                        T.C. Memo. 2003-325



                      UNITED STATES TAX COURT



      RICKY SCHMIDT AND SUZETTA J. SCHMIDT, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent

               HILLSIDE DAIRY, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 5267-01, 5268-01.       Filed November 25, 2003.



     Douglas Bleeker, for petitioners.

     Douglas Polsky and Charles Berlau, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     JACOBS, Judge:   These cases have been consolidated for

trial, briefing, and opinion.   In separate notices of deficiency,

respondent determined deficiencies in petitioners’ Federal income
                                  - 2 -

tax and accuracy-related penalties under section 66621 for 1995,

1996, and 1997 as follows:

Ricky & Suzetta Schmidt, Docket No. 5267-01:

                                           Penalty
          Year       Deficiency           Sec. 6662(a)

          1995         $4,550                 --
          1996          3,715                 --
          1997          2,827                 --

Hillside Dairy, Inc., Docket No. 5268-01:

          Year                             Penalty
          Ended      Deficiency           Sec. 6662(a)

          11/30/95     $2,179               $435.80
          11/30/96      2,698                539.60
          11/30/97      1,846                369.20

     The issues for decision are:

     (1) Whether amounts paid by Hillside Dairy, Inc. (Hillside

Dairy or the corporation), to provide medical care, food, and

lodging to its shareholders, Ricky Schmidt (Mr. Schmidt) and

Suzetta J. Schmidt (Mrs. Schmidt) (collectively the Schmidts),

and their children are (a) constructive dividends, as respondent

maintains, or (b) employee medical care expenses and/or

reimbursed employee expenses that are excluded from the Schmidts’

gross income and deductible by Hillside Dairy as ordinary and

necessary business expenses, as petitioners maintain; and




     1
      All section references are to the Internal Revenue Code in
effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
                                - 3 -

     (2) whether Hillside Dairy is liable for the accuracy-

related penalty under section 6662(a) for the taxable years ended

November 30, 1995, 1996, and 1997.

                          FINDINGS OF FACT

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

The stipulation of facts and the attached exhibits are

incorporated herein by this reference.

     When the petitions were filed in these cases, the residence

of the Schmidts, as well as the principal place of business of

Hillside Dairy, was in Parker, South Dakota.

A.   The Schmidts

     The Schmidts are husband and wife; they have two children.

In March 1981, the Schmidts entered into a contract for deed to

acquire 20 acres (the homestead).2      The homestead includes a

house (the farmhouse), where the Schmidts have resided since

1981.    Between February 1985 and January 1986, the Schmidts

acquired 140 additional acres adjoining the homestead.      The

homestead and the 140 acres are referred to collectively as the

Schmidt farm.    The Schmidt farm consists of pasture, farmland,

and cow lots.    A dairy barn, machine sheds, grain bins, and feed

grain bulk bins, as well as the farmhouse, are located on the

Schmidt farm.



     2
      The homestead was Mr. Schmidt’s childhood home where he
lived with his parents until he married Mrs. Schmidt in 1974.
                                 - 4 -

     The Schmidts raise corn and operate a dairy on the Schmidt

farm.    In the dairy operation, cows are milked twice daily.     In

addition, the cows are bred once a year (usually in the winter).

When the cows are calving (especially with first-time calving

heifers), they must be checked at least every 4 hours, usually on

a 24-hour basis.

     In addition to the Schmidt farm, Mr. Schmidt individually

owns 80 additional acres which he acquired in 1987.    The 80 acres

are farmed by Mr. Schmidt as a sole proprietor.

B.   Hillside Dairy

     On January 7, 1993, Hillside Dairy was incorporated under

the laws of the State of South Dakota.3    Hillside Dairy was

organized primarily to raise grain and operate a dairy.

        The Schmidts have been the sole shareholders, officers, and

directors of Hillside Dairy since its incorporation.     Mr. Schmidt

has been president, treasurer, and a director, and Mrs. Schmidt

has been vice president, secretary, and a director, of Hillside

Dairy.

        Article IV, section 10, of the bylaws of Hillside Dairy

provides:

          SECTION 10. Repayment of Disallowed Expenses.
     Any expense paid by the Corporation which is finally
     determined as a personal expense of any officer or
     employee and disallowed as Corporation expense shall be

     3
      Douglas Bleeker, counsel for petitioners, prepared the
articles of incorporation, bylaws, minutes of meetings, and other
corporate documents for Hillside Dairy.
                               - 5 -

     repaid by the officer or employee to the Corporation
     within Twenty-four (24) months of the final
     determination by the Internal Revenue Service with
     interest at Three (3%) below the New York Prime Rate on
     the date of final determination.

     A similar repayment obligation was set forth in a resolution

adopted by the board of directors of Hillside Dairy at the

directors’ first meeting, held on January 10, 1993.   At that

meeting, the directors also adopted the following resolution:

          RESOLVED that the corporation [sic] officers and
     employees shall be required to live at the worksite of
     the corporation to ensure security for the corporation
     property and operations. The officers and employees
     shall be required to live on the worksite to supervise
     the care and feeding of the livestock of the
     corporation. The corporation shall supply said
     officers and employees all of their food and lodging
     while living at said worksite. That all officers and
     employees shall be considered on duty when at the
     worksite and therefore entitled to such benefits.

     In addition, at their first meeting, the directors adopted a

medical reimbursement plan covering all “employees and officers

executing management responsibilities” and their spouses and

dependents.   The medical reimbursement plan provides for the

payment of all medical expenses “deductible on Form 1040”,

including expenses for drugs, doctor, hospital, and eyeglasses,

to the extent not compensated by insurance or otherwise.   Under

the plan, each participant is entitled to a maximum reimbursement

of $10,000 per year.   Hillside Dairy also paid the premiums on a

health insurance policy covering the Schmidts and their children.
                                - 6 -

     On January 25, 1993, the Schmidts conveyed to Hillside Dairy

their interest in the Schmidt farm, including the farmhouse.4

Hillside Dairy raises corn and maintains between 30 and 35

milking cows (half owned by the corporation and the other half by

Mr. Schmidt individually).

     On August 9, 1994, Mr. Schmidt acquired a one-fourth

interest as a tenant in common in 166 acres located approximately

1 mile from the Schmidt farm.    On November 30, 1994, Mr. Schmidt

conveyed his interest in the 166 acres to Hillside Dairy by

warranty deed.    On the same date, the other three tenants in

common transferred their interests in the property to Hillside

Dairy.

C.   Farm Lease

     Hillside Dairy leased the Schmidt farm and the 166 acres to

Mr. Schmidt under a written agreement titled “Farm Lease”, dated

December 1, 1995.    The initial term of the lease was 1 year (to

November 30, 1996); the lease continued on a year-to-year basis

until otherwise canceled.    During the years at issue, Hillside

Dairy leased a pasture to a neighbor of Mr. Schmidt.

     Mr. Schmidt agreed to pay $6,000 rent to Hillside Dairy for

the use of “the building site and improvements”.    In addition,



     4
      The Schmidts held   their interest in the homestead under a
contract for deed until   January 1998. In January 1998, the
Schmidts acquired title   to the homestead. In April 1998, the
Schmidts conveyed title   of the homestead to Hillside Dairy.
                                - 7 -

Hillside Dairy was to receive all of the gross proceeds from the

sales of crops grown on the farm, as well as all payments

received under Federal conservation programs (or any other

Federal, State, or local governmental programs).    Hillside Dairy

supplied all of the fertilizer, chemicals, and seed necessary to

plant and treat the crops.5

     Mr. Schmidt agreed (1) to farm the land; (2) to protect the

crops from injury and waste; (3) to till the land after

harvesting the crops; and (4) to rotate the crops from year to

year.    Hillside Dairy agreed to furnish all tools, farm

implements, machinery, and hired help necessary to cultivate and

manage the farm.    Hillside Dairy agreed to furnish all necessary

materials, and the Schmidts agreed to supply all necessary labor,

to maintain all fences and other improvements.

     Mr. Schmidt was permitted to use the corporation’s combine

and tractor on the land he owned individually.    He also had use

of one of the pastures.

D.   Mr. Schmidt’s Separate Farming Activity

     During the years at issue, Mr. Schmidt individually (and not

as an employee of Hillside Dairy) farmed land that was not owned

by Hillside Dairy.    He kept his personal grain separate from that


     5
      Although a contradictory provision required Mr. Schmidt to
“provide all seed, labor, and other expenses of producing,
harvesting, and marketing crops”, Hillside Dairy in fact paid all
those expenses and deducted the costs in computing its income.
                               - 8 -

of the corporation.   In addition, Mr. Schmidt had a dairy

operation separate from that of the corporation.   Mr. Schmidt

also did custom hire work for his brother on land approximately

4-1/2 miles from the Schmidt farm.

E.   Compensation and Payment of Food, Lodging, and Medical
     Expenses

     Mr. Schmidt was the sole employee of Hillside Dairy.

Hillside Dairy paid Mr. Schmidt, as an officer/employee, $750 in

1995 and $200 in 1996 and 1997.

     Following the transfer of the Schmidt farm to Hillside

Dairy, the Schmidts continued to use the farmhouse as their

residence.   Hillside Dairy paid for (1) the food consumed by the

Schmidts and their children, (2) the utilities, property tax, and

insurance for the farmhouse, and (3) the cost of some of the

meals consumed by the Schmidts and their children away from the

farmhouse (dining-out expenses).   In addition, Hillside Dairy

paid all the medical care expenses of the Schmidts and their

children.

     Hillside Dairy did not pay dividends for fiscal years ended

November 30, 1995, 1996, and 1997.

F.   Income Tax Returns

     Mr. Schmidt was responsible for keeping the books and paying

bills for Hillside Dairy.   Mr. Bleeker (petitioners’ counsel)
                              - 9 -

prepared the Schmidts’ joint Forms 1040, U.S. Individual Income

Tax Return, and Hillside Dairy’s Forms 1120, U.S. Corporation

Income Tax Return, for the years at issue.

     1.    Hillside Dairy

     Hillside Dairy filed timely its Forms 1120 for the taxable

years ended November 30, 1995, 1996, and 1997.    On these returns,

Hillside Dairy reported total income and total deductions as

follows:

                            11/30/95    11/30/96      11/30/97

     Total income           $54,988     $68,465      $57,679
     Total deductions        54,987      68,465       63,215
      Taxable income/loss         1       -0-         (5,536)

     Included in the total expenses deducted by Hillside Dairy

were the following items for food, lodging, and medical expenses

provided to the Schmidts (amounts are rounded to the nearest

dollar):
                                    - 10 -

                                         11/30/95    11/30/96     11/30/97
  Food & lodging
   Property tax--house                      $523         $400        $388
   Insurance--house                          --           120         132
   Food for employees                      6,724        8,760       8,161
   Utilities--house                        2,567        2,439       2,557
   Depreciation--house                     1,667        1,667       1,667
   Meals & entertainment1                    994        1,338       1,369
    Food & lodging expenses               12,475       14,724      14,274
  Medical
   Medical insurance                      $2,052       $2,286      $1,586
   Medical expenses                         –-            978       1,985
   Medical costs                           2,052        3,264       3,571

          1
        The meals and entertainment expenses claimed by
  Hillside Dairy included a portion of the Schmidt family’s
  dining-out expenses.

     2.        The Schmidts

     The Schmidts timely filed their joint income tax returns for

1995, 1996, and 1997.         On these returns, the Schmidts reported

Mr. Schmidt’s wages from Hillside Dairy.            They did not report any

income attributable to their food, lodging-related, and medical

expenses paid by Hillside Dairy.          They reported Mr. Schmidt’s

income from his separate farming activities as self-employment

income.       Mr. Schmidt reported gross income, total expenses, and

net profit from his separate farming activities on Schedule F,

Profit or Loss from Farming, for 1995, 1996, and 1997 as follows:

                                 1995         1996              1997

     Gross income              $80,928       $50,634       $75,333
     Total expenses             73,110        47,791        75,261
       Net profit                7,818         2,843            72
                              - 11 -

G.   Notices of Deficiency

     On January 25, 2001, respondent timely mailed to the

Schmidts a statutory notice of deficiency for 1995, 1996, and

1997 (the Schmidt notice of deficiency).   Also on January 25,

2001, respondent timely mailed to Hillside Dairy a statutory

notice of deficiency for its fiscal years ended November 30,

1995, 1996, and 1997 (the Hillside Dairy notice of deficiency).

     In the Hillside Dairy notice of deficiency, respondent

disallowed the food, lodging, and medical expenses deducted by

Hillside Dairy, totaling $14,527 for 1995, $17,988 for 1996, and

$17,845 for 1997.   Respondent determined that (1) Hillside Dairy

failed to establish that the food and lodging expenses were

ordinary and necessary business expenses under section 162 and

(2) those items were the Schmidts’ personal expenses.

Respondent further determined that Hillside Dairy was liable for

the accuracy-related penalty under section 6662(a).

     In the Schmidt notice of deficiency, respondent determined

that payments by Hillside Dairy of the Schmidts’ food, lodging,

and medical expenses resulted in constructive dividends as

follows:
                                  - 12 -

                                   11/30/95   11/30/96   11/30/97

     Food & lodging1               $13,470    $15,722    $15,272
     Medical                         2,052      3,264      3,571
      Total dividends               15,522     18,986     18,843
             1
           The record does not explain why the amounts of
     dividends for food and lodging expenses included in the
     Schmidts’ income exceed the amounts disallowed as
     deductions to Hillside Dairy.

                                  OPINION

Issue 1.   Expenses Incurred by Hillside Dairy To Provide Medical
           Benefits, Food, and Housing to the Schmidts in 1995,
           1996, and 1997

A.   Positions of the Parties6

     Respondent disallowed deductions taken by Hillside Dairy for

medical costs (health insurance premiums and other medical care

expenses), food, lodging (including property insurance, property

taxes, and utilities for the farmhouse), and depreciation of the

farmhouse.       Respondent asserts that the medical costs, food, and

lodging expenses are the Schmidts’ personal, family, and living


     6
      Under certain circumstances, sec. 7491 places the burden of
proof or production on the Commissioner. Sec. 7491 applies to
court proceedings arising in connection with tax examinations
beginning after July 22, 1998. Internal Revenue Service
Restructuring and Reform Act of 1998, Pub. L. 105-206, sec.
3001(a), 112 Stat. 726. Petitioners timely filed their returns
for the years at issue. Hence, all of the returns were filed on
or before Apr. 15, 1998. The record does not disclose when the
examination of petitioners’ tax returns began, and it is possible
that the examination began before July 23, 1998. Petitioners do
not contend that sec. 7491 applies in these cases, and they have
not otherwise asserted that respondent has the burden of proof or
production with respect to any issue presented in these cases.
We therefore conclude that sec. 7491 does not apply, and
petitioners have the burden of proof and production.
                              - 13 -

expenses and that payments of these expenses by Hillside Dairy

constitute constructive dividends to the Schmidts.   On the other

hand, petitioners assert that all the expenditures are reasonable

and necessary business expenses, deductible by Hillside Dairy and

excluded from the Schmidts’ income.

     Petitioners contend that the medical costs are employee

benefits, deductible by the employer and excludable from the

employee’s income under sections 105 and/or 106.   Petitioners

further maintain that Hillside Dairy provided food and lodging to

Mr. Schmidt in his capacity as an employee and that such was done

for the convenience of Hillside Dairy.   Consequently, petitioners

assert that the food and lodging expenses are employer-provided

“meals and lodging”, the costs for which are excluded from the

Schmidts’ income under section 119 and deductible by Hillside

Dairy.   Petitioners further assert that, as owner and lessor of

the farmhouse, Hillside Dairy is entitled to deduct (1) the

expenditure for insurance on the farmhouse as a reasonable and

necessary business expense under section 162, (2) the property

taxes under either section 162 or 164, and (3) the depreciation

of the farmhouse under section 167.    Petitioners posit that these

latter expenses are not the Schmidts’ personal expenses because

they are not the owners of the property.
                               - 14 -

     B.     Medical Expenses

     We first shall decide whether the payments by Hillside Dairy

of the medical expenses are excludable from the Schmidts’ gross

income under sections 105 and 106 and deductible by the

corporation as ordinary and necessary business expenses under

section 162(a).

     Under section 106, “an employee’s gross income does not

include employer-provided coverage (e.g., accident and health

insurance premiums) under an accident and health plan.”    Rugby

Prods. Ltd. v. Commissioner, 100 T.C. 531, 535 (1993).    The

employer may provide coverage under an accident or health plan by

paying the premium (or a portion of the premium) on an accident

or health insurance policy covering one or more employees or by

contributing to a separate trust or fund.   Sec. 1.106-1, Income

Tax Regs.

     Under the general rule of section 105(a), amounts received

by an employee through accident and health insurance for personal

injury or sickness, to the extent attributable to nontaxed

employer contributions, are includable in the employee’s gross

income.   Amounts received under an accident or health plan for

employees are treated as amounts received through accident or

health insurance.   Sec. 105(e).   An exception to the general rule

allows an employee to exclude from gross income amounts received

to reimburse the employee for expenses incurred by the employee
                               - 15 -

for the medical care (as defined in section 213(d)7) of the

employee and the employee’s spouse and dependents.    Sec. 105(b).

     For the reasons set forth below, we agree with petitioners

that pursuant to sections 105 and/or 106 payments by Hillside

Dairy for medical expense reimbursements and health insurance

premiums need not be included in the Schmidts’ gross income for

1995, 1996, and 1997.

     Section 105(e) requires first, that the benefits be received

under a “plan”, and second, that the plan be “for employees”,

rather than for some other class of persons such as shareholders

and their relatives.    Larkin v. Commissioner, 48 T.C. 629, 635

(1967), affd. 394 F.2d 494 (1st Cir. 1968).    After giving due

consideration to the record before us, we conclude that Hillside

Dairy’s medical plan (payment of health insurance premiums and

medical expense reimbursements) satisfies both the “plan” and

“for employees” requirements of section 105(e).

     Section 1.105-5(a), Income Tax Regs., provides guidelines as

to what constitutes an accident or health plan.    A plan may cover

one or more employees, and different plans may be established for

different employees or classes of employees.    Id.   The

regulations do not require that there be a written plan or that

there be enforceable employee rights under the plan, so long as



     7
      Sec. 213(d)(1)(D) includes amounts paid for medical
insurance in the definition of medical care.
                              - 16 -

the participant has notice or knowledge of the plan.       Wigutow v.

Commissioner, T.C. Memo. 1983-620.

     In the instant case, a plan (as defined in section

1.105-5(a), Income Tax Regs.) existed.    Hillside Dairy adopted a

written medical reimbursement plan identifying who was eligible

to participate, what expenses would be reimbursed, and how

participants were to make claims for reimbursement.       The plan was

adopted at the first meeting of the board of directors.

     Mr. Schmidt had knowledge of the medical reimbursement plan

as well as the health insurance policy.    Moreover, there is no

doubt that the medical reimbursements provided under the written

plan were intended to complement benefits provided by health

insurance.   Thus, the corporation’s medical plan included health

insurance as well as the medical reimbursements.    And finally, we

are satisfied that the corporation’s medical plan was for Mr.

Schmidt as an employee of Hillside Dairy, and not for his benefit

as one of the corporation’s shareholders.

     Plans limited to employees who are also shareholders are not

per se disqualified under section 105(b).     Larkin v.

Commissioner, supra at 635 n.5.    In this regard, we have

sustained plans for corporate officers who were also shareholders

because those officers had central management roles in conducting

the business of the corporation.     Wigutow v. Commissioner, supra;

Epstein v. Commissioner, T.C. Memo. 1972-53; Seidel v.
                              - 17 -

Commissioner, T.C. Memo. 1971-238; Smith v. Commissioner, T.C.

Memo. 1970-243; Bogene, Inc. v. Commissioner, T.C. Memo.

1968-147.

     Respondent has stipulated that during the years at issue Mr.

Schmidt was an employee of Hillside Dairy.    Indeed, Mr. Schmidt

was the corporation’s only employee.   And without Mr. Schmidt’s

involvement, Hillside Dairy could not have raised its crops or

conducted its dairy operations.

     Mr. Schmidt’s compensation for services rendered to Hillside

Dairy was his salary and employee benefits.   Respondent does not

contend that Mr. Schmidt received excessive compensation.

Indeed, respondent contends that Mr. Schmidt was undercompensated

for his services

     Although Mrs. Schmidt did not work for Hillside Dairy,

payment of her medical expenses was based on her status as Mr.

Schmidt’s spouse.   Likewise, payment of the medical expenses for

the Schmidts’ children was based on their status as Mr. Schmidt’s

dependents.   The derivative participation of Mr. Schmidt’s spouse

and dependents is plainly contemplated both by the medical plan

and by section 105(b).

     On the basis of the record before us, we conclude that

medical payments for the benefit of the Schmidts and their

children were made under a plan for employees and not for

shareholders.   Accordingly, during the years at issue, the
                                - 18 -

medical payments made by Hillside Dairy pursuant to its medical

plan (including the insurance premiums and other medical care

expenditures) are excludable from the Schmidts’ gross income

under section 105(b).

     Section 162(a) permits a taxpayer to deduct all ordinary and

necessary expenses incurred during the taxable year in carrying

on the taxpayer’s trade or business.     An expense is ordinary if

it is customary or usual within a particular trade, business, or

industry or relates to a transaction “of common or frequent

occurrence in the type of business involved.”     Deputy v. du Pont,

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

appropriate and helpful for the development of the business.    See

Commissioner v. Heininger, 320 U.S. 467, 471 (1943).

     When payments for medical care are properly excludable from

an employee’s income because they are made under a “plan for

employees,” they are deductible by the employer as ordinary and

necessary business expenses under section 162(a).    Sec.

1.162-10(a), Income Tax Regs.    Consequently, Hillside Dairy is

entitled to deduct the insurance premiums and medical

reimbursement payments under section 162(a).

C.   Food, Utilities, Property Insurance, Property Taxes, and
     Depreciation

     1.   Section 119:   Employer-Provided Meals and Lodging

     We next decide whether the food (food for employees and

meals and entertainment) and lodging-related expenses (utilities,
                              - 19 -

property insurance, property taxes, and depreciation related to

the farmhouse) qualify as employer-provided meals and lodging

expenses, excludable from the Schmidts’ income under section 119

and deductible by Hillside Dairy under section 162.

     Meals and lodging furnished to an employee by his employer

are excluded from the employee’s gross income under section 119

if the meals and lodging are provided for the convenience of the

employer on the premises of the employer.   In the case of

lodging, the employee must be required to accept the lodging on

the business premises of his employer as a condition of

employment.

     Meals and lodging are furnished for the “convenience of the

employer” if there is a direct nexus between the meals and

lodging furnished and the asserted business interests of the

employer served thereby.   McDonald v. Commissioner, 66 T.C. 223,

230 (1976).   Petitioners assert that Mr. Schmidt, as the

corporation’s sole employee, was required to be available for

duty 24 hours a day.

     Hillside Dairy leased the Schmidt farm to Mr. Schmidt.

Hillside Dairy contracted with Mr. Schmidt as a tenant, not as

its employee, to perform all necessary work.

     It is well settled that “Ordinarily, taxpayers are bound by

the form of the transaction they have chosen; taxpayers may not

in hindsight recast the transaction as one that they might have
                              - 20 -

made in order to obtain tax advantages.”   Framatome Connectors

USA Inc. v. Commissioner, 118 T.C. 32, 70 (2002) (citing Estate

of Leavitt v. Commissioner, 875 F.2d 420, 423 (4th Cir. 1989),

affg. 90 T.C. 206 (1988), and Grojean v. Commissioner, 248 F.3d

572, 576 (7th Cir. 2001), affg. T.C. Memo. 1999-425).   Here,

inasmuch as Mr. Schmidt farmed the Schmidt farm as a tenant, and

not as an employee of Hillside Dairy, the food and lodging in

question were not furnished to Mr. Schmidt as a corporate

employee for the convenience of his employer.   Thus, the food and

lodging expenses at issue are not section 119(a) meals and

lodging expenses.

     2.   Deductibility of Expenses Related to the Leasing of the
          Schmidt Farm

     During the years at issue, Hillside Dairy’s business

activities included leasing the Schmidt farm.   It leased the

farm, including the farmhouse, to the Schmidts and received rent.

Therefore, we look to the terms of the farm lease to determine

whether expenses for insurance, utilities, depreciation, and

taxes are the expenses of Hillside Dairy or the Schmidts.

          a.   Property Insurance

     Hillside Dairy deducted $120 in 1996 and $132 in 1997 for

property insurance.   “Certain business-related insurance expenses

unquestionably are deductible under section 162(a).”    Metrocorp,

Inc. v. Commissioner, 116 T.C. 211, 245 (2001) (citing section

1.162-1(a), Income Tax Regs.).   The farm lease does not require
                                 - 21 -

the Schmidts to provide property insurance covering the farmhouse

or other improvements on the property.     The property insurance is

an ordinary and necessary business expense of Hillside Dairy (the

owner of the property) and not a personal, family, or living

expense of the Schmidts.      We hold, therefore, Hillside Dairy is

entitled to deduct the insurance expenses as claimed in 1996 and

1997.

             b.   Utilities

        Hillside Dairy deducted utilities expenses of $2,567 in

1995, $2,439 in 1996, and $2,557 in 1997.     Utilities expenses may

be deductible under section 162(a) if the expenses incurred are

ordinary and necessary in carrying on a trade or business.

Vanicek v. Commissioner, 85 T.C. 731, 742 (1985); Sengpiehl v.

Commissioner, T.C. Memo. 1998-23; Green v. Commissioner, T.C.

Memo. 1989-599.

        Here, the farm lease did not contain any provisions

regarding the utilities for the farmhouse.     Petitioners did not

produce any utility bills, canceled checks, or testimony to

identify that portion, if any, of the utilities expenses related

to the corporation’s business.     We have no basis for making any

allocation of the expenses.     Thus, petitioners have failed to

establish that Hillside Dairy is entitled to any deduction for

utilities expenses.
                                   - 22 -

            c.      Depreciation

     Hillside Dairy deducted $1,667 in 1995, 1996, and 1997 for

depreciation of the farmhouse.       Section 167(a) allows a

depreciation deduction from gross income for property used in the

taxpayer’s trade or business or held for the production of

income.    Ordinarily, depreciation or amortization is available to

an owner of an asset with respect to the owner’s basis in the

asset.    Hillside Dairy owned the Schmidt farm, including the

farmhouse.       One of the business activities of Hillside Dairy was

the leasing of the Schmidt farm, including the farmhouse.      Thus,

the farmhouse is property used in the corporation’s trade or

business.

     We hold that Hillside Dairy is entitled to a deduction for

depreciation of the farmhouse for each of the years at issue as

claimed.

            d.      Taxes

     Hillside Dairy deducted property taxes of $523 in 1995, $400

in 1996, and $388 in 1997 attributable to the farmhouse.

Hillside Dairy owned the Schmidt farm.       Section 164(a)(1) allows

the owner of property a deduction for real property taxes.      We

hold, therefore, that Hillside Dairy may deduct property taxes as

claimed in the years at issue.
                               - 23 -

            e.   Summary of Food and Lodging Expenses

     To summarize, Hillside Dairy may deduct the following

expenses for the years at issue:

                                 11/30/95       11/30/96   11/30/97

  Property tax--house                $523          $400       $388
  Property insurance--house           --            120        132
  Depreciation--house               1,667         1,667      1,667
    Total                           2,190         2,187      2,187

     Hillside Dairy may not deduct the following food and lodging

expenses:

                                 11/30/95       11/30/96   11/30/97

  Food for employees               $6,724        $8,760     $8,161
  Meals & entertainment               994         1,338      1,369
  Utilities--house                  2,567         2,439      2,557
    Total                          10,285        12,537     12,087

     3.     Inclusion of Payments in the Schmidts’ Gross Income

     When a corporation makes an expenditure that primarily

benefits the corporation’s shareholders, the amount of the

expenditure may be taxed to the shareholders as a constructive

dividend.    Hood v. Commissioner, 115 T.C. 172 (2000); Magnon v.

Commissioner, 73 T.C. 980, 993-994 (1980); Am. Insulation Corp.

v. Commissioner, T.C. Memo. 1985-436.       We have found that

expenses for food for employees, meals and entertainment, and

utilities paid by Hillside Dairy are the Schmidts’ expenses.

Petitioners contend that the payments are not constructive

dividends because Mr. Schmidt was required to repay any amounts

that Hillside Dairy could not deduct for Federal income tax
                              - 24 -

purposes.   Petitioners cite Cepeda v. Commissioner, T.C. Memo.

1993-477, to support their position.   Cepeda, however, is

inapposite.   In that case, the taxpayers claimed that advances

made by the corporation were loans rather than employee

compensation or constructive dividends.   Petitioners do not

contend that the corporate payments of Mr. Schmidt’s expenses

were loans.

     For Federal income tax purposes, a transaction will be

characterized as a loan if there was “an unconditional obligation

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

unconditional intention on the part of the transferor to secure

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

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

instant case, when the payments were made there was no

unconditional obligation on the part of Mr. Schmidt to repay a

specific dollar amount to the corporation.    His obligation to

repay any of the payments was in general terms.    The amount of

repayment could not be determined when the payments were made.

Any obligation to repay any amount could not arise before

respondent disallowed the deduction for the expenses; i.e, when

the Hillside Dairy notice of deficiency was issued in January

2001.   Thus, the payments were not loans.   Since the payments

when made by Hillside Dairy did not constitute business expenses

of the corporation or loans to the Schmidts, the conclusion is
                              - 25 -

inescapable that the payments constituted distributions by

Hillside Dairy to the Schmidts.

     In N. Am. Oil Consol. v. Burnett, 286 U.S. 417, 424 (1932),

the Supreme Court stated:

     If a taxpayer receives earnings under a claim of right
     and without restriction as to its disposition, he has
     received income which he is required to return, even
     though it may still be claimed that he is not entitled
     to retain the money, and even though he may still be
     adjudged liable to restore its equivalent. * * *

It is clear, therefore, under the claim of right doctrine, the

amounts paid by Hillside Dairy in 1995, 1996, and 1997 were

taxable to the Schmidts in those years.   See Pahl v.

Commissioner, 67 T.C. 286, 289 (1976).

     If a taxpayer is required to repay income recognized under

the claim of right doctrine in an earlier tax year, section 1341

permits the taxpayer, in effect, to elect to compute his taxes

for the year of repayment in a manner that gives the taxpayer the

equivalent of a refund (without interest) of tax for the earlier

year.   Specifically, section 1341(a)(5) permits the tax for the

year of repayment to be reduced by the amount of the tax paid for

the year of receipt that was attributable to the inclusion of the

repaid amount in that year’s gross income.    United States v.

Skelly Oil Co., 394 U.S. 678, 682 (1969).    Section 1341, however,

requires actual repayment, restoration, or restitution.    Chernin

v. United States, 149 F.3d 805, 816 (8th Cir. 1998); Kappel v.
                               - 26 -

United States, 437 F.2d 1222, 1226 (3d Cir. 1971); Estate of

Smith v. Commissioner, 110 T.C. 12 (1998).

     Although the bylaws of Hillside Dairy require Mr. Schmidt to

repay amounts for which the corporation is disallowed a

deduction, Mr. Schmidt does not claim that he has repaid the

disallowed amounts.    Indeed, there is no evidence in the record

to show that he did.   Therefore, section 1341 does not apply.   We

hold that Hillside Dairy’s payment of the Schmidts’ food, meals

and entertainment, and utilities expenses constitutes income to

the Schmidts.

     Petitioners argue that the expenses are meals and lodging

expenses excludable under section 119.   We have found to the

contrary.   Thus, the food, meals and entertainment, and utilities

expenses are the Schmidts’ personal living expenses.

     Personal, family, or living expenses are not deductible

except as otherwise expressly permitted.   Sec. 262.   A taxpayer’s

expenses for his or her own meals and lodging are personal

because they would have been incurred whether or not the taxpayer

had engaged in any business activity.    Christey v. United States,

841 F.2d 809, 814 (8th Cir. 1988); Moss v. Commissioner, 80 T.C.

1073, 1078 (1983), affd. 758 F.2d 211 (7th Cir. 1985).    In order

for personal living expenses to qualify as a deductible business

expense under 162(a), the taxpayer must demonstrate that the

expenses were different from, or in excess of, what he would have
                               - 27 -

spent for personal purposes.   Sutter v. Commissioner, 21 T.C.

170, 173 (1953).   Petitioners did not produce any bills, canceled

checks, or testimony to substantiate any portion of the expenses

that relates to Mr. Schmidt’s separate farming business.   Thus,

petitioners have failed to establish that the Schmidts are

entitled to a deduction for any portion of the expenses under

section 162.8

     4.   Rental Value of Residence

     The Schmidts leased the Schmidt farm, including the

farmhouse, from Hillside Dairy for $6,000.   We are satisfied, on

the basis of the property taxes for the farmhouse, that the fair

rental value of the farmhouse for each year at issue did not

exceed $6,000.

     5.   Summary of Adjustments to the Schmidts’ Income

     The following personal expenses paid by Hillside Dairy are

included in the Schmidts’ income as constructive dividends for

the years at issue:


     8
      Except as otherwise provided, an individual is not allowed
a deduction with respect to the use of a dwelling unit that is
used by the individual as a residence. Sec. 280A(a). The
individual, however, may deduct expenses allocable to portions of
the dwelling that are exclusively used for business purposes.
Sec. 280A(c). In the cases at bar, the Schmidts did not argue
that the utility expenses are deductible under sec. 280A.
Therefore, we do not address the question of whether any portion
of the utility expenses may be deductible under that section. We
note, however, that the Schmidts made no showing that the
farmhouse, or any portion thereof, was used exclusively for
business purposes.
                              - 28 -

                                11/30/95      11/30/96    11/30/97

  Food for employees               $6,724      $8,760      $8,161
  Meals & entertainment               994       1,338       1,369
  Utilities--house                  2,567       2,439       2,557
    Total                          10,285      12,537      12,087

Issue 2.   Accuracy-Related Penalty Under Section 6662(a)

     Respondent determined that Hillside Dairy is liable for the

accuracy-related penalty under section 6662(a).      As pertinent

here, section 6662(a) imposes a 20-percent penalty on the portion

of an underpayment attributable to negligence or disregard of

rules or regulations.   Sec. 6662(b)(1).    Negligence includes any

failure to make a reasonable attempt to comply with the

provisions of the Internal Revenue Code.    Sec. 6662(c); sec.

1.6662-3(b)(1), Income Tax Regs.

     The penalty under section 6662(a) does not apply to any

portion of an understatement of tax if it is shown that there was

reasonable cause for the taxpayer’s position and that the

taxpayer acted in good faith with respect to that portion.      Sec.

6664(c)(1).   The determination of whether a taxpayer acted with

reasonable cause and in good faith is made on a case-by-case

basis, taking into account all the pertinent facts and

circumstances.   Sec. 1.6664-4(b)(1), Income Tax Regs.     The most

important factor is the extent of the taxpayer’s effort to assess

his/her proper tax liability for the year.     Id.   The good faith

reliance on the advice of an independent, competent professional
                              - 29 -

as to the tax treatment of an item may meet this requirement.

Sec. 1.6664-4(b), Income Tax Regs.

     Despite the fact that petitioners have the burden of proof,

see supra note 6, petitioners have made no showing that they made

an attempt to comply with the tax rules and regulations with

regard to those deductions taken by Hillside Dairy for the years

at issue which have been disallowed.   Hence, with respect to

those deductions, petitioners have failed to show that Hillside

Dairy was not negligent.   Nor have petitioners showed that they

acted in good faith with respect to, or that there was reasonable

cause for, the position they took.

     Further, petitioners do not claim that they relied on Mr.

Bleeker or any other professional as to the tax treatment of the

expenses for food and lodging.9   Petitioners simply assert that

the accuracy-related penalty does not apply because Hillside

Dairy properly claimed the deductions under section 162(a) and




     9
      Before the trial in these cases, respondent filed a motion
to disqualify Mr. Bleeker from his representation of petitioners.
Respondent’s motion was based, in part, on the premise that, if
petitioners contend that they reasonably relied on Mr. Bleeker’s
advice with respect to the proper tax treatment of the payments
at issue, then Mr. Bleeker would be required to testify as a
witness in the trial of these cases. The Court held a telephone
conference call with Mr. Bleeker and counsel for respondent to
discuss respondent’s motion. During that call, Mr. Bleeker
informed the Court that petitioners did not intend to raise
reasonable reliance on a tax professional as a defense to the
accuracy-related penalties.
                             - 30 -

the Schmidts properly excluded the payments under section 119.

We have found to the contrary.

     Under these circumstances, we are compelled to hold that

Hillside Dairy is liable for the accuracy-related penalty for the

years at issue.

     To reflect the foregoing,

                                             Decisions will be

                                        entered under Rule 155.
