                          T.C. Memo. 1996-519



                        UNITED STATES TAX COURT



    ESTATE OF ROBERT G. KLUENER, DECEASED, DONALD E. HATHAWAY, CO-
          EXECUTOR AND CHARLOTTE J. KLUENER, Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



       Docket No. 3867-95.               Filed November 25, 1996




       David E. Hathaway, for petitioners.

       Jeffrey L. Bassin, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


       WELLS, Judge:   Respondent determined a deficiency of

$284,247 in, and an accuracy-related penalty of $56,093 pursuant

to section 6662(a) on, Robert G. Kluener's1 and Charlotte J.

1
       Robert G. Kluener died prior to the issuance of the notice
                                                     (continued...)
Kluener's 1989 Federal income taxes (Robert G. Kluener and

Charlotte J. Kluener are sometimes hereinafter referred to as the

Klueners, Robert G. Kluener is referred to individually as Mr.

Kluener, and Charlotte J. Kluener is referred to individually as

Ms. Kluener).   Unless otherwise noted, all section references are

to the Internal Revenue Code in effect for the year in issue, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.

     After concessions, the issues remaining for decision are

whether petitioners are liable for:   (1) Income tax on the gain

realized from the sales of certain horses that Mr. Kluener

transferred2 to his wholly owned corporation prior to the sales;

and (2) the accuracy-related penalty provided by section 6662(a)

for a substantial understatement of income tax.

                         FINDINGS OF FACT

     Some of the facts have been stipulated for trial pursuant to

Rule 91.   The parties' stipulations of fact are incorporated

herein by reference and are found as facts in the instant case.

     Mr. Kluener died on October 14, 1991.   At the time the

petition in the instant case was filed, the executors of Mr.

Kluener's estate were Donald E. Hathaway (Mr. Hathaway), who

1
 (...continued)
of deficiency. Respondent accordingly determined the deficiency
and penalty in issue against his estate.
2
     The use of the words "transfer", "receive", "receipt",
"pay", and similar terms to describe the form of the transaction
in issue does not indicate that we accept that the substance of
that transaction accords with its form.
resided in Florida, Vincent H. Beckman, who resided in Ohio, and

John W. Kreutzcamp, who resided in Indiana.    Mr. Hathaway served

as Mr. Kluener's financial and tax adviser prior to Mr. Kluener's

death.   At the time the petition in the instant case was filed,

Ms. Kluener resided in Cincinnati, Ohio.

     During relevant times, each of the Klueners maintained an

account (agency account) with the Fifth Third Bank (Fifth Third

or bank) in which the bank held securities as the account

holder's agent.    As of July 31, 1989, the market value of the

securities held in Mr. Kluener's agency account was

$5,081,394.79.    As of June 30, 1989, the market value of the

securities held in Ms. Kluener's agency account was

$7,536,314.33.    As of September 30, 1989, Mr. and Ms. Kluener

each held securities in separate street accounts with Legg Mason

Wood Walker, Inc. (Legg Mason), that were valued at $213,088 and

$201,426, respectively.

     Additionally, during 1989, Mr. Kluener owned interests in

certain highly leveraged real estate ventures, to which he had

advanced $12,200,000.    Mr. Kluener had borrowed those funds from

Fifth Third in the form of personal unsecured loans.    The

interest that Mr. Kluener collected from the ventures with

respect to his loans to them afforded him a source of funds from

which to pay the interest on his personal debts to Fifth Third.

Due to changes in the tax law by the Tax Reform Act of 1986 and

saturation of the real estate market, real estate values fell,
and the properties held by the ventures in which Mr. Kluener held

an interest could not be sold.   During 1986 through 1989, the

ability of the ventures to pay interest to Mr. Kluener

deteriorated, and, during 1989, (1) the ventures were not

generating sufficient cash-flow to afford him an adequate source

of funds to pay the interest on his debt to Fifth Third, (2) the

real estate held by the ventures could not be sold for an amount

sufficient to retire their debts to Mr. Kluener, and (3) Mr.

Kluener's loans to the ventures were considered worthless.

     During 1989, Mr. Kluener owned stock in ALUCHEM, an

aluminum-grinding company.   Also, during all times (prior to Mr.

Kluener's death) relevant to the instant case, Mr. Kluener was

the sole shareholder and chief executive officer of American

Power Equipment Co., Inc. (APECO).   During 1989 and 1990, Mr.

Kluener was also a director of APECO.   Mr. Kluener had previously

been the principal executive of the Campbell Hausfeld Co.

(Campbell Hausfeld), a successful manufacturer of paint-spraying

equipment in which Ms. Kluener's family held an interest and

which had been sold around 1971.   Although APECO had originally

produced chain saws, upon the expiration of the covenant not to

compete that he had signed when Campbell Hausfeld was sold, Mr.

Kluener made APECO into a manufacturer of paint-spraying

equipment, which was its business when the events in issue in the

instant case occurred.   APECO's business activities were
conducted at a site in Harrison, Ohio, that had been acquired

from Campbell Hausfeld.

     APECO had a history of losses.   On its Federal income tax

return for its fiscal year ending June 30, 1989, it reported that

a net operating loss (NOL) of $4,472,915 was available for

carryover to its fiscal year ending June 30, 1990, and that NOL

was carried over.   During relevant times, APECO received loans

from Mr. Kluener and Fifth Third to finance its operations.     As

of January 1, 1989, APECO owed Mr. Kluener $800,000.   On or about

April 19 and June 12, 1989, he made loans of $700,000 apiece to

APECO using funds from his agency account to fund all or a

portion of each loan.   As of June 30, 1989, APECO owed Fifth

Third $3,885,000, and, on or about July 31, 1989, APECO obtained

a final loan of $1,500,000 from the bank, bringing its

indebtedness to Fifth Third to $5,385,000.   Mr. Kluener

guaranteed Fifth Third's loans to APECO.

     During 1989, APECO's personnel were developing a variety of

new or improved products, including more durable sprayer parts, a

high-volume, low-pressure spray gun, and a Do-It-Yourself paint

sprayer.   Mr. Kluener dictated the products that APECO's

personnel were to develop.   During mid-1989, a project to develop

a new type of paint sprayer was just beginning and did not yet

have a name.   The concept on which the sprayer was based called

for a new method of powering the sprayer mechanism and involved a

different design than had been used previously.   At a June 8,
1989, meeting of APECO's board, the concept of a "turbo airless

sprayer" was discussed, but such a product was not mentioned in

the minutes of subsequent board meetings on November 20, 1989,

and January 16, 1990.   Eventually, the sprayer developed from the

concept came to be known as the "Planatronic".   During mid-1989,

APECO's personnel had not allocated a specific amount of money to

the development of the Planatronic.   APECO experienced continuing

difficulties in developing the Planatronic into a reliable

product that were not solved as late as July 1991.

     Mr. Kluener owned 41 thoroughbred horses, and he had at one

time owned as many as 120 to 125 such horses.    His horse-related

activities were conducted through a sole proprietorship known as

Robert G. Kluener Enterprises, which maintained an office in

Cincinnati.   Mr. Kluener's assistant worked in that office and

was responsible for a variety of administrative tasks relating to

his personal and business activities, including the paperwork and

check-writing connected with the horse-related activities.

     As a result of the collapse of the real estate ventures, his

obligations to Fifth Third, and the need to fund APECO, Mr.

Kluener could no longer afford the losses generated by the horse-

related activities, which, for the first 7 months of 1989,

amounted to approximately $400,000.   Moreover, due to declining

health, Mr. Kluener did not enjoy those activities as much as he

formerly had enjoyed them, and he began to lose interest in them.

Accordingly, Mr. Kluener decided to sell his horses.   His tax
advisers recommended that the horses be transferred to APECO and

sold in its name so as to use APECO's NOL's to shelter any gain

realized on their sale.   Had Mr. Kluener sold the horses

directly, a certain portion of any gain realized would have been

taxed as ordinary income pursuant to section 1245, and the

balance would have been taxed as capital gain.   Consequently, the

amount netted from the sale would have been substantially reduced

by taxes.

      On or about August 1, 1989, Mr. Kluener transferred to APECO

title to his entire collection of 41 horses, with an estimated

fair market value of $2,428,654.   A separate division, APECO

Equine, was created to handle the horse-related activities.     Only

Mr. Kluener, his assistant, and his tax advisers knew of the

transfer when it occurred.   The other directors and officers of

APECO, including its president, Marvin Stock (Mr. Stock), were

not informed of the transfer, and Mr. Kluener and his advisers

made every effort to ensure that those others did not learn of

it.   Mr. Stock also was unaware of the existence of APECO Equine.

The transfer was not reflected in APECO's monthly financial

statements for its year ending June 30, 1990.

      After the horses were transferred, Mr. Kluener's assistant

continued to perform the same functions with respect to the

horses as she had prior thereto, and the functions were performed

at Mr. Kluener's office in Cincinnati, rather than at APECO's

office in Harrison.   Although Mr. Kluener's assistant was
nominally an employee of APECO both before and after the

transfer, Mr. Kluener personally had reimbursed APECO for the

cost of her compensation and continued to do so after the

transfer.

     Horses of the quality of those transferred by Mr. Kluener

are generally sold at open auction, at which the animals offered

for sale are displayed and bid upon.    It is very unusual for

sales to be effected privately.   Auctions occur at certain times

of the year, including the fall; to be sold at auction, a horse

must be registered by a cutoff date so that it may be placed on

the auction list.   Between August and December 1989, 37 of the

horses transferred were sold at auction, realizing net proceeds

after deduction of expenses in the amount of $2,177,685,

resulting in gain realized in the amount of $1,235,595.    Of the

remaining horses, two were sold for nominal amounts during early

1990, one died, and one was given away because it was infertile.

     The sales proceeds were paid to APECO Equine beginning in

October 1989.   The bulk of the proceeds was paid in two checks,

each in the amount of $949,400, that were received on December

21, 1989, and January 11, 1990, respectively, with the remainder

being paid over several following months.    The proceeds initially

were deposited in a checking account in the name of APECO Equine

that was maintained at Fifth Third.    Only Mr. Kluener and his

assistant had signature authority with respect to that account.

The sales proceeds were thereafter deposited in a brokerage
account with Legg Mason in the name of APECO Equine and were

invested in stocks and bonds.    Only Mr. Kluener could authorize

transactions, such as sales and purchases, with respect to that

account.

     APECO's other directors and officers, including its

president, were not informed that the horses were sold in APECO's

name or of the funds held in accounts in APECO Equine's name, and

Mr. Kluener and his advisers made every effort to ensure that

those others did not know of the manner in which the sales were

effected or of the accounts.    The sales were not recorded in

APECO's monthly financial statements for its year ending June 30,

1990.    The account in which the securities were held was

maintained with Legg Mason rather than Fifth Third to keep

APECO's personnel from learning of it.    At a January 16, 1990,

meeting of APECO's board, Mr. Kluener stated that between

$1,500,000 and $2,500,000 would be required to bring APECO's new

product lines to market, but that there did not appear to be any

source of such an amount of capital available to the company.

Suggestions as to potential sources of capital were solicited

from the board.    Mr. Kluener purposely did not reveal to the

board the existence of the funds held in APECO Equine's name.

During the time when the proceeds of the horse sales were held in

its name, none of those proceeds were paid by APECO Equine to

APECO.
     Mr. Kluener made loans to APECO instead of using the funds

held in the name of APECO Equine in order to, inter alia, keep

the existence of those funds a secret from APECO personnel.      Mr.

Kluener made loans to APECO during the time the sales proceeds

were held in the name of APECO Equine as follows:

             Approximate Date             Amount

               Nov. 3, 1989              $700,000
               Jan. 29, 1990              300,000

     The foregoing loans were funded in whole or part by

distributions from Mr. Kluener's agency account.      During December

1989, APECO collected approximately $1,600,000 with respect to a

disputed account receivable.    On or about December 29, 1989,

APECO made a distribution to Mr. Kluener in the amount of

$1,437,488.90 that (1) repaid the $1,400,000 in loans that he had

made on or about June 12, and November 3, 1989, and (2) paid

interest to him in the amount of $37,488.90.    The payment was

deposited in Mr. Kluener's agency account.

     On or about June 4, 1990, Mr. Kluener's personal debts to

Fifth Third became due.   Fifth Third refused to renew its loans

to Mr. Kluener that totaled $12,200,000 and its loans to APECO

that totaled $4,785,0003 because Mr. Kluener had submitted to it

a financial statement showing that his liabilities exceeded his

assets by $3,856,608 as of September 30, 1989.      The loans were

renegotiated shortly thereafter.    As part of the renegotiation,

3
     APECO reduced its debt to Fifth Third from $5,385,000 to
$4,785,000 by making principal payments of $400,000 and $200,000
on or about Apr. 10 and July 9, 1990, respectively.
Mr. Kluener was required to make a principal payment of $500,000

to Fifth Third, and his remaining debt of $11,700,000 was

consolidated into one note that required monthly interest

payments at the prime rate and principal payments of $500,000 on

each of December 31, 1990, and June 30, 1991, with the balance

due on September 30, 1991.    APECO's debt was consolidated into

one $4,785,000 note requiring monthly interest payments at the

prime rate and was due on September 30, 1991.    Mr. Kluener

guaranteed APECO's note.

     Mr. Kluener pledged the assets in his agency account to

secure the renegotiated notes, and the pledge agreement provided

that Mr. Kluener could not withdraw more than $100,000 of

principal per year from the account without the bank's

permission, except that withdrawals for the purpose of paying the

bank interest or principal on his or APECO's notes were not

restricted.    Prior to the execution of the pledge agreement,

there were no restrictions on Mr. Kluener's ability to use the

assets in the agency account.    Additionally, Mr. Kluener pledged

his APECO stock and certain interests connected with his real

estate investments to secure the notes.    Pursuant to the pledge

agreement, the net distributions that he received with respect to

his APECO stock were also to be applied to pay his obligations to

Fifth Third.

     Effective June 25, 1990, Mr. Kluener, as sole shareholder of

APECO, reduced the number of directors of APECO to one, and
dismissed all of the directors, except himself.   As sole

director, Mr. Kluener declared, effective June 25, 1990, a

distribution to himself of $2,176,000, to be paid by July 31,

1990, representing the remaining amount of the proceeds of the

horse sales and the earnings thereon held in the Legg Mason

account in the name of APECO Equine.   The balance of the Legg

Mason account was distributed to Mr. Kluener during July 1990.

APECO's president was unaware of the distribution when it

occurred.   The timing of the distribution was set with the

assistance of Mr. Kluener's tax advisers.   For its year ending

June 30, 1990, APECO had no current or accumulated earnings and

profits, and the distribution was treated as a nontaxable return

of capital.

     The transaction involving the horses was reflected in

APECO's financial records for the first time when its audited

financial statement for the year ending June 30, 1990, was

prepared.   APECO's audited financial statement for its year

ending June 30, 1990, describes the transaction involving the

horses as follows:

     In August 1989, the Company's shareholder contributed
     equine property to the Company with the intent of
     selling the property and utilizing the Company's tax
     loss carryforwards to shelter the gain on the sale.
     The contribution to capital of this nonmonetary asset
     was valued at the net proceeds from the sale of the
     property which took place within two months of the
     contribution. Such value was $2,152,288.

     In June 1990, the Company declared a distribution of
     $2,176,000 which was paid in July 1990. This
     distribution was recorded as a reduction of additional
     paid in capital. The distribution was intended to
     return the 1989 capital contribution plus earnings on
     the invested funds to the shareholder. The shareholder
     then loaned $176,000 to the Company. The transaction
     also reduced the tax loss carryforward for tax purposes
     by $1,210,200.

APECO's audited financial statement for its year ending June 30,

1990, also stated that APECO might not be able to continue as a

going concern in view of its losses, and APECO's balance sheet as

of that date reflected negative shareholder's equity of

$2,308,869.

     The $2,176,000 that Mr. Kluener received as a distribution

from APECO was used as follows:    On July 27, 1990, he repaid a

$400,000 loan from Ms. Kluener; also on or about both that date

and September 10, 1990, he made loans of $600,000 and $176,000,

respectively, to APECO; on or about both September 10 and

December 31, 1990, he made payments of $500,000 to Fifth Third to

reduce his personal indebtedness.

     The horse sales were reported on APECO's Federal income tax

return for its taxable year ending June 30, 1990, and no tax was

paid with respect to the sales because the gain realized was

offset against APECO's NOL's.    The Klueners did not report the

sales on their Federal income tax return for 1989.

     During 1991, Mr. Kluener made loans to APECO as follows:

              Approximate Date           Amount

                 Jan. 30                $250,000
                 Mar. 22                  75,000
                 Mar. 27                  75,000
                 May 7                   204,000
                 July 29                 400,000
                 Sept. 23                400,000
     All or a portion of the funds for the loans made on or about

March 27, July 29, and September 23, 1991, were funded by

distributions from Mr. Kluener's agency account.

     During mid-1991, Mr. Kluener's and APECO's notes to Fifth

Third were renegotiated.   As part of that renegotiation, the

pledges of assets made during 1990 were canceled, and a new

arrangement was substituted.   The Klueners signed a new

promissory note to Fifth Third that was dated June 25, 1991, in

the principal amount of $15,985,000 and that bore interest at the

prime rate.   The note provided that its principal amount would be

due in full 60 days after the death of the last of them to die.

By letter dated June 25, 1991, and addressed to Fifth Third, the

Klueners agreed, inter alia, to maintain substantially all of

their investment assets in the agency accounts in each of their

names, to not substantially increase their expenditures to

maintain their standard of living, and to invest no more than an

additional $3 million in APECO.   Prior to this time, Ms.

Kluener's assets were not subject to the claims of Fifth Third

arising from its loans to Mr. Kluener and APECO.

     Between Mr. Kluener's death on October 14, 1991, and May

1992, his estate made additional advances to APECO totaling

$1,292,000.   APECO eventually was sold for $2,500,000.

                               OPINION

     The issue to be decided in the instant case is whether APECO

was the actual seller of the horses, as petitioners contend, or

Mr. Kluener was the seller, as respondent contends.   If we decide
that APECO is the true seller, it would be charged with the gain

realized on the sale of the horses, and no tax would be due

because APECO's substantial NOL carryforwards would offset that

gain.   Moreover, because APECO had no current or accumulated

earnings and profits at the time the sales proceeds and the

earnings accumulated on them were distributed to Mr. Kluener, the

distribution would be treated as a nontaxable return of capital

and not as a taxable dividend.   If we decide that Mr. Kluener is

the true seller, he would be charged with the gain on the sale of

the horses, and an additional amount of income tax would be due

from petitioners.

     Petitioners contend that, on or about August 1, 1989, Mr.

Kluener transferred title to the horses to APECO in a transaction

intended to meet the requirements of section 351(a).   Mr. Kluener

did not negotiate or contract to sell the horses prior to the

transfer, but, subsequent to the transfer, the horses were sold

at auction or otherwise disposed of.   The sales proceeds were

paid to APECO, which reported the sales for tax purposes.

Petitioners acknowledge that the form of the transaction was

designed to use APECO's NOL's to shelter the gain realized on the

sale of the horses but argue that the transfer was for a

legitimate business purpose.   According to petitioners, the

purpose for the transfer of the horses was to provide APECO with

a source of funds for the development of the Planatronic, and the

horses were the only asset Mr. Kluener could contribute to APECO

without diminishing his interest-paying capability to Fifth
Third.   They argue that the sales proceeds were not used by APECO

because other sources of funds were available to it.   Petitioners

further contend that there was no intention to withdraw the sales

proceeds from APECO when the horses were contributed and the

distribution of the sales proceeds was precipitated by events

that were unforeseen at the time of the transfer.

     Respondent's position is that, although the transaction was

cast as a sale of the horses by APECO, the substance of the

transaction was that Mr. Kluener sold the horses using APECO as a

conduit and that the gain realized on the sale therefore must be

charged to him.   Respondent contends that Mr. Kluener had decided

to sell the horses for personal reasons prior to transferring

them to APECO and that the sole purpose for transferring the

horses to APECO was to use its NOL's to avoid tax on the gain

realized on the sale.   Respondent maintains that Mr. Kluener kept

control of the horses and the sales proceeds while they were

nominally held by APECO, concealing from the other officers and

directors of APECO the fact that the transaction involving the

horses was conducted in the name of APECO, as well as the e

xistence of the accounts in which the sales proceeds were held.

Respondent notes that the sales proceeds were never used to fund

APECO's operations, which instead were financed by loans from Mr.

Kluener using funds from his bank accounts.   Respondent also

points to the distribution to Mr. Kluener of all of the sales

proceeds and earnings held in the name of APECO several months
after the sales, which was effected after he dismissed all other

directors of APECO.

     Respondent relies upon a line of cases holding that, in

certain circumstances, a transfer of property followed by the

sale of the property by the transferee will be treated for tax

purposes as a sale by the transferor, with the result that the

gain realized on the sale will be charged to the transferor.

Stewart v. Commissioner, 714 F.2d 977, 991-992 (9th Cir. 1983),

affg. T.C. Memo. 1982-209; Hallowell v. Commissioner, 56 T.C.

600, 607-609 (1971); Palmer v. Commissioner, 44 T.C. 92, 94-96

(1965), affd. per curiam 354 F.2d 974 (1st Cir. 1965); Rollins v.

Commissioner, T.C. Memo. 1993-643.   The holdings of these cases

are derived from the reasoning of Commissioner v. Court Holding

Co., 324 U.S. 331, 334 (1945), in which the Supreme Court stated:

     The incidence of taxation depends upon the substance of
     a transaction. The tax consequences which arise from
     gains from a sale of property are not finally to be
     determined solely by the means employed to transfer
     legal title. Rather, the transaction must be viewed as
     a whole, and each step, from the commencement of
     negotiations to the consummation of the sale, is
     relevant. A sale by one person cannot be transformed
     for tax purposes into a sale by another by using the
     latter as a conduit through which to pass title. To
     permit the true nature of a transaction to be disguised
     by mere formalisms, which exist solely to alter tax
     liabilities, would seriously impair the effective
     administration of the tax policies of Congress. [Fn.
     ref. omitted.]

     Petitioners contend that the foregoing cases do not govern

the instant case, relying principally upon two cases holding that

the form of a transaction involving a transfer of property will

be respected where a legitimate business purpose for the transfer
is shown.    Smalley v. Commissioner, T.C. Memo. 1973-85; Caruth v.

United States, 688 F. Supp. 1129, 1138-1142 (N.D. Tex. 1987),

affd. on another issue 865 F.2d 644 (5th Cir. 1989).4

       As we have noted, "The distinction between the two lines of

cases is often shadowy, particularly in the context of a

purported transfer between a closely held corporation and one or

more of its shareholders."     Hallowell v. Commissioner, supra at

607.    However, it is for us to decide, upon consideration of all

the circumstances, the factual category in which a particular

transaction belongs.    Id.   We must resolve the question of who in

substance, and not simply in form, made the sale.     Id.

       For convenience, we recapitulate the facts, which are

straightforward.    Mr. Kluener was the sole shareholder of APECO,

its chief executive officer, and a director.    Having decided to

sell his horses, on or about August 1, 1989, Mr. Kluener

transferred title to the horses to APECO, and a separate division

of APECO called APECO Equine was created to handle the horse-

related activities.    Most of the horses were sold at auction

between August and December 1989.5    The net proceeds derived from

the sales during 1989 were $2,177,685, and the amount of gain



4
     Although petitioners do not rely on United States v.
Cumberland Public Service Co., 338 U.S. 451 (1950), we note that,
in that case, the Supreme Court gave effect to the form of a
transaction involving a transfer and sale of property where the
substance of the transaction accorded with that form.
5
     The 41 horses transferred were disposed of as follows:
Thirty-seven were sold at auction during 1989; two were sold for
nominal amounts during 1990; one died; and one was given away
because it was infertile.
realized was $1,235,595.   The gain was reported on APECO's return

for the taxable year ending June 30, 1990, but, after application

of its NOL's, no taxable income or tax resulted from the sales.

The sales proceeds were initially deposited in a checking account

with Fifth Third, and were later transferred to a brokerage

account with Legg Mason.   Only Mr. Kluener and his assistant had

signature authority for the checking account, and only Mr.

Kluener could authorize transactions on the account with Legg

Mason.   Mr. Kluener made every effort to keep secret from APECO's

other directors6 and officers (1) the transfer of the horses to

APECO, (2) the sale of the horses in its name, (3) the receipt of

the sales proceeds by APECO Equine, and (4) the existence of the

accounts containing those proceeds.   During the time when the

sales proceeds were held in the name of APECO Equine, Mr. Kluener

continued to lend money to APECO to fund its operations so as to

preserve the secret.   None of the sales proceeds were paid to

APECO by APECO Equine.   Having dismissed the other directors of

APECO, Mr. Kluener, as sole director of APECO, declared a

distribution to himself of $2,176,000, representing the balance

of the account with Legg Mason in APECO Equine's name, that was

effective as of June 25, 1990, and was to be paid by July 31,



6
     Respondent contends that APECO's Board did not vote on
whether to (1) accept the transfer of the horses or (2) to sell
or retain them. Petitioners respond by claiming that there is no
evidence in the record showing whether or not the board voted on
those matters. We note that petitioners bear the burden of
proof, and the absence of evidence on this score can hardly be
considered to operate in their favor. Hallowell v. Commissioner,
56 T.C. 600, 608 (1971).
1990.   Because APECO had no accumulated earnings and profits, the

distribution was treated as a nontaxable return of capital.

     Petitioners urge a number of points in an effort to

distinguish the instant case from the cases relied on by

respondent.   We have considered each of petitioners' contentions

and discuss certain of them below.   Petitioners' first contention

is that no negotiations for the sale of the horses were

undertaken prior to their transfer to APECO.    We, however, are

not persuaded that the absence of prearrangement dictates the

result in the instant case.   Although prearrangement of the sale

of transferred property is cogent evidence that the transferee

passing title is a conduit and is not in substance the seller of

property, Palmer v. Commissioner, 44 T.C. at 94-96; Abbott v.

Commissioner, T.C. Memo. 1964-65, affd. per curiam 342 F.2d 997

(5th Cir. 1965), where property is readily marketable, and prior

arrangements are therefore superfluous, the absence of

prearrangement is not decisive, Hallowell v. Commissioner, supra

at 608.   In the instant case, the horses that were sold at

auction during 19897 were readily marketable.   Moreover, it is

customary for horses of the quality of those transferred by Mr.

Kluener to be sold at open auction, and very unusual for a sale

to be made privately.   Consequently, we conclude that the absence

of prearrangement is not decisive of the issue at hand.    Id.


7
     Inasmuch as it is the gain realized from the sale of 37
horses at auction during 1989 that has given rise to the present
controversy, we need not consider whether the four remaining
horses that were not disposed of in that manner were readily
marketable.
     Petitioners further rely on the fact that title to the

horses was transferred to APECO prior to their sale and that

APECO was not a shell corporation used merely for tax avoidance.

We have considered those facts; however, in reaching our

decision, we do not conclude that any particular aspect of the

transactions in issue is fictitious or a sham.    Rather, we view

the transactions as a whole and, when the transactions are so

considered, the transactions amount in substance to a sale of the

horses by Mr. Kluener.    Id. at 609.   As the Supreme Court noted

in Commissioner v. Court Holding Co., 324 U.S. at 334:     "the tax

consequences which arise from gains from a sale of property are

not finally to be determined solely by the means employed to

transfer legal title.    Rather, the transaction must be viewed as

a whole".   Moreover, a corporation need not be a shell in order

to be treated as a conduit.    Bank of Am. Natl. Trust & Sav.

Association v. Commissioner, 15 T.C. 544, 552-553 (1950), affd.

per curiam 193 F.2d 178 (9th Cir. 1951); Gaw v. Commissioner,

T.C. Memo. 1995-531.    Accordingly, the circumstances to which

petitioners point are not conclusive.

     Additionally, petitioners, noting that we have in the past

considered whether a nontax, business purpose exists for the

transfer of property for purposes of identifying the actual

seller of the property, contend that the transfer to APECO was

supported by a business purpose; namely, providing APECO with a

source of funds to develop the Planatronic.    Petitioners also

contend that, having decided to put additional capital into
APECO, Mr. Kluener was not obligated to use the method of doing

so that would incur the most tax and that it was appropriate to

use APECO's NOL's to shelter the gain realized on the sales of

the horses so that the full amount of the sales proceeds would be

available for APECO's purposes.

     We have considered petitioners' arguments; however, after

considering all of the circumstances of the instant case, we

conclude that petitioners have not established that there was a

legitimate business purpose, in addition to the admitted tax

avoidance purpose, for the transfer of the horses to APECO.    At

the time that the horses were transferred, the development of the

Planatronic was just beginning, and the project did not yet have

a name.   Although the concept of a "turbo airless sprayer" was

described at a meeting of APECO's board on June 8, 1989, there is

no mention of such a product in the minutes of subsequent board

meetings on November 20, 1989, and January 16, 1990.   During mid-

1989, APECO's personnel had not allocated a specific amount of

money to the development of the Planatronic.   Furthermore, APECO

had received a $1,500,000 loan from Fifth Third at approximately

the same time as the transfer occurred.   Moreover, it was Mr.

Kluener's practice at all relevant times to finance APECO's

operations with loans, rather than capital contributions.   Mr.

Hathaway, Mr. Kluener's adviser, testified that Mr. Kluener

preferred to finance APECO in that manner.

     Even after the sales proceeds were received, they were not

used for any purpose of APECO during the time when they were held
in the name of APECO Equine.    Petitioners attempt to explain this

by claiming that their use was unnecessary because APECO was

breaking even with respect to its cash-flow for the year ending

June 30, 1990.    Petitioners' explanation, however, does not

account for the fact that during that year, APECO received a loan

of $1,500,000 from Fifth Third, and Mr. Kluener advanced

substantial amounts to APECO to finance its operations using

funds from his agency account.    Moreover, APECO's financial

condition during that year was tenuous.    Its audited financial

statement for its year ending June 30, 1990, stated that APECO

might not be able to continue as a going concern in view of its

losses, and APECO's balance sheet as of that date reflected

negative shareholder's equity of $2,308,869.

     Additionally, the secrecy surrounding APECO's involvement in

the sale of the horses casts doubt upon whether the horses were

transferred to APECO for a legitimate business purpose.    The

titling of the horses in the name of APECO, their sale in its

name, and the receipt and possession of the sales proceeds were

not reflected in APECO's financial records until APECO's audited

financial statements for its year ending June 30, 1990, were

prepared, which occurred after the proceeds had been distributed

to Mr. Kluener.    Mr. Stock, APECO's president, was unaware of

APECO Equine's existence, and Mr. Kluener made every effort to

ensure that APECO's other personnel did not learn of APECO's

involvement in the sale of the horses or of the funds held in

APECO Equine's name.
     We note that, at a January 16, 1990, board meeting, Mr.

Kluener estimated that between $1,500,000 and $2,500,000 would be

required to bring APECO's new product lines to market.    He also

stated that there did not appear to be any place the corporation

could obtain such a quantity of capital, and he solicited

suggestions for sources of capital from the board.   Mr. Kluener

made the foregoing statements even though he was aware that the

proceeds of the horse sales were being paid to APECO Equine.   Mr.

Hathaway admitted at trial that, in making those statements, Mr.

Kluener was engaging in a "charade".   Although petitioners claim

that Mr. Kluener did so in order to maintain the fiscal

discipline of APECO's personnel, Mr. Kluener's misrepresentation

to the board indicates to us that the proceeds of the horse sales

were not intended for use by APECO.

     Petitioners contend that Mr. Kluener intended the secrecy to

keep APECO's personnel focused on the development of the

Planatronic because they would have attempted to use the money

for other projects had they known of it.   Mr. Kluener, however,

was an experienced businessman, the sole shareholder of APECO,

its chief executive officer, and a director.   According to Mr.

Stock, Mr. Kluener attended meetings of APECO personnel and

designated the products to be developed.   Moreover, APECO's

personnel were working on a variety of projects, with Mr.

Kluener's apparent approval, during the time that the Planatronic

was being developed, and the minutes of meetings of APECO's board

during 1989 and 1990 do not indicate that the corporation's
resources were focused on promoting only one product.    We are not

persuaded that, even with his health problems, Mr. Kluener did

not have control over how APECO's resources were to be used

without resorting to deception.   We note that Mr. Kluener did not

appear concerned that he could not control the $1,500,000 that

Fifth Third loaned to APECO at approximately the time of the

transfer of the horses into the name of APECO.    Furthermore, Mr.

Kluener appears generally to have dealt with concerns about

control by funding APECO with periodic loans rather than by

hiding funds.

     The complete control exercised by Mr. Kluener over the

horses and the accounts containing the sales proceeds also

indicates to us that the proceeds of the horse sales were not

intended for use by APECO.   APECO Equine's affairs were handled

at Mr. Kluener's business office by himself and his assistant,

and the financial and administrative affairs relating to the

horses were conducted in the same manner as they had been when

the horses were titled in Mr. Kluener's name.    While his

assistant was nominally an APECO employee, Mr. Kluener continued

to reimburse APECO for the cost of her compensation after the

transfer, indicating that all of her services were performed for

his, rather than APECO's, benefit.   Only Mr. Kluener and his

assistant had signature authority with respect to the checking

account in APECO Equine's name, and only Mr. Kluener could

authorize transactions with respect to the Legg Mason account in

its name.
     Moreover, despite APECO's evident need for the sales

proceeds, they were distributed to Mr. Kluener8 within several

months of the sales of the horses in issue.   Petitioners

acknowledge that the timing of the distribution was influenced by

tax considerations, noting that, for its taxable year ending June

30, 1990, APECO had no current or accumulated earnings and

profits, while it was expected that APECO would have earnings and

profits during the following year, which would have rendered a

distribution to Mr. Kluener taxable at least in part.

     We have previously considered distributions made for the

benefit of the transferors of property as having "overriding

significance", regardless of any claimed business purpose, in

deciding whether to charge taxpayers with the gain realized on

the sale of the property.9   Hallowell v. Commissioner, 56 T.C. at


8
     The fact of the distribution of the funds held in the name
of APECO Equine and the identity of the distributee afford a
further basis for distinguishing the instant case from those
relied on by petitioners. In Caruth v. United States, 688 F.
Supp. 1129, 1138-1142 (N.D. Tex. 1987), affd. on another issue
865 F.2d 644 (5th Cir. 1989), the property transferred was
retained by the corporation for its own business purposes and was
not sold or distributed. In Smalley v. Commissioner, T.C. Memo.
1973-85, certain property transferred was sold, but the sales
proceeds were, in response to pressure from outside creditors,
used to reduce the corporation's debt to third-party lenders. In
the instant case, however, even though APECO owed a substantial
amount to Fifth Third, the funds held in the name of APECO Equine
were not used to reduce APECO's debt to the bank.
9
     We note that in Hallowell v. Commissioner, 56 T.C. at 609
n.5, we found the distribution for the benefit of the taxpayer of
overriding significance even where the taxpayer attempted to show
a corporate purpose for the distribution; viz, repayment of a
debt of the corporation to the taxpayer. In the instant case,
the distribution to Mr. Kluener was not made in the form of a
loan repayment, and petitioners do not attempt to argue that the
                                                   (continued...)
609 n.5.   We also note that in Hallowell v. Commissioner, supra

at 607-609, we found it highly significant that the amount of

distributions to the taxpayers from their controlled corporation

during a year "roughly corresponded" to the gains realized on the

sale during that year of stock transferred to the corporation.

The instant case involves the distribution, within a year of the

transfer and sale of the horses, of an amount not merely "roughly

corresponding" to the gain realized on the sale of the horses,

but exactly equal to the full amount of the sales proceeds and

the earnings thereon held in the name of APECO Equine.

Furthermore, the audited financial statement of APECO for the

year ending June 30, 1990, notes that the distribution was made

for the purpose of returning Mr. Kluener's earlier

contribution.10   Consequently, we feel that the grounds for

attaching significance to the subsequent distribution and for

holding APECO a mere conduit are at least as compelling in the

instant case as in Hallowell.

     Moreover, in distributing the funds held in APECO Equine's

name, Mr. Kluener continued his policy of keeping their existence


9
 (...continued)
distribution served a corporate purpose of APECO.
10
     APECO's audited financial statement for its year ending June
30, 1990, states:

     In June 1990, the Company declared a distribution of
     $2,176,000 which was paid in July 1990. This
     distribution was recorded as a reduction of additional
     paid in capital. The distribution was intended to
     return the 1989 capital contribution plus earnings on
     the invested funds to the shareholder. The shareholder
     then loaned $176,000 to the Company. * * *
secret from APECO's other personnel, dismissing all of APECO's

directors besides himself before authorizing the distribution.

Petitioners have suggested no reason for the dismissal of APECO's

other directors, and it seems that Mr. Kluener felt it necessary

to do this in order to preserve his "charade" as to the

availability of funds to APECO.   That Mr. Kluener did not reveal

to APECO's personnel the existence of the funds held in APECO

Equine's name, even when the funds were not to be used for any

APECO project and the purported reason for secrecy had passed,

indicates that APECO's possession of the funds was kept secret

because the funds in reality were Mr. Kluener's.

     Petitioners attempt to blunt the significance of the

distribution of the sales proceeds to Mr. Kluener by contending

that, at the time when title to the horses was transferred to

APECO, there was no intention to distribute the proceeds of their

sale to Mr. Kluener and that the subsequent distribution of the

proceeds was prompted by circumstances unforeseen at the time

that the transfer occurred; namely, the refusal in June 1990 of

Fifth Third to renew APECO's loans and the need to make principal

payments with respect to Mr. Kluener's personal debts to the

bank.

     We, however, are not persuaded that the distribution of the

sales proceeds should be treated as unrelated to the other steps

of the transaction in issue or that those steps were "old and

cold" at the time the distribution was made.   The circumstances

noted above strongly suggest to us that the distribution of the
funds held in APECO Equine's name was preconceived.   Hallowell v.

Commissioner, supra at 608-609.

     We also are not inclined to credit petitioners' assertion

that Fifth Third's refusal to renew APECO's loans during June

1990 was unexpected.   APECO was sustaining losses and was having

difficulty developing the Planatronic prior to that time.    Mr.

Kluener guaranteed its debt, but his financial condition was poor

during 1989 and 1990, due principally to the collapse of his real

estate ventures, which was one of the reasons that the decision

was made to sell the horses.

     Mr. Kluener's need to make payments on his debts to Fifth

Third does not even explain why all funds held in APECO Equine's

name were distributed because, pursuant to the renegotiation of

his loans from Fifth Third, he was obligated to reduce the

principal amount of his debt by at most $1,500,000, and he

reduced it by only $1 million before it was again renegotiated.

In fact, Mr. Kluener lent $776,000 of the amount distributed back

to APECO.

     Furthermore, it is difficult to justify Mr. Kluener's use of

the funds that had been held in APECO Equine's name to pay down

his loans to Fifth Third.   As part of the renegotiation of the

loans, Fifth Third restricted Mr. Kluener's ability to withdraw

funds from his agency account for purposes other than the payment

of his or APECO's obligations to it.   Moreover, the net

distributions that he received with respect to his APECO stock

were also to be applied to pay his obligations to Fifth Third.
The funds held in APECO Equine's name were not so restricted.     We

are hard pressed to understand the business reason for the use of

those funds to reduce Mr. Kluener's indebtedness instead of funds

that generally could be used only for the purpose of loan

repayment.   Moreover, Mr. Kluener subsequently used funds from

his agency account to finance APECO.11   That Mr. Kluener would

use funds ostensibly earmarked for financing APECO's operations

to pay down his own indebtedness and then finance APECO using

funds that were to be used to pay down that indebtedness

indicates to us that, as respondent puts it, he viewed the

accounts in which those funds were held "as merely different

sections of his personal wallet."

     Petitioners have also presented varying reasons for the

distribution of the sales proceeds.   Mr. Hathaway, on whose

testimony petitioners rely to establish the reason for the

distribution, has previously offered another explanation for the

distribution.   In an affidavit made in connection with the

instant case, Mr. Hathaway states that the distribution was made

to Mr. Kluener in an effort to control the sales proceeds because

of the "attitude of management" that sought to use them for other

projects, an attitude "had not been foreseen or expected", rather



11
     Petitioners contend that the record does not show the source
of the funds Mr. Kluener used to make loans to APECO. However,
because petitioners bear the burden of proof, the absence of
evidence on the matter can hardly operate in their favor.
Hallowell v. Commissioner, 56 T.C. at 608. Moreover, the records
of Mr. Kluener's accounts with Fifth Third are sufficiently
detailed to show that the agency account was the source of at
least a portion of the funds lent to APECO.
than because of Fifth Third's refusal to renew Mr. Kluener's

loans.12   We note that, at trial, Mr. Hathaway testified that

every effort was made to conceal the existence of the funds from

APECO's other personnel, that Mr. Kluener simply feared that the

sales proceeds might be diverted to other uses, and that the

actions of the bank prompted the distribution.   Furthermore, in

the petition, petitioners alleged that the sales proceeds were

distributed pursuant to an accord with Fifth Third, but no

evidence of such an accord was presented at trial.   The change in

the reasons offered for the distribution lessens the weight we

are inclined to give to petitioners' evidence on this point.

Petitioners have not persuaded us that the distribution of the

funds was not a step in a single transaction that began with the

transfer of the horses into APECO's name.

     In sum, when we combine the distribution for Mr. Kluener's

benefit with the (1) efforts made to keep secret from APECO's

other personnel its role in the events in issue, including (a)

the transfer of the horses to APECO, (b) their sale in its name,

(c) the receipt of the sales proceeds by APECO Equine, and (d)

the distribution to Mr. Kluener of the balance of the Legg Mason

account in APECO Equine's name, (2) control Mr. Kluener

maintained over both the horses and the sales proceeds while they

were held in APECO's or APECO Equine's name, and (3) Mr.

Kluener's preference for financing APECO by means of loans, we


12
     Mr. Hathaway's affidavit indicates that no effort was made
to keep the existence of the sales proceeds secret from APECO's
personnel, while his testimony at trial is the opposite.
are compelled to the conclusion that, in substance, Mr. Kluener

sold the horses using APECO as a conduit for the passage of title

and receipt of the proceeds.    Consequently, we hold that

petitioners are liable for the tax payable on the gain realized

from the sales.

     Having concluded that the transaction in issue is properly

viewed as a sale by Mr. Kluener using APECO as a conduit, we need

not address respondent's contention that the gain from the sale

of the horses should be allocated, pursuant to section 482, to

Mr. Kluener in order to clearly reflect the income of both

himself and APECO.    We note, however, that we have previously

stated that, if the conduit analysis of Commissioner v. Court

Holding Co., 324 U.S. at 334, and its progeny applies to a

transaction, all prerequisites for application of section 482 are

likewise met.     Southern Bancorporation v. Commissioner, 67 T.C.

1022, 1026 (1977).

     We next consider whether petitioners are liable for the

penalty provided by section 6662(a) for substantial

understatement of income tax.    Respondent determined that the

penalty applied to the underpayment of tax resulting from the

omission from Mr. and Ms. Kluener's 1989 return of the capital

gain and section 1245 recapture income realized upon the sales of

the horses that occurred during that year.    Petitioners bear the

burden of establishing error in respondent's determination.    Rule

142(a).
       Section 6662(a) and (b)(2) imposes an accuracy-related

penalty equal to 20 percent of any portion of an underpayment

that is attributable to a substantial understatement of income

tax.    An underpayment is defined as the excess of the tax imposed

pursuant to the Code over the amount of tax shown on the return

plus amounts not shown but previously assessed, less rebates.

Sec. 6664(a).    A substantial understatement is one that exceeds

the greater of 10 percent of the tax required to be shown on the

taxpayer's return for the taxable year or $5,000.    Sec.

6662(d)(1)(A).    An understatement is defined as the excess of the

amount of tax required to be shown on the return over the amount

of tax which is shown on the return, reduced by any rebate.      Sec.

6662(d)(2)(A).    The amount of an understatement is reduced by the

portion of the understatement attributable to the tax treatment

of any item for which, inter alia, there is or was substantial

authority for the treatment.    Sec. 6662(d)(2)(B)(i).   The

substantial authority standard is objective and involves an

analysis of the law and application of the law to relevant facts.

Sec. 1.6662-4(d)(2), Income Tax Regs.    Substantial authority

exists for the tax treatment of an item where, considering all

relevant authorities, the weight of authorities supporting the

tax treatment of an item is substantial in relation to the weight

of authorities supporting contrary treatment.    Antonides v.

Commissioner, 91 T.C. 686, 702 (1988), affd. 893 F.2d 656 (4th

Cir. 1990); sec. 1.6662-4(d)(3)(i), Income Tax Regs.     The weight

accorded an authority depends on its relevance and
persuasiveness, as well as its type.    Sec. 1.6662-4(d)(3)(ii),

Income Tax Regs.    A case having some facts in common with the tax

treatment of the item in issue is not particularly relevant if it

is materially distinguishable on its facts or is otherwise

inapplicable.     Id.

     In the instant case, petitioners contend that substantial

authority exists for treating APECO, rather than Mr. Kluener, as

the seller of the horses.    Petitioners contend that the

transaction involving the horses complied with the express

provisions of the relevant Code sections and that there was a

business purpose for the transfer of the horses.    Literal

compliance with the provisions of the Code, however, is not alone

sufficient to sustain the form in which a transaction is cast

where the form lacks a nontax, business purpose and simply

disguises the true nature of the transaction.    Commissioner v.

Court Holding Co., supra at 334; Gregory v. Helvering, 293 U.S.

465, 469 (1935).    We have found above that petitioners have not

shown that there was a nontax, business purpose for the

transaction in issue.    The authorities relied on by petitioners,

Smalley v. Commissioner, T.C. Memo. 1973-85, and Caruth v. United

States, 688 F. Supp. 1129 (N.D. Tex. 1987), are substantially

distinguishable on their facts.

     Accordingly, we conclude that petitioners have failed to

show that there was substantial authority for the items giving

rise to the understatement in issue and that the understatement

is substantial.    Consequently, we sustain respondent's
determination that petitioners are liable for the accuracy-

related penalty for substantial understatement of income tax.

     To reflect the foregoing and concessions,

                                        Decision will be entered

                                   for respondent.
