                        T.C. Memo. 1996-130



                      UNITED STATES TAX COURT



         MIDWEST INDUSTRIAL SUPPLY, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 7828-94.                  Filed March 18, 1996.



     Wayne R. Kaschak, for petitioner.

     Anita A. Gill, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     FOLEY, Judge:   Respondent has determined deficiencies,

additions, and an accuracy-related penalty with respect to

petitioner's Federal income taxes as follows:
                                             - 2 -

                                          Additions to Tax                                         Penalty

Year   Deficiency    Sec. 6653(a)(1)(A)    Sec. 6653(a)(1)(B)   Sec. 6653(a)   Sec. 6661(a)     Sec. 6662(a)
                                                  1
1986   $22,116            $1,106                                 --       $5,529                --
                                                  2
1987    21,873             1,094                                 --        5,468                --
1988    12,489              --                    --            $624       3,122                --
1989     5,943              --                    --             --         --                $1,189
       1
        50 percent of the interest due on $22,116.
       2
        50 percent of the interest due on $21,873.

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.

       This case presents the following issues:

       1.   Whether amounts claimed as advertising expenses by petitioner in

1986, 1987, 1988, and 1989 are ordinary and necessary business expenses

pursuant to section 162.       We hold that they are not.

       2.   Whether petitioner is liable for additions to tax for negligence

and substantial understatement of income tax and for an accuracy-related

penalty.    We hold that petitioner is so liable.

                                     FINDINGS OF FACT

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

       Petitioner is an Ohio corporation whose principal place of business was

in Canton, Ohio, at the time the petition was filed.                During the years in

issue, petitioner manufactured deicing and dust control products.                   These

products were used in coal mining, manufacturing, railroad, construction, and

other operations in which dust and/or freezing weather is a problem.

       Robert W. Vitale, the sole shareholder and director of petitioner, has

had a longstanding interest in horses.            During the 1970's, Mr. Vitale owned a

horse farm known as Highspring Farm.            Beginning in 1979, Mr. Vitale joined a

number of equestrian organizations.           He has served as president of the North

American Trakehner Association and has been a member of the United States

Dressage Federation, the United States Combined Training Association, and the

Jumping Association.      He has also written several articles on the breeding of
                                     - 3 -
Trakehner horses.   Around 1980, he sold Highspring Farm and began to board his

horses with a fee-for-service operation in Nashville, Ohio.   The boarding

facility took care of feeding the horses, but Mr. Vitale continued to breed

them.

        On March 1, 1982, Mr. Vitale, acting in his capacity as petitioner's

sole director, adopted a resolution authorizing petitioner to provide

"sponsorship and advertising funds" to underwrite the costs of Mr. Vitale's

equestrian activities.   The resolution provided in relevant part:

             WHEREAS, Highspring Farm's name is to be changed and its
        activities are hereby transferred to Sussex Farm * * * in the
        hope that horses would be produced as a result of Sussex Farm's
        breeding operation which would achieve a national or world class
        level of performance under the name or names of the
        Corporation's products, such as Ice Free Nogarro, Ice Free
        Nobella, and Ice Free Czest, highlighting MIDWEST INDUSTRIAL
        SUPPLY, INC.'S winter line products under the trade names of Ice
        Free Conveyor, Ice Free Switch, etc., which is on a par with the
        finest products available,

            *        *         *        *        *        *          *

             IT IS HEREBY RESOLVED that in order for a corporate product
        line to be able to acquire the prestige associated with
        dressage, 3-Day, and show jumping and its current sponsors, the
        Corporation is authorized to provide the funds to acquire and/or
        breed horses in reasonable amounts necessary to support Sussex
        Farm, and further, Robert W. Vitale, as President, is hereby
        authorized to enter into contracts and leases and take other
        actions on behalf of the Corporation, to obtain the necessary
        facilities, horses, property, equipment and supplies to maintain
        Sussex Farm.

        Notwithstanding this 1982 resolution, petitioner did not begin to

sponsor Sussex Farm until 1986.    In addition, the horses ultimately competed

under such names as Nogarro and Czropa rather than "under the name or names of

the Corporation's products".

        During the 1986-89 period, Mr. Vitale's individual income tax returns

included Schedule F, "Profit or Loss From Farming", which reported the income

and expenses relating to his equestrian activities conducted under the name

"Sussex Farm".   Sussex Farm was not a farm but simply the name that Mr. Vitale

used to conduct his equestrian activities.
                                      - 4 -
       In 1985, petitioner advertised through trade publications and product

brochures and claimed an advertising deduction of approximately $11,000.    In

1986, while continuing to advertise through trade publications and product

brochures, petitioner also began to sponsor Sussex Farm.     Prior to doing so,

petitioner consulted with John Alan Cohan, an attorney specializing in

equestrian matters, and was informed that petitioner's sponsorship of Sussex

Farm might be deductible as an ordinary and necessary business expense.     The

terms of petitioner's sponsorship of Sussex Farm were not formalized in a

written contract.    Instead, Mr. Vitale, in his capacity as petitioner's sole

director, determined how much to pay Sussex Farm.   On its 1986, 1987, 1988,

and 1989 tax returns, petitioner deducted advertising expenses in the amounts

of $66,145, $66,323, $42,295, and $30,314, respectively.     Of those amounts,

the total advertising expenses attributable to payments to or on behalf of

Sussex Farm in 1986, 1987, 1988, and 1989 were $55,850, $51,500, $35,206, and

$20,650, respectively.    In each of these years, the amount paid was equal to

Sussex Farm's net expenses.

       During the years in issue, Sussex Farm owned between 15 and 19 horses.

Sussex Farm showed one horse in 1986 and two horses in 1987, 1988, and 1989 in

various equestrian competitions.   Whenever one of Sussex Farm's horses was

shown, petitioner's name was announced over a loudspeaker as the sponsor of

the horse.

       On audit respondent challenged petitioner's advertising deductions

relating to Sussex Farm, and petitioner in response discontinued its

sponsorship of Sussex Farm in 1990.

                                      OPINION

I.   Deductibility of Petitioner's Payments to Sussex Farm

       A.    In General

       The initial question before us is whether the payments in issue

constituted deductible business expenses, as petitioner maintains, or
                                    - 5 -
constituted payment by petitioner of its sole shareholder's personal expenses,

as respondent maintains.   This is a factual question, and the burden of proof

rests with petitioner.   Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115

(1933).

      Two legal principles are central to this case.    First, taxpayers may

deduct "all the ordinary and necessary expenses paid or incurred during the

taxable year in carrying on any trade or business".    Sec. 162.   Second,

transactions between closely held corporations and their shareholders are

examined with special scrutiny.   Electric & Neon, Inc. v. Commissioner, 56

T.C. 1324, 1339 (1971), affd. without published opinion 496 F.2d 876 (5th Cir.

1974); Georgiou v. Commissioner, T.C. Memo. 1995-546.

      B.   Qualification of Expenses as "Ordinary"

      Deductions are not "ordinary" unless they bear a reasonably proximate

relationship to the operation of the taxpayer's business.   Deputy v. du Pont,

308 U.S. 488, 495-496 (1940).   It is well established that, where the primary

purpose of a corporate sponsorship is to pay an individual's personal

expenses, the amounts expended are not deductible.    See, e.g., W.D. Gale, Inc.

v. Commissioner, T.C. Memo. 1960-191, affd. 297 F.2d 270 (6th Cir. 1961)

(concluding that a corporate taxpayer could not deduct costs of a powerboat

that bore the corporation's name and competed in races, because racing was

primarily a hobby of the principal shareholder); Burrous v. Commissioner, T.C.

Memo. 1977-364.

      At trial, Mr. Vitale attempted to establish a nexus between

petitioner's business and the advertising deductions by asserting that

petitioner had sold dust control products to horse-related facilities as a

result of its sponsorship of Sussex Farm.   Mr. Vitale did not provide the

purchasers' names or any documentary evidence to support this assertion.     In

short, Mr. Vitale has failed to persuade us that these sales were made.
                                     - 6 -
      Mr. Vitale operated Sussex Farm before the sponsorship arrangement

began in 1986, and he continues even today to operate Sussex Farm.     We believe

that petitioner's 1982 resolution authorizing petitioner's sponsorship of

Sussex Farm was a halfhearted attempt to legitimize as a corporate deduction

the payment of Mr. Vitale's personal expenses.   In fact, Mr. Vitale did not

even follow the terms of his corporation's resolution.     Although the

resolution authorizing the sponsorship was predicated, in large part, on

selecting horse names that refer to petitioner's products (e.g., "Ice Free

Nogarro, Ice Free Nobella, and Ice Free Czest"), no such horse names ever were

selected.

      Because the primary purpose of the corporate sponsorship was to benefit

Mr. Vitale personally, petitioner's deductions were not proximately related to

the operation of its business.    Mr. Vitale's ownership of a horse farm during

the 1970's, his activity in several equestrian organizations, his authorship

of articles on horse breeding, and his testimony at trial demonstrate that he

has an ardent and longstanding interest in horses.     Mr. Vitale would have

pursued his equestrian activities whether or not petitioner "sponsored" his

horses.    We conclude that Mr. Vitale created this sponsorship arrangement in

an effort to allow petitioner to pay (and deduct) all net expenses associated

with his equestrian activities.

      C.    Qualification of Expenses as "Necessary"

      Deductions are not "necessary" unless the taxpayer establishes that

they are appropriate and helpful to its business.      Carbine v. Commissioner, 83

T.C. 356, 363 (1984), affd. 777 F.2d 662 (11th Cir. 1985).     In attempting to

make this showing, Mr. Vitale made three claims:    (1) Petitioner's name was

announced over loudspeakers at horse shows as the sponsor of Sussex Farm's

horses; (2) petitioner placed printed advertisements in the programs of a

couple of shows; and (3) petitioner received a request for a price quotation
                                      - 7 -
as a result of its sponsorship of Sussex Farm.   These claims are unpersuasive

for reasons we address below.

      First, Mr. Vitale testified, and respondent has stipulated, that

petitioner's name was announced at shows as the sponsor of Sussex Farm's

horses.   Mr. Vitale has not shown, however, that these loudspeaker

announcements were helpful to petitioner's business.   He did not testify that

the loudspeaker announcements contained any information beyond petitioner's

name (e.g., information about petitioner's products or the nature of its

business) or that such announcements were reasonably calculated to help, or

did help, petitioner's business.   See, e.g., Schulz v. Commissioner, 16 T.C.

401 (1951) (concluding that a watchmaker-jeweler named Schulz could not deduct

the costs of showing a horse called Schulztime, because the watchmaker did not

advertise his business in the show program and failed to establish that the

expenses were reasonably calculated to publicize or otherwise benefit his

business).

      Second, Mr. Vitale testified that petitioner had placed advertisements

in the programs of a couple of shows.   Petitioner did not, however, submit

copies of any such advertisements.    We are not convinced that petitioner

placed these advertisements.    Petitioner did submit a copy of an advertisement

published in an equestrian magazine entitled "The Chronicle of the Horse" that

referred to two Sussex Farm horses.   The magazine, however, was dated August

24, 1990--after the period in issue and during the period when petitioner was

under audit.

      Third, Mr. Vitale testified that petitioner received a general

contractor's request for a price quotation regarding one of petitioner's

products.    After receiving this request, Mr. Vitale wrote a letter dated April

11, 1994, asking the general contractor to indicate in writing that he

contacted petitioner "as a result of Midwest's advertising in the equestrian

field."   In reply, the general contractor wrote a letter to Mr. Vitale dated
                                     - 8 -
April 27, 1994, which stated that the request was prompted by petitioner's

"advertisement in an equestrian publication."   Respondent had been auditing

petitioner's tax returns for several years and had issued its notice of

deficiency almost 2 months prior to this exchange of letters.   Nevertheless,

neither letter connects the inquiry to the 1986-89 period, and such a

connection is unlikely, because both letters were dated almost 5 years after

that period.   Moreover, petitioner advertised through trade journals, product

brochures, and loudspeaker announcements during the years in issue.

Petitioner did not advertise in equestrian magazines during those years.    We

thus conclude that the equestrian magazine advertisement mentioned by the

general contractor in his letter did not relate to the 1986-89 period.

      In sum, we conclude that petitioner entered into this sponsorship

arrangement primarily to pay personal expenses of its sole shareholder and

that petitioner was not reasonably likely to, and did not, benefit from its

payments to Sussex Farm.    Therefore, we hold that the payments in issue were

not deductible as ordinary or necessary business expenses within the meaning

of section 162.

II.   Applicability of the Additions to Tax and Accuracy-Related
      Penalty Provisions

      We now consider the additions to tax and the accuracy-related penalty

determined by respondent.   As with the deficiency itself, petitioner bears the

burden of proof.   See Rule 142(a); Bixby v. Commissioner, 58 T.C. 757, 791

(1972).

      Section 6653(a), which is applicable to petitioner's 1986, 1987, and

1988 tax years, imposes an addition to tax for underpayments attributable to

negligence or disregard of rules or regulations.   For petitioner's 1986 and

1987 tax years, the additions to tax are equal to the sum of 5 percent of each

underpayment and 50 percent of the interest payable on the portion of any

underpayment attributable to negligence or disregard of rules or regulations.
                                      - 9 -
Sec. 6653(a)(1)(A) and (B).    For petitioner's 1988 tax year, the addition to

tax is equal to 5 percent of the underpayment if any portion of the

underpayment is attributable to negligence or disregard of rules or

regulations.   Sec. 6653(a).   We have defined negligence in this context to

mean "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) (quoting Marcello v. Commissioner, 380 F.2d 499, 506 (5th

Cir. 1967)).

      Petitioner failed to meet its burden of proving that the underpayments

were not due to negligence or disregard of rules or regulations.   Petitioner

contends that it is not responsible for the section 6653(a) additions to tax

because it relied on a tax professional in creating the corporate sponsorship.

To bolster its argument, petitioner cites Ewing v. Commissioner, 91 T.C. 396

(1988), affd. without published opinion 940 F.2d 1534 (9th Cir. 1991).   In

Ewing, the Tax Court declined to impose additions to tax under section 6653

where the taxpayers had "[relied] in good faith on the attorneys to formulate

and implement" an arrangement.   Reliance on a professional, however, will not

shield a taxpayer from liability where the transaction giving rise to the

deduction lacked substance or the expert's advice was ignored in material

respects and was vague.   In the present case, Mr. Vitale received a general

letter from an attorney in California whom he had never met.   There is no

evidence in the record that (1) explains what information Mr. Vitale provided

to the attorney or (2) indicates that the attorney either proposed or endorsed

a particular plan.   Thus, the attorney did not "formulate and implement" a

plan, but appears merely to have provided broad comments on Mr. Vitale's idea.

We have found that the sponsorship arrangement was designed primarily to

benefit Mr. Vitale, not petitioner.   Therefore, we hold that petitioner is

liable for the section 6653(a) additions to tax.
                                    - 10 -
      Section 6661(a), which is applicable to petitioner's 1986, 1987, and

1988 tax years, imposes an addition to tax of 25 percent of any underpayment

attributable to a substantial understatement of income tax.    In the case of a

corporate taxpayer, an understatement is substantial if it exceeds $10,000.

Sec. 6661(b)(1).   An understatement shall be reduced to the extent that it

results from a reporting position for which substantial authority exists or to

the extent that the item giving rise to the understatement was adequately

disclosed on the return or on a statement attached to the return.   Sec.

6661(b)(2)(B).

      In light of our finding that petitioner's sponsorship was designed

primarily to benefit Mr. Vitale, we hold that no substantial authority exists

to support petitioner's reporting position.    Nor was the deduction disclosed

adequately on the return.   Therefore, we hold that petitioner is liable for

the section 6661(a) addition to tax.

      Section 6662(a), which is applicable to petitioner's 1989 tax year,

imposes an accuracy-related penalty of 20 percent of any underpayment

attributable, inter alia, to (1) a substantial understatement of income tax

(at least $10,000 for most corporations) or (2) negligence or disregard of

rules or regulations.   For the reasons described above, we find that the

underpayment was attributable to negligence or disregard of rules or

regulations.   Therefore, we hold that petitioner is liable for the section

6662(a) accuracy-related penalty.

      To reflect the foregoing,


                                                 Decision will be entered

                                             for respondent.
