                      T.C. Memo. 1999-188



                  UNITED STATES TAX COURT



     MARK D. PRIDGEN AND KAY D. PRIDGEN, Petitioners v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent

   DEWEY GASKINS AND FRANCINE P. GASKINS, Petitioners v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 2048-97, 2075-97.   Filed June 9, 1999.



     Trawick H. Stubbs, Jr. and J. Douglas McCullough, for

petitioners.

     J. Craig Young, for respondent.



          MEMORANDUM FINDINGS OF FACT AND OPINION

     WHALEN, Judge:   Respondent determined the following

deficiencies in, and penalties with respect to, the Federal

income tax of petitioners Mark and Kay Pridgen, in the case

at docket No. 2048-97:
                            - 2 -


                                              Penalty
     Year            Deficiency             Sec. 6662(a)

     1990             $129,169               $25,834
     1991              232,416                46,483


Unless stated otherwise, all section references are to the

Internal Revenue Code as in effect during the years in

issue.   Respondent also determined the following

deficiencies in, addition to, and penalties with respect

to the Federal income tax of petitioners Dewey and Francine

Gaskins, in the case at docket No. 2075-97:


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

     1990      $131,723           $26,345                 --
     1991       240,086            48,017              $12,004


References in this opinion to "petitioners" are references

to Mr. Pridgen and Mr. Gaskins.     Petitioners and their

wives resided in the State of North Carolina at the time

the subject petitions were filed.

     The above-captioned cases were consolidated for trial,

briefing, and opinion by an order of the Court issued

pursuant to Rule 141, Tax Court Rules of Practice and

Procedure.   In this opinion, all Rule references are

to the Tax Court Rules of Practice and Procedure.
                            - 3 -


     After concessions, the issues for decision are:

(1) Whether a partnership, Beaufort Leaf Tobacco Co.

(hereinafter referred to as Beaufort Leaf), in which each

petitioner held an interest, failed to report tobacco sales

of $888,528 in 1990 and $1,054,576 in 1991; (2) whether

respondent erred in disallowing alleged tobacco purchases

of $429,421 in 1990 and $1,173,203 in 1991 that were

included in Beaufort Leaf's cost of goods sold; and (3)

whether petitioners are liable for the penalties and

addition to tax determined by respondent.   The parties have

stipulated that Mrs. Pridgen and Mrs. Gaskins are entitled

to innocent spouse relief "under section 6013(e)".    Thus,

it appears that respondent concedes that Mrs. Pridgen and

Mrs. Gaskins are eligible for relief from joint and several

liability with respect to their joint returns for 1990 and

1991 under section 6015(a)(1), assuming that an appropriate

election is made as required by section 6015(b)(1)(E).

     The deficiencies determined in the notices of

deficiency are based upon adjustments to each petitioner's

distributive share of the net income of Beaufort Leaf for

taxable years 1990 and 1991.   Respondent adjusted Beaufort

Leaf's net income without a proceeding at the partnership

level.   See generally section 6221 through 6233.   It

appears that all parties agree that Beaufort Leaf is a
                            - 4 -


small partnership, as defined under section 6231(a)(1)(B),

and is exempt from the partnership audit and litigation

procedures.

                       FINDINGS OF FACT

     In 1987, petitioners and another individual who is

now deceased, Mr. Harry Lee Roberts, formed Beaufort Leaf,

a North Carolina general partnership, to engage in the

purchase and sale of tobacco.   The three partners agreed

that petitioners would finance the partnership's operations

and, for that purpose, that petitioners would cosign a note

in the principal amount of $300,000.      The partners also

agreed that Mr. Roberts would be responsible for the day-

to-day management and operation of the partnership and

would be paid approximately $20,000 per year in addition to

his share of any partnership income.      There was no written

partnership agreement, but the partners orally agreed that

each partner would have a one-third distributive share of

all partnership income, gain, loss, deduction, or credit.

Petitioners initially intended that Beaufort Leaf would be

in business for only 1 year, but it continued to conduct

business until 1992.

     During the time Beaufort Leaf was in business,

Mr. William H. Dawson, Jr., a licensed accountant,

maintained its books and prepared its Federal income tax
                                         - 5 -


returns.      The partnership's returns for 1988, 1989, and

1990 respond to the question "which accounting method" by

indicating that the partnership is on the "cash" method of

accounting.           The partnership's return for 1991 indicates

that the partnership is on the "accrual" method of

accounting.           The final return of the partnership for 1992

does not respond to that question.

       Beaufort Leaf's returns for 1988 through 1992 report

the following items on Schedule K, Partner's Shares of

Income, Credits, Deductions, Etc.:

                                1988         1989        1990         1991        1992

Ordinary income from trade
 or business activities      $6,595.45   $15,075.65   $47,204.60   $46,952.60     $30.33

Interest income              2,471.80     6,734.72        -0-       3,286.00       -0-

Guaranteed payments
 to partners                 30,000.00    30,000.00   30,000.00    30,000.00    17,000.00

Net long-term capital gain     267.33        -0-          -0-          -0-         -0-

                             39,334.58    51,810.37   77,204.60    80,238.60    17,030.33



The above-guaranteed payments of $30,000 per year for 1988

through 1991 and $17,000 for 1992 were paid entirely to

Mr. Roberts.          The record does not explain why Mr. Roberts

was paid $30,000 per year after the partners had initially

agreed that he would be paid $20,000 per year.

       According to Beaufort Leaf's returns, the share of

each of the partners in the net income of the partnership

is as follows:
                               - 6 -


                    Net Income of Beaufort Leaf

    Year    Gaskins          Pridgen        Roberts       Total

    1988    $3,111.53       $3,111.53      $3,111.51    $9,334.57
    1989     7,270.12        7,270.12       7,270.12    21,810.36
    1990    15,734.87       15,734.87      15,734.86    47,204.60
    1991    16,746.20       16,746.20      16,746.20    50,238.60
    1991        10.11           10.11          10.11        30.33

            42,872.83       42,872.83      42,872.80    128,618.46


For 1991, the second of the 2 years in issue, the above

net income, $50,238.60, is composed of ordinary income

from trade or business activity of $46,952.60 and interest

income of $3,286.

    Beaufort Leaf's returns report the following with-

drawals and distributions:

                    Withdrawals and Distributions

    Year    Gaskins           Pridgen        Roberts      Total

    1988    $11,414.60      $10,000.00     $10,546.70   $31,961.30
    1989      3,111.53        3,111.53       2,500.00     8,723.06
    1990      7,270.12       19,270.12      22,220.15    48,760.39
    1991     32,481.07       20,481.07      16,746.20    69,708.34
    1992        -0-             -0-            -0-          -0-

            54,277.32        52,862.72      52,013.05   159,153.09


    Set out below is a summary of the income and deduc-

tions reported on Beaufort Leaf's income tax returns for

the years in issue, 1990 and 1991:
                                - 7 -


                                          1990                         1991

Gross receipts or sales               $1,264,701                   $2,849,451
Cost of goods sold                     1,123,852                    2,661,781

Gross profit                              140,849                      182,670

Salaries and wages         $6,604                     $10,638
Guaranteed payments
  to partners              30,000                      30,000
Rent                        2,652                       6,000
Interest                   18,257                      16,721
Taxes                       1,132                       1,629
Repairs                     1,619                       3,692
Depreciation                1,079                       1,186
Other deductions           32,302                      65,851
  Total deductions                         93,644                      135,717

Ordinary income (loss)                     47,205                      46,953


     Mr. Dawson, the partnership's accountant, computed the

gross receipts of the partnership for Federal income tax

purposes based on the aggregate deposits made to Beaufort

Leaf's bank account, less certain deposits identified as

repayments of loans or cash advances.             Mr. Dawson computed

Beaufort Leaf's cost of goods sold for 1990 and 1991 based

on canceled checks and some accounting adjustments.                His

computation of the cost of goods for each year is as

follows:

                                           1990                 1991

Inventory at beginning of year           $199,602           $132,914
Purchases                               1,057,163          2,713,562
Other costs (wholesale commissions)        -0-                47,429

 Total                                  1,256,765          2,893,905

Inventory at end of year                 132,914                227,124

Cost of goods sold                      1,123,851          2,666,781
                              - 8 -


     Mr. Dawson kept a "journal" and "ledger" for Beaufort

Leaf.   He used bank statements, deposit slips, and checks

from Beaufort Leaf's bank account to post entries to the

journal.   The record of these consolidated cases contains

the journal for 1991.    It does not include the journal for

1990 or the ledger for 1990 or 1991.    The journal for 1991

shows that the sales and purchases reported for Federal

income tax purposes on the partnership's 1991 return

include the sales and purchases booked in the journal on

a monthly basis, together with substantial yearend adjust-

ing entries.    Beaufort Leaf's journal for 1991 shows the

following sales and purchases:

           Month         Sales             Purchases

            1/91        $25,336.74         $64,244.28
            2/91         39,716.55           1,461.20
            3/91            -0-                283.00
            4/91            781.78           4,242.75
            5/91            -0-              4,813.52
            6/91            -0-              4,563.52
            7/91        116,348.66             -0-
            8/91        184,228.86          77,757.50
            9/91        195,899.47         133,243.66
           10/91        609,273.97          82,953.54
           11/91        349,861.40         214,793.94
           12/91          7,215.00         501,845.96

                      1,528,662.43        1,090,202.87

Adjusting entries     1,320,788.88        1,273,359.59
Adjusting entry             -0-             350,000.00

 Totals per journal   2,849,451.31        2,713,562.46
                            - 9 -


Beaufort Leaf's return for 1991 reports sales and purchases

in the same amounts; i.e., $2,849,451.31 and $2,713,562.46,

respectively.

     Neither the journal for 1991 nor anything else in the

record explains the nature of the "adjusting entries"

shown in the journal increasing sales in the amount of

$1,320,788.88 and increasing purchases in the amount of

$1,273,359.59.   The adjusting entry to purchases of

$350,000 is labeled "Accts Payable--OK Leaf" without any

other explanation.

     We note that Beaufort Leaf's journal for 1991 shows

the following checks issued by the partnership to

"HLRoberts" or "HLR":
                          - 10 -


           Date          Check No.          Amount

          1/05/91           663             $946.00
          2/26/91           681            1,500.00
          3/18/91           690            1,000.00
          3/21/91           693            2,600.00
          4/05/91           702            1,500.00
          4/05/91           705              300.00
          4/10/91           707              200.00
          4/15/91           708            1,200.00
          4/16/91           709            5,000.00
          4/19/91           712            2,000.00
          4/19/91           713              500.00
          4/19/91           714            1,777.96
          4/26/91           720            7,500.00
          5/01/91           727            1,000.00
          5/03/91           734            1,054.43
          5/03/91           735            1,000.00
          5/13/91           742            1,000.00
          5/23/91           744              500.00
          5/29/91           749              599.77
          5/29/91           750              500.00
          6/07/91           762              500.00
          6/07/91           764            2,200.00
          6/17/91           768            1,375.00
          6/17/91           769            1,200.00
          6/25/91           772              300.00
          7/02/91           775              500.00
          7/16/91           783            1,200.00
          7/18/91           786              900.00
          7/24/91           797              300.00
          8/01/91           808              500.00
          8/07/91           818            3,500.00
          8/07/91           820            1,200.00
          8/16/91           833              500.00
          8/29/91           850            1,500.00
          8/29/91           851              150.00
          9/19/91           874            1,500.00
          9/25/91           878            5,835.00
         10/03/91           887            5,000.00
         10/14/91           904            4,580.00
         10/18/91           907            2,520.00
         10/24/91           917            1,120.00
         10/25/91           920            1,500.00
         10/31/91           921           13,500.00
         11/07/91           934            1,500.00
         11/18/91           938            1,000.00
         11/20/91           940            2,000.00

           Total                          87,558.16


The nature of the above payments is not described in the

journal or elsewhere in the record of these cases.
                            - 11 -


     As mentioned above, Beaufort Leaf was in the business

of buying and selling tobacco.   The marketing of tobacco

is subject to Government regulation under the Agricultural

Adjustment Act of 1938, ch. 30, secs. 311-314, 52 Stat. 45,

current version at 7 U.S.C. secs. 1311-1316 (1994), which

includes a record-keeping mechanism that is designed to

account for all tobacco sales and purchases.   See

generally, Cole v. USDA, 33 F.3d 1263, 1265-1266 (11th Cir.

1994).   As part of that record-keeping mechanism, dealers,

like Beaufort Leaf, are required to maintain a Dealer's

Record on Form MQ-79 issued by the U.S. Department of

Agriculture.   The Form MQ-79 is a comprehensive record of

each purchase and resale of tobacco including the date, the

amount of tobacco, the identity of the seller or purchaser,

and a running balance of the amount of tobacco on hand

after each transaction.   In the case of purchases or

resales at auction, the Form MQ-79 lists the warehouse at

which the purchase or sale took place and requires a

warehouse representative to sign the dealer's Form MQ-79.

     Dealers are required to file their Dealer's Record

with the Agriculture Stabilization and Conservation Service

(ASCS) on a weekly basis.   The amount of tobacco marketed

is controlled by a quota system that establishes an allot-

ment of tobacco for each tobacco-producing farm.     See Cole
                            - 12 -


v. USDA, supra.   The marketing of tobacco in excess of a

producer's allotment, so-called excess-quota tobacco, is

subject to a penalty.    See id.

     In the notices of deficiency issued to petitioners,

respondent made two principal adjustments to Beaufort

Leaf's returns for 1990 and 1991.    First, respondent

increased the gross sales reported by the partnership.

The explanation of that adjustment in the subject notices

of deficiency is as follows:


          It is determined that the partnership had
     additional income from tobacco sales for tax
     years 1990 and 1991 that was not reported on
     the returns. It has been determined that
     tobacco sales totaled $2,153,228.00 in 1990
     and $3,904,027.00 in 1991 instead of the amounts
     of $1,264,700.00 and $2,849,451.00 as shown on
     the returns. Accordingly, the partnership net
     income is increased $888,528.00 in 1990 and
     $1,054,576.00 in 1991. (See attached.)


     The attachment referred to in the above explanation

states that Beaufort Leaf's tobacco sales for 1990 were

recomputed as follows:


    (1) Sales of flue-cured tobacco            $1,225,535
    (2) Sales of burley tobacco                   853,015
    (3) Sales of tobacco "not in the form"         74,678

    TOTAL TOBACCO SALES FOR 1990                2,153,228

    Claimed on return                           1,264,700

    Net adjustment to gross income                888,528
                           - 13 -


The parties have stipulated that the Forms MQ-79 filed on

behalf of Beaufort Leaf for 1990 report aggregate sales

of flue-cured tobacco of $1,225,535, the amount used by

respondent in computing the partnership's sales.

Similarly, the parties have stipulated that the Forms

MQ-79, filed on behalf of Beaufort Leaf for 1990, report

aggregate sales of burley tobacco of $853,015, the amount

used by respondent in recomputing the partnership's sales.

Thus, the additional income from sales of flue-cured and

burley tobacco computed by respondent for 1990 is based

upon the sales reported in the Forms MQ-79 filed on behalf

of Beaufort Leaf.   Respondent determined the amount of

unreported sales from so-called pickens tobacco on the

basis of three receipts which state that Beaufort Leaf

sold pickens tobacco to H.D. Pegram on June 5, 1990, in

the aggregate amount of $74,678.

     The attachment referred to in the explanation

accompanying the notices of deficiency also states that

the unreported tobacco sales of Beaufort Leaf for 1991

were recomputed on the basis of "checks written to Beaufort

Leaf Tobacco Company from auction sales of tobacco but not

deposited to the business account" in the aggregate amount

of $1,054,576 and not included in the gross income reported

by the partnership for 1991.   The record of this case
                               - 14 -


contains a list of the undeposited checks showing the date

of each auction sale, the name and location of the

warehouse in which the sale took place, the amount of the

check, and other information.      Beaufort Leaf is listed as

the dealer for each sale and was the payee of each

undeposited check.    All of the undeposited checks were

endorsed by Mr. Roberts on behalf of Beaufort Leaf to

other persons who endorsed the checks, so-called second

endorsers.   The following is a summary of the list of

undeposited checks grouped according to the second

endorsers:

             Second Endorser                Total Received

             A.H. Pruit                         $5,428
             Albert E. Vaughan                  16,442
             Bobby W. Griffin                  256,360
             Cash N/A Flash                    159,538
             Classic Pawn Shop                  45,444
             Coastal Tobacco                    19,758
             Day & Nite, Inc.                  235,590
             Estel D. Simmons                   72,232
             Greenville TV                       2,780
             Harold Simmons                     63,301
             James L. Vaughan                  151,134
             Martin Van Lee                     16,813
             Pawn & Shoppe, Inc.                 9,756

              Total unreported tobacco
                sales for 1991                1,054,576


     The list of undeposited checks, described above,

consists of 247 transactions.      Of those transactions, 75

occurred at the Big Dixie Warehouse and 6 occurred at

Bob Clark's Warehouse.     These transactions are shown below:
                         - 15 -


 Date      Warehouse      Amount     Second Endorser

09/11/91   Big   Dixie   $3,533.25   Classic Pawn Shop
09/17/91   Big   Dixie    5,222.93   Bobby W. Griffin
10/10/91   Big   Dixie      928.97   Estel D. Simmons
10/10/91   Big   Dixie      251.07   Estel D. Simmons
10/10/91   Big   Dixie    4,056.35   Day & Nite, Inc.
10/10/91   Big   Dixie    7,680.98   Day & Nite, Inc.
10/10/91   Big   Dixie    5,657.07   Day & Nite, Inc.
10/10/91   Big   Dixie    5,553.79   Day & Nite, Inc.
10/10/91   Big   Dixie    5,053.79   Day & Nite, Inc.
10/10/91   Big   Dixie    3,475.33   Estel D. Simmons
10/10/91   Big   Dixie    3,214.88   Day & Nite, Inc.
10/10/91   Big   Dixie    2,856.89   Day & Nite, Inc.
10/10/91   Big   Dixie    3,310.14   Estel D. Simmons
10/10/91   Big   Dixie    4,340.97   Day & Nite, Inc.
10/10/91   Big   Dixie    3,679.90   Estel D. Simmons
10/10/91   Big   Dixie    6,311.83   Estel D. Simmons
10/10/91   Big   Dixie    1,061.84   Harold Simmons
10/10/91   Big   Dixie    4,664.55   Harold Simmons
10/10/91   Big   Dixie    2,209.76   Harold Simmons
10/14/91   Big   Dixie    1,794.68   Cash N/A Flash
10/14/91   Big   Dixie    1,671.69   Cash N/A Flash
10/14/91   Big   Dixie    2,779.71   Greenville TV
10/16/91   Big   Dixie    5,250.06   Cash N/A Flash
10/16/91   Big   Dixie    6,109.56   Cash N/A Flash
10/16/91   Big   Dixie    2,481.27   Cash N/A Flash
10/16/91   Big   Dixie    6,437.98   Cash N/A Flash
10/16/91   Big   Dixie    4,895.64   Cash N/A Flash
10/16/91   Big   Dixie    2,606.77   Day & Nite, Inc.
10/16/91   Big   Dixie    2,296.31   Cash N/A Flash
10/16/91   Big   Dixie    6,400.79   Cash N/A Flash
10/17/91   Big   Dixie    3,708.50   Cash N/A Flash
10/17/91   Big   Dixie    5,677.61   Cash N/A Flash
10/17/91   Big   Dixie    6,568.49   Cash N/A Flash
10/17/91   Big   Dixie    5,947.32   Cash N/A Flash
10/17/91   Big   Dixie    5,281.77   Cash N/A Flash
10/17/91   Big   Dixie    5,495.07   Cash N/A Flash
10/17/91   Big   Dixie    4,974.55   Cash N/A Flash
10/17/91   Big   Dixie    5,062.22   Cash N/A Flash
10/17/91   Big   Dixie    5,166.51   Cash N/A Flash
10/17/91   Big   Dixie    5,428.28   A.H. Pruit
10/17/91   Big   Dixie    7,189.61   Day & Nite, Inc.
10/17/91   Big   Dixie      216.78   Day & Nite, Inc.
10/21/91   Big   Dixie    6,723.67   Cash N/A Flash
10/21/91   Big   Dixie    3,079.56   Cash N/A Flash
10/21/91   Big   Dixie    1,081.65   Cash N/A Flash
10/21/91   Big   Dixie    1,943.41   Cash N/A Flash
10/21/91   Big   Dixie    2,959.36   Cash N/A Flash
10/21/91   Big   Dixie    4,231.81   Cash N/A Flash
10/21/91   Big   Dixie    3,495.18   Cash N/A Flash
10/21/91   Big   Dixie    5,101.46   Cash N/A Flash
10/21/91   Big   Dixie    5,910.94   Cash N/A Flash
10/21/91   Big   Dixie    6,367.52   Cash N/A Flash
10/21/91   Big   Dixie      301.81   Cash N/A Flash
10/21/91   Big   Dixie    6,549.17   Cash N/A Flash
10/21/91   Big   Dixie    7,190.33   Cash N/A Flash
                             - 16 -


10/21/91   Big   Dixie        6,726.40   Cash N/A Flash
10/21/91   Big   Dixie        6,725.89   Cash N/A Flash
10/22/91   Big   Dixie        1,119.27   Harold Simmons
10/22/91   Big   Dixie        6,531.59   Estel D. Simmons
10/22/91   Big   Dixie        2,651.59   Estel D. Simmons
10/22/91   Big   Dixie        3,319.38   Estel D. Simmons
10/22/91   Big   Dixie        4,698.06   Estel D. Simmons
10/22/91   Big   Dixie        4,858.18   Estel D. Simmons
10/22/91   Big   Dixie        4,258.52   Harold Simmons
10/22/91   Big   Dixie        6,601.78   Estel D. Simmons
10/22/91   Big   Dixie        4,113.32   Harold Simmons
10/22/91   Big   Dixie        3,000.10   Pawn & Shoppe
10/22/91   Big   Dixie        5,605.59   Harold Simmons
10/22/91   Big   Dixie        4,561.06   Harold Simmons
10/22/91   Big   Dixie        4,530.43   Harold Simmons
10/22/91   Big   Dixie          998.80   Harold Simmons
10/23/91   Big   Dixie          927.19   Pawn & Shoppe
10/23/91   Big   Dixie        4,132.13   Harold Simmons
10/23/91   Big   Dixie          802.81   Estel D. Simmons
10/23/91   Big   Dixie        5,828.91   Pawn & Shoppe

                           $313,432.33


 Date      Warehouse         Amount      Second Endorser

10/07/91   Bob   Clark's   $7,155.31     Harold Simmons
10/07/91   Bob   Clark's    3,673.92     Estel D. Simmons
10/07/91   Bob   Clark's    6,926.55     Estel D. Simmons
10/07/91   Bob   Clark's    7,286.44     Estel D. Simmons
10/07/91   Bob   Clark's    6,980.13     Harold Simmons
10/21/91   Bob   Clark's    2,439.72     Cash N/A Flash

                           $34,462.07


     Mr. Gaskins purchased the Big Dixie Warehouse in 1990.

Set out below is a summary of the transactions reported on

the Forms MQ-79 filed on behalf of Beaufort Leaf for 1990

and 1991 that took place at the Big Dixie Warehouse:
                                - 17 -


              Purchases         Resales
 Date      Pounds Dollars   Pounds    Dollars    Executed By

 9/12/90     --      -0-      4,017   $7,017    Linda Mercer
 9/18/90     --      -0-      3,772    6,619    Linda Mercer
 9/24/90     --      -0-     11,145   17,063    Mary D. Lancaster
 9/25/90     --      -0-      7,866   13,841    Mary D. Lancaster
 9/26/90     --      -0-     10,465   18,105    Mary D. Lancaster
 9/27/90     --      -0-      2,811    5,005    Mary D. Lancaster
10/01/90     --      -0-      9,721   17,374    Mary D. Lancaster
10/02/90     --      -0-     11,033   19,509    Mary D. Lancaster
10/03/90     --      -0-      5,881   10,138    Mary D. Lancaster
10/04/90     --      -0-      7,723   13,284    Mary D. Lancaster
10/09/90     --      -0-     11,006   19,368    Mary D. Lancaster
10/09/90     --      -0-     18,037   22,210    Dewey Gaskins
10/10/90     --      -0-      5,287    8,961    Mary D. Lancaster
10/15/90     --      -0-     15,412   26,632    Mary D. Lancaster
10/16/90     --      -0-     16,730   28,080    Mary D. Lancaster
10/17/90     --      -0-      1,529    2,373    Mary D. Lancaster
10/18/90     --      -0-      6,167    9,606    Mary D. Lancaster
10/22/90     --      -0-      7,149   12,137    Mary D. Lancaster
10/23/90     --      -0-     19,525   29,897    Mary D. Lancaster
10/24/90     --      -0-      7,896   12,532    Mary D. Lancaster
10/25/90     --      -0-      8,294   12,804    Mary D. Lancaster
10/29/90     --      -0-     19,184   28,528    (No Signature)
10/30/90     --      -0-     11,500   17,730    (No Signature)
10/31/90   6,784   $6,784      --       -0-     Dewey Gaskins
 8/01/91     --      -0-      6,784    6,784    Dewey Gaskins
 8/01/91     --      -0-     27,421   31,534    Dewey Gaskins
 9/11/91     --      -0-      3,447    6,157    Dewey Gaskins
 9/17/91     --      -0-      4,588    8,402    Dewey Gaskins
 9/19/91     --      -0-      4,517    8,176    Dewey Gaskins
10/10/91     --      -0-     40,477   72,727    Dewey Gaskins
10/15/91     --      -0-     39,632   69,381    Mary D. Lancaster
10/16/91     --      -0-     38,125   66,787    Mary D. Lancaster
10/17/91     --      -0-     39,421   69,278    Mary D. Lancaster
10/21/91     --      -0-     40,135   70,572    Dewey Gaskins
10/22/91     --      -0-     39,694   67,379    Dewey Gaskins
10/23/91     --      -0-     28,387   47,586    Dewey Gaskins

           6,784   6,784    534,778   883,576


As shown above, in 1990 and 1991, Mr. Dewey Gaskins, acting

on behalf of Big Dixie Warehouse, executed 11 of the Forms

MQ-79 filed on behalf of Beaufort Leaf to document trans-

actions at the Big Dixie Warehouse.

     Mr. Gaskins also had a relationship with the Big

Burley Warehouse, but the record does not state the precise
                               - 18 -


nature of that relationship.      The Forms MQ-79 filed on

behalf of Beaufort Leaf report the following transactions

at the Big Burley Warehouse:


                           Resales
      Date           Pounds       Dollars     Executed By

      1/08/90         5,922         $9,890   Jennie E. Tingle
      1/09/90        14,910         24,900   Jennie E. Tingle
      1/10/90        11,168         18,710   Dewey Gaskins
      1/11/90         6,504         10,907   Dewey Gaskins
      1/16/90        20,211         33,788   Jennie E. Tingle
      1/17/90           290            484   Jennie E. Tingle
      1/22/90         3,702          6,193   Dewey Gaskins
      1/23/90         4,218          7,044   Dewey Gaskins
      1/24/90           602          1,014   Dewey Gaskins
      1/25/90         4,550          7,652   Dewey Gaskins
      1/29/90         7,306         12,263   Dewey Gaskins
      1/30/90         6,212         10,418   Dewey Gaskins
     12/06/90        40,136         70,490   Dewey Gaskins
     12/12/90        40,265         70,308   Jennie E. Tingle
     12/13/90           440            770   (No Signature)
      1/30/91        12,030         21,293   Dewey Gaskins

                     178,466       306,124


As shown above, Mr. Gaskins, acting on behalf of Big Burley

Warehouse, executed 10 of the Forms MQ-79 filed by Beaufort

Leaf during 1990 and 1991 to document transactions at the

Big Burley Warehouse.

     It appears that during 1990 and 1991, Mr. Mark Pridgen

had a relationship with Bob Clark's Warehouse, but the

record does not describe the precise nature of that

relationship.   The Forms MQ-79 filed on behalf of Beaufort

Leaf for 1990 and 1991 report the following transactions at

Bob Clark's Warehouse:
                               - 19 -


              Purchases            Resales
 Date      Pounds   Dollars    Pounds    Dollars    Executed By

 7/30/90   42,362    $61,425     --         -0-    Mark Pridgen
 7/31/90     --        -0-      4,474     $6,899   Mark Pridgen
 8/02/90     --        -0-     14,515     22,217   Mark Pridgen
 8/03/90   12,325     17,748     --         -0-    Mark Pridgen
 8/22/90     --        -0-      7,713     11,630   Louise W. Broome
 8/27/90     --        -0-      2,649      4,550   Louise W. Broome
 8/28/90     --        -0-      5,608      9,594   Louise W. Broome
 8/29/90     --        -0-      1,998      3,304   Louise W. Broome
 8/30/90     --        -0-      3,314      5,704   Louise W. Broome
 9/06/90     --        -0-      7,679     13,100   Louise W. Broome
 9/10/90     --        -0-      2,042      3,257   Louise W. Broome
 9/18/90     --        -0-      6,279     11,009   Louise W. Broome
 9/25/90     --        -0-      6,271     10,945   Louise W. Broome
10/04/90     --        -0-     25,297     37,440   Mark Pridgen
10/24/90     --        -0-      2,836      3,511   Mark D. Pridgen
10/29/90     --        -0-      5,717      6,509   Mark D. Pridgen
 7/15/91     --        -0-     63,025     75,630   Louise W. Broome
 9/02/91   63,182    91,614      --         -0-    Louise W. Broome
 9/24/91     --        -0-     63,498     88,262   Mark Pridgen
10/07/91     --        -0-     18,146     33,034   Louise W. Broome
10/09/91     --        -0-      2,973      4,402   Louise W. Broome
10/21/91     --        -0-      1,650      2,521   Louise W. Broome

           117,869   170,787   245,684   353,519


As shown above, during 1990 and 1991, Mr. Mark Pridgen,

acting on behalf of Bob Clark's Warehouse, executed eight

of the Forms MQ-79 filed on behalf of Beaufort Leaf to

document transactions at Bob Clark's Warehouse.

     It is not evident from the record of this case

whether any of the 247 transactions set out on the list

of undeposited checks, including the 81 transactions at

the Big Dixie Warehouse and Bob Clark's Warehouse, were

reported in any of the Forms MQ-79 filed on behalf of

Beaufort Leaf.
                             - 20 -


     The second adjustment to Beaufort Leaf's 1990 and 1991

returns that was made by respondent in the subject notices

of deficiency is the disallowance of certain purchases

included as cost of goods.    The explanation of that

adjustment in the notices of deficiency is as follows:


          The amount of $1,057,163.00 and
     $2,173,562.00 [sic] shown on your respective
     1990 and 1991 tax returns as tobacco purchases
     is reduced by $429,421.00 and $1,173,203.00
     because it has not been established that any
     amount more than $627,742.00 and $1,000,359.00
     was for an ordinary and necessary business
     expense, or was expended for the purpose
     designated. Therefore, the partnership
     income is increased $429,421.00 in 1990 and
     $1,173,203.00 in 1991.


We note that Beaufort Leaf's 1991 return includes purchases

of $2,713,562.46 in computing cost of goods sold, rather

than "$2,173,562.00", as stated in the notices of

deficiency.   Set out below is a list of the date, check

number, payee, and amount of each check disallowed by

respondent:
                       - 21 -


               1990 Disallowed Purchases

 Date      Check No.          Payee           Amount

 1/17/90    2777       Blue Ridge Tobacco   $9,500.00
 1/17/90    2778       Blue Ridge Tobacco    9,500.00
 1/21/90    2782       Blue Ridge Tobacco    9,500.00
 1/21/90    2783       Blue Ridge Tobacco    9,500.00
 1/21/90    2785       Blue Ridge Tobacco    9,500.00
 1/21/90    2786       Blue Ridge Tobacco    9,500.00
 1/21/90    2787       Blue Ridge Tobacco    9,500.00
 1/21/90    2788       Blue Ridge Tobacco    7,717.70
 1/31/90    2797       Blue Ridge Tobacco    7,000.00
 1/31/90    2798       Blue Ridge Tobacco    7,012.14
 1/31/90    2799       Blue Ridge Tobacco    5,100.00
 1/31/90    2800       Blue Ridge Tobacco    4,710.92
 2/28/90    2810       James V. Wells        8,000.00
 2/28/90    2811       Blue Ridge Tobacco    8,000.00
 2/28/90    2812       Blue Ridge Tobacco    8,000.00
 2/28/90    2813       Blue Ridge Tobacco    7,908.00
 6/29/90    2844       Blue Ridge Tobacco   93,000.00
 9/24/90     545       Blue Ridge Tobacco    1,700.00
11/22/90     586       Blue Ridge Tobacco    8,000.00
11/22/90     587       Blue Ridge Tobacco    2,021.25
12/19/90     643       James Vaughn          9,000.00
12/19/90     644       Albert Vaughn         9,000.00
10/03/90     553       Coastal Tobacco       7,000.00
10/04/90     554       Coastal Tobacco       8,000.00
10/05/90     555       Coastal Tobacco       9,500.00
10/05/90     558       Coastal Tobacco       8,746.72
10/09/90     566       Coastal Tobacco       9,000.00
10/10/90     567       Coastal Tobacco       8,000.00
10/17/90     577       Coastal Tobacco       9,000.00
10/17/90     578       Coastal Tobacco       9,000.00
10/17/90     579       Coastal Tobacco       9,000.00
10/25/90     591       Coastal Tobacco       9,500.00
12/04/90     635       Graham Day           54,004.08
12/14/90     640       Tammy Short           9,000.00
12/14/90     639       Dennis Hawley         9,000.00
12/21/90     646       Dennis Hawley         9,000.00
12/26/90     652       Dennis Hawley         9,000.00

                                            429,420.81
                              - 22 -


                     1991 Disallowed Purchases

      Date      Check No.           Payee            Amount

     8/22/92       836        Coastal Tobacco        $9,800
     8/22/91       837        Coastal Tobacco         9,800
     8/23/91       838        Coastal Tobacco         3,700
     8/28/91       847        Coastal Tobacco         9,800
     8/03/91       854        Cash                    9,000
     8/03/91       855        Cash                    9,000
     9/03/91       856        Coastal Tobacco           571
     9/30/91       881        Martin Lee              9,500
    10/01/91       882        Martin Lee              9,500
    10/01/91       883        Martin Lee              4,991
    10/09/91       897        Martin Lee              9,800
    10/09/91       898        Martin Lee              9,800
    10/10/91       899        Martin Lee              8,000
    10/18/91       910        Martin Lee              9,800
    10/18/91       911        Martin Lee              9,800
    10/18/91       912        Martin Lee              9,800
    10/18/91       913        Martin Lee              5,541
    11/20/91       939        Okay Leaf             200,000
    12/19/91       953        Okay Leaf             200,000
    12/31/91       963        Okay Leaf             150,000
    12/12/91       954        Coastal Tobacco        35,000
    12/31/91       962        C.L. Gurganus Whse    100,000

                                                    823,203

    Accounts payable--"OK Leaf"                     350,000

                                                   1,173,203


    On his income tax returns for 1990 and 1991, each

petitioner included one-third of the net income reported

by Beaufort Leaf.    Mr. Pridgen's returns were prepared by

the certified public accounting firm of Anthony & Tabb or

its predecessor.    Mr. Gaskins' returns were prepared by a

certified public accountant, Mr. Frank Harper.

    The two adjustments that respondent made to Beaufort

Leaf's 1990 and 1991 returns, described above, increased

the partnership's income and increased each partner's
                            - 23 -


one-third distributive share of the partnership's income

by the following amounts:

                                        1990        1991

   Amount reported                    $47,205      $46,953
   Unreported gross receipts          888,528    1,054,576
   Disallowed purchases               429,421    1,173,203

   Adjusted income                   1,364,154   2,274,732

   One-third share                    455,051      758,244
   Less: amounts reported              15,735       15,651

   Increase in partner's share         439,316     742,593


     Based on the adjustments to the partnership's income,

respondent issued a notice of deficiency to each petitioner

adjusting his individual income as follows:


     Mr. Pridgen                        1990         1991

Share of partnership income          $439,316      $741,498
Self-employment tax deduction            (461)       (1,027)
Deduction for exemptions                              4,300

  Total adjustments                   438,855       744,771

Reported income                        56,863        64,890

Adjusted income                       495,718       809,661
                             - 24 -


     Mr. Gaskins                      1990           1991

Share of partnership income      $439,316          $742,593
Self-employment tax deduction      (1,635)           (4,971)
Deduction for exemptions                              8,600

  Total adjustments               437,681           746,222
Reported income                    27,753            42,626

Adjusted income                   465,434           788,848


                              OPINION
Unreported Sales

     The first issue for decision is whether unreported

income in the amount of $888,528 in 1990 and $1,054,576 in

1991 should be included in Beaufort Leaf's gross receipts,

as determined by respondent.    If Beaufort Leaf's gross

receipts are increased as determined by respondent, then a

one-third distributive share of the additional partnership

income attributable to this adjustment is includable in the

income of each petitioner.    See sec. 702(a); United States

v. Basye, 410 U.S. 441, 453-454 (1973).

     Petitioners advance two arguments in support of their

position that respondent erred by increasing Beaufort

Leaf's gross receipts.   First, they argue that the sales

that are the source of the unreported income were outside

the scope of the business of Beaufort Leaf.    Accordingly,

petitioners argue that the unreported income is the income

of Mr. Roberts, not the income of Beaufort Leaf, and there
                           - 25 -


is no basis to assess tax on the unreported income against

petitioners as partners of Beaufort Leaf.   In support of

this argument, petitioners assert that the unreported

income was derived from "illegal sales of nonexistent or

over-quota tobacco * * * contrary to Federal law" and were

made by Mr. Roberts without the knowledge, consent, or

ratification of petitioners.

     According to petitioners, under North Carolina

partnership law, activities are outside the scope of the

partnership unless expressly authorized by the partnership

agreement or the other partners.    See, e.g., Shelton v.

Fairley, 356 S.E.2d 917 (N.C. Ct. App. 1987); Investors

Title Ins. Co. v. Herzig, 350 S.E.2d 160 (N.C. Ct. App.

1986), revd. on other grounds 360 S.E.2d 786 (N.C. 1987);

see also Reed Coal Co. v. Fain, 89 S.E. 29 (N.C. 1916).

Petitioners assert that Beaufort Leaf's oral partnership

agreement did not authorize Mr. Roberts to engage in such

illegal activities.   Thus, petitioners argue that the

income realized is not includable in Beaufort Leaf's gross

receipts.

     In further support of this argument, petitioners

assert that neither Beaufort Leaf nor petitioners knew of

or received any economic benefit from Mr. Roberts' illegal

sales of tobacco, and, therefore, only Mr. Roberts is
                           - 26 -


subject to tax on the income from such sales.   Petitioners

rely on Commissioner v. Smith, 285 F.2d 91 (5th Cir. 1960),

affg. Griffin v. Commissioner, T.C. Memo. 1958-210.     The

taxpayer in that case had received "over-ceiling payments"

from the purchasers of bottled whiskies.   See id. at 92.

The whiskies were owned by partnerships of which the

taxpayer was a partner.   See id.   The Court of Appeals

affirmed the finding of this Court that the "overceiling

payments" were income to the taxpayer and not to the

partnerships.   See id. at 98.   Petitioners argue that the

Court of Appeals "ruled that there was no evidence

suggesting that the partnership agreement in question

'comprehended' illegal transactions or 'entitled' the

other partners 'to part of the illegal payments * * *'".

(Petitioners' brief quoting from Commissioner v. Smith,

285 F.2d, supra at 97.)

     Second, petitioners argue that, even if the Court

finds that the unreported income was partnership income,

it was derived by Mr. Roberts from illegal activities,

involving the "sale of excess or non-existent quota

tobacco", and respondent has failed "to establish any

foundation linking petitioners with the underlying illegal

activity."   Petitioners cite Williams v. Commissioner, 999

F.2d 760, 764 (4th Cir. 1993), affg. T.C. Memo. 1992-153;
                           - 27 -


Portillo v. Commissioner, 932 F.2d 1128 (5th Cir. 1991),

affg. in part and revg. in part T.C. Memo. 1990-68;

Petzoldt v. Commissioner, 92 T.C. 661 (1989); and Tokarski

v. Commissioner, 87 T.C. 74 (1986).   Petitioners

acknowledge that there is evidence linking the unreported

income to Beaufort Leaf, such as the fact that each of the

undeposited checks for 1991 was made payable to Beaufort

Leaf.   Nevertheless, petitioners argue that such evidence

is not sufficient to satisfy respondent's burden of proof

under the cases cited above.   According to petitioners,

respondent must introduce "significantly more compelling

evidence, such as proof that the Petitioners received the

proceeds of Robert's [sic] over-quota transactions."

     At the outset, we note that there is evidence that,

during the years in issue, Mr. Roberts joined a group

of persons headed by Mr. James V. Wells to engage in a

fraudulent scheme to acquire and sell excess-quota tobacco.

In paragraph 5(d) of both petitions, petitioners describe

the scheme as a widespread scheme, involving Mr. Roberts

and "numerous other bogus dealers and/or legitimate

dealers".   Paragraph 5(d) of the subject petitions states

as follows:


          In 1990 and 1991, the managing partner
     entered into an illegal scheme to fraudulently
                           - 28 -


     use Dealer Books, MQ-79, of the Company for his
     own personal gain. Roberts became involved with
     numerous other bogus dealers and/or legitimate
     dealers to defraud the U.S. Department of Agri-
     culture by selling excess quota or nonexistent
     quota. The bogus dealers and/or legitimate
     dealers conspired to create nonexistent quota by
     entering false purchases on the bogus dealer's
     MQ-79 dealer books. The participants then
     secured tobacco inventory directly from farmers
     who had produced excess farm quota. These were
     cash transactions. With the actual receipt of
     new tobacco and a MQ-79 dealer book reflecting
     legitimate purchases the various bogus and
     legitimate dealers were able to sell excess
     quota and profit there from [sic].


Respondent admitted that Mr. Roberts engaged in the above

"illegal scheme" but denied that he did so "for his own

personal gain."

     In order to describe the scheme further, petitioner

introduced into evidence the report of an agent of the

Internal Revenue Service who audited Mr. Wells' returns

for 1988 through 1991.   That report describes the scheme

as follows:


     Wells is believed to be a key figure in a
     fraudulent scheme within the tobacco industry.
     The source of the omitted income is excess
     tobacco which is sold via a tobacco dealer card.
     Because tobacco is a highly regulated commodity,
     the sales of excess tobacco (without imposition
     of penalty on the farmer's subsequent year quota)
     are illegal. Wells uses individuals and
     corporate entities as nominees and/or alter egos.
     No one in the conspiracy reports the receipts.
     Essentially, the fraud is perpetrated by
     fictitious purchases on the tobacco dealer's
                      - 29 -


weekly report to the Agricultural Stabilization
and Conservation Service (ASCS). Against these
purchases the dealer is allowed sales at auction
of an equal number of pounds. In actuality, it
is the excess tobacco purchased from farmers that
is sold on the dealer's card.

Wells used individuals by recruiting people to
register with ASCS as a dealer in tobacco, which
allowed them to purchase and resell tobacco.
Primarily, purchases were from individuals and
resales were primarily at warehouses, but a few
exceptions were entered. When the tobacco is
sold at the warehouses, the checks are written
to the dealer who is the owner of record. The
dealers endorse the checks and turn them over
to Wells or one of his nominees/alter egos who
handled his money. Often they would cash the
checks and turn the cash over to Wells or one
of his moneymen. Alternatively, the check will
be deposited into a nominee/alter ego corporate
account, or the warehouse check may be endorsed
over to a co-conspirator, or used directly to
purchase an asset.

The dealers are required to file with ASCS weekly
reports of all their purchases and sales of
tobacco, form MQ-79. Wells and his inner circle
of associates actually prepared and submitted to
ASCS the false MQ-79's. A few of the individuals
in the conspiracy were Bud Howard, Albert Earl
Vaughan, James Brake, Rodney Howard, Graham Lee
Day, Milton J. Elder, Ronald Bowen, Harvey Moore
and Harry Lee Roberts.

          *   *   *   *   *    *   *

In addition, other individuals and their
controlled corporations were used to launder
money and/or hold assets. These include:

     Harry Lee Roberts and Beaufort Leaf Tobacco
     Dennis Hawley and Coastal Tobacco Co.
     C. L. Gurganus and Gurganus Tobacco Warehouse
     H. D. Pegram and Pegram Tobacco Co.
                           - 30 -


     According to the audit report involving Mr. Wells,

various checks made payable to Beaufort Leaf were deposited

into accounts controlled by Mr. James V. Wells.      Set out

below are the dates, amounts, and payors of these checks:


Centura (Planters) Bank Account:

  Date       Amount           Payor                    Payee

 9/26/91   $7,265.90    Farmers Whse               Beaufort   Leaf
 9/26/91    5,424.50    Farmers Whse               Beaufort   Leaf
 9/24/91    6,685.14    New Independent     Whse   Beaufort   Leaf
 9/24/91    4,553.33    New Independent     Whse   Beaufort   Leaf
 9/23/91    5,043.50    New Independent     Whse   Beaufort   Leaf
 9/23/91    6,957.42    New Independent     Whse   Beaufort   Leaf
 9/23/91    4,982.96    New Independent     Whse   Beaufort   Leaf
 9/23/91    4,892.93    New Independent     Whse   Beaufort   Leaf
 9/25/91    6,391.56    New Independent     Whse   Beaufort   Leaf
 9/25/91    5,820.56    New Independent     Whse   Beaufort   Leaf
 9/26/91    2,785.54    New Independent     Whse   Beaufort   Leaf
 9/25/91    6,623.22    Farmers Whse               Beaufort   Leaf
 9/23/91    6,648.22    Farmers Whse               Beaufort   Leaf
 9/23/91    5,686.96    Farmers Whse               Beaufort   Leaf
 9/24/91    6,422.40    Farmers Whse               Beaufort   Leaf

           86,184.14


BB & T Account:

  Date        Amount              Payor                Payee

10/23/91    $5,567.10       Big   Dixie   Whse     Beaufort   Leaf
10/23/91     2,514.26       Big   Dixie   Whse     Beaufort   Leaf
10/23/91     6,549.91       Big   Dixie   Whse     Beaufort   Leaf
10/23/91     6,682.55       Big   Dixie   Whse     Beaufort   Leaf
10/23/91     2,828.85       Big   Dixie   Whse     Beaufort   Leaf
10/23/91     3,609.56       Big   Dixie   Whse     Beaufort   Leaf
10/23/91     5,404.87       Big   Dixie   Whse     Beaufort   Leaf
10/23/91     5,333.97       Big   Dixie   Whse     Beaufort   Leaf
10/23/91     4,347.10       Big   Dixie   Whse     Beaufort   Leaf

            42,838.17
                          - 31 -


First Citizens Bank Account:

  Date        Amount            Payor              Payee

11/06/91    $4,974.55     Big   Dixie Whse     Beaufort   Leaf
11/06/91     6,568.49     Big   Dixie Whse     Beaufort   Leaf
11/06/91     3,079.56     Big   Dixie Whse     Beaufort   Leaf
11/06/91     6,726.40     Big   Dixie Whse     Beaufort   Leaf
11/06/91     5,101.46     Big   Dixie Whse     Beaufort   Leaf
11/06/91     1,081.65     Big   Dixie Whse     Beaufort   Leaf
11/06/91       301.81     Big   Dixie Whse     Beaufort   Leaf
11/06/91     6,723.67     Big   Dixie Whse     Beaufort   Leaf
11/06/91     3,495.18     Big   Dixie Whse     Beaufort   Leaf
11/06/91     4,231.81     Big   Dixie Whse     Beaufort   Leaf
11/06/91     5,910.94     Big   Dixie Whse     Beaufort   Leaf
11/06/91     6,367.52     Big   Dixie Whse     Beaufort   Leaf
11/06/91     2,959.36     Big   Dixie Whse     Beaufort   Leaf
11/06/91     7,190.33     Big   Dixie Whse     Beaufort   Leaf
11/06/91     6,725.89     Big   Dixie Whse     Beaufort   Leaf
11/06/91     1,943.41     Big   Dixie Whse     Beaufort   Leaf
11/06/91     6,549.17     Big   Dixie Whse     Beaufort   Leaf
11/06/91     3,708.50     Big   Dixie Whse     Beaufort   Leaf
11/06/91     1,671.69     Big   Dixie Whse     Beaufort   Leaf
11/06/91     1,794.68     Big   Dixie Whse     Beaufort   Leaf
11/06/91     5,166.51     Big   Dixie Whse     Beaufort   Leaf
11/06/91     2,296.31     Big   Dixie Whse     Beaufort   Leaf
11/06/91     5,062.22     Big   Dixie Whse     Beaufort   Leaf
11/06/91     5,495.07     Big   Dixie Whse     Beaufort   Leaf
11/06/91     4,895.64     Big   Dixie Whse     Beaufort   Leaf
11/06/91     6,437.98     Big   Dixie Whse     Beaufort   Leaf
11/06/91     5,250.06     Big   Dixie Whse     Beaufort   Leaf
11/06/91     2,481.27     Big   Dixie Whse     Beaufort   Leaf
11/06/91     6,109.56     Big   Dixie Whse     Beaufort   Leaf
11/06/91     2,439.72     Bob   Clark's Whse   Beaufort   Leaf
11/07/91     3,490.26     New   Greenville     Beaufort   Leaf
11/07/91     5,947.32     Big   Dixie Whse     Beaufort   Leaf
11/07/91     6,400.79     Big   Dixie Whse     Beaufort   Leaf
11/07/91     5,281.77     Big   Dixie Whse     Beaufort   Leaf
11/07/91     5,677.61     Big   Dixie Whse     Beaufort   Leaf

           159,538.16
                          - 32 -


Respondent concedes that the above checks, totaling

$288,560.47, were included in Beaufort Leaf's unreported

income for 1991, as determined by respondent.    There is no

evidence that any other unreported income was related in

any way to the scheme to sell excess-quota tobacco.

     As a preliminary matter, several comments about the

facts of these cases are in order.    First, we disagree

with petitioners' assertion that the source of all of

the unreported income at issue was the "illegal scheme

engineered by Harry Lee Roberts whereby Roberts was engaged

in numerous sales of over-quota tobacco, in violation of

federal law and Department of Agriculture regulations."

Petitioners assert that respondent's answer acknowledged

that the unreported sales of tobacco were "the direct

result" of the illegal scheme.   Contrary to petitioners'

assertion, respondent's answer admitted only that

Mr. Roberts engaged in such a scheme, but it did not

admit that the scheme was the source of all or any of the

unreported income determined in these cases.    As discussed

above, there is no evidence that any of the unreported

income in 1990 or 1991 was related in any way to the

scheme, except for $288,560 in 1991 that was deposited into

accounts controlled by Mr. Wells.    Even as to this amount,

there is nothing in the audit report involving Mr. Wells
                           - 33 -


which suggests that such amount is not includable in

Beaufort Leaf's gross income in 1991.   In passing, we

note that petitioners do not claim that such amount is a

deductible expense in 1991.

     Second, we do not credit the testimony of each

petitioner suggesting that he did not know of or approve

Beaufort Leaf's participation in the scheme.   Both

petitioners owned or had a financial interest in tobacco

warehouses and were actively engaged in the tobacco

business.   They are knowledgeable and sophisticated members

of the relatively small community of persons who engage in

that business.   We do not believe that Mr. Roberts'

activities in furtherance of the scheme that petitioners

describe as widespread, could have escaped the attention

of both petitioners.   Indeed, we note that some of the

unreported sales were made at the warehouses in which

petitioners had an interest.   Furthermore, we do not

accept the testimony of each petitioner that he agreed

to finance the operation of Beaufort Leaf by cosigning a

note for $300,000 and he took no action to supervise those

operations by reviewing the partnership's Forms MQ-79 or

taking any other action.
                            - 34 -


     Third, we do not accept petitioners' assertion that

Beaufort Leaf or petitioners realized no proceeds of, or

economic benefit from, Beaufort Leaf's participation in

the scheme.   The testimony of both petitioners focuses on

the list of unreported checks for 1991.    Each petitioner

testified that he never received the proceeds or economic

benefit from those specific checks.    Each petitioner also

testified that he did not receive moneys or economic

benefit from Beaufort Leaf other than what is shown on

his income tax returns.    However, the testimony of both

petitioners leaves open the possibility that moneys or

economic benefit was received by other persons or entities

related to them.    It also leaves open the possibility that

moneys or economic benefit was received from someone other

than Beaufort Leaf.

     In sum, petitioners have not established the facts

underlying their argument that the unreported sales

determined by respondent were outside the scope of the

business of Beaufort Leaf or that petitioners did not know

of or receive any economic benefit from the unreported

sales of tobacco.

     We also disagree with petitioners' argument that

respondent failed to meet the Government's burden of

establishing a link between petitioners and the underlying
                           - 35 -


illegal activity.   While it is by no means clear that

respondent bears such a burden in this case, there is ample

evidence that Beaufort Leaf received the unreported income

determined by respondent for 1990 and 1991.    Respondent

determined the unreported income for 1990 on the basis of

the Forms MQ-79 filed by the partnership for that year.

Respondent determined the unreported income for 1991 on the

basis of checks made payable to Beaufort Leaf and given to

the partnership's managing partner.    Petitioners admit

that they were partners in Beaufort Leaf and as partners

received withdrawals of moneys from the partnership.     In

light of those facts, which are not disputed, there is no

basis to conclude that there is an inadequate evidentiary

foundation for respondent's determination of unreported

income in the subject notices of deficiency or that the

notices of deficiency are arbitrary or without rational

foundation.   Cf. Williams v. Commissioner, 999 F.2d 760

(4th Cir. 1993); Portillo v. Commissioner, 932 F.2d 1128

(5th Cir. 1991).


Substantiation of Purchases

     We turn to the second issue.     Petitioners take the

position that respondent erred in reducing Beaufort Leaf's

cost of goods sold by disallowing purchases in the amount
                             - 36 -


of $429,421 in 1990 and $1,173,203 in 1991.   Petitioners

acknowledge that "they bear the burden of proof as to

substantiation", but they claim in their posttrial brief

to have substantiated the subject purchases based upon the

following grounds:

     (1)   All of the disallowed checks "were issued to

individuals or entities that were known tobacco vendors."

     (2)   The Forms MQ-79 filed on behalf of Beaufort Leaf

"list tobacco pounds for the transactions challenged by

Respondent that correspond to the pounds of tobacco

represented by the disallowed purchases."

     (3)   The subject checks were honored by the banks at

which they were presented.

     (4)   Beaufort Leaf's accountant, Mr. Dawson,

testified that the account payable from Okay Leaf of

$350,000 was for tobacco purchases and that testimony is

corroborated by the Forms MQ-79 which show tobacco

purchases from Okay Leaf in 1991 in excess of $700,000.

     (5)   All available books and records of Beaufort Leaf

properly record the disputed transactions as purchases of

tobacco.

     We do not agree that petitioners have substantiated

the amounts disallowed by respondent as purchases of

tobacco.   None of the points that they advance prove that
                           - 37 -


any of the disallowed checks or the accounts payable to

Okay Leaf was used to purchase tobacco.   Petitioners'

evidence in the form of the audit report covering

Mr. Wells' returns for 1988 through 1991 suggests that

Beaufort Leaf sold excess-quota tobacco after having filed

fraudulent Forms MQ-79 and paid some of the proceeds of

the sales to Mr. Wells or members of his organization.

The checks disallowed by respondent are payable to persons

identified in the audit report as persons associated with

Mr. Wells.   The same is true of the account payable to

Okay Leaf, a company identified in the audit report as

controlled by Mr. Wells.   Therefore, petitioners' own

evidence suggests that the Forms MQ-79 filed by Beaufort

Leaf were falsified to document purchases of tobacco when,

in fact, purchases of tobacco were not made by Beaufort

Leaf.   The audit report suggests that the checks were

issued to persons related to Mr. Wells in order to transmit

proceeds of the scheme to Mr. Wells.   Furthermore, we note

that petitioners did not seek testimony from any of the

check payees or Okay Leaf to show the nature of the

payments made.   See Wichita Terminal Elevator Co. v.

Commissioner, 6 T.C. 1158 (1946), affd. 162 F.2d 513

(10th Cir. 1947).   We also note that petitioners do not

claim that the checks were paid for any purpose other
                            - 38 -


than to purchase tobacco or that they are deductible in

connection with an activity other than Beaufort Leaf's

business of purchasing and selling tobacco.    Cf. Brizell

v. Commissioner, 93 T.C. 151 (1989).


Penalties and Additions to Tax

     The third issue for decision is whether petitioners

are liable for the penalties and addition to tax determined

in the notices of deficiency.    Respondent determined an

accuracy-related penalty under section 6662(a) with respect

to each petitioner's returns for 1990 and 1991.    Section

6662 imposes a penalty of 20 percent of the portion of an

underpayment of tax related to, inter alia, "Negligence or

disregard of rules or regulations" or "Any substantial

understatement of income tax".    For this purpose, the term

"negligence" includes any failure to make a reasonable

attempt to comply with the provisions of the income tax,

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

or intentional disregard.   Sec. 6662(c).   In substance,

an understatement of income tax is the excess of the

amount of tax required to be shown on the taxpayer's return

over the amount that is shown on the return.    See sec.

6662(d)(2)(A).   A substantial understatement is defined

by section 6662(d)(1)(A) as an understatement exceeding
                            - 39 -


the greater of "10 percent of the tax required to be shown

on the return for the taxable year, or * * * $5,000."

     Petitioners' answering brief addresses the penalties

under section 6662(a) determined by respondent in the

following sentence:


     Finally, if the Court rules in favor of the
     Respondent, the Petitioners request that the
     Court waive penalties and interest associated
     with the understatement of income as the
     Petitioners filed their tax forms in good faith,
     reasonably relying on the managing partner and
     the partnership bookkeeper's expertise to file
     a complete and accurate tax return for the
     partnership.


This Court has jurisdiction over interest determinations

to the limited extent provided by section 7481(c), which

is not applicable here.   Nor does section 6404(i) apply in

the absence of a determination by respondent not to abate

interest.   See Melin v. Commissioner, 54 F.3d 432 (7th Cir.

1995).   Therefore, we shall not consider petitioners'

request that this Court "waive" the "interest associated

with the understatement."

     We interpret petitioners' request that this Court

"waive penalties * * * associated with the understatement"

as an assertion that they qualify to be relieved of

liability for the subject penalties under the reasonable
                           - 40 -


cause exception set forth in section 6664(c).   Section

6664(c)(1) provides as follows:


     (1) In General.--No penalty shall be imposed
     under this part with respect to any portion of
     an underpayment if it is shown that there was a
     reasonable cause for such portion and that the
     taxpayer acted in good faith with respect to
     such portion.


Petitioners have not shown that there was reasonable cause

for the underpayment in this case or that they acted in

good faith.   In this regard, we point to the earlier

discussion in this opinion in which we did not accept

petitioners' testimony that they did not know of or

approve Beaufort Leaf's participation in the scheme.

     Respondent also determined that Mr. Gaskins is liable

for an addition to tax under section 6651(a)(1) for failing

to timely file his 1991 tax return on the ground that the

return was filed after October 15, 1992, the due date of

the return.   Respondent's determination is based upon the

postmark on the envelope in which Mr. Gaskins' return was

mailed to the Internal Revenue Service.   Petitioners did

not address this issue at trial or mention it in their

posttrial briefs.   Accordingly, we hereby sustain

respondent's determination and find Mr. Gaskins liable

for the addition to tax under section 6651(a)(1).
                     - 41 -


In light of the foregoing,


                             Decisions will be entered

                      for respondent.
