, she raised

the question of scrap metal sales with Mr. Boyer.    Ms. Zaremba

prepared a checklist, dated October 10, 1991, explaining some of

the reporting requirements used in the review and compilation.

Ms. Brodsky added the following handwritten note to the

checklist:    “Scrap sales will be looked into by Wayne’s client”.

However, following the review and compilation, Mr. Boyer did not

raise the issue of scrap metal sales with anyone associated with

Simco.

     Dix Scrap was audited by the Internal Revenue Service (IRS)

beginning sometime in 1992 and ending in October of the same

year.    While the audit was taking place, Mr. Brooks called

individuals from whom he had purchased scrap metal for cash,

including John, and advised them that the IRS was auditing Dix

Scrap and examining documentation with respect to Dix Scrap’s

cash purchases.    After receiving the call from Mr. Brooks, John

called Mr. Boyer sometime between April and July of 1992, to

inform Mr. Boyer about the scrap metal sales that he had been


     3
      (...continued)
to ensure records are being kept properly.
                                - 8 -


engaged in since 1989.   Mr. Boyer began to prepare amended tax

returns for Simco and John sometime prior to August of 1992.

     During the period from 1989, when he began selling Simco’s

scrap metal, until 1992, John did not tell Neal, or anyone else

associated with Simco, about the scrap metal sales.   Neal did not

become aware of the sales of scrap metal until August of 1992,

during one of Simco’s shareholders’ meetings.   The meeting was

attended by Neal, John, and Mr. Boyer.   At the meeting, either

John or Mr. Boyer brought up the issue of the scrap metal sales.

After Neal heard about the scrap metal sales at the meeting, he

contacted Simco’s comptroller, James Kissick, who was unaware of

the sales to that point.   Thereafter, Simco decided that John

could keep all of the proceeds from the scrap metal sales.4    Neal

asked Mr. Boyer to adjust Simco’s books and file the amended

returns.   John had been unable to locate the weight tickets

previously issued by Dix Scrap, so he obtained copies from Mr.

Brooks to ascertain the amounts received from the scrap metal

sales in order to permit the filing of the amended returns.      Mr.

Boyer decided how to treat the proceeds from the scrap metal

sales on Simco’s tax returns.

Recording and Reporting the Income



     4
       As discussed infra, Simco treated some of the proceeds as
compensation paid to John and some of the proceeds as repayment
of part of a loan from John to Simco.
                                 - 9 -


     Simco’s Books and Records

     Simco did not record any scrap metal sales on its books and

records for the period July 1, 1989, through December 31, 1991.

As of the date of the filing of Simco’s tax returns for the 1990

and 1991 fiscal years, the corporate books did not reflect that

the proceeds from the scrap metal sales for the period July 1,

1989, through June 30, 1991, were compensation to John.

     The total proceeds received from the sale of scrap metal to

Dix Scrap and retained by John during Simco’s fiscal year ended

June 30, 1992, equaled $78,621.02.       Sometime after June 30, 1992,

Simco recorded this amount in its books as a reduction in the

balance of loans previously made to Simco by John.5      Of this

amount, $33,870.00 was received and retained by John during the

period from July 1 through December 31, 1991, and the remainder

was received from January 1 through June 30, 1992.

     Simco’s Tax Returns

     Neal assumed responsibility for filing Simco’s tax returns

and signed both the original and the amended returns on behalf of

Simco.   Simco’s original tax returns for fiscal years ended


     5
       Although the parties stipulated that the $78,621.02 in
scrap metal sales proceeds received from Dix Scrap “was booked as
a loan to John MacLean from Simco”, the exhibits and testimony
demonstrate that the $78,621.02 was actually recorded as a
repayment of amounts previously lent to Simco by John. The Court
may disregard a stipulation where it is clearly contrary to the
evidence in the record, and we do so here. See Cal-Maine Foods,
Inc. v. Commissioner, 93 T.C. 181, 195-196 (1989).
                              - 10 -


June 30, 1990 and 1991, did not report any proceeds from the

sales of scrap metal.   On its original tax returns, Simco

reported the following compensation for Neal and John:

      Fiscal year             Neal                  John

     June 30, 1990          $297,150              $316,398
     June 30, 1991           367,350               352,850

On its amended returns for fiscal years ended June 30, 1990, and

June 30, 1991, which were filed on or about September 25, 1992,

Simco reported the following income and claimed the following

deductions:

                          Net change        Net change in
      Fiscal year          in income          deductions

     June 30, 1990          $54,178               $54,178
     June 30, 1991           79,728                79,728

Each income adjustment was explained as an “increase in sales”,

and each deduction adjustment as an “increase in salaries”.

     John’s Tax Returns

     John’s original returns for his tax years 1989 through 1991

did not report proceeds from scrap metal sales.       On his amended

returns, John reported the following income:

                                       Net change
          Calendar year                in income

          Dec. 31, 1989                 $11,353
          Dec. 31, 1990                 210,734
          Dec. 31, 1991                  41,819

Each income adjustment was explained as “additional income”.

Notices of Deficiency
                               - 11 -


     In the notice of deficiency with respect to Simco,

respondent determined inter alia that Simco had unreported income

in the amounts of $8,521 for its taxable year ended June 30,

1990, and $860 for its taxable year ended June 30, 1991.     The

amounts determined to be unreported income in these years

represent the difference between the proceeds from the scrap

metal sales to Dix Scrap and the amounts reported as additional

income on Simco’s amended returns, as follows:

     Fiscal    Scrap metal Amount reported        Unreported
      year       proceeds on amended return    income determined

     6/30/90     $62,699       $54,178              $8,521
                                1
     6/30/91      80,589          79,728               860
     1
      Respondent treated the amount reported on the amended
     return as being $79,729.

In addition, respondent determined that Simco is not entitled to

the claimed offsetting deductions for “increase in salaries” in

the amounts of $54,178 and $79,728 for its 1990 and 1991 taxable

years, respectively.

     In the notice of deficiency with respect to John, respondent

determined inter alia that John had unreported income in the

amounts of $9,905 for tax year 1989 and $34,731 for tax year

1991.    The amounts determined to be unreported income in these

years represent the difference between the scrap metal sales

proceeds retained by John and the amounts he reported as

additional income on his amended returns, as follows:
                               - 12 -


              Scrap metal Amount reported         Unreported
     Year       proceeds on amended return     income determined

     1989       $21,258        $11,353              $9,905
     1991        76,550         41,819              34,731

                               OPINION

Unreported Income

     The first issue is whether John had unreported income in the

amounts determined by respondent.   The parties have stipulated

that Simco sold scrap metal in exchange for the proceeds

specified above during the years at issue and that such proceeds

were retained by John.    Simco reported as income on its amended

returns a significant portion of those proceeds.   Simco concedes

on brief that the balances of the proceeds not reported on

Simco’s amended returns, $8,521 in fiscal year 1990 and $860 in

fiscal year 1991, are unreported income as determined by

respondent.   With respect to John, for tax year 1989 petitioners

present no argument as to the unreported income determined by

respondent, and we treat the issue as conceded.    With respect to

John’s 1991 tax year, petitioners argue that the proceeds he

retained from the sale of scrap metal from July 1, 1991 through

December 31, 1991 (the first half of Simco’s fiscal year ended

June 30, 1992) represent repayment by Simco of money that John
                                  - 13 -


had previously lent to Simco, and therefore that such proceeds

were not income to him.6

       In general, amounts received as repayment of a loan are not

included in income.       See Kudo v. Commissioner, T.C. Memo. 1998-

404.       “Whether * * * an advance made by a shareholder to a

corporation creates a true debtor-creditor relationship is a

factual question to be decided based on all relevant facts and

circumstances.”       Haag v. Commissioner, 88 T.C. 604, 615 (1987),

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

Whether or not a loan exists depends on the intent of the parties

at the time of the transaction.       See Haber v. Commissioner, 52

T.C. 255, 266 (1969), affd. per curiam 422 F.2d 198 (5th Cir.

1970).       By the same token, whether or not the transfer of funds

constitutes the repayment of a loan depends on the intent of the

parties at the time of the transfer.       Where the transaction

claimed to be a loan is between a corporation and a controlling

shareholder, the situation invites special scrutiny.       See



       6
       Petitioners’ argument applies to the proceeds from scrap
metal sales retained by John during the latter half of his 1991
tax year, which the parties have stipulated totaled $33,870.
However, respondent determined that John had unreported income of
$34,731 for tax year 1991 and maintained that position on brief.
Petitioners have not addressed this $861 discrepancy, and we
accordingly treat this difference as either conceded by
petitioners or decided adversely to them, due to our rejection
hereinafter of the claim that any portion of the scrap metal
proceeds received by John in 1991 constituted the repayment by
Simco of a loan to it by John.
                                - 14 -


Electric & Neon, Inc. v. Commissioner, 56 T.C. 1324, 1339 (1971),

affd. without published opinion 496 F.2d 876 (5th Cir. 1974);

Haber v. Commissioner, supra at 266.     Because both Simco

shareholders acquiesced in the treatment of the proceeds from the

latter half of 1991 as a loan repayment, we believe special

scrutiny is appropriate in the instant cases.

        Based on all the facts and circumstances, we find that

petitioners have failed to prove that John’s retention of the

proceeds from scrap metal sales during the period July 1 through

December 31, 1991, was intended to be the repayment of a loan.

First, we note the general confusion on the part of petitioners

about who lent what to whom.     Petitioners executed stipulations

in these cases stating that Simco characterized the scrap metal

proceeds received during its fiscal year ended June 30, 1992 as a

loan from Simco to John.     In his opening statement at trial,

petitioners’ counsel argued that these proceeds “should be

considered a loan to Mr. McLean”.     However, on brief, for the

first time, petitioners take a different position; namely, that

these proceeds constituted Simco’s repayment of a loan to it by

John.     This mutation in petitioners’ position is emblematic of

the confused state of the record regarding the purported loan

transaction.     Although the record contains copies of certain

demand notes obligating Simco to pay John (and Neal) various

amounts, the notes themselves are ambiguous as to their date of
                              - 15 -


execution,7 and there is no other evidence in the record of the

time when the notes were executed.     Further, the notes provide

for interest at a rate of 9 percent, yet there is no evidence

that Simco paid John any interest.     Certainly John has not

claimed that any portion of the retained proceeds that he now

seeks to characterize as a loan repayment is interest; he claims

the entire amount as nontaxable return of principal.     Although

Neal and Simco’s comptroller both testified that John and Neal

typically lent their annual bonuses back to the corporation,

petitioners have not demonstrated any relationship between these

bonus amounts and the purported indebtedness of Simco to John and

Neal.8   Finally, even if Simco had any indebtedness to John, it

is indisputable that Simco lacked intent to make a loan repayment

at the time when John was secretly diverting corporate proceeds;

no one acting in behalf of the corporation had knowledge of the

diversions at that time.   The loan repayment characterizations

are entirely ex post facto; although Simco’s books reflect that



     7
       Although the three notes for John each recite that they
were signed on “the day and year first above written”, at the top
of each document the only dates which appear are as follows:
“Effective: June 30, 1989”, “Effective: June 30, 1990”, and
“Effective: June 30, 1991”. We find that this phrasing raises an
ambiguity as to the date of execution.
     8
       Similarly, certain corporate minutes introduced into the
record recite salaries for John and Neal that do not bear any
discernible connection to amounts purportedly lent back to the
corporation.
                               - 16 -


as of June 30, 1992, the outstanding balance of Simco’s loans to

John was reduced in an amount equal to the purported loan

repayment amount, Simco’s comptroller testified that such an

entry was likely made after that date.   Based on the foregoing,

we hold that John is not entitled to exclude from income the

$33,870 in scrap metal proceeds he retained during the latter

half of 1991.

Compensation Deduction

     Section 162(a)(1) allows as a deduction “a reasonable

allowance for salaries or other compensation for personal

services actually rendered”.   The test for deductibility under

this provision is two-pronged:   Payments are deductible as long

as they “(1) do not exceed the reasonable compensation for the

services actually rendered, and (2) are actually intended to be

paid purely for the services.”   Electric & Neon, Inc. v.

Commissioner, supra at 1340; see sec. 1.162-7(a), Income Tax

Regs.   Petitioners have the burden of proof.   See Rule 142(a);

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

     In the instant case, Simco fails the second prong, if not

both.   To satisfy the second prong, the payments in question must

have been made with the intent to compensate.    See King’s Court

Mobile Home Park, Inc. v. Commissioner, 98 T.C. 511, 514 (1992)

(citing Paula Constr. Co. v. Commissioner, 58 T.C. 1055, 1058

(1972), affd. without published opinion 474 F.2d 1345 (5th Cir.
                                  - 17 -


1973)).    The question of whether payments were made with an

intent to compensate is a question of fact, bearing in mind that

transactions between closely held corporations and their

stockholders are examined with close scrutiny.       See Paula Constr.

Co. v. Commissioner, supra at 1058-1059.       The requisite intent

must have existed when the purported compensation payment was

made.     See id. at 1059-1060.   In the instant case, Neal, the

other 50-percent shareholder, did not even know about the scrap

metal sales until August 1992, well after John had received the

payments, for which Simco claims a compensation deduction.       The

contemporaneous corporate records obviously did not record the

amounts as compensation because the amounts were not recorded at

all.    It was only after Neal learned about the scrap metal sales

that the proceeds therefrom were recorded and characterized in

the amended returns as compensation.       There was no intent to

compensate when John actually received the payments.       See Tool

Producers, Inc. v. Commissioner, T.C. Memo. 1995-407, affd. per

curiam without published opinion 97 F.3d 1452 (6th Cir. 1996).

Therefore, we hold that petitioner Simco is not entitled to the

claimed deduction for compensation.
                               - 18 -


Fraud of John

     Fraud exists if “any part of any underpayment of tax

required to be shown on a return is due to fraud”.     Sec. 6663(a).

John filed amended tax returns for each of the tax years 1989-

1991 showing increases in tax owed, effectively conceding that

there was an underpayment in each year.     Thus, we must decide

whether any portion of each underpayment was due to fraud.

     The existence of fraud is a question of fact.     See Hagaman

v. Commissioner, 958 F.2d 684, 696 (6th Cir. 1992), affg. and

remanding on other grounds T.C. Memo. 1987-549.     Respondent has

the burden of proof to show fraud by clear and convincing

evidence.    See sec. 7454(a); Rule 142(b).   To establish fraud,

respondent must show that the taxpayer “engaged in conduct with

the intent to evade taxes that he knew or believed to be owing.”

United States v. Walton, 909 F.2d 915, 926 (6th Cir. 1990).        We

may rely on circumstantial evidence to establish fraud.     See id.

Fraud may be inferred from “any conduct, the likely effect of

which would be to mislead or to conceal.”     Spies v. United

States, 317 U.S. 492, 499 (1943).

     John engaged in much conduct that was likely to mislead or

conceal.    He engaged in a consistent pattern of underreporting

income.    See Holland v. United States, 348 U.S. 121, 137 (1954).

He diverted corporate funds for his own use and concealed the

diversion from his brother, the other 50-percent shareholder of
                                - 19 -


the corporation.    See United States v. Thetford, 676 F.2d 170,

175 (5th Cir. 1982).     When arranging the sales with Dix Scrap, he

asked that he be paid in cash, and he did not ask for any record

of the sales to be sent to Simco.     See Bradford v. Commissioner,

796 F.2d 303, 307-308 (9th Cir. 1986), affg. T.C. Memo. 1984-601.

He failed to maintain the records of the sales; i.e., the weight

tickets.   See Solomon v. Commissioner, 732 F.2d 1459, 1461 (6th

Cir. 1984), affg. per curiam T.C. Memo. 1982-603.     He failed to

inform Mr. Boyer, his return preparer, about the income from the

scrap metal sales until after he learned that Dix Scrap was being

audited by the IRS.     See Korecky v. Commissioner, 781 F.2d 1566,

1568 (11th Cir. 1986), affg. per curiam T.C. Memo. 1985-63.      The

transactions in which the foregoing occurred were not isolated

but extensive.     There were 229 separate transactions over a

period of 2-½ years.     Based on all the facts and circumstances,

we find that John committed fraud in each year in issue in

connection with his failure to report the income from the scrap

metal sales.

Fraud of Simco

     A corporation can act only through its officers and agents.

See Botwinik Bros. of Mass., Inc. v. Commissioner, 39 T.C. 988,

996 (1963).    Thus, the only way Simco would be liable for fraud

is if its officers or agents engaged in some fraudulent acts.      In

arguing that Simco is liable for fraud, respondent relies largely
                              - 20 -


on the actions of John.   Respondent also contends, however, that

Neal’s actions were likewise fraudulent, claiming on brief that

Neal “actively participated in the concealment of John’s scheme

to divert corporate funds”.   Accordingly, we must consider

whether Neal’s actions were fraudulent and attributable to Simco.

     Although respondent’s charges against Neal are somewhat

scattershot, as best we can assemble them the specifics of Neal’s

“active * * * [participation] in the concealment of John’s

scheme” are:   first, Neal’s participation in the decision to

treat the diverted proceeds, after the fact, as compensation to

John and to file amended corporate returns on that basis; second,

Neal’s testimony at trial concerning an audit interview with

respondent’s agents relating to the transfer of materials between

Simco facilities, which is at a variance with the agents’

contemporaneous notes; and third, certain other improbable trial

testimony of Neal’s concerning who first raised the issue of

scrap metal sales at the August 1992 shareholders’ meeting.

     We first note our finding that Neal was unaware of the

diversion of corporate funds until August 1992.   The evidence in

the record strongly supports this conclusion, and it is entirely

plausible.   John, who the parties agree had a problem with

alcohol abuse at the time, was effectively stealing from Neal

when he diverted the scrap metal proceeds, and it is not

surprising that he hid his activities from Neal and others at
                                - 21 -


Simco.     Any assessment of Neal’s actions, therefore, begins with

his learning of John’s diversions in August 1992.    Neal’s

participation in the decision to treat the diverted funds as

compensation and to file amended corporate returns on that basis

was not fraudulent, certainly not without a showing that Neal was

aware that claiming compensation deductions in these

circumstances was erroneous.    Respondent has not produced such

evidence; rather, the evidence shows that Neal was acting on the

advice of Simco’s accountant.    Cf. King’s Court Mobile Home Park,

Inc. v. Commissioner, 98 T.C. at 517 (“We have a strong suspicion

that * * * [the taxpayer] took the deduction knowing that there

was a substantial question as to the validity of that action.

But suspicion of fraud is not enough.”).    While we do not doubt

that Neal’s actions in filing the amended corporate returns were

also influenced by the knowledge that the audit of Dix Scrap was

likely to produce IRS scrutiny of Simco, this motivation does not

change our conclusion.    The amended returns, although claiming

erroneous deductions, substantially disclosed the diverted

income.9


     9
       In King’s Court Mobile Home Park, Inc. v. Commissioner, 98
T.C. 511 (1992), the taxpayer filed an original return that
failed to report certain income and then filed an amended return
that reported the income but claimed offsetting compensation
deductions, similar to the instant case. However, in King’s
Court Mobile Home Park, Inc., the amended return was filed within
the time required to file a return, so the amended return took
                                                   (continued...)
                              - 22 -


     As to respondent’s contention that Neal gave false testimony

at trial concerning an audit interview with respondent’s agents,

this claim rests on conflicting testimony.   One of the agent’s

notes of the interview recorded that John said he followed a

procedure for ensuring that the weight tickets that reflected the

scrap metal sales were forwarded from his work location in the

Prospect building to the main office in the Buchanan building.

At trial, both John and Neal denied that John had made the

statements recorded in the notes, while both agents gave

contradicting testimony.   The agent’s notes are not in evidence,

although John and Neal obtained the notes and reviewed them just

prior to trial.   On this record, respondent has failed to prove,

by clear and convincing evidence, that Neal gave false testimony

at trial.

     Finally, while we agree with respondent that Neal’s

testimony alluding to the possibility that he himself may have

been the one who first raised the issue of scrap metal sales is

highly improbable, we do not believe this is a material factor in

light of the actions taken by Neal to disclose the diverted

income on Simco’s amended returns.


     9
      (...continued)
the place of the original return. Thus, the question was whether
the deductions were claimed fraudulently, not whether the income
was omitted fraudulently. In the instant case, the amended
returns were not filed within the time required for filing
returns, so they do not take the place of the original returns.
                              - 23 -


     For the foregoing reasons, we do not believe that respondent

has shown by clear and convincing evidence that Neal’s actions

provide a basis for attributing fraud to Simco.   If Simco has

committed fraud, it can only be because John’s actions are

attributable to it.

     Simco filed amended tax returns for each of the fiscal years

1989 and 1990 showing increases in tax owed, effectively

conceding that there was an underpayment in each year.     Thus, the

issue is whether Simco acted with fraudulent intent.     See sec.

6663(a).   In deciding this issue, the pertinent questions are:

(1) Whether the wrongdoing officer or agent had sufficient

control of the corporation that his fraudulent acts should be

imputed to the corporation, and (2) whether the wrongdoer was

acting in behalf of, and not against the interests of, the

corporation.   See Ruidoso Racing Association, Inc. v.

Commissioner, 476 F.2d 502, 506 (10th Cir. 1973), affg. in part

and remanding in part on another ground T.C. Memo. 1971-194;

Botwinik Bros. of Mass., Inc. v. Commissioner, 39 T.C. at 996;

Federbush v. Commissioner, 34 T.C. 740, 750 (1960), affd. per

curiam 325 F.2d 1 (2d Cir. 1963); Moore v. Commissioner, T.C.

Memo. 1977-275, affd. 619 F.2d 619 (6th Cir. 1980).    In the

instant case, John, the wrongdoer, was not the sole stockholder.

Cf. Federbush v. Commissioner, supra.   He did not so dominate the

corporation that it was a creature of his will.   Cf. Frankland
                               - 24 -


Racing Equip., Inc. v. Commissioner, T.C. Memo. 1987-210.    If

anything, Neal, the president of Simco, was more dominant than

John.   Thus, John did not have sufficient control of Simco to

impute his acts to Simco on that basis, and we proceed to

consider whether John was acting in behalf of, and not against

the interests of, Simco.   See Botwinik Bros. of Mass., Inc. v.

Commissioner, supra at 996.

     We find that the wrongdoer, John, acted against the

interests of Simco.   He diverted proceeds for his own use that

belonged to Simco.    Simco did not benefit from the sales of scrap

metal, except for the incidental tax benefit resulting from the

fact that Simco did not report the income from the sales, but it

did suffer a detriment in the form of the revenue taken by John.

The diverted revenue was not money that would otherwise have been

available to him as dividends because he was a controlling or

dominant shareholder.   See Alexander Shokai, Inc. v.

Commissioner, 34 F.3d 1480, 1488 (9th Cir. 1994), affg. T.C.

Memo. 1992-41; American Lithofold Corp. v. Commissioner, 55 T.C.

904, 926 (1971).

     Petitioners invoke the Court of Appeals for the Third

Circuit’s opinion in Asphalt Indus., Inc. v. Commissioner,     384

F.2d 229 (3d Cir. 1967), revg. 46 T.C. 622 (1966), and invite us

to rely on what has become known as the “‘innocent stockholder’

defense”.   Alexander Shokai, Inc. v. Commissioner, supra at 1489.
                               - 25 -


We decline petitioners’ invitation.     Although we hold that Simco

is not liable for fraud, we do so because we find that John was

not the dominant shareholder of Simco and was not acting in

behalf of Simco when he sold scrap metal that belonged to the

corporation, retained the proceeds, and failed to disclose the

income to the corporation, its other shareholder and advisers, or

the IRS.

Accuracy-Related Penalty With Respect to Simco

     In the alternative to fraud, respondent determined that

Simco was liable for the accuracy-related penalty under section

6662(a) and (b)(1).   Respondent’s determinations are presumed

correct, and petitioners bear the burden of proving that the

penalty does not apply.   See Rule 142(a); Bixby v. Commissioner,

58 T.C. 757, 791-792 (1972).

     Section 6662(a) imposes a penalty in an amount equal to 20

percent of the portion of an underpayment of tax attributable to

negligence or disregard of rules or regulations.    See sec.

6662(b)(1).   The term “negligence” includes a failure to make a

reasonable attempt to comply with the provisions of the Internal

Revenue laws, and “disregard” includes any careless, reckless, or

intentional disregard of rules or regulations.    See sec. 6662(c);

sec. 1.6662-3(b)(1) and (2), Income Tax Regs.

     The penalty for negligence or disregard of rules or

regulations is inapplicable, however, to any portion of the
                              - 26 -


underpayment for which the taxpayer can show that he acted in

good faith and had reasonable cause.   See 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 relevant facts and circumstances.   See sec.

1.6664-4(b)(1), Income Tax Regs.   “Circumstances that may

indicate reasonable cause and good faith include an honest

misunderstanding of fact or law that is reasonable in light of

all of the facts and circumstances, including the experience,

knowledge, and education of the taxpayer.”    Id.   In addition,

“Reliance on * * * professional advice * * * constitutes

reasonable cause and good faith if, under all the circumstances,

such reliance was reasonable and the taxpayer acted in good

faith”.   Id.

     In determining whether a corporation is liable for the

accuracy-related penalty, the acts of officers on behalf of the

corporation are imputed to the corporation.   See O.S.C. &

Associates, Inc. v. Commissioner, T.C. Memo. 1997-300; Ibabao

Med. Corp. v. Commissioner, T.C. Memo. 1988-285.    As we have

already held, John did not act in behalf of Simco, so his acts

are not imputed to Simco.   Thus, respondent’s determination of

Simco’s negligence or disregard of rules or regulations depends

on a finding of negligence or disregard of rules or regulations

on the part of Neal.   As we have also found, John concealed the
                              - 27 -


fact of the scrap metal proceeds from Neal.   Thus, Neal had an

“honest misunderstanding of fact”, sec. 1.6664-4(b)(1), Income

Tax Regs., that Simco was reporting all of its income.    This

misunderstanding was certainly reasonable in light of the fact

that Neal had no “knowledge” about the scrap metal sales until

August of 1992, after Simco’s original returns were filed.    See

sec. 1.6664-4(b)(1), Income Tax Regs.   Moreover, in filing

Simco’s amended returns, Neal relied upon the advice of the

company’s accountant.   Such reliance was reasonable and in good

faith.   See id.; sec. 1.6664-4(c), Income Tax Regs.    Therefore,

imputing Neal’s acts to Simco, we hold that Simco is not liable

for accuracy-related penalties.

     To reflect the foregoing,

                                    Decision will be entered for

                                  respondent with respect to the

                                  deficiencies and for petitioner

                                  with respect to the penalties in

                                  docket No. 1730-96.

                                    Decision will be entered for

                                  respondent in docket No.

                                  1731-96.
