                         T.C. Memo. 1998-279



                       UNITED STATES TAX COURT



         WILLIAM NORWALK, TRANSFEREE, ET AL.,1 Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 20685-96, 20686-96,           Filed July 30, 1998.
                 20767-96, 20772-96,
                 20773-96.



     Harry J. Kaplan and John F. Hopkins, for petitioners.

     LaVonne D. Lawson, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION

     RUWE, Judge:    These consolidated cases involve transferee

liability, deficiencies, penalties, and an addition to tax

determined by respondent as follows:


     1
      The following cases are consolidated: Robert DeMarta,
Transferee, docket No. 20686-96; DeMarta & Norwalk, CPA's, Inc.,
docket No. 20767-96; William R. Norwalk, docket No. 20772-96; and
Robert and Patricia DeMarta, docket No. 20773-96.
                                     - 2 -

                        William Norwalk, Transferee
                            docket No. 20685-96

                 Year                    Transferee Liability

                 1992                            $165,940


                        Robert DeMarta, Transferee
                            docket No. 20686-96


                 Year                        Transferee Liability

                 1992                            $505,935


                      DeMarta & Norwalk, CPA's, Inc.
                            docket No. 20767-96

                                                Accuracy-related Penalty
         Year             Deficiency                   Sec. 6662

         1992             $232,540                     $46,508


                             William R. Norwalk
                            docket No. 20772-96

                                                Accuracy-related Penalty
        Year              Deficiency                   Sec. 6662

        1992              $44,088                      $8,818


                        Robert and Patricia DeMarta
                            docket No. 20773-96

                            Addition to Tax        Accuracy-related Penalty
Year      Deficiency        Sec. 6651(a)(1)               Sec. 6662

1992       $150,249            $7,512                       $30,050


       After concessions by the parties, the issues for decision

are:    (1) Whether DeMarta & Norwalk, CPA's, Inc. (the

corporation), realized a gain of $588,297 on the distribution of
                              - 3 -

its intangible assets to its shareholders in a liquidation; (2)

whether the corporation is liable for depreciation recapture in

the amount of $15,643 on the distribution of its tangible assets

to its shareholders in a liquidating distribution in 1992; (3)

whether Robert and Patricia DeMarta realized a capital gain of

$505,935 on the receipt of property from the corporation in a

liquidating distribution in 1992; (4) whether William R. Norwalk

realized a capital gain of $165,940 on the receipt of property

from the corporation in a liquidating distribution in 1992; (5)

whether the corporation is entitled to a deduction, reported as

consulting fees, of $40,000 for payments to the shareholders in

1992; (6) whether Robert DeMarta and William R. Norwalk are

required to report such payments, in the amounts of $23,320 and

$16,680, respectively, as dividend income; (7) whether Robert and

Patricia DeMarta are liable for an addition to tax under section

6651(a)(1)2 and an accuracy-related penalty under section 6662;

(8) whether the corporation is liable for an accuracy-related

penalty under section 6662; (9) whether William Norwalk is liable

for an accuracy-related penalty under section 6662; and (10)

whether Messrs. DeMarta and Norwalk are liable as transferees for

the corporation's 1992 Federal income tax liability.

                        FINDINGS OF FACT

     2
      Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable year in
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
                                 - 4 -


     Some of the facts are stipulated and are incorporated herein

by this reference.

     At the time of the filing of the petitions in these

consolidated cases, each of the individual petitioners resided in

Fremont, California, and the corporate petitioner, DeMarta &

Norwalk, CPA's, Inc., maintained its principal office in Fremont,

California.   Robert DeMarta and William Norwalk (sometimes

referred to as the shareholders) are certified public accountants

(C.P.A.'s) and provide accounting services on a full-time basis.

Mr. DeMarta became a C.P.A. in approximately 1970, while Mr.

Norwalk became a C.P.A. in 1980.

     In 1985, Messrs. DeMarta and Norwalk organized DeMarta &

Norwalk, CPA's, Inc., which was incorporated in California on

August 14, 1985.   The business of the corporation was the

practice of public accounting.    At all times during the

corporation's existence, Messrs. DeMarta and Norwalk have been

its only shareholders.

     On September 3, 1985, Messrs. DeMarta and Norwalk signed

separate agreements with the corporation regarding their

respective ownership interests in, and rights and duties

regarding, the corporation.   Each agreement is entitled

"Employment Agreement".   The effective date set forth on these

agreements was October 1, 1985, and each provides, among other

things, the following:
                            - 5 -

                            TERM

     5. The term of employment shall be five years
from the date specified in Schedule A attached to this
Agreement, subject to the following conditions:

          (a) This Agreement may be terminated at any
time by mutual agreement in writing of the Corporation
and Employee.

          (b) Employee shall have the absolute right
to unilaterally terminate this Agreement by providing
the Board of Directors with written notice of
termination and, in that case, termination shall occur
upon the expiration of ninety (90) days after the date
of the notice.

          *     *       *     *     *      *   *

          (h) Either party may terminate this
Agreement after the expiration of 15 months by giving
the other 30 days written notice.

                    RESTRICTIVE COVENANT

     6. Employee agrees that during the term of this
Agreement he will not engage in any other business
duties or pursuits whatsoever, directly or indirectly,
except activities approved in writing by the Board of
Directors, directorships in companies not in
competition with the Corporation, and passive personal
investments. Furthermore, Employee will not, directly
or indirectly, acquire, hold, or retain any interest in
any business competing with or similar in nature to the
business of the Corporation, and will not own or hold
to any substantial degree any securities in any company
competing with the Corporation.

          *     *       *     *     *      *   *

               DISCLOSURE OF INFORMATION

     8. Employee recognizes and acknowledges that the
list of the Corporation's clients, as it may exist from
time to time, is a unique asset of the Corporation's
business. Employee will not, during or after the term
                                 - 6 -

     of employment, disclose the list of the Corporation's
     clients or any part of it to any person, firm,
     corporation, association, or other entity for any
     reason or purpose whatsoever. In the event of a breach
     or threatened breach by Employee of the provisions of
     this Paragraph, the Corporation shall be entitled to an
     injunction restraining Employee from disclosing, in
     whole or in part, the list of the Corporation's
     clients, or from rendering any services to any person,
     firm, corporation, association, or other entity to whom
     the list, in whole or in part, has been disclosed or is
     threatened to be disclosed. Nothing in this Agreement
     shall be construed as prohibiting the Corporation from
     pursuing any other remedies available to the
     Corporation for disclosure, including the recovery of
     damages from Employee.

               *     *      *      *      *   *   *

                                RECORDS

          11. On the termination of this Agreement,
     Employee shall not be entitled to keep or preserve
     records or charts of the Corporation as to any client
     unless a client specifically requests a different
     disposition of those records, and in no event shall
     Employee be entitled to the records of clients not
     served by him.


     Subsequent to the term of the shareholders' respective

agreements with the corporation, no other agreements between the

shareholders and the corporation were entered into.   Accordingly,

Messrs. DeMarta and Norwalk were not bound by any covenant not to

compete on June 30, 1992.

     As of June 30, 1992, in addition to the shareholders, the

corporation had eight employees, four of whom were accountants.

No other employee of the corporation signed any employment

agreement with the corporation.
                                  - 7 -

     On June 30, 1992, the corporation's assets were distributed

to its shareholders.      On that date, Mr. DeMarta held 75 percent

of the corporation's stock, while Mr. Norwalk held the remaining

25 percent.    Only a nominal amount of assets was left in the

corporation after this distribution.         This distribution

constituted a complete liquidation of the corporation in 1992.

The corporation did not continue to provide accounting services

after June 30, 1992, and the business of the corporation did not

continue.    The corporation has never been dissolved.

     The corporation reported the following revenues and

expenditures on its Federal income tax returns for the years 1988

through 1992:


Item from returns      1988       1989         1990      1991       1992

Gross receipts        $666,185   $850,527    $938,096   $967,495   $730,989
Form 4797 gain/loss       --       (5,481)       --         --         --
Other income              --         --           480       --          194

Deductions
Comp. of officers     168,024    187,383      177,363   197,341     74,654
Salaries & wages      249,091    343,935      377,676   381,135    218,813
Repairs                 2,404      4,528         --       6,664       --
Bad debts                 602       --           --        --         --
Rents                  62,039     54,471       82,219   101,628     56,379
Taxes                  29,245     36,732       41,200    44,283     26,048
Interest               14,563     16,421       30,993    23,622     11,162
Charitable contr.         --        --           --        --           99
Depreciation           11,516     19,019       32,371    27,190      8,045
Amortization              334        334          252      --         --
Pension plan              --      41,337       44,264    51,589       --
Bank charges              --        --           --          68       --
Meals & enter.          1,930      6,577       18,266     1,761     10,323
Books & journals        6,527      3,708        2,757     1,791      2,774
Client costs               38        118        3,997    12,331         80
Computax costs         41,897     49,762       15,228      --         --
Computer costs          3,543     15,571       14,161    11,314       --
Continuing educ.       10,273     17,447       12,524     7,807      9,408
Dues & subscript.       4,376     19,005       18,136     8,903     10,564
Insurance              26,474     42,401       49,475    45,219     29,466
Meetings                3,089       --           --       6,825       --
Per diem fees             --        --           --      15,677       --
                                       - 8 -
Library service             --           --           --           1,000       --
Office expense           13,333        24,640       25,567        26,073     14,197
Employment agency         5,486          --           --            --         --
Payroll processing          767         1,067          659          --         --
Postage                   4,546         6,940        6,944         7,441      7,684
Telephone                 8,289         7,803        9,911         8,013      5,182
Travel                    2,838         6,825        7,022         1,971      6,445
Tax processing costs       --            --           --           1,577      3,590
Advertising               1,718         2,551        1,755         4,449      4,094
Consulting fees            --           3,225         --            --       40,000
Peer review expense        --           4,952         --            --         --
Pension administration     --             700          372           270        465
Legal & professional        450          --          8,986          --         --
Supplies                   --            --         10,001          --        8,492
Equipment rental            631           219        7,459         1,808      5,611
Moving expenses            --             500        4,522          --         --

 Total expenses          674,023      918,171    1,004,080       997,750     553,575

 Taxable income/loss     (7,838)      (73,125)     (65,504)      (30,255)    177,608


     From 1988 to 1992, the shareholders received the following

salaries from the corporation:


        Year                   Mr. DeMarta                    Mr. Norwalk

        1988                       $98,024                    $70,000
        1989                       107,463                     79,920
        1990                       107,440                     69,923
        1991                       107,440                     89,901
        1992                        40,880                     33,774


A portion of the salaries paid to Messrs. DeMarta and Norwalk was

derived from bank loans guaranteed by the shareholders and from

loans made to the corporation by the shareholders.                  At the

beginning of the corporation's 1992 tax year, it had outstanding

loans from shareholders of $22,533.              At the end of the

corporation's 1992 tax year, its liabilities included outstanding

loans from the shareholders of $96,678.

     In addition to their salaries from the corporation, Messrs.

DeMarta and Norwalk received $23,320 and $16,680, respectively,
                               - 9 -

in 1992.   A total of $40,000 representing these additional

amounts was deducted by the corporation as consulting fees on its

1992 Federal income tax return.    Mr. Norwalk reported this

additional amount as ordinary income on his 1992 Federal income

tax return.   Mr. DeMarta did not report any of this additional

amount on his Federal income tax return.

     On January 3, 1992, as reflected in the corporation's

minutes, the board of directors (Messrs. DeMarta and Norwalk)

authorized the distribution of the corporation's assets and

liabilities to the shareholders.    These corporate minutes

provided the following reason for this distribution:


          Due to lack of profitability, it was decided to
     stop practice as Certified Public Accountants within
     the structure of DeMarta & Norwalk. It was further
     decided to distribute all available assets and
     liabilities to the shareholders. Each shareholder
     would then be able to pursue a professional practice on
     their own or as partners with other CPA(s).


     On July 1, 1992, following the distribution of the

corporation's assets, Messrs. DeMarta and Norwalk became partners

of the accounting firm Ireland, San Filippo (the partnership),

and transferred assets, distributed to them by the corporation,

to the partnership.   The partnership did not use the

corporation's name.   The tangible assets distributed to the

shareholders included all the corporation's furniture and

equipment, which the corporation reported on its 1992 Federal

income tax return at a value of $59,455.    These assets were
                                - 10 -

contributed to the partnership at an agreed value of $59,455.

The shareholders also transferred their share of the

corporation's receivables to the partnership.    These assets were

contributed to the partnership (less liabilities assumed by the

partnership) in exchange for the opening balances of the

respective partnership capital accounts of Messrs. DeMarta and

Norwalk.   The partnership did not assume tax obligations of the

corporation, nor did it assume the debts owed by the corporation

to the shareholders.   The opening capital account balances in the

partnership for Messrs. DeMarta and Norwalk were $39,202 and

$28,041, respectively.

     Messrs. DeMarta and Norwalk each executed a partnership

agreement when they joined the partnership.   Under the terms of

the partnership agreement, Messrs. DeMarta and Norwalk were

treated as equal partners and subject to the same formula for

allocation of compensation.   This partnership agreement also

contained certain provisions restricting the partners' ability to

compete with the partnership.

     The partnership assumed the corporation's lease and occupied

its former offices from July 1, 1992, to April 25, 1994.   On

April 28, 1994, after vacating these offices, the partnership

subleased the space.   At the time of the sublease, the remaining

term of the lease was 8 months.    The partnership subsidized one-

third of the rent when it subleased the space.
                                - 11 -

     As of June 30, 1992, other than the shareholders, the

corporation employed the following persons:    Barbara Bailey;

Karin Laster; Beverly Hagan, C.P.A.; Thomas Tang, C.P.A.; Don

Christman, C.P.A.; Jeanette Joyce, accountant; Judy Cunningham,

administrator; and Joan Long, secretary.    After the liquidation

of the corporation, many of its former employees were

subsequently employed by the partnership.    By the end of October

1992, both Beverly Hagan and Thomas Tang left the partnership to

set up their own separate accounting practices.    When Mr. Tang

left, Barbara Bailey, a computer consultant, and Karin Laster, a

bookkeeper, also left the partnership to work for Mr. Tang.

     When Ms. Hagan and Mr. Tang left to set up their individual

practices, they each sent announcements to former clients of the

corporation and to clients of the partnership informing them of

their move.    The partnership received at least 92 requests from

former clients to have the information contained in their files

made available to either Ms. Hagan or Mr. Tang.    Pursuant to

these client authorizations, the partnership permitted Ms. Hagan

and Mr. Tang to copy the files of clients that left the

partnership.   Neither Messrs. DeMarta and Norwalk nor the

partnership requested any compensation for any clients lost to

either Ms. Hagan or Mr. Tang.    Five years following the

liquidation of the corporation, only about 10 percent of the
                                - 12 -

accounts serviced by the corporation remained with the

partnership.


                                OPINION


     The principal issue underlying all these consolidated cases

is the fair market value of the corporation's assets on the date

of distribution.

Customer-Based Intangibles


     Respondent contends that when the corporation was

liquidated, it distributed to its shareholders "customer-based

intangibles" in addition to tangible assets.       Respondent

describes the intangible assets at issue to include the

corporation's client base, client records and workpapers, and

goodwill (including going-concern-value).       Respondent's position

is that these intangibles were assets of the corporation that had

a specific value and that when distributed to the shareholders in

the liquidation, triggered taxable gain to the corporation.

Liability in respect of a deficiency in the corporation's tax and

penalty was then asserted by respondent against the shareholders

of the corporation as transferees.       Respondent also determined

that the transfer of the customer-based intangibles received by

the shareholders generated taxable gain to the shareholders.

     Petitioners maintain that the corporation did not own the

intangibles in question.     Rather, petitioners argue that the
                               - 13 -

accountants themselves owned the intangibles, and, thus, there

was no transfer nor any corresponding taxable gain attributable

to these intangibles.

     Generally, gain or loss must be recognized by a liquidating

corporation on the distribution of property in complete

liquidation as if such property were sold to the distributee at

its fair market value.    Sec. 336(a).    Petitioners do not contend

that the provisions of section 336(a) should not apply here.      The

corporation must recognize gain calculated as the difference

between the fair market value of the distributed property and the

corporation's basis in that property.

     Moreover, amounts received by the shareholders in a

distribution in complete liquidation of the corporation must be

treated as in full payment in exchange for the corporation's

stock.   Sec. 331(a).   The shareholders must recognize any gain on

the receipt of the property in the liquidating distribution.      The

gain to the shareholder is computed by subtracting the

shareholder's adjusted basis in the stock from the amount

realized.   Sec. 1001(a); sec. 1.331-1(b), Income Tax Regs.     The

amount realized is the sum of any money received on the

distribution plus the fair market value of the property received

(other than money).3    Sec. 1001(b).    This gain is reduced by the


     3
      Sec. 1.331-1(e), Income Tax Regs., provides that a
shareholder's gain or loss on a liquidating distribution be
                                                   (continued...)
                                  - 14 -

outstanding corporate liabilities assumed by the shareholders, if

any.       Here, the loans payable to the shareholders totaled $96,678

as of June 30, 1992.4

       We have recognized that goodwill is a vendible asset which

can be sold with a professional practice.       LaRue v. Commissioner,

37 T.C. 39, 44 (1961); Watson v. Commissioner, 35 T.C. 203, 209

(1960).       Goodwill is often defined as the expectation of

continued patronage.       Newark Morning Ledger Co. v. United States,

507 U.S. 546 (1993).      In Rudd v. Commissioner, 79 T.C. 225, 238

(1982), we stated:


            The goodwill of a public accounting firm can
       generally be described as the intangibles that attract
       new clients and induce existing clients to continue
       using the firm. These intangibles may include an
       established firm name, a general or specific location
       of the firm, client files and workpapers (including
       correspondence, audit information, financial
       statements, tax returns, etc.), a reputation for
       general or specialized services, an ongoing working
       relationship between the firm's personnel and clients,
       or accounting, auditing, and tax systems used by the
       firm. * * *




       3
      (...continued)
calculated on a per-share basis. The parties have stipulated the
shareholders' bases in the corporation's stock, which are used
for purposes of calculating the shareholder gain on the
distribution.
       4
      It is not clear from the record whether respondent allowed
any reduction for liabilities assumed by the shareholders in
making his determination.
                               - 15 -

In determining the value of goodwill, there is no specific rule,

and each case must be considered and decided in light of its own

particular facts.    MacDonald v. Commissioner, 3 T.C. 720, 726

(1944).   Moreover, in determining such value it is well

established that the earning power of the business is an

important factor.    Estate of Krafft v. Commissioner, T.C. Memo.

1961-305.    In Staab v. Commissioner, 20 T.C. 834, 840 (1953), we

stated:


     Goodwill, then, is an intangible consisting of the
     excess earning power of a business. A normal earning
     power is expected of the business assets, and if the
     business has greater earnings, then the business may be
     said to have goodwill. This excess in earning power
     may be due to any one or more of several reasons, and
     usually this extra value exists only because the
     business is a going concern, being successful and
     profitable. Goodwill may arise from: (1) the mere
     assembly of the various elements of a business,
     workers, customers, etc., (2) good reputation,
     customers' buying habits, (3) list of customers and
     their needs, (4) brand name, (5) secret processes, and
     (6) other intangibles affecting earnings.


     Both parties presented testimony from expert witnesses

regarding the value of the corporation's intangible assets.    In

appraising the value of the corporation's intangibles,

petitioners' expert stated:   "Intangible value within a company

(or goodwill value) is based upon the existence of excess

earnings."   After examining financial information from the

corporation's Federal income tax returns, the pay history of

Messrs. DeMarta and Norwalk, and Federal Government guidelines
                              - 16 -

for an accountant's pay, he found that the corporation did not

have excess earnings or earnings over and above a return on

tangible assets.   Consequently, petitioners' expert concluded

that the corporation was worth the value of its tangible assets5

and that there was no intangible or goodwill value at the time of

the distribution to the shareholders.   He then addressed the

valuation of the corporation's client list.   Recognizing that in

a service-related business the client relationship is normally

between the client and the professional who services that client,

petitioners' expert concluded that "Without an effective non-

competition agreement, the clients have no meaningful value."

Recognizing that there was no restriction on the ability of the

individual accountants to compete with the corporation, he

concluded that the client-related goodwill and intangibles

belonged to the professional accountants (individually) who

serviced the clients and that a list of these clients had no

material value.

     We have held that there is no salable goodwill where, as

here, the business of a corporation is dependent upon its key

employees, unless they enter into a covenant not to compete with

the corporation or other agreement whereby their personal

relationships with clients become property of the corporation.



     5
      Petitioners' expert expressed no opinion with respect to
the value of the tangible assets of the corporation.
                             - 17 -

Martin Ice Cream Co. v. Commissioner, 110 T.C. 189, 207 (1998)

("personal relationships of a shareholder-employee are not

corporate assets when the employee has no employment contract

with the corporation"); Estate of Taracido v. Commissioner, 72

T.C. 1014, 1023-1024 (1979); Cullen v. Commissioner, 14 T.C. 368,

372 (1950); MacDonald v. Commissioner, supra at 727; cf.

Schilbach v. Commissioner, T.C. Memo. 1991-556.6

     We have no doubt that most, if not all, of the clients of

the corporation would have "followed" the accountant who serviced

that client if the accountant would have left the corporation.

For instance, when Mr. Tang and Ms. Hagan left the partnership

shortly after the corporation was liquidated, at least 92 clients

engaged these former employees to provide future services.   On

the record here, it is reasonable to assume that the personal

ability, personality, and reputation of the individual

accountants are what the clients sought.   These characteristics

did not belong to the corporation as intangible assets, since the



     6
      In support of his position, respondent cites Schilbach v.
Commissioner, T.C. Memo. 1991-556. In Schilbach, we found that a
medical practice, operating as a corporation, had goodwill
despite the lack of a covenant not to compete. Schilbach is
distinguishable from the instant case in that in Schilbach some
of the goodwill of the medical practice was inherent in the
operating entity and was not solely dependent upon the employee-
shareholder's ability. Moreover, in Schilbach, we found it
doubtful that the employee-shareholder would have competed with
the medical practice due to his inability to obtain malpractice
insurance and his physical and mental condition. We do not find
that the same circumstances exist in the instant cases.
                              - 18 -

accountants had no contractual obligation to continue their

connection with it.   There is no persuasive evidence that the

name and location of the corporation had any value other than for

their connection with the accountants themselves.

     The situation in the instant case is similar to that in

MacDonald v. Commissioner, supra.   In MacDonald, the taxpayer and

his wife were the sole shareholders in an incorporated insurance

agency.   They subsequently liquidated the corporation,

distributing all assets to the husband, who proceeded to set up

an insurance agency under a name similar to the name of the

liquidated corporation and solicited the clients of the

corporation.

     The issue presented to us in that case was whether there was

any valuable goodwill passing from the corporation to the

taxpayers upon liquidation of the corporation.   The corporation

had no exclusive right to the business of any policyholder, and

without a covenant not to compete from the taxpayer, the business

of the corporation had no market value.   In holding that there

was no goodwill passing to the taxpayers because the goodwill was

solely attributable to the personal abilities of the taxpayers,

we stated:


          The facts in the instant cases established that
     any value which this business may have had on July 31,
     1941, in addition to its tangible assets, was due to
     the personal ability, business acquaintanceship, and
     other individualistic qualities of D. K. MacDonald. As
                              - 19 -

    one witness put it, "Mr. MacDonald was the Company."
    The policy of the corporation was decided by D. K.
    MacDonald and all employees worked under his direction
    and supervision. There existed no contract between the
    corporation and any of its employees, including D. K.
    MacDonald, with respect to future services. Neither
    the name of the corporation, its location, its agency
    agreements, nor its existing policies with customers
    had any value. If the law prevents the recognition of
    the personal ability and personality of D. K. MacDonald
    as an element of this corporation's goodwill for income
    tax purposes, then petitioners did not receive any
    goodwill as a result of their acquisition of this
    corporation's assets.

         We find no authority which holds that an
    individual's personal ability is part of the assets of
    a corporation by which he is employed where, as in the
    instant cases, the corporation does not have a right by
    contract or otherwise to the future services of that
    individual. * * * [MacDonald v. Commissioner, 3 T.C.
    at 727.]


     We further held in MacDonald that there was no marketable

asset embodying the goodwill of the corporation which could be

sold to a third party.   We recognized the possibility that a

purchaser might take over the customer list of the corporation on

a contingency basis.   In holding that this type of an arrangement

has no fair market value, we stated:

     It is true that goodwill may be the subject of
     exchange. Here, however, Cassatt and Company [the
     seller] did not undertake to transfer its goodwill to
     Pierce [the purchaser] in exchange for property of an
     ascertainable market value. On the contrary the
     transfer was made in consideration of Pierce's promise
     to share with Cassatt and Company for six years in the
     future any commissions which it might earn during that
     period from business with Cassatt customers. The
     receipt of such commissions was wholly contingent upon
     Pierce's remaining in business and obtaining business
     from the former Cassatt customers, neither of which it
                              - 20 -

     was under any obligation to do. It is settled that
     such a promise to make payments in the future "wholly
     contingent upon facts and circumstances not possible to
     foretell with anything like fair certainty" has no
     ascertainable fair market value. Burnet v. Logan, 283
     U.S. 404, 413, 51 S. Ct. 550, 552, 75 L.Ed. 1143. [Id.
     at 729 (quoting Cassatt v. Commissioner, 137 F.2d 745,
     748 (3d Cir. 1943), affg. 47 B.T.A. 400 (1942)).]


Therefore, for the same reasons as given in MacDonald, we hold

that at the time of the corporation's liquidation it had no

goodwill, either in terms of a client list or in any other form,

which could be distributed to the individual shareholders or sold

to a third party.

     We have carefully considered the testimony of respondent's

experts who testified that in their opinion a fair value of the

corporation would be $870,000, of which $266,000 would represent

the value of the client list and $369,000 would represent

goodwill.7   However, we conclude that their opinion regarding the

intangible assets of the corporation is of no probative force in

light of other evidence of record and existing case law.

     Respondent's experts based their opinion as to the value of

the goodwill and the client list upon an approximation of

earnings that they made based upon the volume of business

actually done by the corporation but using cost percentages



     7
      Respondent made no separate determination as to any going-
concern-value that the corporation may have had. Moreover,
respondent's experts fail to attribute any value to such an
asset.
                              - 21 -

normal to the industry, which were far less than the

corporation's actual operating costs.   These approximations are

not in line with the actual experience of the corporation, and

the record does not establish that there was any reasonable

expectation that such costs could have been so reduced.    See

Estate of Krafft v. Commissioner, T.C. Memo. 1961-305.

     More importantly, respondent's experts valued the

corporation's client list and goodwill as if a covenant not to

compete was in effect on the date of distribution.   Respondent's

expert, Mr. Kettell, testified that such a restriction is a very

important factor in valuing the intangibles of the corporation.

However, we have found that there were no restrictions on the

corporation's employees to compete with it on the date of

distribution.   Nevertheless, in determining the corporation's

value, respondent's experts relied upon the restrictions

expressed in the partnership agreement executed by Messrs.

DeMarta and Norwalk after the distribution of the corporation's

assets.   The parties to the partnership agreement are Messrs.

DeMarta and Norwalk and the existing partners of the partnership,

not the corporation.   This agreement was not enforceable by the

corporation and should have no bearing on the valuation of the

corporation on the date that it distributed its assets.

     In view of the foregoing, we conclude that there were no

transferable "customer-based intangibles" belonging to the
                              - 22 -

corporation independent of the abilities, skills, and reputation

of the individual accountants.   "Ability, skill, experience,

acquaintanceship, or other personal characteristics or

qualifications do not constitute goodwill as an item of property,

nor do they exist in such form that they could be the subject of

transfer."   Providence Mill Supply Co. v. Commissioner, 2 B.T.A.

791, 793 (1925).   In O'Rear v. Commissioner, 28 B.T.A. 698, 700

(1933), affd. 80 F.2d 473 (6th Cir. 1935), we stated that "it is

at least doubtful whether a professional man can sell or dispose

of any goodwill which may attach to his practice except perhaps

by contracting to refrain from practicing."   (Emphasis added.)

Because there was no enforceable contract which restricted the

practice of any of the accountants at the time of the

distribution, their personal goodwill did not attach to the

corporation.   Any goodwill transferred to the partnership was

that of the individual accountants, not the corporation.   Under

these circumstances, we conclude that the value of any "customer-

based intangibles" that the corporation may have had was nominal.

We hold that petitioners have met their burden of establishing

that value is not allocable to the customer-based intangibles as

determined by respondent.

Tangible Asset Value
                              - 23 -

     Respondent increased the corporation's taxable income by

$15,643 for section 1245 depreciation-recapture income, resulting

from the distribution of its tangible assets to the

shareholders.8   Section 1245(a)(1) provides for the recapture of

depreciation as ordinary income upon the disposition of section

1245 property.   Personal property used in a trade or business is

section 1245 property.   Sec. 1245(a)(3)(A).   Here, the amount

recaptured is the amount by which the lower of the recomputed

basis of the property or the fair market value of such property,

exceeds the adjusted basis of the property.    Sec. 1245(a)(1).

Recomputed basis means the adjusted basis of the property

recomputed by adding thereto all adjustments reflected in such

adjusted basis on account of deductions allowed or allowable to

the taxpayer for depreciation.9   Sec. 1245(a)(2)(A).

     The corporation reported an adjusted basis in its tangible

assets of $59,455 on its 1992 Federal income tax return.

Respondent's experts stated that the corporation's tangible

assets, which were distributed to the shareholders and then

transferred to the partnership, had a fair market value of


     8
      Neither party argues that any of the tangible assets of the
corporation is other than sec. 1245 property.
     9
      Petitioners submitted a list of the tangible assets at
issue, which reflects an approximate recomputed basis of
$179,880. Because both parties contend that the fair market
value of the property is less than this amount, we rely on the
fair market value to determine any gain recognized from
depreciation recapture.
                              - 24 -

$102,000.   Respondent's experts arrived at their opinion by

estimating the replacement cost of items listed on an asset

ledger and then subtracting an amount for accumulated

depreciation based upon an estimate using each item's age and

useful life.   The amount of depreciation was calculated using the

experts' own "in house developed software."10   However, none of

the tangible assets were inspected by respondent's experts, nor

did they have any actual knowledge of the nature or condition of

the assets distributed.

     Petitioners, on the other hand, argue that the tangible

assets of the corporation had a fair market value equal to, or

less than, the corporation's adjusted basis in the assets on the

date of distribution.   The tangible assets at issue were

contributed to the partnership at an agreed value equal to the

corporation's basis as reported on its 1992 Federal income tax

return.   Petitioners rely upon the contribution value of the

tangible assets as evidence of the assets' fair market value.      It

is well established that the best evidence of fair market value

is the amount paid for property in an arm's-length transaction at

or near the relevant valuation date.   Chiu v. Commissioner, 84

T.C. 722, 734 (1985).   Respondent does not argue that the

contribution of the tangible assets by the shareholders was other

than at arm's length, and the opinions of respondent's experts do


     10
      Additionally, the market approach was used as a check for
some items, such as computer equipment.
                                - 25 -

not convince us that the fair market value of the tangible assets

at the time of the distribution was anything other than $59,455.

Accordingly, the corporation did not realize recapture income on

the distribution.


Consulting Fees


     The corporation paid the shareholders $40,000 in addition to

their salaries for 1992, which the corporation deducted as

consulting fees.    Respondent determined that the corporation was

not entitled to the subject deduction and that the shareholders

must report the amounts they received with respect to this

deduction as dividend income.    No documentary evidence has been

presented to establish that the $40,000 deducted by the

corporation was paid to the shareholders for services provided to

the corporation in the year deducted.    The corporation has failed

to meet its burden of establishing that it is entitled to deduct

the $40,000 payment to the shareholders in 1992 as consulting

fees or that it should not characterize the amounts as dividends

as respondent contends.

     Petitioners Robert and Patricia DeMarta conceded

respondent's determination in regard to this issue.   Petitioner

William Norwalk reported the $16,680 as business income and

deducted $1,425 as business expenses.    Respondent adjusted this

by determining that the $16,680 was unreported dividend income

and simultaneously reducing reported business income by $15,255
                              - 26 -

(the difference between the $16,680 business income and $1,425

expense) that Mr. Norwalk reported.    This results in a net

increase in taxable income of $1,425, which we uphold.


Failure To File--Section 6651(a)


     Respondent determined that Robert and Patricia DeMarta are

liable for an addition to tax under the provisions of section

6651(a).   Section 6651(a) imposes an addition to tax for failure

to timely file a return, unless the taxpayer establishes that

such failure is due to reasonable cause and not due to willful

neglect.   Mr. and Mrs. DeMarta failed to file their 1992

individual tax return within the period allowed for filing.    An

extension to file their return was granted until October 15,

1993.   According to the notice of deficiency issued to Mr. and

Mrs. DeMarta, their 1992 return was filed on October 27, 1993.

Petitioners have provided no evidence or argument on this issue.

We find that Mr. and Mrs. DeMarta are liable for the addition to

tax in accordance with section 6651(a)(1).


Imposition of Accuracy-Related Penalty--Section 6662(a)


     Respondent has determined that the corporation, William R.

Norwalk, and Robert and Patricia DeMarta are liable for accuracy-

related penalties under section 6662(a).    Section 6662(a)

provides that, if it is applicable to any portion of an

underpayment in taxes, there shall be added to the tax an amount
                              - 27 -

equal to 20 percent of the portion of the underpayment to which

section 6662 applies.   Section 6662(b)(1) provides that section

6662 shall apply to the portion of any underpayment attributable

to negligence or disregard of rules or regulations.   Section

6662© provides that the term "negligence" includes any failure to

make a reasonable attempt to comply with the provisions of this

title, and the term "disregard" includes any careless, reckless,

or intentional disregard of rules or regulations.   Negligence is

the lack of due care or failure to do what a reasonable and

ordinarily prudent person would do under the circumstances.

Neely v. Commissioner, 85 T.C. 934, 947 (1985).

     However, under section 6664(c), no penalty shall be imposed

under section 6662(a) with respect to any portion of any

underpayment if it is shown that there was a reasonable cause for

such portion and that the taxpayer acted in good faith with

respect to such portion.   The Commissioner's determination is

presumptively correct and will be upheld unless the taxpayer is

able to rebut the presumption.   Luman v. Commissioner, 79 T.C.

846, 860-861 (1982); Bixby v. Commissioner, 58 T.C. 757, 791

(1972); Reily v. Commissioner, 53 T.C. 8, 13-14 (1969).

     In the notices of deficiency issued to the corporation,

William R. Norwalk, and Robert and Patricia DeMarta, respondent

applied the section 6662(a) penalty to "all or part of the

underpayment of tax".   With regard to the $23,320 adjustment

conceded by petitioners Robert and Patricia DeMarta, they have
                               - 28 -

presented no evidence to show that they acted with reasonable

cause or good faith.11   Therefore, we find that the accuracy-

related penalty under section 6662(a) applies to the underpayment

of tax associated with this settled issue.

     In regard to the $40,000 deducted by the corporation as

consulting fees, we have upheld respondent's determination.

After thoroughly reviewing the record in these cases, we find no

persuasive evidence or argument that the corporation acted with

reasonable cause or good faith with respect to this issue.    On

this record, we hold that the corporation negligently or

intentionally disregarded rules or regulations with regard to the

underpayment of tax associated with this issue.   Accordingly, the

accuracy-related penalty under section 6662(a) is sustained with

respect to the underpayment of tax associated with this deduction

by the corporation.

     Mr. Norwalk reported his allocable portion of the dividend

($16,680) on his return.   Even though he did not characterize

this amount as a dividend, the net effect of this was de minimis.

We find that any understatement attributable to this was not due

to negligence.   Thus, Mr. Norwalk is not liable for the accuracy-

related penalty under section 6662(a).

Transferee Liability


     11
      With respect to the adjustments in the notice of
deficiency issued to Robert and Patricia DeMarta, the parties
filed a stipulation of settled issues with this Court on Oct. 24,
1997.
                              - 29 -

     Section 6901(a)(1)(A) authorizes the assessment of

transferee liability in the same manner as the taxes in respect

of which the liability was incurred.   This provision does not

create a new liability; it merely provides a remedy for enforcing

the existing liability of the transferor.   Coca-Cola Bottling Co.

v. Commissioner, 334 F.2d 875, 877 (9th Cir. 1964), affg. 37 T.C.

1006 (1962); Mysse v. Commissioner, 57 T.C. 680, 700-701 (1972).

The Commissioner has the burden of proving all the elements

necessary to establish the taxpayer's liability as a transferee

except for proving that the transferor was liable for the tax.

Sec. 6902(a); Rule 142(d).

     The substantive questions of whether a transferee is liable

for the transferor's obligation and the extent of his liability

depend on State law.   See Commissioner v. Stern, 357 U.S. 39, 45

(1958); Adams v. Commissioner, 70 T.C. 373, 389 (1978), affd.

without published opinion 688 F.2d 815 (2d Cir. 1982).    All the

transfers in the instant case occurred in California; hence,

California law governs.   Adams v. Commissioner, supra at 390.

     Respondent contends that Messrs. DeMarta and Norwalk are

liable as transferees under Cal. Corp. Code section 2009 (West

1990).   That section provides creditors with a cause of action

against shareholders who have received assets improperly

distributed upon dissolution of a corporation.    Id.   Cal. Corp.

Code section 2004 (West 1990) provides the proper method of

distributing corporate assets in a dissolution:
                              - 30 -


          After determining that all the known debts and
     liabilities of a corporation in the process of winding
     up have been paid or adequately provided for, the board
     shall distribute all the remaining corporate assets
     among the shareholders according to their respective
     rights and preferences or, if there are no
     shareholders, to the persons entitled thereto. * * *


Therefore, in order to impose transferee liability on the

shareholders under this California law, respondent must prove

that the shareholders improperly distributed the assets of the

corporation.

     At the time the corporation was liquidated, its liabilities

included outstanding loans from the shareholders of $96,678.12

On the basis of our findings in this case, we hold that

respondent has not shown that the assets the shareholders

received exceeded this amount.13   The corporate minutes signed by

Messrs. DeMarta and Norwalk and dated May 1, 1992, state:


          It was resolved that the Corporation, DeMarta &
     Norwalk, would distribute most of its assets and
     liabilities to the shareholders.

          Each shareholder would be    distributed his share of
     assets and liabilities (except    for shareholders loans).
     The net asset received by each    shareholder would be
     credited as payment toward his    shareholder loan.




     12
      Loans from shareholders increased by more than $74,000
from Jan. 1 to June 30, 1992.
     13
      If we had upheld respondent's principal determination
regarding the value of the "customer-based intangibles", there
would be no question that the assets exceeded the corporate debt
owed to the shareholders.
                              - 31 -

          There does not appear to be sufficient net assets
     to pay back the full amount of the shareholder loans
     and therefore there will be no assets available for
     distribution against stock, retained earnings or
     dividends.

          This distribution is to take place prior to June
     30, 1992.


There is nothing in the record that would indicate that the

receipt of the corporate assets was anything other than partial

payment of this debt.   Based upon the meager record presented on

this issue, we do not find that the assets were improperly

distributed under Cal. Corp. Code section 2004; thus, this law is

not a valid basis for transferee liability in this case.

     Respondent also contends that the shareholders are liable as

transferees under Cal. Civ. Code section 3439.04 (West 1997),

which provides:


          A transfer made or obligation incurred by a debtor
     is fraudulent as to a creditor, whether the creditor's
     claim arose before or after the transfer was made or
     the obligation was incurred, if the debtor made the
     transfer or incurred the obligation as follows:

          (a) With actual intent to hinder, delay, or
     defraud any creditor of the debtor.

          (b) Without receiving a reasonably equivalent
     value in exchange for the transfer or obligation, and
     the debtor:

               (1) Was engaged or was about to engage in a
     business or a transaction for which the remaining
     assets of the debtor were unreasonably small in
     relation to the business or transaction; or

               (2) Intended to incur, or believed or
     reasonably should have believed that he or she would
                                - 32 -

     incur, debts beyond his or her ability to pay as they
     became due.


Therefore, in order to establish that Messrs. DeMarta and Norwalk

are liable as transferees for the amounts they received from the

corporation, respondent must prove:      (1) The corporation

transferred the assets with "actual intent to hinder, delay, or

defraud" the Internal Revenue Service; or (2) the corporation

made the transfer without receiving a reasonably equivalent value

in exchange for the transfer.

     Actual intent may be established from circumstances

surrounding the transfer of the assets.      Menick v. Goldy, 280

P.2d 844 (Cal. Ct. App. 1955); Burns v. Radoicich, 176 P.2d 77

(Cal. Ct. App. 1947).   As respondent recognizes, transferee

liability generally results:


     when stockholders receive corporate distributions for
     which they do not pay an adequate and full
     consideration at a time when the corporation is
     insolvent, or thereby becomes insolvent, or is in
     process of liquidation. [Lesser v. Commissioner, 47
     T.C. 564, 585 (1967).]


After carefully reviewing the record, we find that respondent has

not met his burden of proving either actual intent to defraud or

that the shareholders received assets for which they did not pay

adequate and full consideration.    Accordingly, we hold that

Messrs. DeMarta and Norwalk are not liable as transferees.



                                            Decisions will be entered
- 33 -

     under Rule 155.
