                        T.C. Memo. 1996-451


                      UNITED STATES TAX COURT




     GROUP ADMINISTRATION PREMIUM SERVICES, INC., ET AL.,1
Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 16405-93, 16430-93,          Filed October 3, 1996.
                 16435-93.


     Edward J. Gildea, for petitioners.

     Claire R. McKenzie and Patricia Pierce Davis, for

respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     BEGHE, Judge:   Respondent determined the following

deficiencies in, additions to, and penalty on petitioners’

Federal income taxes for the year 1989:


     1
      Cases of the following petitioners are consolidated
herewith: Jerome J. and Joanne L. Mancuso, docket No. 16430-93;
and Jerome J. Mancuso & Associates, Inc., docket No. 16435-93.
                                - 2 -


                                           Additions and Penalty
                                          Sec.     Sec.      Sec.
Petitioner            Deficiency        6651(a)    6655   6662(b)(1)
Group                 $23,201      $5,800.25     $1,543      ---
 Administration
 Premium Services,
 Inc.

Jerome J. and          39,446       9,668.00        ---   $7,998.29
 Joanne L. Mancuso

Jerome J. Mancuso       5,845       1,461.25        389      ---
 & Associates,
 Inc.

     The cases were consolidated for trial, briefing, and

opinion.   All references to petitioner are to Jerome J. Mancuso.

All section references are to the Internal Revenue Code in effect

for the year in issue, and all Rule references are to the Tax

Court Rules of Practice and Procedure.

     After concessions by the parties, the issues remaining for

decision are:   (1) Whether petitioner corporations Group

Administration Premium Services, Inc. (GAPS), and Jerome J.

Mancuso & Associates, Inc. (JJM), are entitled to expense

deductions in excess of the amounts allowed in the notices of

deficiency and conceded by respondent; (2) whether GAPS's and

JJM's payments to petitioner, and on his behalf, were repayments

of shareholder loans or corporate distributions; and (3) whether

the respective petitioners are liable for the following:      (a) all

petitioners for the addition to tax under section 6651(a)(1) for

failure to file timely income tax returns; (b) petitioners

Jerome J. and Joanne L. Mancuso for the accuracy-related penalty
                               - 3 -


under section 6662(b)(1) for negligence or disregard of rules and

regulations; and (c) GAPS and JJM for additions to tax under

section 6655 for failure to pay estimated tax.

     We hold that: (1) GAPS and JJM are not entitled to any

additional expense deductions; (2) the payments by GAPS and JJM

were corporate distributions--dividends to the extent of earnings

and profits, returns of capital to the extent of petitioner's

basis in his shares, and capital gains as to the remaining

amounts; and (3) the respective petitioners are liable for the

additions to tax and penalty, in amounts to be determined by Rule

155 computations.



                         FINDINGS OF FACT

     The parties have stipulated some of the facts, and the

stipulations of facts and attached exhibits are incorporated in

this opinion.   Petitioners Jerome J. and Joanne L. Mancuso

resided in Glenview, Illinois, when they filed their petition in

this case.   GAPS and JJM maintained their principal places of

business in Arlington Heights, Illinois, when they filed their

petitions.   At all relevant times, petitioner was the sole

shareholder and director and president of both GAPS and JJM,

which were accrual basis taxpayers.    Petitioner and Joanne L.

Mancuso are cash basis taxpayers.

     Petitioner has been an insurance agent/broker since 1969.

Prior to 1986, petitioner conducted his insurance business as a
                                - 4 -


sole proprietor under the name of J.J. Mancuso & Associates.

Petitioner’s business was divided into two lines:     Group employee

benefit plans and individual life and disability contracts.

     In late 1985, petitioner purchased a corporation named Rapid

Dictation Service, Inc. (Rapid Dictation), from an attorney for

less than $500.   Petitioner believed, based on the seller's

representations, that the name of Rapid Dictation was changed to

Group Administration Premium Services, Inc., sometime in early

1986 and that it was a corporation in good standing under

Illinois law.

     Early in 1986, petitioner began to conduct a portion of his

business under the name GAPS.   Petitioner intended to use GAPS to

sell and administer all group employee benefit plans of his

clients.   From 1986 to March 1, 1989, petitioner continued to

operate Rapid Dictation, under the name GAPS, on the basis of his

belief that it was a valid corporation.

     In February 1989, petitioner’s then attorney advised him

that Rapid Dictation was an invalid corporation and that a new

corporation should be organized.   On March 1, 1989, GAPS filed

articles of incorporation with the Illinois secretary of state.

     On March 7, 1989, petitioner, acting as sole director,

transferred to the newly organized corporation GAPS all of the

assets and liabilities of the business that he had been

conducting under the name of GAPS.      These assets consisted of two

bank accounts containing $154,000 and furniture and equipment
                                - 5 -


valued by petitioner at $100,000.       Both the bank accounts and the

furniture and equipment had been used by petitioner while he was

operating under the name of GAPS.       Sometime after the

incorporation of GAPS in March 1989, petitioner also transferred

$1,000 to GAPS in exchange for 1,000 shares of GAPS common stock.

     The bank accounts transferred by petitioner to GAPS were the

claims account and the premium account.       The claims account was

an account through which funds flowed from employers and

insurance carriers to employee beneficiaries and service

providers.    The premium account was a collection account that was

used to bill employers, collect premiums, and remit net premiums

to insurance carriers.

     Petitioner and his accountant, John Pritten, prepared 10

promissory notes from GAPS to petitioner.       All of the notes are

preprinted "fill in the blank" promissory notes.       Each of the notes

bears a typed-in issuance date and due date and a stamped

cancellation date and purports to bear interest at 5.25 percent.2


     2
      Copies of the notes assembled as petitioners' Exhibit 109
also show the following:
NOTE NUMBER       AMOUNT     ISSUANCE       DUE DATE     CANCELED
    1           $23,364.36    1/1/86        12/31/86     12/31/??
    2            30,313.13   12/31/86       12/31/87     12/31/87
    3           104,427.00   12/31/87       12/31/88     12/31/88
    4            48,686.21   12/31/87       12/31/88     12/31/88
    5            57,857.81   12/31/88       12/31/89     12/31/89
    6            31,637.00   12/31/88       12/31/89     12/31/89
    7            38,686.21   12/31/88       12/31/89     12/31/89
                                     - 6 -


All of the notes are signed, in what appears to be the same ink,

by petitioner as president of GAPS.             On Schedule L of its 1988

and 1989 U.S. corporation income tax return forms, GAPS showed

liabilities as of the beginning and end of each year in the

following amounts:

Schedule L Entry as of:              1/1/88      12/31/88     1/1/89      12/31/89
Loans from stockholders                ---          ---        ---            $8,281
Notes payable in less than 1 yr.     $36,427     $31,637      $31,637         16,356
Notes payable in 1 yr. or more        48,686      38,686      38,686          38,686


     In 1989, GAPS paid $119,760 either directly to petitioner or

on his and his family's behalf.3          In 1989, GAPS had $65,376 of



    8            17,061.02         12/31/89        12/31/90            12/31/90
    9             8,281.04         12/31/89        12/21/90            12/31/90
   10            38,686.05         12/31/89        12/31/90            12/31/90

     3
      The parties introduced stipulated Exhibit 14-N which
purports to include the total amounts of corporate payments made
by GAPS and JJM to petitioner or on his or his family's behalf.
The amounts and applications of all corporate payments to
petitioner were as follows:

 DESCRIPTION          AMOUNT                 DESCRIPTION             AMOUNT
Auto payments       $6,887.76            Cable                       $645.90
Home insurance            971.00         ConEd                    1,949.28
Home insurance       2,060.00            Gas                      1,882.21
Carsons              2,484.86            Telephone                1,650.33
Chembank             9,461.73            Equipment               14,383.11
Fields               1,576.81            Advertising              2,394.47
Sears                     440.19         Commissions             47,140.49
State use tax             525.00         Personal auto                 395.00
                                - 7 -


earnings and profits available for distribution to shareholders.

See infra pp. 23-27.

     On February 24, 1987, petitioner incorporated the individual

life and disability portion of his business under the name

Jerome J. Mancuso & Associates, Inc. (JJM).      Petitioner

transferred $1,000 to JJM in exchange for 1,000 shares of JJM

common stock.    Petitioner also transferred to JJM a $20,000 bank

deposit, an account receivable of $16,000, and office furniture,

fixtures, and equipment valued by petitioner at $37,000.

     Petitioner and Mr. Pritten prepared six promissory notes

from JJM to petitioner.    All of the notes issued by JJM are

preprinted "fill in the blank" promissory notes and signed in


Residential         9,389.13       Telephone/Sprint     782.86
Cash-personal      61,553.50       Legal/prof.         2,100.00
Bonus-JJM          13,064.20       Travel/ent.        27,666.94
Medical/dental      1,889.47       Repairs              156.00

     The total of all payments listed in Exhibit 14-N is
$211,450. Respondent contends that the amounts contained in
Exhibit 14-N should be increased by $930.11 for the payment of
petitioner’s auto insurance. With this amount added to the
amounts in Exhibit 14-N, the total payments amount to $212,380.

     We do not know which payments were made by JJM and which
payments were made by GAPS. Petitioner used one operating
account, in the name of JJM, to make all the payments.
Consequently, all the copied checks attached to Exhibit 14-N are
JJM checks. Exhibit 14-N does not differentiate between payments
made by GAPS and JJM, and respondent never apportioned the
specific payments between the two corporations. Of the $212,380,
we have apportioned $119,760 as the amount of the payments from
GAPS and $92,620 as the amount of the payments from JJM. For a
discussion of how we apportioned the total payments between GAPS
and JJM, see infra note 8.
                                     - 8 -


what appears to be the same ink as the GAPS notes.                Each of the

notes bears a typed-in issuance date and due date and a stamped

cancellation date, and purports to bear interest at 5.25

percent.4     All the JJM notes are signed by petitioner as

president of JJM.      On Schedule L of its 1988 and 1989 U.S.

corporation income tax return forms, JJM showed liabilities as of

the beginning and end of each year in the following amounts:

Schedule L Entry as of:              1/1/88     12/31/88     1/1/89      12/31/89
Loans from stockholders              $14,735    $10,000      $10,000      $10,000
Notes payable in less than 1 yr.        ---       9,000       9,000        15,208
Notes payable in 1 yr. or more          ---      54,381      54,381        44,381



     In 1989, JJM paid a total of $92,620 to petitioner or third

parties for petitioner's or his family's benefit.               See supra note

3.   In 1989, JJM had $22,257 of earnings and profits available

for distribution to shareholders.             See infra pp. 23-27.

     Some of the corporate payments to, or on behalf of,

petitioner were also deducted by the corporations as ordinary and

     4
      Copies of the notes assembled as petitioners' Exhibit 108
also show the following:
NOTE NUMBER        AMOUNT          ISSUANCE       DUE DATE            CANCELED
     1            $40,715.00       12/31/87       12/31/88            12/31/88
     2            14,735.00        12/31/87       12/31/88            12/31/88
     3            19,000.00        12/31/88       12/31/89            12/31/89
     4            54,381.12        12/31/88       12/31/89            12/31/89
     5            15,208.00        12/31/89       12/31/90            12/31/90
     6            44,381.00        12/31/89       12/31/90            12/31/90
                               - 9 -


necessary business expenses.   They include payment by GAPS and

JJM for several of petitioner’s trips during 1989.5    In total,

respondent disallowed expense deductions of $104,411 and $39,607

claimed by GAPS and JJM, respectively.

     On the Mancusos' 1989 individual income tax return, Form

1040, petitioner reported wages of $4,000 from JJM and

nonemployee compensation of $6,259 from GAPS.     Petitioner also

maintained an independent insurance agent license with

Massachusetts Mutual Insurance Co. (Mass Mutual); in 1989

petitioner earned gross wages from Mass Mutual, which he reported

on his 1989 Form 1040.   After deductions and withholdings,

petitioner received net wages of $39,117.98, $38,412 of which he

deposited into the bank account of one of the corporate

petitioners.6

     The Mancusos' 1989 individual tax return, Form 1040, was due

on April 15, 1990.   The Mancusos did not request an extension of

time to file their 1989 Form 1040.     On August 28, 1990, the




     5
      Petitioner traveled to Kansas City, Missouri, from Mar. 3
through 5. He also traveled to Denver, Colorado, from Mar. 23
through 26. From June 11 through 18, petitioner traveled to Lake
Wales, Florida. From July 19 through 20, petitioner traveled to
Sacramento, California. Finally, petitioner made three more
Denver, Colorado, trips from Aug. 27-28, Sept. 9 through 13, and
Nov. 3 through 5, respectively.
     6
      The record is unclear as to which corporate account
actually received the deposit. Because petitioner used the JJM
operating account for both corporations, we assume that the funds
were deposited in this account.
                              - 10 -


Mancusos signed and mailed their 1989 Form 1040 to the IRS Kansas

City Service Center, which received it on August 30, 1990.

     GAPS's and JJM's 1989 U.S. Corporation Income Tax Returns,

Forms 1120, were due on March 15, 1990.   GAPS and JJM did not

request extensions of time to file these returns, and the IRS

Kansas City Service Center never received them.   On September 20,

1992, GAPS and JJM provided unsigned copies of these returns,

bearing their names, to the revenue agent conducting the GAPS

examination (the GAPS and JJM pro forma returns, respectively).

Neither of the pro forma returns showed taxable income or tax

due, and neither GAPS nor JJM made any estimated tax payments for

the taxable year 1989.


                             OPINION

     This case is another banal example of a sole shareholder who

used his C corporations not only to carry on his business but

also as personal pocketbooks without observing corporate

formalities and record-keeping requirements.   Petitioner used

GAPS and JJM to pay his and his family's personal living

expenses.   Petitioner has claimed some of these payments as

repayments of shareholder loans, thereby not recognizing income

at the individual level, while the corporate petitioners that he

controlled claimed some of the same payments as business expense

deductions, thereby reducing income taxes that should have been

reported at the corporate level.   By claiming some of these same
                              - 11 -


payments as both corporate expense deductions and repayments of

loans, petitioners have tried to avoid tax at both the corporate

and individual levels.7   Of course, to the extent the corporate

payments were for ordinary and necessary business expenses of the

corporate payor, they would reduce income tax at the corporate

level, while if they were truly repayments of bona fide loans,

they would not be includable in petitioners' income.    However,

petitioner has tried to have it both ways, treating the same

payments as both corporate expense deductions at the corporate

level and repayment of loans at the individual level.

     We realize that shareholders of closely held C corporations

often withdraw substantial amounts of corporate earnings as

salaries, which the corporations deduct, thereby reducing income

tax at the corporate level, and sometimes raising the question

whether the salaries are reasonable.   By contrast, petitioner has

reported relatively small amounts of compensation from JJM and

GAPS, while those corporations have claimed their payments of his

personal living expenses as business deductions.   If allowed to



     7
      Respondent determined in her statutory notice that GAPS and
JJM paid a total of $212,380 in 1989 to petitioner or on his or
his family's behalf. Respondent also disallowed, in the
corporations' statutory notices, $144,411 of corporate expense
deductions claimed on the corporations' 1989 pro forma U.S.
corporation income tax returns. Therefore, $144,411 of the
$212,380 paid to petitioner by GAPS and JJM were also deducted by
the corporations at the corporate level. In addition, the
Mancusos reported only $10,259 as compensation to petitioner from
the corporations ($4,000 wages from JJM and $6,259 non-employee
compensation from GAPS) on their 1989 Form 1040.
                               - 12 -


stand, what petitioner and his corporations have done would make

corporate income disappear completely from the income tax system.

     Although these cases concern taxes at both the corporate and

individual levels, and were properly consolidated for trial,

briefing, and opinion, respondent's and petitioners'

presentations have blurred the corporate and individual tax

issues.    For example, the relationships between the disallowed

corporate deductions and the corporate payments to petitioner are

not shown anywhere in the record.    We have the $212,380 total of

the corporate payments in joint exhibit 14-N.     However, we are

unable to determine how respondent apportioned the $212,380 total

amount of corporate payments listed in exhibit 14-N between GAPS

and JJM.    At trial and on brief, respondent continually referred

to GAPS and JJM as one entity for purposes of determining the

amount of corporate distributions.      However, the statutory notice

apportions corporate distributions between GAPS and JJM, in the

amounts of $105,220 and $40,208, respectively.     We have had to

review a spotty record to try to glean the actual amounts that

GAPS and JJM each paid to and for petitioner.8

     8
      Respondent made two adjustments to the amount of total
payments of $212,380.35 to arrive at the amounts of taxable
corporate distributions determined in the statutory notice. One
of the adjustments was for the amounts listed as shareholder
loans on the GAPS and JJM corporate income tax returns for 1989.
The other adjustment was for amounts that petitioner reported on
his individual return. This included the $38,412 of payments
from Mass Mutual deposited in the corporate account, the $4,000
of wages from JJM, and the $6,259 of non-employee compensation
                                                   (continued...)
                                  - 13 -


Issue 1.   Corporate Expense Deductions

     The corporate petitioners bear the burden of establishing

that they are entitled to the deductions claimed on their 1989

pro forma tax returns.      Rule 142(a); Welch v. Helvering, 290 U.S.

111, 115 (1933).       After concessions by the parties, four business

expense categories remain in issue.




     8
      (...continued)
from GAPS. However, respondent did not apportion the adjustments
between the corporations, instead reducing the total amount of
payments by the total amount of adjustments to arrive at a total
amount of $145,428 in corporate distributions. Only at this
point did respondent apportion this amount between the two
corporations to arrive at the amounts of $105,220 and $40,208 for
GAPS and JJM respectively.

     We have worked backwards from the amounts of $105,220 and
$40,208 to reapportion the $212,380 between GAPS and JJM,
assuming that petitioner deposited his Mass Mutual wage payments
in the JJM account. We therefore assume that respondent reduced
the JJM payments by this amount. It is clear from the record
that the $4,000 in wages and the loan amount of $10,000 are
allocable to JJM. We have likewise assumed that the $6,259 of
non-employee compensation was from GAPS. It is clear from the
record that the loan amount of $8,281 is allocable to GAPS. With
these adjustments we arrive at the following amounts:
                                                      GAPS      JJM
Amount of distribution in statutory notice          $105,220   $40,208
Non-employee compensation and wages                   6,259     4,000
Mass Mutual payments                                  ---      38,412
Shareholder loans reflected on the Schedules L        8,281    10,000
  Total payments                                    119,760    92,620

     At trial, respondent allowed an additional reduction in the
amount of distributions for advertising expenses and conceded
additional deductions therefor of $655 and $656 by JJM and GAPS,
respectively.
                                - 14 -


     There remain in issue $7,000 for GAPS and $5,000 for JJM for

the salary/wage category, and $949 for GAPS for the legal/

professional category.   Neither GAPS nor JJM produced any

evidence, beyond their 1989 pro forma tax returns, that they

incurred these additional salaries/wages and legal/professional

fees.   Petitioners introduced no evidence concerning the nature

and business purpose of the alleged salaries and wages.

Petitioners made no argument in either their opening or reply

brief on either issue.   Petitioners have failed to meet their

burden of proof on the additional salaries and wages and the

additional legal and professional fees.    Therefore, we uphold

respondent’s determinations on these issues.

     Respondent allowed all deductions for corporate supplies,

and the only amounts still at issue in this case are additional

office expenses for GAPS of $1,277, and for JJM of $1,502.    In

support of these additional expenses, petitioners proffered

exhibit 102, a purported summary and compilation of receipts

evidencing business expenses.    Petitioners claim that exhibit 102

supports these additional deductions.    Respondent objected to

exhibit 102 at trial, and renewed her objection on brief, on the

grounds of relevancy, completeness, and hearsay.    Although we

reserved ruling on this objection, we find it unnecessary to

rule.   Even if exhibit 102 were admitted, it would not establish

the deductibility of the additional office expenses.    The first

page of exhibit 102 is a purported summary of the amounts still
                               - 15 -


at issue.   However, the summary is titled “supplies”, and there

are no disputed deductions on the supplies issue.

     Exhibit 102 is most deficient, however, with respect to the

copies of the receipts included therein.    There is no indication

of the relationship between the additional expenses and the

corporations' business.    In order to be deductible, a business

expense must be an ordinary and necessary expense of doing

business.   Sec. 162(a).   The receipts do not show the ordinary

and necessary business purposes of the expenses, but rather

reflect mostly personal items, including groceries and minor

office supply items.   Even with the supply items listed, there is

no way to determine whether these receipts correspond to the

additional deductions claimed.    Exhibit 102 does not carry

petitioners’ burden of substantiating the office expense

deductions.   Therefore, we uphold respondent’s determination on

the office expenses.

     Petitioners claim additional travel and entertainment

expenses for GAPS of $11,119 and for JJM of $3,565.    Petitioners’

claim that exhibit 104 supports these deductions.    Respondent

objects to the exhibit on the grounds of relevancy, lack of

completeness, hearsay, and lack of trustworthiness.

     As with exhibit 102, we find it unnecessary to rule on

respondent’s objection, because the evidence on the claimed

travel and entertainment deductions is similarly deficient.    Even
                              - 16 -


if admitted, exhibit 104 would not prove the deductibility of the

additional travel and entertainment expenses.    In addition to

petitioners’ burden under section 162(a) of proving that the

expenses were ordinary and necessary business expenses, section

274(d) imposes a stringent substantiation requirement for

deductions for travel and entertainment expenses.    Under section

274(d), no deduction will be allowed for travel and entertainment

expenses unless the taxpayer substantiates these expenses by

adequate records or by sufficient evidence corroborating the

taxpayer’s own statement regarding:    (1) The amount of such

expense or other item; (2) the time and the place of the travel

and entertainment; (3) the business purpose of the expense; and

(4) the business relationship to the taxpayer of the person

entertained.   Sec. 274(d); sec. 1.274-5, Income Tax Regs.

     While exhibit 104 is a fairly comprehensive compilation of

airline, rental car, hotel, and entertainment receipts, none of

these receipts describes the business purposes of the trips or

entertainment expenses.   Petitioner’s testimony is the only

evidence of the business purposes of the trips, and his

uncorroborated testimony of the business purposes of the trips

fails to satisfy the substantiation requirements of section

274(d).   Sec. 1.274-5, Income Tax Regs.   We therefore sustain

respondent's determination disallowing the travel and

entertainment expenses.
                               - 17 -


Issue 2. Corporate Payments:     Taxable Corporate Distributions or
Nontaxable Loan Repayments

     (a) Amounts of payments

     After generous allowances by respondent, and respondent's

concessions on advertising expenses, see last sentence of note 8

supra, the amounts of GAPS’s and JJM’s payments to petitioner or

for his benefit were $104,564 and $39,553, respectively.

     Petitioners did not present any evidence of the amounts of

money and other property that GAPS and JJM paid to petitioner, or

on his or his family's behalf.    The Mancusos have not met their

burden of proving that respondent’s determinations of the amounts

of the corporate payments are incorrect.9

     (b) Loan Repayments or Taxable Distributions

     A corporate payment to, or on behalf of, a shareholder is a

corporate distribution if it is a payment made with respect to

the shareholder’s stock.   Sec. 301(a).   Petitioner contends that

the amounts GAPS and JJM paid to him, or paid on his behalf, were

nontaxable repayments of loans.

     Whether the GAPS and JJM payments to petitioner were

distributions with respect to their stock or loan repayments



     9
      These amounts included respondent's determination that
petitioner received constructive distributions through purported
corporate commissions paid to his children by GAPS and JJM.
After testimony by one of his children on this issue, which
seriously undermined his credibility, petitioners conceded this
issue at trial. Petitioners presented no other evidence on the
amount of distributions.
                                - 18 -


depends, in part, on whether petitioner’s alleged transfers of

property to GAPS and JJM in earlier years were loans or

contributions to capital.    The corporate payments cannot be loan

repayments if there are no loans to repay.       Whether an advance by

a shareholder to a corporation is a loan or a contribution to

capital is a question of fact, Georgia-Pac. Corp. v.

Commissioner, 63 T.C. 790, 795 (1975); Magee v. Commissioner,

T.C. Memo. 1993-305, and each debt-equity case must be decided on

its own facts.   We therefore take a facts and circumstances

approach in deciding whether the payments from petitioner to GAPS

and JJM were debt or equity.

     When a shareholder makes an otherwise undocumented transfer

of money or property to his corporation, a strong inference

arises that the transfer is a contribution to capital rather than

a loan.   Dobkin v. Commissioner, 15 T.C. 31, 33 (1950).

Petitioner bears the burden of proving that he lent the cash and

furniture to GAPS and JJM.     Arlington Park Jockey Club v. Sauber,

262 F.2d 902, 905 (7th Cir. 1959).       In distinguishing debt from

equity, courts have looked through taxpayers' labels to determine

whether an advance creates a debtor-creditor relationship.

     The Court of Appeals for the Seventh Circuit, to which an

appeal in this case would lie, said in Commissioner v. Meridian &

Thirteenth Realty Co., 132 F.2d 182, 186 (7th Cir. 1942), revg.

44 B.T.A. 865 (1941):   "the essential difference between a
                               - 19 -


creditor and a stockholder is that the latter intends to make an

investment and take the risks of the venture, while the former

seeks a definite obligation, payable in any event."    In Nassau

Lens Co. v. Commissioner, 308 F.2d 39, 46 (2d Cir. 1962),

remanding 35 T.C. 268 (1960), the Court of Appeals for the Second

Circuit observed that whatever interests a stockholder chooses to

take in a corporation, whether debt or equity, should be

recognized as such, "so long as that investment has substantial

economic reality in terms of the objective factors which normally

surround the type [of investment] chosen", and so long as it

complies "with arm's-length standards".    See also Dixie Dairies

Corp. v. Commissioner, 74 T.C. 476, 494 (1980) (quoting Estate of

Mixon v. United States, 464 F.2d 394, 403 (5th Cir. 1972)

(referring to the need to determine whether "the transaction

complies with arm's length standards and normal business

practice")).    These objective factors include the corporation's

ability to repay and the likelihood of repayment, as well as

whether the parties complied with arm's-length standards and

normal business practice.

     Against this background, it is clear that petitioner's

transfers to GAPS and JJM were capital contributions, rather than

debt.    The only evidence of loans is petitioner's and his

accountant's testimony and the "fill in the blank" promissory

notes.    However, there were no prepayment schedule, no source
                                - 20 -


documents, and no interest payments, and the categories and

amounts shown on the Schedules L that petitioner said reflected

the loan balances outstanding at yearend between him and the

corporations were inconsistent with the face amounts of the

corporations' notes to him.

     There are no loan documents beyond “fill in the blank”

promissory notes, all signed in what appears to be the same ink

with the same stated interest rate.      Respondent argues that these

promissory notes were created in preparation for trial.

Petitioner has not convinced us otherwise, nor has he proven that

these notes were prepared each year to keep track of the "running

balances" between himself and the corporations.     We believe it

more likely that these notes were created in preparation for

trial to try to save the bacon that had fallen into the fire when

petitioners' numbers turned up in the audit lottery.

     Even if the notes were not prepared for trial, they do not

evidence normal business practices.      Although the notes contain

maturity dates, there is no evidence, beyond cancellation stamps,

that either the corporations or petitioner enforced payment at

the purported maturity dates.    In addition to obtaining repayment

of principal, a true lender is concerned with receiving interest.

Curry v. United States, 396 F.2d 630, 634 (5th Cir. 1968).

Although there was stated interest on the notes of 5.25 percent,
                               - 21 -


there is no evidence that any interest was ever paid.10    In

addition, the rate of interest on the notes did not change,

although quoted interest rates were changing during the 3-year

period when the notes purported to be outstanding.    This is not

evidence of normal business practice.

       There are no source documents evidencing a loan.   Both

petitioner and his accountant referred to internal accounting

records and work papers when asked how each of the 16 loan

balances was calculated.    Petitioner never offered these internal

accounting documents into evidence.     Petitioner stated that these

records were available but that he would have to find them.

Petitioners never produced them.

       There are many inconsistencies between the categories and

amounts shown on the Schedules L that petitioner said reflected

the loan balances outstanding at yearend between him and the

corporations and the face amounts of the corporations' notes to

him.    The corporate Schedules L do not show significant loans

from stockholders.    GAPS showed no loans from stockholders as of


       10
      GAPS claimed an interest deduction of $30,632 on its 1989
pro forma tax return. Respondent disallowed this entire amount,
and GAPS has conceded this issue. Even if this interest was
paid, there is no evidence that it was paid to petitioner for
these purported loans. Even if the interest was paid to
petitioner for these purported loans, petitioners did not report
these payments as ordinary income. If the deduction was based
upon an accrual of interest payable to petitioner, the deduction
would properly be disallowed under sec. 267(a)(2) by reason of
the relationship between petitioner and GAPS, as defined in sec.
267(b)(2).
                              - 22 -


January 1, 1988, or as of December 31, 1988, on its 1988 Schedule

L.   JJM showed no loans from stockholders as of January 1, 1988,

or as of December 31, 1988, on its 1988 Schedule L.    On the 1989

Schedule L, GAPS showed loans from stockholders of zero on

January 1, 1989, and $8,281 as of December 31, 1989.     On the 1989

Schedule L, JJM showed loans from stockholders of $10,000 on

January 1, 1989, and $10,000 as of December 31, 1989.11    The

Schedule Ls do not evidence sufficient loans to cover the

payments made by GAPS and JJM to and for petitioner.12


     11
      In the statutory notice, respondent generously reduced the
amounts of corporate payments by the amounts of the stockholder's
loans listed on GAPS's and JJM's 1989 pro forma corporate income
tax return schedule L. Petitioners provided no substantiation
for these amounts beyond the pro forma returns.
     12
      John Pritten testified that petitioner's "loans" are
reflected on the Schedules L under headings different from "Loans
from stockholders". He testified that the headings "Mortgages,
notes, bonds payable in less than 1 year" and "Mortgages, notes,
bonds payable in 1 year or more" also reflect petitioner's
"loans". Although it is true that these headings list
substantially more than the stockholder loans category and that
some of the amounts listed on the Schedules L equal the face
amounts of the promissory notes, we do not find this testimony
persuasive. Each of the promissory notes has a 1-year maturity
date. This contradicts the distinction between notes payable in
1 year or more and notes payable within less than 1 year. For
example, GAPS note No. 6 for $31,637 is exactly the same amount
as the GAPS Schedule L entry under notes payable in less than 1
year for 12/31/88 although note No. 6 is payable in one year.
Also, neither Mr. Pritten nor petitioner provided a sufficient
business reason for separating any shareholder loans into the
three different categories. We find it much more plausible that
Mr. Pritten and petitioner created the notes in preparation for
trial and had to rely on the other Schedule L categories for the
appropriate amounts because the amounts actually stated in the
shareholder loans category were not sufficient to cover the
amounts of the loans claimed.
                              - 23 -


     The notes were not reduced in 1989 by amounts commensurate

with the alleged loan repayments.   The 1989 GAPS notes, Nos. 5

through 7, equal $128,181, whereas the 1990 GAPS notes, Nos. 8

through 10, equal $64,028.   This illustrates a reduction in total

loans for GAPS in 1989 of $64,153, compared with the total amount

of GAPS payments to petitioner of at least $104,564.    This still

leaves a difference of more than $40,000.

     The JJM calculations show similar discrepancies.    The 1989

JJM notes, Nos. 3 and 4, equal $73,381, whereas the 1990 JJM

notes, Nos. 5 and 6, equal $59,589.    This would indicate a

reduction in total loans for JJM in 1989 of $13,792, compared

with the total amount of JJM payments to petitioner of at least

$39,553, leaving a difference of more than $25,000.    There is no

evidence that petitioner lent GAPS or JJM any cash or property in

1989 that would account for these differences.13   The lack of

correlation between the face amounts of the notes and the amounts

shown on the pro forma Schedules L belies petitioner's position.

     We conclude that petitioner's transfers to GAPS and JJM

constituted equity investments rather than debt.   Therefore, the

amounts that GAPS and JJM paid to petitioner, or on his or his

family's behalf, were not repayments of shareholder loans but



     13
      Petitioner claimed that the Mass Mutual payments account
for some of this difference. However, we have already taken the
Mass Mutual salary check and payments into account in reducing
the amount of the total corporate payments.
                               - 24 -


rather payments with respect to petitioner's stock.     (See infra

pp. 27-30 for a discussion of petitioner's basis in GAPS and JJM

by virtue of these contributions.)

     (c) Tax Treatment of Corporate Distributions

     Section 301 provides a three-tiered sequence for determining

the tax treatment of corporate distributions.     Sec. 301(c).

First, the distributions are dividends, as determined under

section 316, to the extent of the corporation’s earnings and

profits.   Sec. 301(c)(1).   Second, further distributions are

nontaxable returns of capital to the extent of the shareholder’s

basis in the stock of the corporation.    Sec. 301(c)(2).    Third,

further distributions are capital gain to the extent they exceed

the shareholder’s basis in his stock.    Sec. 301(c)(3).

     Corporate distributions are dividends to the extent of

corporate earnings and profits.    Sec. 316.   The parties

stipulated to using current earnings and profits only.

Respondent contends that GAPS's and JJM's 1989 current earnings

and profits were $65,367 and $22,257, respectively.     Petitioners

contend that GAPS's 1989 earnings and profits were between

$51,174 and $65,376, and that JJM's 1989 earnings and profits

were between $17,664 and $23,365.

     Petitioners did not explain the factors that created the

ranges of earnings and profits argued in their briefs.       They did,

however, argue that certain items, such as accrued taxes,
                               - 25 -


interest on the corporate tax deficiencies, and ordinary and

necessary business expenses, disallowed for lack of section 274

substantiation, reduce earnings and profits.

     Petitioners contend that accrued taxes reduce current

earnings and profits, Commissioner v. James, 49 F.2d 707 (2d Cir.

1931); Stern Brothers & Co. v. Commissioner, 16 T.C. 295 (1951),

and respondent has not argued otherwise.    Respondent calculated

and took into account the accrued taxes in determining the

corporations' earnings and profits.

     Petitioners are correct that accrued interest on taxes

should be accrued ratably each year as it becomes due.     Stark v.

Commissioner, 29 T.C. 122, 128 (1957).     However, the interest did

not become due until the returns for 1989 were due, March 15,

1990.    Therefore, the GAPS and JJM earnings and profits for 1989

cannot be reduced by the interest due on the tax deficiencies in

issue.   Id.

     We have already found that petitioner failed to meet the

substantiation requirement of section 274 regarding his travel

and entertainment expenses, and we find that he has failed to

prove that the travel and entertainment expenses were ordinary

and necessary business expenses.   Therefore, the earnings and

profits of GAPS and JJM should not be reduced by the amounts of

the purported travel and entertainment expenses, which will be
                                - 26 -


aggregated with the other payments for petitioner's benefit as

corporate distributions.

     The parties are in agreement that GAPS was not a de jure

corporation until March 1989.    Petitioners also argued that GAPS

was not a de facto corporation before the date of incorporation.

Although petitioners did not explain the effect of this argument

on their case, we assume that petitioners' argument is that

earnings of the group employee benefit plan business carried on

in the name of GAPS during January and February 1989 could not

increase earnings and profits because GAPS was not in

existence.14   Petitioners' argument also implies that any GAPS's

payments to petitioner during January and February could not be

corporate distributions because GAPS had no corporate existence

during that period.

     Petitioners' argument is not persuasive.    An enterprise

that conducts business in a corporate manner and files U.S.

corporation income tax returns may be subject to income tax, even

if its incorporation was ineffective under State law.    United


     14
      Petitioners' argument could be a two-edged sword. First,
it would seem to rule out any decrease in GAPS's earnings and
profits during January and February 1989 because the corporation
was not in existence. Therefore, if GAPS had more expenses
during January and February than income, the earnings and profits
of GAPS for 1989 would actually be higher if we were to find that
GAPS was not in existence during those 2 months. Second, if GAPS
was not taxable as a corporation between Jan. 1 and Feb. 28,
1989, then the income for those 2 months should be taxable as
sole proprietorship income on the Mancusos' personal return.
They reported no such income on their 1989 Form 1040.
                              - 27 -


States v. Scornavacco's Restaurant, Inc., 528 F.2d 19, 23 (7th

Cir. 1975) (citing with approval United States v. Theodore, 479

F.2d 749, 753 (4th Cir. 1973)).   Petitioner consistently treated

GAPS as an incorporated entity beginning in 1986.   Petitioner

also caused corporate tax returns to be filed during the prior

periods when he now argues GAPS was not in existence.   On its

1989 pro forma tax return, GAPS claimed, and respondent allowed,

a net operating loss deduction carried forward from its 1988

return.   Petitioner held GAPS out as a corporation.   Therefore,

regardless of the status of GAPS under Illinois law for the

period January-February 1989, we will treat GAPS as a corporation

for Federal income tax purposes for the entire calendar year.

     Petitioners have also failed to provide evidence of how

expenses and distributions should be allocated between the sole

proprietorship and the corporation.    Therefore, we will make no

adjustment to the amount of GAPS's earnings and profits, or

GAPS's corporate distributions, based on petitioners' corporate

existence argument.   In light of petitioners' failure to prove

otherwise, we accept respondent's calculations of the 1989

earnings and profits of both JJM and GAPS.

     Under section 301(c)(2), the amount of distributions in

excess of earnings and profits is a non-taxable return of capital

to the extent of petitioner’s basis in the stock.   We therefore

must determine petitioner’s basis in the stock of his
                              - 28 -


corporations.   The burden is on petitioner to prove his basis in

the corporations at the time of the distributions.15

     On the GAPS Schedule L, $1,000 is shown as petitioner’s

original capital contribution.   Respondent has conceded this

amount, so petitioner's basis in GAPS is at least $1,000.

Petitioner claims that he lent the proceeds of two bank accounts,

totaling $154,000, to GAPS.   While we have found that these

amounts were not loans, we do believe that petitioner transferred

these accounts to GAPS.   However, petitioner has failed to prove

that he had a sufficient interest in the funds in these accounts

to give him any basis in the accounts, or in his GAPS stock after



     15
      Petitioners, in their reply brief, argued that respondent
has the burden of proof on the issue of petitioner's basis
because this is a new issue raised by respondent. However, we
disagree with petitioners' contention that this is a new issue.
Respondent, in her statutory notice, determined that this case
dealt with GAPS's and JJM's constructive dividends. The
statutory notice did not address petitioner's basis in the
corporations because respondent assumed that earnings and profits
were sufficient to cover the amount of distributions. After
concessions, it became clear that this was not the case. This
change in the factual framework does not render the issue of
petitioner's basis a new issue. The issue of corporate
distributions, which is the broad issue in this case, encompasses
the need to determine petitioner's basis in the corporation.
Sec. 301, the controlling Code section, requires knowledge of a
taxpayer's basis in the corporation in order to determine the
taxpayer's return of capital and capital gain. Once the issue of
corporate distributions was raised in the statutory notice, the
burden was on petitioners to prove all the facts relevant to that
inquiry. This not only included the burden of proving loans,
which petitioners spent most of their efforts on, but it also
included the burden of proving the amounts of the corporate
distributions, the corporations' earnings and profits, and
petitioner's basis in the corporations.
                              - 29 -


the contribution.   Petitioner testified as follows regarding

these bank accounts:

     Well, [the] claims [account] was strictly a function
     where we received funds from clients to administer and
     pay their employee benefit plans. The monies flowed
     from the employer through our system and bank directly
     to employees and providers. The other account, or the
     premium account, was a collection account where we were
     doing billings to employers, collecting premiums, and
     remitting net premiums, which are premiums minus
     commissions and fees, expenses, to insurance carriers.
     So one went from employer to insurance carriers and one
     went from the employer to providers.

Petitioner's testimony indicates that these accounts were flow-

through accounts, perhaps even trust accounts.   The funds were

collected from one source and paid to another.   If this is so,

whatever funds were in the accounts at the time of transfer were

subject to the corporate liabilities to the designated

distributees of the funds.   Petitioners have not presented any

evidence that these funds actually had a basis to petitioner, net

of liabilities, when he transferred them to GAPS.   We conclude,

therefore, that petitioner's basis in GAPS cannot be increased by

the amounts of the two bank accounts.

     Petitioner also claims to have lent $100,000 in furniture

and equipment to GAPS.   We have already found, supra p. 23, that

petitioner has failed to prove that he lent this property to

GAPS.   Although we believe that petitioner transferred the

furniture to GAPS, petitioner's basis in GAPS cannot be increased

by any amount for this contribution, because he has not proven
                                - 30 -


what his basis in the assets was at the time of contribution.16

After considering all of the evidence, we conclude that

petitioner's basis in GAPS was $1,000.

     On the JJM Schedule L, $1,000 is shown as petitioner’s

original capital contribution.     Petitioners also claim that

petitioner transferred the proceeds of a bank account, totaling

$20,000, to JJM.     We do believe that this account was

transferred.     Unlike the GAPS accounts, there is no indication

that this account was a flow-through account.     Therefore,

petitioner’s basis in JJM was increased by the bank account

contributed.     Petitioner also claims to have transferred $37,000

in furniture and equipment.     Although we believe that petitioner

contributed this property to JJM, petitioners have not proven

what petitioner's basis in the assets was at the time of

contribution.     There is insufficient evidence to justify

increasing petitioner's basis by any amount on account of this

transfer.17




     16
      We note that petitioners could have argued that the Cohan
rule may be used to estimate petitioner's basis in the furniture
and equipment at the time of transfer. Cohan v. Commissioner, 39
F.2d 540 (2d Cir. 1930). However, even if petitioners had raised
this argument, they would have had to provide some reasonable
evidentiary basis for estimating petitioner's basis under Cohan.
Polyak v. Commissioner, 94 T.C. 337, 345-346 (1990); Vanicek v.
Commissioner, 85 T.C. 731, 743 (1985). Petitioners failed to do
so.
     17
          See supra note 16.
                               - 31 -


     Petitioners also claim that petitioner transferred $16,000

in accounts receivable to JJM.     Petitioner was a cash basis

taxpayer.   A cash basis taxpayer has a zero basis in accounts

receivable.    Raich v. Commissioner, 46 T.C. 604, 610 (1966); see

also P.A. Birren & Son v. Commissioner, 116 F.2d 718, 720 (7th

Cir. 1940).    Therefore, petitioner's contribution of the accounts

receivable has no effect on his basis in JJM.     After

consideration of all of the evidence, we conclude that

petitioner's basis in JJM was $21,000.

     Finally, section 301(c)(3) treats the amount of the

distribution, not treated as a dividend, to the extent it exceeds

basis, as gain from the sale or exchange of property.     This

calculation we leave to the parties under Rule 155.

Issue 3.    Additions to Tax and Penalty

     (a) Section 6651(a)(1)--All Petitioners

     Section 6651(a)(1) provides, in the case of failure to file

a return by the due date, that the taxpayer is subject to an

addition to tax in the amount of 5 percent of the tax for each

month, or fraction thereof, that the delinquency continues (not

to exceed 25 percent), unless it is shown that such failure is

due to reasonable cause and not willful neglect.

     Petitioners' 1989 joint individual income tax return was due

April 15, 1990.    Sec. 6072(a).   On August 30, 1990, the Internal

Revenue Service received the individual petitioners' 1989 joint
                               - 32 -


return, Form 1040, dated August 15, 1990, with a postmark of

August 28, 1990.

     Petitioners' (GAPS and JJM) 1989 U.S. Corporation Income Tax

Returns, Forms 1120, were due on March 15, 1989.    Sec. 6072(b).

The Internal Revenue Service did not receive GAPS's and JJM's

Forms 1120 until September 20, 1992.    These forms were hand

delivered, were not signed, and were undated.    Petitioners claim

that these Forms 1120 were mailed, along with the Form 1040, at

the end of August 1990.

     Neither the individual nor the corporate petitioners

requested extensions to file their Federal income tax returns for

the taxable year 1989.    The regulations tell how to count the

number of delinquent months.    Sec. 301.6651-1(b), Proced. &

Admin. Regs.    If the filing date is a day other than the last day

of a month, the period that terminates with the date numerically

corresponding thereto in the succeeding calendar month and each

successive period shall constitute a month for purposes of

section 6651.   Sec. 301.6651-1(b)(2), Proced. & Admin. Regs.     As

of August 15, 1990, the corporate returns were already 5 months

delinquent; as of August 16, the individual return was 5 months

delinquent because any fraction of a month counts as an entire

month for section 6651 purposes.    Sec. 6651(a)(2).   Therefore,

even if all the returns were mailed on August 28, as petitioners

assert, they are subject to the 5-percent-per-month addition to
                              - 33 -


the tax due, or the maximum 25 percent of the tax due, unless

petitioners had reasonable cause for the delay.

     Petitioners bear the burden of proving that the delay was

due to reasonable cause and not willful neglect.    Rule 142(a);

Welch v. Helvering, 290 U.S. 111 (1933).    Petitioners presented

no evidence regarding the reasons for their delay in filing (or

failure to file) their returns.   Petitioners have not met their

burden of proving that the delay was due to reasonable cause and

not willful neglect.   Therefore, we hold for respondent on this

issue.

     (b) Section 6662(b)(1)--Jerome J. and Joanne L. Mancuso

     Section 6662(b)(1) provides that, if any part of any

underpayment of income tax is due to negligence or disregard of

the rules or regulations, an accuracy-related penalty equal to 20

percent of the underpayment is added to the tax.    Respondent's

determination is presumed correct, and the burden is on

petitioners to prove that they were not negligent.     Accardo v.

Commissioner, 942 F.2d 444, 452 (7th Cir. 1991), affg. 94 T.C. 96

(1990).   The Mancusos presented no evidence on this issue, nor

did they argue this issue in either their opening or reply

briefs.

     Negligence has been defined as a "lack of due care or

failure to do what a reasonable and ordinarily prudent person

would do under the circumstances."     Id. (citing Marcello v.
                              - 34 -


Commissioner, 380 F.2d 499, 506 (5th Cir. 1967); Neely v.

Commissioner, 85 T.C. 934, 947 (1985)).    Petitioner is an

experienced businessman and insurance agent.    There is evidence

in the record that petitioner through GAPS created and maintained

a fairly complex record-keeping system to document and administer

the employee benefit programs of his business clients.    However,

when it came to his own affairs and those of his wholly owned

corporations, petitioner did not institute and implement similar

procedures for creating and maintaining documentation.

Petitioner never produced any loan source documents, nor did he

provide sufficient substantiation of the purported business

travel expenses through contemporaneous records or otherwise.

     Petitioner used his corporations as his personal

pocketbooks, paying both his and his family's personal and living

expenses out of the corporate till.    He not only failed to

include these amounts in his gross income, but he also deducted

many of the same amounts from the income of his corporations.    We

do not believe petitioner's actions and omissions were

reasonable.   In light of his actions and omissions, and with no

argument or evidence presented by petitioner to the contrary, we

sustain respondent on this issue.

     (c) Section 6655--GAPS and JJM Estimated Tax Additions

     The final issue is whether GAPS and JJM are liable for the

addition to tax under section 6655 for failure to pay estimated
                               - 35 -


income tax for 1989.   Petitioners have the burden of disproving

respondent's determination.   Rule 142(a).   Inasmuch as

petitioners introduced no evidence to disprove or rebut

respondent's determinations, we sustain them.

     To reflect the foregoing,


                                  Decisions will be entered under

                              Rule 155.
