                   T.C. Memo. 2005-120



                 UNITED STATES TAX COURT



    ALAN D. LENZEN AND DIANNE LENZEN, Petitioners v.
      COMMISSIONER OF INTERNAL REVENUE, Respondent

ROYAL AMERICAN FOODS, INC., Petitioner v. COMMISSIONER OF
               INTERNAL REVENUE, Respondent



Docket Nos. 7422-03, 7423-03.       Filed May 24, 2005.



Gregory R. Troy, for petitioners in docket No. 7422-03.

Daniel W. Schermer, for petitioner in docket No. 7423-03.

Helen H. Keuning, for respondent.
                                   - 2 -

                  MEMORANDUM FINDINGS OF FACT AND OPINION


       GOEKE, Judge:     Respondent determined a deficiency of $46,666

and an accuracy-related penalty under section 66621 of $9,333.20

in petitioners Alan D. and Dianne Lenzen’s (Mr. Lenzen and Mrs.

Lenzen or collectively, the Lenzens) Federal income tax for 1999.

Respondent also determined a deficiency of $34,270 and an

accuracy-related penalty under section 6662 of $6,854 in

petitioner Royal American Foods, Inc.’s (RAF) Federal income tax

for 1999.       In 1999, Mr. Lenzen held the majority of the stock of

RAF.       After concessions, there are four issues remaining for

decision.

       First, was RAF entitled to deduct the expenses disallowed by

respondent that remain in dispute?         Because the expenses at issue

were personal expenses of the Lenzens, we hold that RAF may not

deduct them.

       Second, were RAF’s payments of the Lenzens’ personal

expenses constructive dividends to the Lenzens?        Because the

payments were not loan repayments or additional compensation, we

hold that they were constructive dividends.




       1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code as amended, and all Rule references are
to the Tax Court Rules of Practice and Procedure.
                                 - 3 -

     Third, did the Lenzens have unreported gambling losses

offsetting their unreported gambling income in 1999?      We hold

that they did not.

     Fourth, are petitioners liable for accuracy-related

penalties under section 6662?    We hold that they are.

                           FINDINGS OF FACT

     Some of the facts are stipulated.    The stipulation of facts,

supplemental stipulation of facts, and attached exhibits are

incorporated herein by this reference.    At the time the petition

was filed, the Lenzens resided in Prior Lake, Minnesota, and

RAF’s principal place of business was in Le Center, Minnesota.

     In 1991, Mr. Lenzen and James A. Schoenecker incorporated

RAF under Minnesota law.    RAF produced a variety of gourmet

desserts, specializing in cheesecakes, marketed under the trade

name “Lady Dianne’s Desserts”.    RAF’s products were produced in a

plant in Le Center, Minnesota, and were marketed in several

regions of the country by sales representatives to grocery

stores, restaurants, and other food distributors.    In 1999, Mr.

Lenzen and Mr. Schoenecker were the only two officers and

directors of RAF.    Mr. Lenzen owned 59.5 percent of RAF’s stock

and Mr. Schoenecker owned 25.5 percent of RAF’s stock in 1999.

In addition, Steven Lenzen and David Lenzen, the Lenzens’ two

sons, and Steven Countryman were employees and 5-percent

shareholders of RAF in 1999.    RAF issued only common stock.    In
                               - 4 -

1999, RAF did not declare or authorize a dividend for any

shareholders.   In February 2002, RAF was sold by its

shareholders.

A.   RAF’s 1999 Return and Audit

     RAF filed Form 1120, U.S. Corporation Income Tax Return, for

1999.   RAF reported that it did not declare a dividend in 1999.

Among its deductions on the 1999 return, RAF listed $654,318 as

“Sales Expense” (the sales expense deduction).   RAF also reported

that it had loans from its shareholders of $535,544 at the end of

1999 and interest expense totaling $157,125 during 1999.

     In April 2002, respondent commenced an audit of RAF’s 1999

return.   During the audit, respondent’s agent requested that RAF

provide

     Any and all records relating to the “Sales Expense” in
     the amount of $654,318.00 claimed for the period ended
     December 31, 1999. The records may include but are not
     limited to cancelled checks, invoices, receipts, bank
     and credit card statements, workpapers, and internal
     vouchers, statements or claims.

In response, RAF provided records relating to an American Express

corporate credit card (corporate card) issued in RAF’s name.    The

records showed descriptions of each item charged, a miniature

copy of each charge slip, the date and amount of each purchase,

the vendor, and the individual who made each purchase.   No other

documentation was provided with respect to the charges made on

the corporate card.   RAF also provided documentation prepared by
                                - 5 -

RAF’s accountant showing loans to RAF from Mr. Lenzen and Mr.

Schoenecker and RAF’s interest expense on the loans.

     On February 12, 2003, respondent issued RAF a notice of

deficiency disallowing $100,793 of the sales expense deduction.

Specifically, respondent disallowed charges of $62,392 on the

corporate card, charges of $1,807 on an American Express

Corporate Optima Platinum card (Optima card), and a series of

miscellaneous expenses totaling $36,594.43 (miscellaneous

expenses).   Of the disallowed amounts charged to the corporate

card, $27,202.50 was charged by Mr. Lenzen, $28,158.09 was

charged by Mrs. Lenzen, $5,439.01 was charged by Steven Lenzen,

and $1,593.40 was charged by David Lenzen.

     Respondent has conceded that all the Optima card charges,

miscellaneous expenses, and corporate card charges made by Steven

Lenzen and David Lenzen were properly deducted and that $7,687 of

Mr. Lenzen’s corporate card charges were properly deducted.

Respondent maintains that all of Mrs. Lenzen’s corporate card

charges, $28,158, and the remainder of Mr. Lenzen’s corporate

card charges, $19,516, were for personal expenses of the Lenzens.

B.   The Lenzens’ 1999 Return

     The Lenzens filed a joint Form 1040, U.S. Individual Income

Tax Return, for 1999.   On their 1999 return, the Lenzens reported

interest income of $49,598 from RAF.    The Lenzens’ 1999 return

also indicates that they received gambling income of $17,204 and
                               - 6 -

corresponding gambling losses of $17,204 in 1999.   Mrs. Lenzen’s

occupation was listed as “homemaker” on the Lenzens’ 1999 income

tax return.   Mrs. Lenzen did not receive a Form 1099-MISC or Form

W-2, Wage and Tax Statement, from RAF and was not on RAF’s

payroll in 1999.

     On February 12, 2003, respondent issued a notice of

deficiency to the Lenzens with respect to 1999.   Respondent

determined that Mr. Lenzen received constructive dividends from

RAF in the full amount of the disallowed sales expense deduction,

$100,793.   Respondent has conceded that all but $47,674 was not

constructive dividend income to the Lenzens.   Respondent also

determined, and the parties stipulated, that the Lenzens received

$13,619 in gambling income in 1999 in addition to the $17,204 of

gambling income reported on their return.   Respondent did not

disallow the Lenzens’ claimed $17,204 gambling loss.

     Steven Lenzen and David Lenzen each filed individual tax

returns for 1999; neither was a dependent of the Lenzens in 1999.

Additionally, neither of their 1999 returns reflected receipt of

dividend income.   Respondent did not issue a notice of deficiency

to either Steven Lenzen or David Lenzen for 1999.
                               - 7 -

                              OPINION

I.   Burden of Proof

     Petitioners argue that respondent bears the burden of proof

under section 7491(a)(1) because petitioners provided credible

evidence that the payments made by RAF on behalf of the Lenzens

were loan repayments.   Under section 7491(a)(1), the Commissioner

bears the burden of proof if a taxpayer “introduces credible

evidence with respect to any factual issue relevant to

ascertaining the liability of the taxpayer”.    Section 7491(a)(2)

limits the shifting of the burden of proof to situations in which

a taxpayer has complied with substantiation requirements under

the Internal Revenue Code (the Code), has maintained all records

required by the Code, has cooperated with reasonable requests by

the Commissioner for witnesses, information, documents, meetings,

and interviews, and, in the case of a corporation, partnership,

or trust, meets the net worth requirement of 28 U.S.C. sec.

2412(d)(2)(B).   Sec. 7491(a)(2)(A)-(C).

     First, petitioners have not presented credible evidence that

the payments by RAF of the Lenzens’ personal expenses were

repayments of loans Mr. Lenzen made to RAF.    The only evidence

petitioners presented regarding the existence of the loans was an

illegible copy of a ledger and testimony that the loans were

made.   Petitioners presented no evidence that the credit card

payments were intended to repay those loans.
                                - 8 -

     Next, petitioners have not shown that they fulfill the

requirements of section 7491(a)(2).     RAF has not shown that it

meets the net worth requirement of section 7491(a)(2)(C).     In

addition, petitioners have not shown that they complied with the

Code’s substantiation requirements.     Petitioners argue that they

did not provide substantiation to the revenue agent in RAF’s

audit because he did not specifically request substantiation of

the disallowed corporate card items.     However, under section

7491(a)(2)(A), petitioners must show that they complied with the

Code’s substantiation requirements in general, not simply in

response to an audit.    The charges at issue include those made at

restaurants, hotels, airlines, gas stations, clothing stores, and

general retail stores.   Petitioners provided credit card

summaries of these charges, showing only the vendor, the type of

services offered by the vendor, e.g., “Gas/Misc” and “Food/Bev”,

and the amount of the charge.   These summaries do not provide the

substantiation required by section 274 for entertainment and

travel expenses, such as the date and business purpose of each

expense and the business relationship to the person being

entertained.   The statement summaries also do not satisfy the

substantiation requirement under section 162 that a taxpayer who

is related to his employer under section 267(b) keep sufficient

records “to enable the Commissioner to correctly determine income
                                - 9 -

tax liability.”    Sec. 1.162-17(d)(1)(iii), Income Tax Regs.2

Further, Mr. Lenzen testified that he did not keep records of his

gambling losses.    Petitioners’ accountant testified that RAF did

not give him substantiation for the sales expense deduction and

he was not aware of any substantiation in existence for the

corporate card charges.    We hold that neither the Lenzens nor RAF

has shown that section 7491(a) applies to shift the burden of

proof to respondent.

     Petitioners also argue that the burden of proof shifted to

respondent under Rule 142 because respondent has conceded more

than half the deficiencies determined in the notices of

deficiency.   The burden of proof is not placed on the

Commissioner because he concedes a portion of the amount set

forth in the notice of deficiency.      See Forte v. Commissioner,

T.C. Memo. 1991-36; Natl. Oil Co. v. Commissioner, T.C. Memo.

1986-596 (stating:    “To charge respondent, as a consequence of

such concessions, with the burden of going forward with the

evidence to prove any amounts not conceded, would discourage

respondent from settling issues on the basis of information

obtained in discovery.”).    As petitioners have pointed to no new

matters, increases in deficiencies, or affirmative defenses




     2
      Mr. Lenzen, who owned 59.5 percent of RAF’s stock in 1999,
is related to RAF for this purpose. See sec. 267(b).
                               - 10 -

raised by respondent, the burden does not shift to respondent

under Rule 142.3

II.   Corporate Card Charges

      A.   Ordinary and Necessary Business Expenses

      Petitioners contend that the charges at issue qualified as

business expenses of RAF.   Section 162 generally allows a

deduction for ordinary and necessary business expenses.   In

general, an expense is ordinary under section 162 if it is

considered “normal, usual, or customary” in the context of the

particular business out of which it arose.    Deputy v. du Pont,

308 U.S. 488, 495 (1940).   An expense is necessary if it is

appropriate and helpful to the taxpayer’s trade or business.

Commissioner v. Tellier, 383 U.S. 687 (1966).    If an expenditure

is primarily motivated by personal considerations, no deduction

for it will be allowed.   See Henry v. Commissioner, 36 T.C. 879,

884 (1961).   Deductions are a matter of legislative grace, and

the taxpayer bears the burden of proving that it is entitled to

any deduction claimed.    Rule 142(a); New Colonial Ice Co. v.

Helvering, 292 U.S. 435, 440 (1934).    This includes the burden of




      3
      Before and during trial, petitioners made arguments with
respect to shifting the burden of proof to respondent under sec.
7491. At the conclusion of trial, petitioners orally moved that
the burden be shifted to respondent. The Court requested that
the parties address this issue in their briefs. For the reasons
discussed supra, petitioners’ oral motion will be denied.
                               - 11 -

substantiation.   Hradesky v. Commissioner, 65 T.C. 87, 89-90

(1975), affd. per curiam 540 F.2d 821 (5th Cir. 1976).

     The Lenzens used the corporate card for purchases at

restaurants, gas stations, clothing stores, hotels, and general

retail stores, among others.   Mr. Lenzen testified that he was

not able to provide business reasons or substantiation for the

charges at issue because either they were for personal expenses

or he could not recall whether they were for business expenses.

Mrs. Lenzen did not testify at trial.   Although Mr. Lenzen

testified that Mrs. Lenzen did some promotional work for RAF,

including sales trips, he also stated that it was likely that

almost all of the charges made by Mrs. Lenzen on the corporate

card were for personal expenses.   Petitioners did not present

specific evidence with respect to the charges at issue that would

show that any of them were not personal.   Without more than vague

testimony, we cannot conclude that any of the charges at issue

were ordinary and necessary business expenses of RAF.

Petitioners have not met their burden of showing that any of the

remaining charges were not personal expenses of the Lenzens.

     B.   Characterization of the Payments of Personal Expenses

     Respondent argues that RAF’s payments of the Lenzens’

personal expenses were constructive dividends to Mr. Lenzen as a

shareholder of RAF.   Petitioners first argue that RAF’s payments

were repayments of amounts Mr. Lenzen lent to RAF.
                                - 12 -

     For Federal income tax purposes, a transaction will be

characterized as a loan if there was “an unconditional obligation

on the part of the transferee to repay the money, and an

unconditional intention on the part of the transferor to secure

repayment.”   Haag v. Commissioner, 88 T.C. 604, 616 (1987), affd.

without published opinion 855 F.2d 855 (8th Cir. 1988).    The

parties’ intent that the loan be repaid is the controlling factor

in determining whether payments should be termed loans.    See

Berthold v. Commissioner, 404 F.2d 119, 122 (6th Cir. 1968).

Courts have focused on certain objective factors to identify bona

fide loans, including:   (1) The existence or nonexistence of a

debt instrument; (2) provisions for security, interest payments,

and a fixed payment date; (3) treatment of the funds on the

corporation’s books; (4) whether repayments were made; (5) the

extent of the shareholder’s participation in management; and (6)

the effect of the “loan” on the transferee’s salary.   Haber v.

Commissioner, 52 T.C. 255, 266 (1969), affd. 422 F.2d 198 (5th

Cir. 1970).   When the individual is in substantial control of the

corporation, special scrutiny of the situation is necessary.

Id.; Roschuni v. Commissioner, 29 T.C. 1193, 1202 (1958), affd.

271 F.2d 267 (5th Cir. 1959).

     Mr. Lenzen and Mr. Schoenecker made bona fide loans to RAF.

RAF’s 1999 corporate income tax return and financial statements

reflect that $535,544 was owed to stockholders at the end of
                               - 13 -

1999.   Mr. Lenzen and Mr. Schoenecker credibly testified that

they lent money to RAF over the years and that they were paid

interest on the loans.    They documented these loans and RAF’s

payments of interest and principal on a ledger for each year.

The loans were repaid in full as part of the sale of RAF in 2002.

     However, the record does not show that RAF’s payments of the

Lenzens’ personal expenses were intended to be repayments of Mr.

Lenzen’s loans to RAF.    Mr. Lenzen and his accountant admitted

that the corporate card payments were not recorded as loan

repayments or interest payments on the 1999 loan ledger or in any

of RAF’s corporate records.    Mr. Lenzen testified that he

intended to record them that way but “I just procrastinated and I

never did it.”    Petitioners’ accountant had no knowledge that RAF

paid any of the Lenzens’ personal expenses.    Most importantly,

RAF claimed as business expenses all of the Lenzens’ corporate

card charges.    Mr. Lenzen and RAF did not attempt to identify

which charges were purportedly loan repayments until trial.

Petitioners’ current characterization of the unexplained charges

as loan repayments contradicts petitioners’ actions at the time

the payments were made, and we do not accept petitioners’ current

position.   See, e.g., Noble v. Commissioner, 368 F.2d 439, 443-

444 (9th Cir. 1966) (shareholders’ alteration of corporate

records 2 years after payment was not sufficient to properly
                               - 14 -

characterize payments as loan repayments), affg. T.C. Memo. 1965-

84.

      Petitioners alternatively argue that the payments should be

treated as additional compensation.     Whether amounts are paid as

compensation turns on the factual determination of whether the

payor intends at the time that the payment is made to compensate

the recipient for services performed.    See Neonatology

Associates, P.A. v. Commissioner, 115 T.C. 43, 92 (2000), affd.

299 F.3d 221 (3d Cir. 2002).   The fact that petitioners now

choose to characterize the payments by RAF of the Lenzens’

personal expenses as compensation does not establish that the

payments were compensation in fact.     See King’s Court Mobile Home

Park, Inc. v. Commissioner, 98 T.C. 511, 514 (1992).

      The facts of this case do not support petitioners’ assertion

that RAF intended the payments of the Lenzens’ personal expenses

to be additional compensation.    Petitioners did not characterize

the payments as compensation on their 1999 income tax returns and

have not since filed amended returns correcting the

characterization.   Mrs. Lenzen was not an employee of RAF in

1999.   In addition, no evidence is in the record regarding

whether Mr. Lenzen’s compensation, with or without the payments

by RAF, was reasonable in 1999.   The reasonableness of

compensation is an essential element in resolving compensation

versus dividend issues.   See id. at 515.    The payments by RAF of
                                - 15 -

the Lenzens’ personal expenses on the corporate card should not

be treated as additional compensation.

     Lastly, petitioners argue that because RAF did not declare a

formal dividend or make payments ratably to its shareholders in

proportion to their interests, the payments of the Lenzens’

personal expenses cannot be characterized as constructive

dividends.4   We disagree.   A dividend is any distribution of

property made by a corporation to its shareholders out of its

earnings and profits.    Sec. 316(a).    The test for a constructive

dividend is twofold:    (1) The expense must be nondeductible to

the corporation; and (2) it must represent some economic gain,

benefit, or income to the shareholder.      See Meridian Wood Prods.,

Inc. v. United States, 725 F.2d 1183, 1191 (9th Cir. 1984).       The

payments here provided economic benefit to the Lenzens by paying

their personal expenses and are not deductible by RAF as

compensation or business expenses.       The fact that no dividend is

formally declared does not preclude the finding of a dividend in

fact.    See Noble v. Commissioner, supra at 442.     Also, the

disbursement of corporation earnings to a shareholder may

constitute a dividend to the shareholder notwithstanding that it

is not in proportion to stockholdings or that some shareholders

do not participate in its benefits.       Baird v. Commissioner, 25


     4
      Petitioners do not dispute that RAF had sufficient earnings
and profits to cover the amounts in question.
                               - 16 -

T.C. 387, 395 (1955); Thielking v. Commissioner, T.C. Memo 1987-

227, affd. without published opinion 855 F.2d 856 (8th Cir.

1988).    RAF cites Murphy v. Country House Inc., 349 N.W.2d 289

(Minn. Ct. App. 1984), for its assertion that Minnesota law

prohibits disproportionate constructive dividends.    However, that

case held that bonuses paid to shareholder-employees constituted

disproportionate dividends and that the shareholder who was not

paid was entitled to his share of the dividend.     Id. at 293.   We

conclude that RAF’s payments of the charges at issue were

constructive dividends to Mr. Lenzen as a shareholder of RAF.

III.    The Lenzens’ Unreported Gambling Income

       The Lenzens admit that they received $13,619 of unreported

gambling income in 1999.    They claim that they suffered an equal

amount of unreported gambling losses and are not liable for

income tax on the additional gambling winnings.    The Lenzens did

not present at trial any records of the additional winnings or

losses.

       Section 165(d) allows a deduction for gambling losses only

to the extent of gambling winnings.     The Lenzens have the burden

of proving that their alleged gambling losses were in fact

sustained.    See Green v. Commissioner, 66 T.C. 538, 544 (1976).

Section 6001 and the regulations thereunder require taxpayers to

keep permanent records sufficient to substantiate the amounts of

gross income, deductions, and credits shown on their income tax
                              - 17 -

returns.   Sec. 6001; sec. 1.6001-1(a), Income Tax Regs.    Mr.

Lenzen testified that he kept the forms given to him by the

casinos when he won money, but he “missed some of them” when he

gave the accountant the information necessary for completing his

tax returns.   He kept no records of the losses he sustained.     He

admitted that he could have estimated the amounts from bank

statements, but he did not.

     In some cases, we have allowed losses based on estimates

where we are convinced a loss was sustained.   See Cohan v.

Commissioner, 39 F.2d 540 (2d Cir. 1930).   There must be

sufficient evidence in the record to prove that a loss was in

fact sustained before we apply the Cohan rule.   Polyak v.

Commissioner, 94 T.C. 337, 345 (1990); Schooler v. Commissioner,

68 T.C. 867, 871 (1977).   The Lenzens’ accountant testified that

he reported the figures on the Lenzens’ 1999 return on the basis

of the Lenzens’ oral statements to him and without

substantiation.   Mr. Lenzen’s testimony that he has never been a

net winner at the casinos in any year is the only evidence in the

record that the Lenzens sustained gambling losses in addition to

those reported on their return.   Mr. Lenzen’s testimony,

uncorroborated by any documentation or even the testimony of Mrs.

Lenzen, does not convince us that a loss was in fact sustained in

1999 and does not provide any details or evidence with which we

might estimate the Lenzens’ additional losses.   Therefore, the
                                - 18 -

Lenzens are liable for income tax on additional gambling income

of $13,619 for 1999.

IV.   Penalties

      Section 6662 imposes an accuracy-related penalty on the

portion of an underpayment attributable to negligence or

disregard of the rules or regulations.      Sec. 6662(b)(1).    The

term “negligence” includes any failure to make a reasonable

attempt to comply with the provisions of the internal revenue

laws or to exercise ordinary and reasonable care in the

preparation of a tax return.    Sec. 6662(c); Gowni v.

Commissioner, T.C. Memo. 2004-154.       Failure to maintain adequate

books and records or to substantiate items properly also

constitutes negligence.    Sec. 1.6662-3(b), Income Tax Regs.      The

term “disregard” includes any careless, reckless, or intentional

disregard.    Id.   An accuracy-related penalty will not be imposed

with respect to any portion of an underpayment as to which the

taxpayer acted with reasonable cause and in good faith.        Sec.

6664(c).

      We determined above that petitioners did not maintain the

substantiation required by sections 162, 274, and 6001 for the

sales expense deduction.    In addition, Mr. Lenzen admitted that

he did not retain adequate records of his gambling winnings and

losses.    Petitioners have not shown that they had reasonable

cause or acted in good faith in deducting the Lenzens’ personal

expenses as business expenses of RAF and in underreporting the
                              - 19 -

Lenzens’ income from gambling and constructive dividends on their

1999 returns.   Therefore, we sustain respondent’s determination

that both RAF and the Lenzens are liable for accuracy-related

penalties under section 6662 for 1999.

     To reflect the foregoing and concessions by the parties,


                                         An appropriate order will

                                    be issued, and decisions will

                                    be entered under Rule 155.
