                         T.C. Memo. 1996-532



                       UNITED STATES TAX COURT



          MICHAEL W. REHTORIK, ET AL.,1 Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos.    9115-91, 24660-91,   Filed December 2, 1996.
                   24661-91.



     David M. Garvin, for petitioner Michael W. Rehtorik.

     James P. Dawson and Eli J. Dicker, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     SWIFT, Judge:    Respondent determined deficiencies in

petitioners’ joint Federal income taxes and additions to tax for

1984 and 1985 and deficiencies in petitioner Michael W.

1
      Cases of the following petitioners are consolidated
herewith: Michael W. and Barbara B. Rehtorik, docket No. 24660-
91; and Michael W. Rehtorik, docket No. 24661-91.
                                     - 2 -

Rehtorik’s (petitioner’s) individual Federal income taxes and

additions to tax for 1986 and 1987, as follows:


Michael W. and Barbara B. Rehtorik

                                      Additions To Tax
                                Sec.         Sec.             Sec.
     Year     Deficiency     6653(b)(1)   6653(b)(2)          6661

     1984      $131,360       $65,680            *           $32,840
     1985       165,695        82,848            *            41,424

        *   50 percent of interest due on amount of deficiency
            attributable to fraud.


Michael W. Rehtorik


     Year     Deficiency

     1986       $3,337
                                             Additions to Tax
                               Sec.              Sec.             Sec.
     Year     Deficiency    6651(a)(1)       6653(a)(1)(A)    6653(a)(1)(B)

     1987      $125,206       $1,370            $1,346                 *

                               Sec.              Sec.                  Sec.
                           6653(b)(1)(A)     6653(b)(1)(B)             6661

                              $73,715             **              $31,302

        *   50 percent of interest due on amount of deficiency
            attributable to negligence.

       **   50 percent of interest due on amount of deficiency
            attributable to fraud.


     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the years in issue, and

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

Procedure.

     After settlement, the primary issues for decision in these

consolidated cases are:      (1) Whether petitioner is liable for the
                                 - 3 -

fraud and other additions to tax for 1984, 1985, and 1987; and

(2) whether petitioner is entitled for 1986 to deduct $6,033 in

interest expenses and for 1987 $108,037 in legal expenses.     All

issues relating to Barbara B. Rehtorik have been settled.


                        FINDINGS OF FACT

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

     In 1983, petitioner, as sole shareholder, incorporated

Government Securities Corp. (GSC) as a Florida corporation.2

Until May 1987, petitioner was president of GSC.

     In 1984, petitioner incorporated Government Securities Group

of America (GSC America) as a Florida corporation and as the

parent holding company of GSC.    Petitioner was sole shareholder

and president of GSC America.

     GSC was engaged as a broker/dealer in the purchase and sale

for and to investors of Government-backed securities, such as

Government National Mortgage Association and Federal National

Mortgage Association mortgage-backed securities, and U.S.

Government zero coupon bonds.

     Separately from GSC’s above brokerage activities on behalf

of investors, GSC solicited funds from a limited number of

individual investors to be invested on behalf of GSC by

petitioner and by Oscar F. Gomez (Gomez), vice president and

2
      GSC was originally incorporated under the name of the
Federal Government Securities Corp. (FGSC). In 1984, FGSC
changed its name to GSC to comply with Federal law.
                                - 4 -

director of GSC.   These funds were referred to in the relevant

written materials as “managed accounts”.   Funds received from

investors as managed accounts (managed account funds) were to be

invested in various securities to be selected by and at the

discretion of GSC, of petitioner, and of Gomez, and apparently

were not limited to Government-backed securities.

     Managed account funds had the characteristics of loans from

the investors to GSC.   Receipt of managed account funds was

documented by written agreements that were signed by the

individual investors, and, on behalf of GSC, by petitioner and

Gomez.   The written agreements reflected total funds invested, a

fixed term for repayment to individual investors of the funds

invested, and a stated interest rate.   Interest was due monthly.

     Under each managed account investment agreement, at the end

of a stated fixed term, the term of each managed account

investment would be automatically renewed unless the investor

gave 30 days’ notice of cancellation.   Upon cancellation, the

principal amount of the investor’s managed account funds was to

be repaid with any interest due.

     Investors expected to be repaid the total principal amount

invested in managed accounts.   Repayments of principal on some

occasions were made, and payments of interest on many occasions

were made.

     Most of the principal repayments and much of the interest

payments that were due managed account investors, however, were
                                - 5 -

not paid by GSC, by petitioner, or by Gomez.   As explained below,

the total principal of all managed account funds that was not

repaid by GSC, by petitioner, or by Gomez, was repaid to the

investors pursuant to the Securities Investor Protection Act of

1970 (SIPA), Federal legislation that protects investor funds

when security brokerage companies are liquidated.

     Petitioner and Gomez apparently maintained records relating

to the managed account funds.   GSC’s internal accounting office,

however, did not maintain records of the managed account funds,

and GSC’s general sales force apparently did not market or sell

managed account investments and apparently did not know of the

existence of the managed accounts.

     The evidence in the record does not reflect the exact amount

of managed account funds that were received from investors.    The

following schedule reflects Gomez’ estimate of total managed

account funds that petitioner and Gomez received on behalf of GSC

for the years in issue.


                                  Gomez’ Estimate of
                                Total Managed Account
          Year                     Funds Received

          1984                   $500,000 to 600,000
          1985                    500,000 to 600,000
          1987                    200,000 to 300,000


     Some managed account funds received from investors were

deposited into GSC’s corporate bank accounts for use in

purchasing Government-backed securities that GSC, in turn, would
                                    - 6 -

resell to investors in the normal course of GSC’s retail

securities business.

     Some managed account funds, along with other funds such as

petitioners’ substantial salary income, were deposited into bank

accounts in petitioner’s name, from which accounts funds were

used by petitioner for business expenses and investments relating

to GSC and also for personal purposes.

     The following schedule reflects, for the years in issue,

managed account funds that were deposited into GSC’s corporate

bank accounts, our estimate (based on the evidence before us) of

managed account funds that were deposited into bank accounts in

petitioner’s name, and total deposits into bank accounts in

petitioner’s name.


             Managed Account Funds Deposited Into       Total Deposits
                GSC’s            Bank Accounts         Into Bank Accounts
 Year       Bank Accounts     In Petitioner’s Name   In Petitioner’s Name

 1984        $271,13O             $177,778                $299,965
 1985         226,255              158,340                 312,039
 1987           7,000              200,000                 293,212

    Total    $504,385             $536,118                $905,216


     At the end of 1986, petitioner hired a new accounting firm

to perform for 1986 a yearend audit of GSC’s books and records.

This accounting firm determined that GSC’s books and records were

not complete.     In 1987, upon verifying through yet another

accounting firm serious errors and omissions in GSC’s books and

records and on advice of GSC’s corporate counsel, petitioner
                                - 7 -

notified the U.S. Securities and Exchange Commission (SEC) of

GSC’s accounting problems, and the SEC commenced an investigation

of GSC.

     The record does not indicate that the SEC investigation

established anything illegal about GSC’s or petitioner’s use or

management of managed account funds.    Gomez, however, was

subsequently prosecuted and pleaded guilty to making certain

false representations in connection with the solicitation of

managed account funds.   The SEC investigation did conclude that

GSC's financial situation was not healthy.

     On May 12, 1987, either voluntarily or at the insistence of

the Securities Investor Protection Corp. (SIPC), a nonprofit

corporation created by SIPA, GSC entered into a liquidation

proceeding under SIPA in the U.S. Bankruptcy Court for the

Southern District of Florida.   In that proceeding, a trustee

(SIPC trustee) was appointed to liquidate GSC.    As part of that

liquidation proceeding, managed account investors submitted to

the SIPC trustee claims for repayment of managed account funds.

Also in that proceeding, the SIPC trustee sought damages against

petitioner and Gomez personally on behalf of 28 managed account

investors, seeking to recover the principal amount of outstanding

managed account funds of these 28 investors, plus interest,

costs, and other damages.
                                 - 8 -

     In 1987, petitioner hired and paid an attorney $108,037 in

legal fees to represent him in GSC's liquidation proceeding and

against the claim for damages.

     On March 22, 1988, in GSC's liquidation proceeding,

petitioner and Gomez signed consent judgments agreeing to pay

$573,750 and $701,250 in damages, with interest, respectively, to

the SIPC trustee for repayment to managed account investors.

     The evidence in this case does not reflect how much, if any,

of the above damages were actually paid by petitioner and Gomez.

As indicated, however, the SIPC trustee did repay the principal

amount of the managed account funds owed to 26 of the managed

account investors.


Use of Managed Account Funds Deposited
into Bank Accounts in Petitioner’s Name

     From 1984 through 1987, with funds deposited into bank

accounts in his name, including managed account funds, petitioner

paid certain GSC business expenses.      For example, in 1984, GSC

entered into certain investment hedge transactions to offset

risks associated with GSC’s purchase and subsequent holding of

mortgage-backed securities for sale to GSC customers.      Petitioner

made all decisions relating to hedge transactions entered into on

behalf of GSC, and petitioner purchased securities with funds

withdrawn from the bank accounts in his name for the above

purpose of hedging GSC’s investment risks.
                              - 9 -

     From 1984 through 1987, petitioner also made certain

repayments to investors of principal and payments of interest

with respect to managed account funds, and petitioner used funds

withdrawn from the bank accounts in his name for such repayments

of principal and payments of interest.

     Also, in 1987, with funds withdrawn from the bank accounts

in his name, petitioner purchased for and in the name of GSC

$37,725 in gold Krugerrands, which Krugerrands were later sold at

a profit that GSC received.

     On February 27, 1987, after having received $100,000 from a

new managed account investor and after depositing such $100,000

into one of the bank accounts in his name, petitioner purchased

with funds withdrawn from the same bank account into which the

$100,000 had been deposited a cashier’s check for $100,000 that

was endorsed over to GSC America.   This $100,000 was then

transferred from GSC America to GSC and was apparently used for

GSC’s expenses and investments.

     The following schedule reflects and, where necessary,

estimates for each year the amount of GSC’s expenses that were

paid with funds withdrawn from the bank accounts in petitioner’s

name, including funds used to participate in hedge transactions,

funds used to pay principal and interest to managed account

investors, funds used to purchase gold Krugerrands, and the

$100,000 that in February of 1987 petitioner received from a
                                    - 10 -

managed account investor and then transferred through GSC America

to GSC:


                                                  Years in Issue
            Purpose                      1984           1985     1987

  Hedge transactions                   $114,025       $     0       $        0
  Payments of principal                  58,380        25,334           45,865
    and interest on managed
    account funds
  Purchase of Krugerrands                         0             0     37,725
  $100,000 transfer                               0             0    100,000

                      Total            $172,405       $25,334       $183,590


Tax Returns

       The following schedule reflects the date filed, timeliness,

gross income reported, and filing status relating to each of

petitioner’s Federal income tax returns for 1984 through 1987.

                                   Gross Income
Return   Date Filed      Filed       Reported              Filing Status

1984      8/15/85        timely     $147,000          married   filing   jointly
1985      6/13/86       untimely    $174,900          married   filing   jointly
1986      2/26/88       untimely    $254,573          married   filing   separately
1987       4/7/89       untimely     $83,600          married   filing   separately


       The above gross income reported on the tax returns for each

year consisted primarily of petitioner’s salary income from GSC

and Barbara B. Rehtorik’s salary income from her employment as

manager of a retail clothing store.

       Petitioners did not include as income on their 1984 and 1985

joint Federal income tax returns, and petitioner did not include

as income on his 1987 individual Federal income tax return, any
                              - 11 -

managed account funds deposited into the bank accounts in

petitioner’s name.

     On his 1986 individual Federal income tax return, petitioner

claimed $47,802 as an interest expense deduction relating to a

home mortgage.

     On his 1987 individual Federal income tax return, petitioner

claimed $108,037 as an ordinary business expense deduction for

legal fees relating to the claim against him for damages in the

GSC liquidation proceeding.

     Petitioner attached to his 1987 Federal income tax return a

disclosure statement reflecting tax advice that petitioner had

received from his tax accountant that the $573,750 in managed

account funds reflected in the consent judgment against

petitioner in GSC’s liquidation proceeding should not be treated

as income to petitioner but as loans that GSC and petitioner

intended to repay to managed account investors.


Respondent’s Audit

     On audit, using total deposits made into the bank accounts

in petitioner’s name (including deposits of managed account

funds) of $299,965, $312,039, and $293,212, for 1984, 1985, and

      1987, respectively, respondent determined that petitioner

received and was taxable on managed account funds in the

following amounts:
                             - 12 -

          Year                        Unreported Income

          1984                           $287,081
          1985                            275,446
          1987                            255,290


     At trial and in her briefs, respondent has made revisions to

the above determination of unreported income, as reflected below:


                                     Respondent's Revised
                                Determination of Petitioner’s
          Year                       Unreported Income

          1984                              $263,054
          1985                               192,399
          1987                               244,449

                                Total       $699,902


     For 1984, 1985, and 1987, respondent did not allow as

business expenses or otherwise give petitioner credit against any

of the bank deposits that respondent treated as unreported

taxable income to petitioner, any of the investments by

petitioner in hedge transactions, repayments of principal and

interest to managed account investors, transfers to GSC, or other

amounts that petitioner paid on behalf of GSC.

     On February 13, 1991, respondent’s notice of deficiency for

1986 was mailed to petitioner in which notice $6,033 of claimed

interest expenses was disallowed.
                              - 13 -

     On July 29, 1991, respondent’s notices of deficiency for

1984, 1985, and 1987 were mailed to petitioner; in the notice for

1987 $108,037 of claimed legal expenses was disallowed.

     In respondent’s notice of deficiency for 1984 and 1985,

respondent also determined that the underpayments of tax were due

to fraud without which respondent’s assessment of deficiencies

for 1984 and 1985 would be barred by the period of limitations

under section 6501.

     For 1987, respondent also determined that the underpayment

was due to fraud or, in the alternative, negligence.

     Further, for 1987, respondent determined additions to tax

for substantial understatement and failure to timely file.


                              OPINION

Fraud for 1984, 1985, and 1987

     Respondent bears the burden of proving fraud by clear and

convincing evidence.   Sec. 7454(a); Rule 142(b); Korecky v.

Commissioner, 781 F.2d 1566, 1568 (11th Cir. 1986), affg. T.C.

Memo. 1985-63; Clayton v. Commissioner, 102 T.C. 632, 646 (1994).

To establish fraud, respondent must prove for each year:

(1) That a taxpayer’s Federal income tax return, as filed,

reflected an underpayment of tax, and (2) that some part of the

underpayment was due to fraudulent intent.   Sec. 7454(a); Rule

142(b); Clayton v. Commissioner, supra at 646; Recklitis v.
                                - 14 -

Commissioner, 91 T.C. 874, 909 (1988); Stone v. Commissioner, 56

T.C. 213, 220 (1971).

       Funds received by a taxpayer through misappropriation or

embezzlement constitute taxable income to the taxpayer.        James v.

United States, 366 U.S. 213, 219 (1961).

       Funds received as loans, however, are not properly treated

as taxable income.     James v. United States, supra at 219.    If

there exists between a taxpayer who receives funds and the

provider of funds a good-faith expectation that the funds are to

be repaid and an obligation to do so, the funds in the hands of

the taxpayer will be treated as nontaxable loan proceeds.       See

Collins v. Commissioner, 3 F.3d 625, 631 (2d Cir. 1993), affg.

T.C. Memo. 1992-478.    Funds received by a taxpayer as an agent or

conduit of a corporation are not treated as taxable income.       See

Lashells’ Estate v. Commissioner, 208 F.2d 430, 435 (6th Cir.

1953), affg. in part, revg. in part and remanding a Memorandum

Opinion of this Court; Ishijima v. Commissioner, T.C. Memo. 1994-

353.

       With regard to fraudulent intent, respondent must prove that

petitioner intended to evade taxes by conduct intended to

conceal, mislead, or otherwise prevent the collection of taxes.

Clayton v. Commissioner, supra at 647; Parks v. Commissioner, 94

T.C. 654, 661 (1990); Hebrank v. Commissioner, 81 T.C. 640, 642

(1983).    Fraud may be proven by circumstantial evidence because

direct evidence of fraud is generally not available.     Clayton v.
                              - 15 -

Commissioner, supra at 647; Rowlee v. Commissioner, 80 T.C. 1111,

1123 (1983).

     As indicated, respondent argues that all managed account

funds deposited into bank accounts in petitioner’s name during

the years in issue should be treated as unreported taxable income

to petitioner.   Respondent argues that by depositing managed

account funds into bank accounts in his name, petitioner

misappropriated managed account funds from either the managed

account investors, from GSC, or from both.

     Petitioner argues that managed account funds deposited into

bank accounts in his name constituted loans from managed account

investors to GSC, that petitioner did not misappropriate any

managed account funds either directly or through GSC, and that

petitioner used managed account funds deposited into bank

accounts in his name as an agent for GSC, and to pay expenses and

to make purchases of securities on behalf of GSC.

     The evidence before us establishes that, from the standpoint

of managed account investors and GSC, managed account funds

transferred by investors to GSC, to petitioner, and to Gomez,

were regarded as funds loaned from the investors to GSC.    Managed

account investors signed written agreements with GSC that

provided for repayment of principal and interest, and managed

account investors did expect to be repaid all managed account

funds and interest thereon.   The fact that some officers and

employees of GSC did not know of the managed account funds does
                             - 16 -

not eliminate GSC’s obligation, as agreed to by petitioner and by

Gomez, as senior officers of GSC, with regard thereto.

     Petitioner deposited managed account funds into GSC’s bank

accounts and into bank accounts in his name.    Those funds,

including those deposited into bank accounts in petitioner’s name

were in large part used for the benefit of GSC.    Managed account

funds deposited into bank accounts in petitioner’s name were used

by petitioner to pay principal and interest owed to managed

account investors, to pay various business expenses of GSC, and

to purchase securities for GSC that represented hedge

transactions.

     As indicated, for 1984, 1985, and 1987, petitioner deposited

$177,778, $158,340, and $200,000, respectively, in managed

account funds into bank accounts in his name.    The evidence

establishes that for 1984, 1985, and 1987 petitioner withdrew at

least $172,405, $25,334, and $183,590, respectively, from the

same bank accounts and used these funds for GSC’s benefit.

     With regard to the balance of managed account funds that

petitioner deposited into bank accounts in his name, which the

evidence does not establish that petitioner used for GSC’s

benefit, respondent has not established by clear and convincing

evidence that petitioner was not holding these funds as loans and

as an agent for GSC, nor has respondent established by clear and

convincing evidence that petitioner misappropriated these funds

for his personal use.
                               - 17 -

     As indicated, the record does not establish that petitioner

used any managed accounts funds that were deposited into the bank

accounts in his name for personal purposes.   There is no evidence

that such funds were used by petitioner to take vacations,

purchase extravagant items, or entertain himself or others.     We

note that petitioners reported on their tax returns significant

salary income for the years in issue, and the evidence

establishes that much of this salary income was deposited into

the bank accounts in petitioner’s name and that the amount of

petitioners’ salary deposits appears to have been sufficient to

support petitioners’ lifestyle.

     Based on the evidence before us, and for purposes of our

decision as to petitioner’s liability for the fraud additions to

tax, on which respondent has the burden of proof by clear and

convincing evidence, we conclude that respondent has not

established that petitioner was not an agent for GSC in his

receipt of managed account funds, nor that petitioner embezzled

or misappropriated for his personal use any managed account funds

during 1984, 1985, and 1987.   Accordingly, for purposes of the

fraud additions to tax, we conclude that managed account funds

deposited into the bank accounts in petitioner’s name should not

be treated as taxable income to petitioner.

     For 1984, 1985, and 1987, because respondent has not

established by clear and convincing evidence that petitioner
                              - 18 -

underreported his income, one of the required elements of the

fraud addition to tax is not present.

     In particular for 1984 and 1985, because respondent has

failed to prove fraud, the assessment of any tax deficiency and

additions to tax for those years is barred by the statute of

limitations.3   Sec. 6501(a), (c)(1).


Unreported Income for 1987

     For 1987, in spite of our conclusion that fraud has not been

established, respondent’s assessment of a tax deficiency would

not be barred by the 3-year period of limitation under section

6501(a), and we must decide whether petitioner should be charged

with $200,000 in unreported income relating to the managed

account funds deposited into the bank accounts in his name.4    On

this issue for this year, petitioner has the burden of proof by a

preponderance of the evidence.   Rule 142(a).




3
      We note that respondent has not raised the 6-year period of
limitations under sec. 6501(e)(1)(A) for 1984 and 1985. Because
respondent failed to raise the 6-year period of limitations in
pleading, amended pleading, or briefs, we shall not consider its
application. See Estate of Rosenberg v. Commissioner, 86 T.C.
980, 984 n.1 (1986), affd. without published opinion per curiam
812 F.2d 1401 (4th Cir. 1987); Markwardt v. Commissioner, 64 T.C.
989, 997-998 (1975).
4
      Respondent determined that $244,449 in managed account
funds was deposited into bank accounts in petitioner’s name. On
the evidence, we have found that the correct amount of managed
account funds deposited into bank accounts in petitioner’s name
was $200,000.
                              - 19 -

     As indicated, funds received by a taxpayer through

misappropriation or embezzlement are to be treated as taxable

income.   James v. United States, 366 U.S. 213, 219 (1961).    Funds

received as loans, however, are not to be treated as taxable

income.   See Collins v. Commissioner, 3 F.3d at 631.

     Respondent determined that for 1987, the total managed

account funds deposited into the bank accounts in petitioner’s

name should be treated as income to petitioner, not as loan funds

invested by managed account investors that had to be repaid, nor

as loans from GSC to petitioner.   Respondent argues that

petitioner misappropriated the managed account funds deposited

into the bank accounts in his name from either GSC or from

managed account investors.

     Petitioner argues that all managed account funds, including

those deposited into the bank accounts in his name, constituted

loans and were not misappropriated by him from GSC or from

managed account investors.   Petitioner argues that these funds

were used and were intended to be used by him to pay expenses and

to make purchases of securities for and on behalf of GSC and to

make repayments of principal and interest to managed account

investors.

     During 1987, with funds from the bank accounts in his name,

petitioner paid $83,590 for GSC’s benefit, of which $45,865 was

paid for principal and interest on managed accounts and $37,725

was paid for gold Krugerrands.   Also during 1987 and with funds
                               - 20 -

from the same bank accounts, petitioner transferred $100,000 to

GSC America and then to GSC, and this $100,000 was apparently

used for GSC’s expenses and investments.      With regard to this

total $183,5905 of managed account funds deposited into the bank

accounts in petitioner’s name in 1987, petitioner has met his

burden of proof and has established that such funds were not

misappropriated by him, but were used by him as an agent for GSC.

     With regard, however, to $16,410 in managed account funds

deposited in 1987 into the bank accounts in petitioner’s name

that was not used by petitioner to repay managed account

investors, to purchase gold Krugerrands, nor to make a transfer

to GSC, and that was still on deposit in the bank accounts in

petitioner’s name at the end of 1987, petitioner, who has the

burden of proof on this issue, has not adequately established the

nontaxability of such funds.   With regard to this $16,410, we

hold for respondent.   We are not persuaded that such funds should

be treated as loans to petitioner.      We rely primarily on

petitioner’s burden of proof with regard to this $16,410.


$6,033 Claimed Interest Expenses for 1986 and
$108,037 Claimed Legal Expenses for 1987

     With regard to the disallowed $6,033 interest expenses

claimed for 1986, petitioner has offered no evidence and has




5
     $45,865 plus $37,725 plus $100,000 equals $183,590.
                               - 21 -

failed to meet his burden of proof.     We sustain respondent's

determination on this issue.

     With regard to the disallowed $108,037 legal expenses

claimed for 1987, legal expenses that arise from personal,

nonbusiness matters of a taxpayer do not qualify as business

expense deductions.   Commissioner v. Tellier, 383 U.S. 687, 689

(1966); United States v. Gilmore, 372 U.S. 39, 46 (1963); In re

Collins, 26 F.3d 116, 117-118 (11th Cir. 1994).

     Petitioner’s $108,037 in legal expenses that were incurred

in 1987 relates to claims instituted against petitioner by the

SIPC trustee and involves petitioner’s activities as president of

GSC and as a fund raiser and purchaser of securities for GSC and

for others.

     Respondent argues that the legal expenses should be

disallowed because they relate primarily to petitioner’s alleged

misappropriation of managed account funds.     We disagree.   See

Commissioner v. Tellier, supra at 688-693.     Authority cited by

respondent involves taxpayers subject to criminal charges

unrelated to their business activities.     We conclude that the

claimed $108,037 in legal expenses is allowable as a business

expense to petitioner.


Negligence, Substantial Understatement, and
Failure to Timely File Additions to Tax -- 1987

     A taxpayer may avoid liability for additions to tax for

negligence under section 6653(a)(1) if a taxpayer reasonably
                               - 22 -

relies on a competent professional adviser.    United States v.

Boyle, 469 U.S. 241, 250-251 (1985); Freytag v. Commissioner, 89

T.C. 849, 888 (1987), affd. 904 F.2d 1011 (5th Cir. 1990), affd.

501 U.S. 868 (1991).    The reliance must be reasonable, in good

faith, and based upon full disclosure.    Freytag v. Commissioner,

supra at 888-889.

     Respondent alleges that petitioner was negligent under

section 6653(a)(1) for failing to report income on his Federal

income tax return for 1987 relating to managed account funds.

Petitioner argues that he reasonably relied on his accountant and

tax return preparer, and petitioner emphasizes that he disclosed

-- to the accountant who prepared his 1987 Federal income tax

return and to respondent on his 1987 return -- facts relating to

his receipt of managed account funds.

     Petitioner reasonably relied on his accountant’s tax advice

regarding nontaxability of managed account funds, and no evidence

in the record suggests that petitioner acted in bad faith with

regard to his reporting thereof.    For 1987, we reject

respondent's determination of the negligence addition to tax

under section 6653(a)(1).

     The substantial understatement addition to tax under section

6661(b)(1) does not apply where a taxpayer discloses adequate

facts on the tax return to disclose to respondent the nature of

the item in question.    See sec. 1.6661-4(b)(2), Income Tax Regs.
                               - 23 -

Petitioner attached a disclosure statement to his 1987 return

disclosing significant facts relating to receipt of managed

account funds and his involvement with the liquidation of GSC.

We reject respondent’s determination of this addition to tax.

     A taxpayer is subject to an addition to tax for failure to

timely file a tax return unless the taxpayer establishes that the

failure to timely file was due to reasonable cause and not due to

willful neglect.    Sec. 6651(a)(1).    Petitioner untimely filed his

1987 Federal income tax return on April 4, 1989, without

extension.   Petitioner failed to present evidence showing

reasonable cause.   Petitioner is subject to this addition to tax.

     To reflect the foregoing,


                                             Decisions will be

                                         entered under Rule 155.
