                        T.C. Memo. 2002-79



                      UNITED STATES TAX COURT



                 DOMER L. ISHLER, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent

   20TH CENTURY MARKETING, INC., Petitioner v. COMMISSIONER OF
                   INTERNAL REVENUE, Respondent



     Docket Nos. 13468-99, 13469-99.1     Filed March 28, 2002.



     Michael K. Wisner, David E. McGehee, and D. Ashley Jones,
for petitioners.

     Marshall R. Jones, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     COLVIN, Judge:   Respondent determined deficiencies in

petitioners’ Federal income tax and additions to tax as follows:


     1
        These cases were consolidated for trial, briefing, and
opinion.
                                       - 2 -

                                Domer L. Ishler

                                       Additions to tax
Year       Deficiency   Sec. 6653(b)(1)(A) Sec. 6653(b)(1)(B) Sec. 6661
                                                   1
1987        $112,227         $84,170                          $28,057
1988         396,659         297,494               --          99,165
       1
           50 percent of the interest due on $112,227.

                        20th Century Marketing, Inc.

                                            Additions to tax
Year ended       Deficiency Sec. 6653(b)(1)(A) Sec. 6653(b)(1)(B) Sec. 6661
                                                         1
 Dec. 31,         $118,314         $88,736                           $29,579
   1987
       1
           50 percent of the interest due on $118,314.

       Domer L. Ishler (petitioner) was president and owned all of

the stock of petitioner corporation, 20th Century Marketing, Inc.

(TCM).       TCM earned commissions on sales of electronic components

to Chrysler Corp.       Petitioner arranged for a Hong Kong

corporation, Camaro Trading Co., Ltd. (Camaro), to receive

commissions which otherwise would have been paid to TCM.       The

issues in dispute primarily relate to whether Camaro was paid for

services performed by Camaro, as petitioner contends, or as a

device to avoid taxation of most of that commission income, as

respondent contends.
                                - 3 -

     After concessions,2 the issues for decision are:

     1.   Whether TCM had unreported income of $307,696 in 1987

and whether petitioner had unreported income of $308,723 in 1987

and $1,421,218 in 1988.   We hold that they did.

     2.   Whether petitioner is liable for the addition to tax for

fraud under section 6653(b) for 1987 and 1988 and whether TCM is

liable for fraud for 1987.    We hold that petitioner is and that

TCM is not.

     3.   Whether the statute of limitations bars assessment of

tax for 1987 and 1988.    We hold that it does not.

     4.   Whether petitioner is liable for the addition to tax

under section 6661 for substantial understatement for 1987 and

1988, and whether TCM is liable for the section 6661 addition to

tax for 1987.   We hold that they are.

     Unless otherwise indicated, section references are to the

Internal Revenue Code in effect for the years in issue.   Unless

otherwise indicated, Rule references are to the Tax Court Rules

of Practice and Procedure.




     2
        Respondent concedes that petitioner corporation
overreported interest income by $1,632.73 for 1987, and that
petitioner overreported interest income of $6,359 for 1988.
                                 - 4 -

                           FINDINGS OF FACT

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

A.   Petitioners

     1.   Domer Ishler

     Petitioner lived in Huntsville, Alabama, when he filed his

petition in this case.     He graduated from high school and

completed 6 months of trade school in electronics.

     Lela Ishler is petitioner's mother, and her husband is D.

Marvin Ishler.     Marvin M. Ishler is petitioner's brother.   Traci

Ishler is petitioner's daughter.     Joyce Ishler Eller (Eller) is

petitioner's former wife.     Melonee Hudson (Hudson) was

petitioner's niece.     She died in July 1994.

     During the 1980s, petitioner conducted business and

investment activities through a sole proprietorship named Double

D Investments.     Petitioner maintained a checking account at

Central Bank in Huntsville for Double D (the Double D account).

     2.   20th Century Marketing, Inc.

     TCM’s principal office was in Huntsville when it filed its

petition in this case.     Petitioner incorporated TCM in 1967 and

was its only employee until 1970.     TCM was a C corporation for

1987 and an S corporation for 1988.      Petitioner was TCM’s sole

shareholder and chief executive officer in 1987 and 1988.      TCM

had 34 employees and annual sales of about $90 million by 1989.
                               - 5 -



     TCM sold electronic components provided by manufacturers, or

by intermediaries such as Nissei Sangyo America, Ltd. (NSA), to

manufacturers such as Chrysler.   TCM earned commissions on its

sales.

B.   Other Business Entities

     1.   NSA

     NSA is an Illinois corporation and subsidiary of Hitachi.

It supplied electronic and mechanical components to car

manufacturers during the years in issue.

     2.   Camaro

     Camaro was incorporated by Philip Lawrence Choy (Choy) under

the laws of Hong Kong on July 19, 1983.    Choy was Camaro’s

management nominee.3   Camaro opened a Hong Kong dollar-denominated

checking account and a U.S. dollar-denominated savings account at

the Hongkong & Shanghai Banking Corp., Ltd. (HSBC), in Hong Kong

in July 1983.   Petitioner’s initial contact with Camaro was in

1983, through his friend, Richard Adler, whose common law wife,

Kay Adler (also known as Jo Ying Ying or Kay Chou), was one of


     3
        Kay Chou and her brother-in-law Chen paid Choy, a
registered agent in Hong Kong, to incorporate Camaro, using
nominee companies as Camaro’s shareholders. He substituted the
names of the shareholders in the corporate charter. Camaro was
ready for business the next day. The names of Chou and Chen do
not appear in Camaro’s records because Camaro’s shareholders were
nominee companies. Choy was not an officer of Camaro.
                                 - 6 -

Camaro’s beneficial owners.4

     Camaro had no employees, salesmen, traders, or marketers.

Camaro had no office or employees in Alabama.

           a.    Petitioner’s Signature Authority Over Camaro Funds

     On August 4, 1983, Choy and petitioner opened a U.S. dollar-

denominated savings account and a Hong Kong dollar-denominated

checking account in Camaro’s name at Standard Chartered Bank

(SCB) in Hong Kong.    Only Choy and petitioner had signature

authority over those accounts.    The accounts were closed on May

1, 1989.

     In 1986, at petitioner’s suggestion to Choy, Thomson

McKinnon Securities, Inc. (TM), opened a brokerage account for

Camaro.    Only petitioner had signature authority over that

account.   On September 30, 1987, TM issued a $23,250 check to

Camaro from funds in Camaro's TM account.    Petitioner endorsed

the check as Camaro’s agent to Valar Resources, Ltd., a Canadian

company.   Camaro's TM account was closed on February 22, 1988.

           b.    Petitioner’s Diversion of $12,328 of TCM
                 Commissions to Camaro in 1983-84

     NSA sold electronic components to SCI Components, Inc.

(SCI), of Huntsville in 1983 and 1984.    From August 23 to

November 21, 1983, NSA sent seven invoices to SCI for sales of

electronic components.    On March 30, 1984, NSA issued a $12,328



     4
        Kay Chou’s brother-in-law Chen was Camaro’s other
beneficial owner in 1987 and 1988.
                                - 7 -

check to TCM for commissions on those sales.     Petitioner returned

the check to NSA, and NSA voided it.     On June 20, 1984, he wrote

to NSA on TCM letterhead asking that a new commission check be

issued and sent to Camaro at a Hong Kong address.     NSA sent a

check to Camaro for $12,328 on June 25, 1984, and Camaro

negotiated it on July 13, 1984.

           c.   Petitioner’s Representation in 1993 That He Was an
                Owner of Camaro

     On September 16, 1983, Intergraph Corp. (Intergraph) of

Huntsville bought 147,000 16K computer memory chips from Camaro

for $235,200.   Petitioner endorsed the check as “owner” of

Camaro.

           d.   Camaro’s SCB VISA Card

     On November 30, 1985, Choy and petitioner applied to SCB for

a VISA card for Camaro.   A November 29, 1985, Camaro board

resolution authorized petitioner to sign on behalf of Camaro with

respect to the SCB VISA card.   On December 27, 1985, SCB opened a

corporate VISA card account in petitioner's name.

     Petitioner was the only authorized user of the SCB VISA

card.   He used it in 1987 and 1988.    SCB sent the monthly

statements for the SCB VISA card to petitioner at Camaro's Hong

Kong address.   The amounts due were paid from Camaro's HSBC Hong

Kong dollar-denominated current account.     Choy canceled

petitioner’s SCB VISA card on August 17, 1989.
                               - 8 -

C.    The Sale of Shinwa Radio/Cassette Players to Chrysler

      1.   Shinwa Radio/Cassette Players

      NSA supplied electronic and mechanical components from 1983

to 1988 for installation on Chrysler vehicles.    One such

component was a radio/cassette player (the Shinwa) manufactured

by Shinwa, a Japanese company that had a factory in China.

      2.   The NSA/Camaro and Camaro/TCM Agreements

      Chrysler’s Acustar division, located in Huntsville,

manufactured components for installation on Chrysler vehicles.

NSA supplied Shinwas to the Acustar division.    TCM earned

commissions in 1986 as NSA’s representative for sales by NSA of

small quantities of Shinwas to Chrysler.

      In late 1986, Chrysler asked Shinwa to supply all of

Acustar’s radio/cassette players.   Shinwa agreed to supply

radio/cassette players to Chrysler for 3 years beginning in 1987.

Chrysler expected to buy $30 million of Shinwas annually.

      A draft agreement dated January 1, 1987, relating to the

sale by NSA of Shinwas to Chrysler named NSA as the principal and

TCM as the representative.   Koichi Maekawa (Maekawa), president

of NSA, signed the draft agreement, but petitioner did not sign

it.   At petitioner’s request, Camaro, not TCM, was named as the

representative.   A sales representative agreement (the NSA/Camaro
                               - 9 -

agreement), dated January 1, 1987, and executed on September 1,

1987, was signed by Maekawa as president of NSA and by petitioner

on behalf of Camaro.

     Under the NSA/Camaro agreement, Camaro agreed to “use its

best efforts and skills to sell, promote and generally create a

demand for * * * [Shinwas] to * * * [Chrysler]”, in exchange for

which it would receive a commission of 5 percent of the net

proceeds of sales of Shinwas by NSA to Chrysler.

     Despite the NSA/Camaro agreement, NSA did not deal with

Camaro and considered TCM to be its sales representative.     Camaro

did not negotiate, price, or set terms relating to the Shinwa

transaction and had no role in delivering the Shinwas to

Chrysler.   NSA bought and took title to the radio/cassette

players from Shinwa because Camaro could not take title to or

provide financing for $30 million worth of Shinwa cassette

mechanisms.

     NSA began shipping large quantities of Shinwas to Chrysler

in June 1987.   On June 30, 1987, at petitioner’s request, Hideo

Wakashita (Wakashita), a mid-level manager of NSA, sent an

internal NSA memo requesting that future commissions on the sale

of Shinwas to Chrysler/Acustar be paid to Camaro and sent to

petitioner at TCM in Huntsville.

     Choy, on behalf of Camaro, and petitioner, as CEO/president

of TCM, signed an agreement (the Camaro/TCM agreement) on August
                               - 10 -

31, 1987.    The Camaro/TCM agreement provided that TCM would

receive 10 to 30 percent of the commissions earned by Camaro on

the sales of Shinwas to Chrysler.

     Jerry Scott Taylor (Taylor) was a sales representative for

TCM from 1984 to 1989.    Taylor was a member of TCM’s board of

directors from late in 1987 to 1989.     The board began meeting

around 1987.    Taylor attended board meetings.

     Taylor began working on the Chrysler/Acustar account late in

1984 or early in 1985.    He performed the day-to-day business

activities relating to Chrysler’s purchase of the Shinwa cassette

mechanisms.    Taylor used TCM's name and letterhead, not Camaro's,

in dealing with NSA.    Taylor first heard of Camaro in 1988, and

first learned of the 1987 Camaro/TCM agreement in 1992.

     On January 27, 1988, Camaro issued to Taylor a $5,000 check

drawn on its U.S. dollar-denominated savings account.     No company

name appeared on the $5,000 check.      Taylor believed this payment

was an advance from petitioner of a bonus for his work for TCM.

     3.     Termination of the NSA/Camaro Agreement

     NSA terminated the NSA/Camaro agreement on March 31, 1989.

In the notice of termination, NSA stated that Camaro had let NSA

erroneously assume that Camaro was an Alabama corporation when

the agreement was executed.    Because Camaro was a Hong Kong

corporation, NSA faced unexpected liability for a large amount of

withholding tax under section 881(a) (plus penalties and
                               - 11 -

interest).    On April 12, 1989, NSA told Camaro that NSA would

retain unpaid commissions otherwise due to Camaro to offset that

potential tax liability.

D.   Petitioners’ Bank Accounts

     Petitioner maintained a checking account at Central Bank in

Huntsville in 1987 and 1988 for himself (the personal checking

account).    TCM maintained an operating account, a money market

account, and a payroll account at Central Bank in 1987 and 1988.

TCM deposited the following amounts to those accounts in 1987 and

1988:
                                      Account
             Year      Operating    Money market      Payroll

             1987      $1,483,102       $569,428     $688,300
             1988       2,153,995        984,528        --

E.   Payments to TCM Which Were Not Deposited in TCM Accounts

     1.     1987

     Between February 9 and September 22, 1987, on behalf of TCM,

petitioner endorsed and deposited to the Double D account 17

checks payable to TCM totaling $19,738.95.      Midtex Relays, Inc.,

issued a $2,106.63 check to TCM on July 30, 1987.     Petitioner

endorsed the check on behalf of TCM but did not deposit it in any

account maintained by petitioner or TCM.      NSA issued a $1,698.35

check to TCM, which petitioner deposited in his personal checking

account on August 27, 1987.
                                - 12 -

     2.    1988

     On January 8, 1988, Montrose Products Co. issued a $3,918.80

check to TCM.     Petitioner endorsed the check on behalf of TCM but

did not deposit it in an account maintained by petitioner or TCM.

The check was cashed.    In February and March 1988, on behalf of

TCM, petitioner endorsed and deposited in the Double D account

two checks payable to TCM totaling $1,958.60.

F.   Camaro Checks Reported by TCM

     TCM deposited two checks from Camaro totaling $11,789.54 in

its operating account in October 1987.     TCM reported this amount

on its 1987 return.     Between January 4 and October 25, 1988, TCM

deposited checks from Camaro totaling $166,416.10 in its

operating and money market accounts.     TCM reported this amount on

its 1988 return.

G.   Payments From NSA to Camaro in 1987 and 1988

     1.    1987

     Between September 11 and November 20, 1987, NSA issued five

checks totaling $298,601.27 to “Camaro Trading Co., Ltd.” or

“Camaro Trading Co., Ltd.    Attn:   Mr. D. Ishler”.   TCM received

these checks in Huntsville but did not deposit them in a TCM

account.   TCM sent them to Camaro in Hong Kong.

     2.    1988

     Between January 4 and December 22, 1988, NSA issued 13

checks totaling $1,569,596.15 to “Camaro Trading Co., Ltd.” or
                               - 13 -

“Camaro Trading Co., Ltd.   Attn:   MR. D. ISHLER”.   TCM received

these checks in Huntsville but did not deposit them in a TCM

account.   TCM sent them to Camaro in Hong Kong.

     3.    Camaro’s Deposit of the NSA Checks

     Camaro paid Berlin Co. Exchange, Ltd., of Hong Kong a small

fee to cash the NSA checks (discussed above in paragraph G).

From September 1987 to January 1989, Camaro deposited

$1,864,402.71 (of the $1,868,197.42 total proceeds of the NSA

checks) to the HSBC U.S. dollar-denominated savings account.

H.   Camaro’s Payments to or on Behalf of Petitioner

     Petitioner caused Camaro to make the following transfers to

him or on his behalf in 1987 and 1988.

     1.    Camaro’s Payments to Marvin M. Ishler (Petitioner’s
           Brother)

     From October 29, 1987, to March 25, 1988, Camaro transferred

$16,000 from its U.S. dollar-denominated savings account to

Marvin M. Ishler (petitioner’s brother).    On March 25, 1988,

Camaro transferred $5,000 to Odyssey Tours, owned by Marvin M.

Ishler.

     2.    Petitioner’s Payments for the Benefit of Eller

     On June 1, 1988, petitioner told Choy to issue a $6,500

check to Dr. Harvey A. Weiss from Camaro's HSBC U.S. dollar-

denominated savings account.   A $6,500 check dated June 1, 1988,
                                - 14 -

was issued to Dr. Weiss and deposited in his account on June 23,

1988.     These funds were used to pay for plastic surgery

for Eller.     Also on June 1, 1988, Camaro transferred $2,000 from

its U.S. dollar-denominated savings account to Eller.

     3.      Payments to or for the Benefit of Petitioner’s Daughter

     On March 25, 1988, Camaro transferred $5,000 from its U.S.

dollar-denominated savings account to petitioner’s daughter.      On

June 7, 1988, petitioner told the Hong Kong office of HSBC to

wire $27,820 to a BMW dealer to pay for a 1987 BMW for

petitioner’s daughter.     On June 18, 1988, the car dealer issued a

$1,000 check (refunding the deposit paid for the BMW) payable to

the Bank of San Clemente.     This check was used to buy a $1,000

Bank of San Clemente cashier's check, payable to petitioner.      On

June 23, 1988, petitioner deposited the check in his personal

checking account.

     4.      Petitioner's Deposit of Camaro Funds in His Personal
             Checking Account

     On August 23, 1988, petitioner told Choy to issue a $5,000

check payable to Sinja Kim, a friend of petitioner, from Camaro's

HSBC U.S. dollar-denominated savings account.     HSBC issued a

$5,000 check dated August 23, 1988, to Sinja Kim.     Sinja Kim and

Sharon Woodard, an employee of TCM, endorsed the check.      Sharon

Woodard deposited it in petitioner’s personal checking account on

October 6, 1988.
                               - 15 -

     5.    Transfer of $35,000 From Camaro Via Petitioner’s Mother
           to TCM’s Operating Account

     On September 22, 1988, Camaro directed HSBC to issue four

checks totaling $35,000 to Lela Ishler from Camaro's HSBC U.S.

dollar-denominated savings account.     HSBC issued the checks on

September 22, 1988.   On October 10, 1988, Lela Ishler opened a

money market account at Bank of the South, Dothan, Alabama.       She

deposited $17,000 in that account in October 1988.     She also

deposited $17,700 in her account at SouthTrust Bank of Dothan,

Alabama, and received $300 in cash in October and November 1988.

     Marvin M. Ishler had signature authority for Lela Ishler's

money market account.   On November 21, 1988, Bank of the South

issued a $26,000 cashier's check to Marvin M. Ishler from funds

in Lela Ishler's money market account.     Marvin M. Ishler and

petitioner endorsed the check, and petitioner deposited it in the

TCM operating account on November 22, 1988.5

     Marvin M. Ishler also had signature authority for Lela

Ishler’s SouthTrust account.   On November 21, 1988, Marvin M.

Ishler wrote a $9,000 check payable to cash on the SouthTrust

account.   He used those funds to buy a $9,000 SouthTrust official

check payable to petitioner, which petitioner endorsed and

deposited in the TCM operating account on November 22, 1988.


     5
        Although TCM’s 1988 year is not before the Court and
neither party focuses on TCM’s receipt of this $35,000, we note
that the parties stipulated that TCM reported all business
receipts deposited to its accounts in 1988.
                                - 16 -

     6.   Camaro’s Transfer of $5,000 to Hudson (Petitioner’s
          Niece)

     On December 5, 1988, petitioner told Choy to have HSBC issue

a $5,000 check to petitioner’s niece, Hudson, from Camaro's HSBC

U.S. dollar-denominated savings account.   On December 19, 1988,

Hudson deposited the HSBC check in her credit union account.

     Hudson died in July 1994.    By letter dated August 30, 1994,

petitioner stated that he had lent her $5,000 and demanded that

Hudson’s estate repay that amount.

     7.   Transfer of $10,000 From Camaro to Sylvia Mangin

     On May 26, 1988, pursuant to petitioner’s instruction to

Choy, Camaro transferred $10,000 from its U.S. dollar-denominated

savings account to Sylvia Mangin to pay the expenses of a ski

trip taken by the Mangins and petitioner’s family.

I.   Petitioners’ Tax Returns

     1.   Petitioners’ Tax Return Preparer

     Sidney R. White (White), C.P.A., prepared TCM’s and

petitioner’s tax returns for 1987 and 1988 and petitioner’s

amended tax returns for 1987 and 1988.   Petitioner gave White the

information he used to prepare those returns.   Petitioner did not

give White records of any of the Camaro accounts.    Petitioner did

not tell White that TCM had sent NSA checks to Hong Kong or that

petitioner had signature authority over any Camaro accounts.
                               - 17 -

     2.     Petitioner’s 1987 and 1988 Returns

     Petitioner did not report income from the 1987 and 1988 NSA

checks issued to Camaro on his 1987 and 1988 returns or 1987 and

1988 amended returns.

     Petitioner filed his 1987 return on October 19, 1988, and

his amended 1987 return on May 15, 1989.    Petitioner filed his

1988 return on September 28, 1989, and respondent received his

amended 1988 return on January 22, 1990.

     3.     TCM’s 1987 and 1988 Returns

     TCM did not report income from the 1987 and 1988 NSA checks

issued to Camaro on its 1987 and 1988 tax returns.    TCM

overstated its deductions by $6,359 on its 1988 return.

Petitioner signed and filed all of TCM’s tax returns.

J.   Petitioners’ Indictments and Guilty Pleas

     In March 1997, petitioner, TCM, and Camaro were indicted by

a grand jury on several counts.    Petitioner pled guilty to making

a false statement on a 1992 loan application, and TCM pled guilty

under section 7206(1) to filing a false amended income tax return

for 1988.

K.   Statute of Limitations and Petition To Quash Summons

     1.     Proceedings in the U.S. District Court for the Northern
            District of Alabama

     On October 4, 1990, respondent served nine third-party

administrative summonses relating to petitioners’ and Camaro’s

tax liabilities for the 1983 through 1989 tax years.    Petitioners
                              - 18 -

and Camaro filed a petition to quash the nine summonses (the

Alabama petition to quash) in the U.S. District Court for the

Northern District of Alabama (the Alabama District Court) on

October 10, 1990.

     Respondent served four more third-party administrative

summonses relating to petitioners’ and Camaro’s tax liabilities

for the 1983-89 tax years in October 1990.   Around October 29,

1990, petitioners and Camaro amended the Alabama petition to

quash to include the four additional third-party summonses.

     On April 29, 1991, the Alabama District Court denied the

Alabama petition to quash as to 12 of the 13 summonses.   On June

10, 1991, the Alabama District Court granted the petition with

respect to one of the summonses.

     2.    Proceedings in the U.S. District Court for the Southern
           District of New York

     On October 11, 1990, respondent served a third-party

recordkeeper summons on SCB, directing the production of certain

documents relating to petitioners’ and Camaro’s tax liabilities

for the 1983-89 tax years.   On October 12, 1990, respondent

served summonses on the Hongkong Bank (the HKB summons) and on

HSBC (the HSBC summons) relating to petitioners’ and Camaro’s tax

liabilities for the 1983 through 1989 tax years.

     On November 2, 1990, SCB's attorneys responded to the SCB

summons but did not produce the records identified in the

summons.
                              - 19 -

     On August 29 and 30, 1991, the United States moved to

enforce the HSBC and the SCB summonses in the U.S. District Court

for the Southern District of New York (the New York District

Court).   On March 24, 1992, the New York District Court filed a

stipulation and order in which it stated that it would request

judicial assistance from the Supreme Court of Hong Kong to obtain

the discovery sought by the SCB and HSBC summonses, and the

parties agreed to a stay of the summons enforcement proceedings

to permit the United States to seek judicial assistance from the

Supreme Court of Hong Kong.   The order stayed the enforcement of

the SCB and HSBC summonses pending resolution of the judicial

assistance request.

     The Alabama District Court executed a request for judicial

assistance of the Supreme Court of Hong Kong on July 23, 1993.

The Supreme Court of Hong Kong granted the Alabama District

Court’s request for judicial assistance on March 25, 1994.    From

November 1994 to August 1997, the Alabama District Court made

supplemental requests for judicial assistance from the Supreme

Court of Hong Kong seeking documents which had been requested in

the SCB and HSBC summonses but not produced in response to the

granting by the Supreme Court of Hong Kong in March 1994 of the

request for judicial assistance.

     On December 8 and 16, 1998, the New York District Court

entered stipulations in which the United States withdrew its

motions to enforce the HSBC and SCB summonses, respectively.
                              - 20 -

L.   The Notices of Deficiency

     Respondent began the audit of these cases before October

1990 and issued notices of deficiency to petitioner and TCM on

May 12, 1999.

                             OPINION

A.   Unreported Income

     1.   Contentions of the Parties

     Respondent contends that petitioner had unreported income of

$308,723.366 in 1987 and $1,421,217.977 in 1988, and that TCM had

unreported income of $307,695.618 in 1987.9   Respondent contends

that TCM was taxable on the commissions NSA paid to Camaro in

1987 and on the 1987 checks payable to TCM but deposited in

petitioner’s personal checking account or the Double D account or

cashed without being deposited.   Respondent also contends that



     6
        Respondent determined that petitioner had unreported
income of $310,314.00 for 1987 but now contends that petitioner
had unreported income of $308,723.36.
     7
        Respondent determined that petitioner had unreported
income of $1,404,026 for 1988 but now contends that petitioner
had unreported income of $1,421,217.97. Respondent bears the
burden of proving the increased deficiency. Rule 142(a)(1).
     8
        Respondent determined that TCM had unreported gross
receipts of $309,286 for 1987 but now contends that TCM had
unreported gross receipts of $307,695.61.
     9
        Respondent contends that TCM had unreported income of
$307,696 and petitioner had unreported income of $308,723 for
1987. The difference ($1,027) in those amounts is attributable
to adjustments made by respondent affecting only the return of
either petitioner or TCM.
                               - 21 -

TCM’s unreported income for 1987 described above is taxable as a

constructive dividend to petitioner, and that petitioner is

liable for tax on his distributive share of TCM’s income for 1988

from checks (a) payable to TCM but deposited in petitioner’s

personal checking account, the Double D account, or cashed

without being deposited, and (b) payable to Camaro instead of

TCM.

       Petitioners contend that Camaro earned the money it received

from NSA.

       2.   Whether Camaro Earned the Money It Received

       Petitioners contend that Camaro was essential to NSA because

Camaro could take title to the Shinwas and resell them to NSA and

Chrysler.    Petitioners also contend that Camaro could provide

essential services such as financing to meet Chrysler’s needs as

its needs for Shinwas grew.    We disagree; Camaro could not and

did not take title to or provide financing for $30 million worth

of Shinwas annually.

       Petitioners contend Camaro was essential to the Shinwa

transaction because it had an export license which was needed to

ship the Shinwas to Chrysler in the United States.    However,

there is no evidence that Camaro had an export license or that

Camaro shipped the Shinwas.

       Petitioner did not tell Taylor about the NSA/Camaro

contract.    Taylor was the TCM employee who handled Chrysler’s
                              - 22 -

purchase of Shinwas, and he had been a member of TCM’s board of

directors since 1987.   Taylor said that he knew of no legitimate

business purpose for the TCM/Camaro relationship.   To the best of

Taylor’s knowledge, petitioner never reported the existence of

the NSA/Camaro agreement to TCM's board.   TCM's board did not

ratify or approve the NSA/Camaro agreement.

     Wakashita, a mid-level manager of NSA, considered TCM to be

its sales representative on the Shinwa transaction from 1987 to

1989.   He regularly dealt with Taylor and knew of no business

activity by Camaro relating to the Shinwa transaction.   Kerry L.

Langdon, Chrysler’s Huntsville purchasing agent, was not aware of

anything that Camaro contributed to the Chrysler/NSA/TCM

relationship.   Camaro did not negotiate, price, or set terms

relating to the Shinwa transaction and had no role in delivering

the Shinwas to Chrysler.

     Petitioners contend that we should view Wakashita’s

testimony as biased because Camaro had failed to inform NSA that

Camaro was a foreign corporation, payments to which by NSA may

have been subject to withholding tax under section 881(a).   We

disagree, and we note that the testimony of Kerry Langdon and

Taylor corroborated Wakashita’s testimony.

     Petitioner testified that he needed to keep Camaro as a

party to the agreement to protect his business reputation and

because Camaro might be a lucrative source of future business in
                                - 23 -

China for TCM.   We disagree.   There is no credible evidence to

support those claims.   We conclude that Camaro performed no bona

fide services for the Shinwa-Chrysler transaction.

     3.   Conclusion

     Income is taxed to the party which earns it; the incidence

of taxation cannot be shifted by an anticipatory arrangement.

Helvering v. Horst, 311 U.S. 112, 119-120 (1940); Lucas v. Earl,

281 U.S. 111, 114-115 (1930); Kimbrell v. Commissioner, 371 F.2d

897, 901-902 (5th Cir. 1967), affg. T.C. Memo. 1965-115.     We do

not recognize petitioner’s diversion of TCM's commission income

to Camaro for Federal income tax purposes.     We conclude that TCM

understated its taxable income in 1987 by failing to report:

(1) $298,601.27 from NSA checks payable to Camaro; (2) $19,738.65

that TCM received but diverted to petitioner’s Double D account;

(3) $2,106.63 that TCM received but did not deposit to a TCM

account; and (4) $1,698.35 that TCM received but that was

diverted to petitioner’s personal account.10

     Where a shareholder diverts corporate funds to his or her

own use, those funds generally are constructive dividends to the

shareholder and are ordinary income to the extent of the

corporation’s earnings and profits.      Secs. 301, 316; Truesdell v.



     10
        TCM had unreported income of $322,144.90, minus the
amount of Camaro checks TCM deposited and reported ($11,789.54)
and the amount by which TCM overstated its gross business
receipts for 1987 ($2,660).
                              - 24 -

Commissioner, 89 T.C. 1280, 1295 (1987); Falsetti v.

Commissioner, 85 T.C. 332, 356-357 (1985); Henry Schwartz Corp.

v. Commissioner, 60 T.C. 728, 744 (1973).   Petitioner does not

contend that TCM’s earnings and profits were less than the amount

of constructive dividends respondent determined.    We conclude

that all of TCM’s unreported income was constructive dividend

income to petitioner because he caused NSA to divert TCM’s income

to Camaro and he used some of the diverted funds for his own

benefit.   We do not limit our holding to the amount respondent

can prove was spent for petitioner’s personal benefit because

respondent's determination is presumed to be correct for 1987,

see Levitt v. Commissioner, T.C. Memo. 1995-464, affd. without

published opinion 101 F.3d 691 (3d Cir. 1996), and respondent

presented sufficient evidence to carry the burden of proving the

increased deficiency for 1988.

     TCM was an S corporation in 1988, and so it is not taxable

on any unreported income it had for that year; that income passes

through to petitioner.   Sec. 1366.

     We conclude that petitioner understated his taxable income

by failing to report constructive dividends from TCM of

$308,723.36 in 1987 and his 100-percent distributive share of

TCM’s unreported income of $1,421,217.97 in 1988.
                                - 25 -

B.   Additions to Tax for Fraud Under Section 6653(b)

     1.    Background

     Respondent contends that petitioner is liable for the

addition to tax for fraud under section 6653(b) for 1987 and 1988

and that TCM is liable for the addition to tax for fraud under

section 6653(b) for 1987.   Respondent has the burden of proving

fraud by clear and convincing evidence.      See sec. 7454(a); Rule

142(b).   Respondent must establish:     (a) Each petitioner

underpaid tax for each year in issue, and (b) some part of the

underpayment is due to fraud.    See sec. 6653(b); Parks v.

Commissioner, 94 T.C. 654, 660-661 (1990); Petzoldt v.

Commissioner, 92 T.C. 661, 699 (1989).

     2.    Underpayment

     Respondent has shown that TCM underpaid tax for 1987 by

failing to report:   (1) $298,601.27 from NSA checks payable to

Camaro; (2) $19,738.65 from 17 checks from various sources that

TCM diverted to the Double D account; and (3) $3,804.98 from

Midtex Relays and NSA checks deposited to petitioner’s personal

account or cashed by petitioner.    Respondent has also shown that

petitioner underpaid tax by failing to report constructive

dividend income from TCM of $308,723.36 in 1987 and his

distributive share of TCM income of $1,421,217.97 in 1988.

Therefore, respondent meets this requirement.
                               - 26 -

     3.    Fraudulent Intent

     For purposes of section 6653(b), fraud is the intentional

commission of an act to evade a tax believed to be owing.    Webb

v. Commissioner, 394 F.2d 366, 377 (5th Cir. 1968), affg. T.C.

Memo. 1966-81.   Fraud is never presumed; it must be established

by affirmative evidence.   Beaver v. Commissioner, 55 T.C. 85, 92

(1970).

     To establish that petitioner is liable for the fraud penalty

for 1987 and 1988, respondent must show by clear and convincing

evidence that petitioner knew he was taxable in each of those

years on at least some of the funds that he caused NSA to divert

from TCM to Camaro and some of the funds he diverted from TCM to

Double D or to his personal account.    To establish that TCM is

liable for the fraud penalty for 1987, respondent must show by

clear and convincing evidence that petitioner, as president and

CEO of TCM, also knew TCM was liable for tax on at least some of

the funds he caused NSA to divert from TCM to Camaro and some of

the funds he diverted from TCM to Double D or to his personal

account.

     The Commissioner may prove fraud by circumstantial evidence

because direct evidence of the taxpayer's intent is rarely

available.   Stephenson v. Commissioner, 79 T.C. 995, 1005-1006

(1982), affd. 748 F.2d 331 (6th Cir. 1984).
                               - 27 -

     4.     Badges of Fraud

            a.   Fraud as to Petitioner

     Courts have developed several objective indicators, or

“badges”, of fraud.    Recklitis v. Commissioner, 91 T.C. 874, 910

(1988).   Several indicia that petitioner knew that he was taxable

on at least some of the funds he diverted from TCM are present in

this case.

     Concealing income from one’s return preparer can be evidence

of fraud.    Korecky v. Commissioner, 781 F.2d 1566, 1569 (11th

Cir. 1986), affg. T.C. Memo. 1985-63; Farber v. Commissioner, 43

T.C. 407, 420 (1965), modified 44 T.C. 408 (1965).   Petitioner

did not give White records of any Camaro accounts or tell White

that he used Camaro funds for personal purposes or that he had

Camaro make payments to his family and friends.   Petitioner did

not tell White that he received the NSA checks in Huntsville and

sent them to Hong Kong.

     Petitioners contend that petitioner did not have signature

authority over Camaro’s bank accounts in 1987 and 1988 because

Camaro’s board of directors revoked petitioner’s signature

authority over Camaro’s SCB accounts by resolution dated December

13, 1983.

     Respondent contends that SCB did not receive Camaro’s

revocation of petitioner’s signature authority.   Petitioners

maintain that respondent has not proven that SCB did not receive
                                - 28 -

the revocation resolution because respondent did not show that

respondent had possession of all of SCB’s documents relating to

Camaro’s accounts.   We disagree.   A letter from the legal

department of SCB dated September 29, 1997, states that the bank

does not have a copy of Camaro’s December 13, 1983, resolution.

     Petitioners point out that petitioner did not write checks

on Camaro’s SCB accounts while he had signature authority over

those accounts.   That fact is not significant because petitioner

could and did direct Choy to make transfers from the Camaro

accounts to him or on his behalf.

     A taxpayer’s use of a complex scheme to divert income from

his corporation to third parties he controls may be evidence of

the taxpayer’s attempt to conceal income.    Bradford v.

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

Memo. 1984-601.   Petitioner arranged for payments from NSA to

bypass TCM and instead to be paid to Camaro and for payments from

various sources, including Midtex Relays, to bypass TCM and be

paid to Double D or petitioner.

     A taxpayer's diversion of corporate funds for his or her

personal use is evidence that the taxpayer committed fraud.

Solomon v. Commissioner, 732 F.2d 1459, 1460-1461 (6th Cir.

1984), affg. T.C. Memo. 1982-603; United States v. Brill, 270

F.2d 525, 527 (3d Cir. 1959).    Petitioner used Camaro to divert

NSA payments to himself and to his family and friends through an
                              - 29 -

opaque series of transfers in 1987 and 1988.     Petitioner knew

about but did not report the diverted payments.     This badge of

fraud applies to petitioner for 1987 and 1988 because he

knowingly diverted NSA’s payments for his personal use in both

years.

     Petitioners contend that the fact that respondent took 8 to

10 years to determine the taxation of the unreported income in

dispute here shows that respondent had doubts about this case and

so has not proven by clear and convincing evidence that

petitioner and TCM are liable for fraud for the years in issue.

We disagree.   Petitioner should not benefit from the fact that it

took respondent a long time to penetrate the maze petitioner

chose to create.

     Respondent has clearly and convincingly proven that

petitioner had the requisite fraudulent intent, and that all of

petitioner’s underpayments are due to fraud.11    Thus, petitioner

is liable for the addition to tax for fraud under section 6653(b)

for 1987 and 1988.

          b.    Fraud as to TCM

     We have found that petitioner is liable for the fraud

penalty for 1987 and 1988.   See paragraph B-4-a, above.


     11
        Even if we found that respondent established by clear
and convincing evidence that petitioner is liable for fraud only
on the payments he diverted from TCM to Double D or his own
checking account, the burden would then shift to petitioner to
show how much of the underpayment is not due to fraud. Sec.
6653(b)(2). Petitioner has not shown that any of the
underpayments for 1987 and 1988 was not due to fraud.
                                - 30 -

Respondent also contends that TCM is liable for fraud for failure

to report substantially the same amounts for 1987 that petitioner

prevented TCM from receiving.    Specifically, respondent contends

that TCM is liable for fraud for 1987 because petitioner

concealed from TCM’s tax preparer information about the NSA,

Midtex Relays, and other checks diverted from TCM’s account,

petitioner signed TCM’s 1987 return even though he knew it was

inaccurate and omitted substantial income, TCM pled guilty under

section 7206(1) to knowingly making false statements on its

amended 1988 return, and petitioner used a complex series of

transactions to divert payments from NSA to himself and Camaro.

     Fraud is never presumed or imputed; it must be established

by independent evidence of fraudulent intent.    Toussaint v.

Commissioner, 743 F.2d 309, 312 (5th Cir. 1984), affg. T.C. Memo.

1984-25; Petzoldt v. Commissioner, 92 T.C. 661, 700 (1989);

Beaver v. Commissioner, 55 T.C. 85, 92 (1970).    We may not impute

from our finding that petitioner is liable for fraud that TCM is

also liable for fraud.   To establish that TCM is liable for the

fraud penalty for 1987, respondent must show by clear and

convincing evidence that, as president and CEO of TCM,

petitioner, in addition to having knowledge of his own obligation

to report the income he prevented TCM from receiving, knew that

TCM was liable for tax on at least some of the funds he caused
                              - 31 -

NSA to divert from TCM to Camaro in 1987.   We conclude that

respondent has not clearly and convincingly made that showing.

     Petitioner concealed the NSA payments to Camaro from TCM’s

employees.   Respondent has not proven by clear and convincing

evidence that petitioner knew TCM was taxable on funds he

arranged for NSA to pay to Camaro, checks from various sources

that TCM diverted to the Double D account, and checks from Midtex

Relays and NSA deposited to petitioner’s personal account or

cashed by petitioner.   We are convinced that petitioner knew he

was taxable on those funds but not that he knew that both TCM and

he were taxable on the same funds.

     TCM’s conviction under section 7206(1) for filing a false

return for 1988 does not show that TCM committed fraud in 1987.

We do not consider TCM’s conviction under section 7206(1) in

1988, on different facts, as evidence of fraud in 1987.     Klein v.

Commissioner, T.C. Memo. 1984-392, affd. 880 F.2d 260 (10th Cir.

1989); Corson v. Commissioner, T.C. Memo. 1965-214, affd. 369

F.2d 367 (3d Cir. 1966).

     We conclude that respondent has not shown by clear and

convincing evidence that TCM fraudulently intended to underpay

tax for 1987.

C.   Statute of Limitations

     The statute of limitations does not bar respondent from

assessing and collecting tax from petitioner for 1987 and 1988
                               - 32 -

because we have found that petitioner committed fraud for those

years.    Sec. 6501(c)(1).

     TCM timely filed its 1987 Federal income tax return on March

15, 1988.    The 3-year limitation on the time to assess tax for

TCM’s 1987 Federal income taxes normally would have expired on

March 15, 1991.    Petitioners argue that the 3-year limitation

bars assessment of tax for TCM for 1987.    Respondent argues that

it does not because the time to assess tax was tolled during the

pendency of the summons enforcement proceedings.    Sec. 7609(e).

     If an administrative summons served on a “third-party

recordkeeper” requires the production of records on the affairs

of another person, sec. 7609(a), that person may stay compliance

with the summons by giving notice in writing to the person

summoned not to comply with the summons, sec. 7609(b).    SCB

extended credit to petitioner through the SCB VISA card in 1987

and 1988 and, thus, was a third-party recordkeeper.    Sec.

7609(a)(3)(C).

     When a taxpayer commences a proceeding to quash a summons in

which he or she is identified, the period of limitations is

suspended during the period that the proceeding and appeals with

respect to the enforcement of the summons are pending.    Sec.

7609(e)(1).12


     12
          Sec. 7609(e) provides in pertinent part as follows:

     SEC. 7609(e). Suspension of Statute of Limitations.--
                                                    (continued...)
                               - 33 -



     If a third party contests a summons and the summons dispute

is not resolved within 6 months, the period of limitations is

suspended from the date which is 6 months after the service of

the summons until the final resolution of the matter.      Sec.

7609(e)(2).

     1.     Suspension of the Limitation on the Time To Assess Tax
            by Section 7609(e)(1)

     On October 4, 1990, respondent issued nine third-party

administrative summonses concerning TCM’s income tax liability

for 1987.    TCM filed the Alabama petition to quash on October 10,



     12
      (...continued)
          (1) Subsection (b) action.--If any person takes
     any action as provided in subsection (b) and such
     person is the person with respect to whose liability
     the summons is issued (or is the agent, nominee, or
     other person acting under the direction or control of
     such person), then the running of any period of
     limitations under section 6501 (relating to the
     assessment and collection of tax) or under section 6531
     (relating to criminal prosecutions) with respect to
     such person shall be suspended for the period during
     which a proceeding, and appeals therein, with respect
     to the enforcement of such summons is pending.

          (2) Suspension after 6 months of service of
     summons.–-In the absence of the resolution of the
     summoned party’s response to the summons, the running
     of any period of limitations under section 6501 or
     under section 6531 with respect to any person with
     respect to whose liability the summons is issued (other
     than a person taking action as provided in subsection
     (b)) shall be suspended for the period--

                 (A) beginning on the date which is 6
            months after the service of such summons, and

                 (B) ending with the final resolution of
            such response.
                                - 34 -

1990, 156 days before the date which is 3 years after TCM filed

its 1987 return.     Thus, 156 days remained at that time before the

expiration of the 3-year period of limitations with respect to

TCM's 1987 taxable year.

     On June 10, 1991, after it had denied the Alabama petition

to quash as to all but one of the summonses, the Alabama District

Court granted the petition with respect to that summons.     Under

28 U.S.C. section 2107(b) and rule 4(a)(1)(B) of the Federal

Rules of Appellate Procedure, the 60-day period for appeal of the

Alabama District Court's June 10, 1991, order expired August 9,

1991.     Thus, the running of the period of limitations remained

suspended by section 7609(e)(1) until August 9, 1991.     Hefti v.

Commissioner, 97 T.C. 180, 199-200 (1991), affd. 983 F.2d 868

(8th Cir. 1993); sec. 301.7609-5(b), Proced. & Admin. Regs.

     2.      Continuation of the Suspension of the Limitation on
             Time To Assess Tax by Section 7609(e)(2)

     On October 11, 1990, respondent issued a third-party

administrative summons to SCB concerning TCM’s 1987 income tax

liability.     On November 2, 1990, SCB’s attorneys responded to,

but did not produce the documents identified in, the SCB summons.

The 3-year statute was thus tolled by section 7609(e)(2) on April

11, 1991, the date which is 6 months after respondent served the

SCB summons.

     On March 24, 1992, the New York District Court stayed the

enforcement of the SCB summons pursuant to joint stipulation

between the United States and SCB (and HSBC).
                               - 35 -

     On December 16, 1998, the United States withdrew its motions

to enforce the SCB and HSBC summonses.

     3.    Petitioners’ Contentions

     Petitioners contend that section 7609(e) does not suspend

the period of limitations here because of defects in the SCB

summons.   We disagree.   A District Court has jurisdiction to

decide the merits of a petition to quash summons.    Sec.

7609(h)(1).   Petitioners may not collaterally attack the New York

District Court’s proceeding in this Court.    See Shaheen v.

Commissioner, 62 T.C. 359, 364-365 (1974); Roberson v.

Commissioner, 41 T.C. 577, 581 (1964).

     Petitioners also contend that, because the parties agreed

that applying for letters rogatory was the proper procedure for

seeking information and documents from SCB and HSBC, the

stipulation agreed to on March 24, 1992, was the final resolution

of the SCB and HSBC summons dispute and ended the tolling of the

period of limitations.    We disagree that the stipulation ended

the SCB summons dispute for purposes of section 7609(e)(2)(B).

The enforcement of the SCB and HSBC summonses remained pending in

the New York District Court until December 16, 1998, when that

court entered a stipulation in which the United States withdrew

its motion to enforce the SCB summons.



     The deficiency notice was mailed to TCM on May 12, 1999,

which is 147 days after the date of the final resolution of SCB's
                              - 36 -

response to the SCB summons (December 16, 1998).    That is less

than the 156 days remaining in the 3-year period of limitations.

Thus, the notice of deficiency of May 12, 1999, was timely

mailed.

D.   Substantial Understatement Under Section 6661

     Respondent determined that petitioner is liable for the

addition to tax under section 6661 for substantial understatement

of income tax for 1987 and 1988 and that TCM is liable for the

addition to tax under section 6661 for 1987.    Petitioner bears

the burden of proving that respondent erred in imposing the

addition to tax under section 6661.    Rule 142(a)(1).

     Petitioners contend that they did not substantially

understate their income tax for 1987 and 1988.    Petitioners raise

no other defense.   We conclude that petitioners are liable for

the section 6661(a) addition to tax.

     To reflect the foregoing,

                                           Decisions will be entered

                                      under Rule 155.
