UNITED STATES TAX COURT

T.C. Memo. 1997-464

UNITED STATES TAX COURT

ALPHA MEDICAL, INC., f.k.a. ALPHA MEDICAL MANAGEMENT, INC.,

Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 22802-94.

Filed October 14, 1997.

John P. Konvalinka and Thomas E. Smith, for petitioner.

Bonnie L. Cameron, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

PARR, Judge:

Respondent determined a deficiency in

petitioner's 1990 Federal income tax of $1,376,520, and a penalty

under section 66621 of $275,304.

1

All section references are to the Internal Revenue Code

as in effect during the year in issue, and all Rule references

are to the Tax Court Rules of Practice and Procedure, unless

otherwise indicated. All dollar amounts are rounded to the

nearest dollar unless otherwise indicated.

- 2 The issues for decision are:

(1) Whether an amount paid by

petitioner to William T. Rogers (Rogers) as compensation during

taxable year 1990 is reasonable within the meaning of section

162(a)(1).

We find the amount paid was not reasonable to the

extent set out below. (2) Whether petitioner is liable for the

accuracy-related penalty under section 6662(d) for substantially

understating its income for the year in issue.2

2

We find it is.

In its petition to this Court, petitioner raised the

issue of whether a second inspection of petitioner's records,

within the meaning of sec. 7605(b), was conducted by respondent's

agent for the 1990 taxable year.

On Jan. 5, 1993, petitioner received a notice of audit for

1990. Upon receipt of the notice of audit for 1990, petitioner

objected to the audit on the basis that the audit was repetitive

and that the Internal Revenue Service (IRS) already had in its

possession information relating to 1990.

Revenue Agent Arthur W. Horton caused a summons to be issued

for information relating to 1990. By letter dated Nov. 18, 1993,

petitioner informed the IRS that petitioner was not going to

produce the records.

A summons enforcement proceeding was initiated in the U.S.

District Court for the Eastern District of Tennessee on June 20,

1994, and a hearing was held on Aug. 29, 1994. Petitioner's

representative appeared at the hearing and objected to the

summons on the ground, inter alia, that the IRS's request to

examine its books of account for 1990 was a second inspection in

violation of sec. 7605(b). The District Court ruled in favor of

the IRS, and petitioner appealed to the Court of Appeals for the

Sixth Circuit.

In United States v. Alpha Med. Management, Inc., 116 F.3d

1481 (6th Cir. 1997), the Court of Appeals for the Sixth Circuit

by an unpublished opinion remanded the case to the District Court

for a determination of which documents sought by the summons were

already in the possession of or accessible to the IRS. In other

respects the District Court's order enforcing the summons was

affirmed. In its ruling, the Court of Appeals found that the IRS

complied with the statutory requirements of sec. 7605(b).

We conclude that there was no second inspection of

petitioner's books of account in violation of sec. 7605(b).

- 3 FINDINGS OF FACT

Some of the facts have been stipulated.

The stipulated

facts and attached exhibits are incorporated herein by this

reference.

A.

Petitioner's Background

Alpha Medical Management, Inc., also known as Alpha Medical,

Inc. (hereinafter petitioner), is a medical management

corporation duly formed and organized under the laws of

Tennessee.

At the time the petition was filed, its principal

place of business was in Chattanooga, Tennessee.

Rogers

incorporated petitioner in 1982, with an initial capital

contribution of $1,000.

He has not made any additional capital

contributions to petitioner.

January 1, 1986.

Petitioner began operations on

By 1990, petitioner had 60 employees.

Petitioner provides medical management services to home

health care agencies and hospitals with home health care

departments.

Home health care agencies are subject to State

licensing requirements and requirements known as Certificate of

Need.

The services petitioner provides to its clients are

tailored to meet each client's individual needs and to assist

each client in complying with the various licensing requirements,

Certificate of Need requirements, and the various Medicare and

Medicaid regulations.

In most instances, petitioner's services

include the management of four categories of operations:

Reimbursement, (ii) accounting, (iii) accounts receivable,

(i)

- 4 billing, and computer operation, and (iv) clinical/

operational/consulting.

Petitioner's entire operation is located in one office in

Chattanooga, Tennessee.

Petitioner's clients' locations grew

from 1 in 1986 to 60 in 1992 in Tennessee, Kentucky, Arkansas,

and Florida.

In 1990, petitioner managed 43 locations.

B.

William T. Rogers' Background and Duties

Since petitioner began operations in 1986, Rogers has been

its president, sole director, and sole shareholder.

Rogers

worked 12 hours a day and was available at all times of the day

by telephone or pager.

During and prior to 1990, Rogers made all

decisions that affected petitioner's mid- and long-range plans,

and Rogers handled any problems that arose with petitioner's

clients or employees.

Rogers did not routinely deal with

petitioner's day-to-day operations or with the day-to-day care of

patients.

Until sometime in 1990 or 1991, Rogers negotiated each

contract petitioner made with its clients.

Rogers has a bachelor of science in biology from Tennessee

Technological University and a doctorate in pharmacy from the

University of Tennessee.

He has more than 25 years of experience

in the health care field.

Rogers was the founder of a

successful, local drugstore chain with seven stores which he sold

in 1986.

Rogers also began a durable medical equipment business

which he sold to a publicly traded company in 1984.

When Rogers

sold the durable medical equipment business, he was offered a

- 5 million-dollar-plus salary to manage National Medical Equipment

California Home Health Care Division.

Rogers turned down that

job offer because he did not want to move to California.

C.

Petitioner's Divisions and Management Team

1.

The Financial Division

Petitioner is divided into two divisions:

The financial

division and the clinical and operations division.

The financial

division provides a complete array of accounting services for

petitioner's clients, including the review of each client's

expenditures to insure that they are reimbursable by Medicare.

Rayburn H. Tankersly (Tankersly), a certified public accountant,

has been petitioner's senior vice president of finance and chief

financial officer in charge of the financial division since

October 1988, when he began working for petitioner.

Tankersly

has been in the medical accounting field since 1969.

Tankersly

was hired, in part, to help Rogers make technical decisions

dealing with Medicare regulations.

Tankersly provides strategic

focus for petitioner's financial division.

He assists in

strategic planning for clients, develops and maintains client

relationships, provides financial guidelines to clients, and

ensures proper staffing for the financial division.

Tankersly

worked 10 to 12 hours a day in 1990.

Tim Stees (Stees), a certified public accountant, has been

petitioner's vice president of finance since late 1989.

Stees

coordinates tax return preparation, participates in strategic

- 6 planning for petitioner and its clients, and develops and

maintains client relationships.

During 1990, Stees was the

controller, in addition to being responsible for supervising

various functions of the payroll and accounts payable

departments.

Petitioner's reimbursement and information systems

departments are part of petitioner's financial division.

From

1987 to 1990, Libby Walker (Walker) was petitioner's director of

reimbursement.

Walker dealt with the Commerce Clearing House

(CCH) guides, the Health Insurance Manual-11 (HIM-11), all the

Government rules, and Medicare regulations.

2.

The Clinical and Operations Division

The operations division provides surveys, advice, and

evaluations for petitioner's clients and develops the operational

and clinical products that are delivered to clients.

Rebecca

Worley (Worley), a registered nurse, has been petitioner's senior

vice president of operations and chief operations officer since

petitioner's inception in 1986.

Worley provides strategic focus

for petitioner's operations division.

She (1) decides the

direction and timing of client selection and development, (2)

translates Rogers' management vision into operational plans, (3)

is responsible for marketing services and petitioner's

development, (4) ensures proper staffing levels and training

programs, (5) guides clients regarding the direction and actions

of their companies, and at one time, (6) oversaw and assisted in

- 7 the development of petitioner's clinical information system.

From 1986 through 1990, Worley worked 10 to 12 hours a day for

petitioner.

Worley directs the nurses petitioner employs.

Donna Stapleton (Stapleton), a registered nurse, is

petitioner's vice president of operations.

Stapleton earned a

Certification in Nursing Administration in 1985 from the American

Nursing Association.

She is responsible for the operational and

clinical oversight of the field staff, acts as a liaison with

State and Federal fiscal intermediaries regarding regulatory

issues, provides evaluations and advice to clients, and handles

personnel management, development, and recruitment.

Currently, petitioner has three senior consultants with

nursing backgrounds in its operations division.

Each senior

consultant, along with Stapleton, supervises a team of two to

four nurses.

Before the senior consultants were hired sometime

after 1990, these duties were performed under Rogers' guidance.

3.

Petitioner's Management Team--General

From 1986 to 1988, petitioner's management tasks were

performed by Rogers and Worley.

In late 1988, Tankersly joined,

and in late 1989, Stees joined petitioner's management team.

Rogers, Tankersly, and Worley knew petitioner's business; Rogers

had the reputation that brought the clients in and finalized the

contracts.

Sometime in 1990 or 1991, a salesman began working

for petitioner out of Nashville.

executive and management staff.

Rogers recruited petitioner's

- 8 Rogers, Tankersly, and Worley attended State and national

home care association meetings, entertained and recruited

clients, visited exhibit halls to see what vendors were offering,

and shared the information they obtained with each other.

1990, petitioner's board of directors included:

In

Rogers,

president/CEO; Tankersly, vice president/CFO; and Worley,

executive vice president/secretary.

D.

Petitioner's Services

Petitioner provides its clients with a team of employees who

have advanced skills and knowledge in dealing with Medicare and

Medicaid regulations.

The team conducts a mock survey to

determine whether the clients are in compliance with State

licensing, Federal conditions of participation, and the rules of

other accrediting bodies and recommends ways to comply or

improve.

Rogers developed the parameters for the mock survey

team and, together with Worley, developed the product line for

the mock survey.

The mock survey replicates the annual

inspection required by State and Federal regulatory authorities,

and as a result of the mock survey, petitioner's clients have

exceptional records with respect to their inspections.

Petitioner has policy manuals that discuss petitioner's

products and explain how services are to be provided to its

clients.

The policy manuals are periodically revised.

By 1989,

petitioner had 8 policy manuals, and by 1992 petitioner had 11

- 9 policy manuals.

Rogers helped develop most, if not all, of

petitioner's policy manuals.

During 1989 and 1990, there was a nursing shortage.

Rogers

worked with an advertising firm to develop a recruitment plan to

help petitioner's clients recruit adequate staffs.

Rogers

developed the per-visit method of compensation for nurses and

recommended its use to petitioner's clients, which increased the

availability of nurses.

Rogers also suggested developing the Alpha Information

System, a clinical system that provides documentation and

assistance to the clinician providing the services and reduces

paperwork.

The use of the Alpha Information System enhances the

quality of patient care by allowing the nurse to spend more time

on patient care and less time on documentation and ensures

accuracy.

There were no other computer systems like it in the

home health care industry in 1990.

Rogers drew the schematics

about how home health care works for petitioner's computer

programmers, who then developed the system.

Petitioner's clients have to attend Medicare preexit and

exit conferences to determine whether Medicare agrees with the

amounts the clients were reimbursed for.

At preexit conferences

Medicare informs the client of proposed adjustments and items

that may be disallowed.

At exit conferences, the clients present

explanations for the items Medicare proposed to adjust.

If an

item is disallowed, the client has to reimburse Medicare what

- 10 Medicare paid the client.

During the years 1986 through 1990,

Rogers attended all of petitioner's clients' Medicare preexit and

exit conferences and vigorously defended their positions.

Usually a second employee of petitioner attended the conferences

with Rogers.

E.

Petitioner's Key Employees' Compensation

Petitioner awards bonuses to almost all of its employees,

both management and nonmanagement.

Bonuses are based upon

contributions to petitioner's overall profit and employee

performance.

For the years 1988, 1989, and 1990, petitioner paid

its key employees (other than Rogers) the following compensation

amounts:

1988

1989

1990

Employee

Salary Bonus

Total

Salary Bonus

Total

Salary Bonus

Worley

$36,838 $32,500 $69,338 $36,838 $90,000 $126,838 $36,838

Total

$190,000 $226,838 Tankersly 10,417

2,500 12,917

50,000 57,500 107,500

50,000 165,000 215,000

Walker

36,838 23,000 59,838

36,900 46,500

83,400

35,000

50,000

85,000

Frazier

35,006

7,500 42,506

35,000 22,500

57,500

35,000

32,500

67,500

Goodwin

------17,500 10,000

27,500

35,000

31,500

66,500

Stees

------12,250 10,000

22,250

42,000

20,000

62,000

In 1990, Rogers determined the amounts of the bonuses.

F.

Rogers' Compensation

During the years 1986 through 1990, Rogers determined how

much petitioner paid him.

For those years, Rogers gave himself a

base salary, plus a bonus based on a percentage of petitioner's

pretax profit as follows:

- 11 Year

1987

1988

1989

1990

Base Salary

$75,000

300,000

500,000

1,000,000

Bonus

25% of pre-tax profit

25% of pre-tax profit

50% of pre-tax profit

50% of pre-tax profit

Rogers' salary and bonus percentage were reflected in

petitioner's corporate minutes at the beginning of each year.

For 1990, Rogers gave himself a large base salary increase

($500,000 to $1 million) to compensate himself for turning down

the 1984 California job offer.

For 1986 through 1990, Rogers'

compensation compared to the total paid to other employees,

petitioner's taxable income, petitioner's gross receipts, and the

percentage of gross receipts which his compensation made up was

as follows:

Rogers'

Year Compensation

Receipts

1986

$66,943

1987

75,914

1988

431,702

1989

928,883

1990

4,439,180

Other

Employees

Taxable Income

Gross Receipts

$220,273

317,562

595,141

1,054,281

1,636,264

$138,012

240,063

620,313

1,743,853

2,432,253

$848,403

1,196,849

2,542,912

4,993,761

9,880,760

% of Gross

7.8

6.0

16.9

18.6

44.9

During the years 1986 through 1990, petitioner did not have

pension plans or other forms of deferred compensation for Rogers

or other key employees.

Petitioner paid dividends to Rogers, its

sole shareholder, of $1,000 in 1989, $1,500 in 1990, and $5,500

in 1991.

Rogers is the only person who had authority to declare

- 12 dividends for petitioner.

For the years 1986 through 1990,

petitioner's retained earnings were as follows:

Year

1986

1987

1988

1989

1990

G.

Retained Earnings

$96,623

247,338

649,000

1,707,137

3,388,705

Petitioner's Audits

On December 4, 1990, petitioner received a notice of audit

for 1989 (the 1989 audit).

December 4, 1992.

The 1989 audit continued until

During the 1989 audit of petitioner, the

Internal Revenue Service (IRS) analyzed the issue of the

deductibility of compensation paid to Rogers and obtained

information relating to the calculation of compensation in both

1989 and 1990, including the amount of compensation petitioner

paid Rogers, and petitioner's 1990 tax return.

Petitioner paid

Rogers $928,883 of compensation in 1989 and $4,439,180 in 1990.

Respondent allowed $400,000 as a deduction for reasonable

compensation.

OPINION

Issue 1. Whether the Amount Paid by Petitioner to Rogers as

Compensation During Taxable Year 1990 Is Reasonable Within the

Meaning of Section 162(a)(1)

Section 162(a)(1) allows a corporation to deduct as a

business expense "a reasonable allowance for salaries or other

compensation for personal services actually rendered".

To come

within the ambit of section 162(a)(1), the compensation must be

- 13 both:

(1) Reasonable in amount, and (2) paid purely for services

rendered to the corporation.

Charles Schneider & Co. v.

Commissioner, 500 F.2d 148, 151 (8th Cir. 1974), affg. T.C. Memo.

1973-130; sec. 1.162-7(a), Income Tax Regs.

It is clear that

bonuses may be part of the allowable deductions as long as the

sum of the base pay and the bonuses does not exceed a reasonable

Pacific Grains, Inc. v. Commissioner, 399 F.2d

compensation.

603, 605 (9th Cir. 1968), affg. T.C. Memo. 1967-7; sec. 1.162-9,

Income Tax Regs.3

Neither party has suggested that Rogers did

not render valuable services to petitioner.

Accordingly, we will

focus on the first element of the deductibility test--whether the

amounts of the payments were reasonable.

Whether the compensation is reasonable is a question to be

resolved on the basis of an examination of all the facts and

circumstances of the case.

Mayson Manufacturing Co. v.

Commissioner, 178 F.2d 115, 118 (6th Cir. 1949), revg. a

Memorandum Opinion of this Court; Estate of Wallace v.

Commissioner, 95 T.C. 525, 553 (1990), affd. 965 F.2d 1038 (11th

Cir. 1992).

3

Respondent's determination is presumed correct, and

Sec. 1.162-9, Income Tax Regs., provides in part:

Bonuses to employees will constitute allowable

deductions from gross income when such amounts are made

in good faith and as additional compensation for the

services actually rendered by the employees, provided

such payments, when added to the stipulated salaries,

do not exceed reasonable compensation for the services

rendered. * * *

- 14 petitioner bears the burden of proving the reasonableness of the

compensation.

(1933).

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

If petitioner proves respondent's determination to be

wrong, the Court must then decide the amount of compensation that

was reasonable.

Pepsi-Cola Bottling Co. v. Commissioner, 61 T.C.

564, 568 (1974), affd. 528 F.2d 176 (10th Cir. 1975).

In addressing the reasonableness of compensation, the Court

of Appeals for the Sixth Circuit, the court to which an appeal in

this case lies, has adopted a set of basic factors that should be

considered by the Court in reaching its decision:

(1) The

employee's qualifications; (2) the nature, extent, and scope of

the employee's work; (3) the size and complexities of the

employer's business; (4) a comparison of salaries paid with the

employer's gross and net income; (5) the prevailing general

economic conditions; (6) a comparison of salaries paid with

distributions of retained earnings; (7) the prevailing rates of

compensation for comparable positions in comparable concerns; (8)

the salary policy of the employer as to all employees; and (9) in

the case of small corporations with a limited number of officers,

the amount of compensation paid to the particular employee in

previous years.

Mayson Manufacturing Co. v. Commissioner, supra;

see also Home Interiors & Gifts, Inc. v. Commissioner, 73 T.C.

1142, 1155-1156 (1980).

The situation must be considered as a

- 15 whole with no single factor decisive.

Mayson Manufacturing Co.

v. Commissioner, supra.

In analyzing these factors, the Court must carefully

scrutinize the facts of a case in which the paying corporation is

controlled by an employee to whom the compensation is paid.

For

example, section 1.162-7(b)(1), Income Tax Regs., cautions that

in the case of a corporation having few shareholders, "An

ostensible salary paid by a corporation may be a distribution of

a dividend on stock."

supra at 555.

See Estate of Wallace v. Commissioner,

In such a situation, we must be convinced that the

purported compensation was paid for services rendered by the

employee as opposed to a distribution of earnings to him that the

employer could not deduct.

RTS Inv. Corp. v. Commissioner, 877

F.2d 647, 650 (8th Cir. 1989), affg. per curiam T.C. Memo. 198798; Seven Canal Place Corp. v. Commissioner, 332 F.2d 899 (2d

Cir. 1964), remanding T.C. Memo. 1962-307.

1.

Rogers' Qualifications

An employee's superior qualifications for his or her

position with the business may justify high compensation.

See,

e.g., Home Interiors & Gifts, Inc. v. Commissioner, supra at

1158; Dave Fischbein Manufacturing Co. v. Commissioner, 59 T.C.

338, 352-353 (1972).

Although Rogers had no formal training in business

management, he has more than 25 years of practical business

- 16 experience in the health care industry.

Furthermore, Rogers

developed a single drugstore into a chain of stores that he sold

in 1986 and a hospital supply business that he sold to a publicly

traded company in 1984.

Rogers was instrumental in developing petitioner's computer

software programs, mock surveys, and policy manuals, solving its

staffing problems, and developing cost-efficient operating

procedures.

Petitioner's success is mainly attributable to

Rogers' ambition, creativity, vision, and energy, not to its

investment in capital.

See Home Interiors & Gifts, Inc. v.

Commissioner, supra at 1158; Dave Fischbein Manufacturing Co. v.

Commissioner, supra.

2.

This factor favors petitioner.

Nature, Extent, and Scope of Rogers' Work

An employee's position, hours worked, duties performed, and

general importance to the success of a business may justify high

compensation.

Home Interiors & Gifts, Inc. v. Commissioner,

supra at 1158.

In this case, the history of Rogers'

contributions to petitioner must be considered, rather than just

his contributions during the year at issue, because the

compensation petitioner paid to him during the year at issue

represents, in part, an attempt to rectify prior

undercompensation.

(See our discussion under factor 9, infra.)

At one time or another since its inception, Rogers has held

most of the management positions at petitioner.

He has

- 17 consistently worked 12 hours each day in the office and is on

call 24 hours a day.

Rogers' responsibilities have covered a

wide range of activities, including sales, personnel, operations,

finance, planning, and flying the corporate airplane.

The record shows that no other officer of petitioner has the

breadth of experience with the company which Rogers has.

However, his experience has not been a solitary one; he has been

assisted by a hard-working and well-qualified management team,

and in particular by Worley.

By any reasonable measure, Rogers' efforts on behalf of

petitioner have been highly successful.

Petitioner's

profitability is attributable to sales of its services and

effective cost containment.

"Getting and keeping customers is,

of course, the lifeblood of any business".

Kennedy v.

Commissioner, 671 F.2d 167, 176 (6th Cir. 1982), revg. 72 T.C.

793 (1979).

Rogers is petitioner's primary salesman and deal

closer; he personally obtained each of petitioner's clients and

negotiated each contract petitioner made with its clients.4

Since 1986, petitioner's gross receipts have increased

almost 12 times, taxable income has increased almost 18 times,

and net worth has shown an increase of over 35 times.

4

See Home

We note, however, that Tankersly and Worley also

entertained and recruited clients, and since 1989, Stees'

responsibilities have included developing and maintaining client

relationships.

- 18 Interiors & Gifts, Inc. v. Commissioner, supra at 1157-1158

(extraordinary corporate performance is evidence that officer's

compensation is not excessive); see also Kennedy v. Commissioner,

supra; cf. National Cottonseed Prods. Corp. v. Commissioner, 76

F.2d 839 (6th Cir. 1935) (poor performance did not justify

compensation paid), affg. in part and revg. in part 28 B.T.A. 67

(1933).

Furthermore, the 1990 gross receipts were 98 percent

greater than the 1989 receipts, yet expenses increased by only 27

percent.

Petitioner's successful cost containment is

attributable in part to innovative management programs which were

developed by Rogers and Worley.

Significantly, petitioner increased its business and revenues

during a time of a nursing shortage.

Petitioner's ability to

increase its business while presented with a restricted labor

force was due in part to petitioner's use of an innovative

compensation plan for the nurses and the use of the drug

interaction system.

The compensation plan and the drug

interaction system were both developed in part by Rogers.

This

factor favors petitioner.

3.

Size and Complexities of Petitioner's Business

Petitioner's gross receipts--an indicator of its size--were

$9,880,760 in 1990.

From 1986 to 1990, the number of employees

at petitioner increased from 2 (Rogers and his wife) to 60, and

the number of client locations increased from 1 to 43, which

- 19 included locations in the States of Tennessee, Kentucky,

Arkansas, and Mississippi.

Moreover, approximately 30 percent of

the increase in client locations occurred from 1989 to 1990.

Finally, the home health care visits managed by petitioner in

1990 almost doubled from the 500,000 managed in 1989.

Thus,

petitioner's business dramatically increased in 1990 compared to

1989.

Petitioner is in a complex business.

The management of the

home health care business requires special expertise with regard

to Medicare, Medicaid, insurance requirements, and State health

care licensing regulations.

In addition to technical expertise,

compliance with the various insurance programs requires accurate

documentation of each home visit.

Petitioner managed the

documentation and reporting of almost a million home health care

visits in 1990.

The documentation and reporting of these visits

included both clinical information and claims information which

were processed through the Alpha Information System that was

designed in part by Rogers and Worley and implemented by Rogers.

This factor favors petitioner.

4.

Comparison of Salaries Paid to Gross and Net Income

In 1990, Rogers' compensation was 44.9 percent of

petitioner's gross receipts and 64.6 percent of its net taxable

- 20 income (before deduction of Rogers' compensation).5

Although it

is often helpful to consider compensation as a percentage of both

gross receipts and net income, the latter is in most cases more

probative, because it more accurately gauges whether a

corporation is disguising the distribution of dividends as

compensation.

Owensby & Kritikos, Inc. v. Commissioner, 819 F.2d

1315, 1325-1326 (5th Cir. 1987), affg. T.C. Memo. 1985-267.

However, as noted previously, each case turns on its own facts

and circumstances, and no particular ratio between compensation

and gross or net taxable income is a prerequisite for a finding

of reasonableness.

Petitioner cites several cases in which this Court found

that the compensation paid was reasonable notwithstanding the

fact that the compensation was a large portion of the taxpayer's

gross and net income.

See, e.g., Pulsar Components Intl., Inc.

v. Commissioner, T.C. Memo. 1996-129 (reasonable compensation was

27.3 percent of gross receipts of $10,693,635 and 82.4 percent of

$3,546,647 taxable net income (before deduction of the

compensation at issue) in 1985); Mad Auto Wrecking, Inc. v.

Commissioner, T.C. Memo. 1995-153 (reasonable compensation was

34, 28, and 38 percent of gross receipts of $2,554,942,

5

In 1990, Rogers' compensation was $4,439,180;

petitioner's net taxable income after deducting Rogers'

compensation was $2,432,253. Thus, petitioner's net taxable

income before deducting Rogers' compensation was $6,871,433.

- 21 $2,169,125, and $1,884,853 and 93, 91, and 103 percent of net

taxable income of $923,690, $662,974, and $688,801 (before

deducting officer's compensation at issue) for 1989, 1990, and

1991, respectively); Acme Constr. Co. v. Commissioner, T.C. Memo.

1995-6 (reasonable compensation was 10.2 percent of gross income

of $4,330,871 and 73.23 percent of net taxable income of $603,771

(before deduction of compensation at issue in 1990); BOCA

Constr., Inc. v. Commissioner, T.C. Memo. 1995-5 (reasonable

compensation was 27.7 and 31.9 percent of gross receipts of

$2,488,322 and $2,558,903 for 1989 and 1990, respectively, and

approximately 80 percent of net income of $847,328 and $1,055,086

(not including the compensation at issue in each year).

In these cases cited by petitioner, this Court found that

the compensation paid by the taxpayer was reasonable even though

it was a large portion of the taxpayer's gross receipts and net

income.

However, petitioner fails to recognize that unlike the

instant case where the compensation being challenged was paid to

only one employee, Rogers, in Pulsar Components Intl., Inc., Mad

Auto Wrecking, Inc., and BOCA Constr., Inc. the compensation at

issue was paid to two officer/shareholders.

Thus, the facts of

those cases and the case at hand are clearly distinguishable.

Petitioner contends that a portion of the compensation paid

Rogers in 1990 is for services he provided petitioner in prior

years.

Similarly, in Acme Constr. Co., the compensation was paid

- 22 in part to the officer/shareholder for services he performed in

prior years.

In that case, we found that the compensation was

reasonable, notwithstanding the fact that it was 73.23 percent of

net taxable income (before deduction of compensation at issue).

However, as noted in Owensby & Kritikos, Inc. v. Commissioner,

supra at 1326 n.34:

the absolute probative value of compensation as a

percentage of net income as an isolated factor is often

minimal. The main reason for this is that this factor

is dependent upon a variable--the company's income-that, at least in the short run, may be unrelated to

the value of an individual's services. For example, a

company with a high income might pay unreasonable

salaries to its shareholder-employees; yet that

compensation as a percentage of net income would be low

because of the company's high income. On the other

hand, a company with low net income might pay virtually

all of that income to its shareholder-employees in

salaries that are unquestionably reasonable.

In Acme Constr. Co. the net taxable income was $603,771; in

the case at bar the net taxable income is $6,871,433 (before

deduction of the compensation at issue).

The difference in

magnitude of the respective companies' net incomes makes the

comparison of the relevant percentages of limited probative

value.

We find that in this case the large portion of net income

paid in compensation to Rogers is a factor that points to the

conclusion that the compensation paid was in part unreasonable.

5.

General Economic Conditions

This factor helps to determine whether the success of a

business is attributable to general economic conditions as

- 23 opposed to the efforts and business acumen of the employees.

General economic conditions may affect a business' performance

and indicate the extent (if any) of the employees' effect on the

company.

Mayson Manufacturing Co. v. Commissioner, 178 F.2d at

119-120.

Adverse economic conditions, for example, tend to show

that an employee's skill was important to a company that grew

during the bad years.

At trial, petitioner presented expert witness testimony as

to the reasonableness of Rogers' compensation.

Expert witness

testimony is appropriate to help the Court understand an area

requiring specialized training, knowledge, or judgment.

Fed. R.

Evid. 702; Snyder v. Commissioner, 93 T.C. 529, 534 (1989).

Court, however, is not bound by an expert's opinion.

The

We weigh an

expert's testimony in light of his or her qualifications and with

respect to all credible evidence in the record.

Depending on

what we believe is appropriate under the facts and circumstances

of the case, we may either reject an expert's opinion in its

entirety, accept it in its entirety, or accept selective portions

of it.

Helvering v. National Grocery Co., 304 U.S. 282, 294-295

(1938); Seagate Tech., Inc. & Consol. Subs. v. Commissioner, 102

T.C. 149, 186 (1994).

Petitioner's expert, Mr. James V. Hughes (Hughes), is an

expert on compensation with Arthur Anderson & Co.

Hughes

testified at trial and submitted a report that he coauthored with

Bruce K. Benesh (Benesh).

Benesh did not testify at trial.

- 24 Petitioner's experts concluded that the compensation paid Rogers

was reasonable.

Hughes based his conclusion on various sources,

one of which was relevant industry and compensation data.

This

data, according to Hughes and Benesh, describes the economic

conditions in which petitioner operated from 1986 through 1990.

In their report, Hughes and Benesh provided data they

gathered from the Tennessee Board of Licensing Health Care

Facilities and the National Association for Home Care,

Washington, D.C.

The data shows that there were fewer licensed

health care agencies in the State of Tennessee in each year after

1986.

For instance, there were 379 licensed health care agencies

in the State of Tennessee in 1986, 326 in 1989, and 320 in 1990.

Hughes interpreted this data to indicate that the health care

industry was "slowing down".

Hughes and Benesh attributed this

slowing down to the increasing Medicare paperwork and unreliable

payment policies.

Petitioner's gross receipts, net income, and retained

earnings have increased every year since 1986.

It is evident

that petitioner was able to take advantage of the business

opportunities that arose in the consolidating industry.

Hughes

and Benesh attributed this ability to Rogers' business acumen and

knowledge of the industry.

Although we agree that the data supports a finding that

there were fewer health care agencies in the State of Tennessee

in each year after 1986, we note that more than 98 percent of the

- 25 consolidation occurred between 1986 and 1989, and less than 2

percent of the consolidation occurred after 1989.

Furthermore,

Hughes and Benesh have provided no data on the status of the home

health care industry in any of the other States in which

petitioner does business.

Significantly, although Hughes and Benesh characterized the

home care industry as "contracting", they provided no data that

shows that the health care business actually was contracting,

instead of consolidating.

The data shows only that there were

fewer home health care agencies, not that there were fewer

dollars spent on home health care.

In fact, due to the 1989

changes in the regulations governing reimbursements to home

health care agencies by Medicare, payment for a greater number of

services was allowed, which provided potential for increased

revenue.6

Thus, the data actually shows that each year there

were fewer agencies operating in a business that had expanding

6

At trial, Rogers gave the following testimony in response

to petitioner's lawyer's questions:

Q.

And as a result of the number of home health industries

in the State of Tennessee, would you say that it was-A.

It was a free-for-all.

Q.

--a competitive market?

A.

It was a free-for-all.

Thus, Rogers did not characterize the business conditions as

competitive. He chose, instead, to use a description that would

not be unfamiliar to a 49'er participating in the California gold

rush.

- 26 opportunities for greater revenues.

Under these facts and

circumstances, we do not assume that a consolidation phase is a

per se adverse economic condition for a business.

Thus, petitioner's evidence does not support a finding that

the home health care business suffered from adverse economic

conditions, or that the home health care business was

significantly more competitive in 1990 than it was in 1989.

This

factor points to the conclusion that the compensation paid Rogers

in 1990 was in part unreasonable.

6.

Comparison of Salaries Paid With Distributions of

Retained Earnings

The failure to pay more than minimal dividends may suggest

that reported compensation actually is (in whole or in part) a

dividend.

Owensby & Kritikos, Inc. v. Commissioner, 819 F.2d at

1322-1323; Charles Schneider & Co. v. Commissioner, 500 F.2d at

151.

Corporations, however, are not required to pay dividends.

Shareholders may be equally content with the appreciation of

their stock caused, for example, by the retention of earnings.

Owensby & Kritikos, Inc. v. Commissioner, supra; Home Interiors &

Gifts, Inc. v. Commissioner, 73 T.C. at 1162.

In reviewing the reasonableness of an employee's

compensation, we often apply a hypothetical independent investor

standard to determine whether a shareholder has received a fair

return on investment after payment of the compensation in

question.

Owensby & Kritikos, Inc. v. Commissioner, supra at

- 27 1326-1327; Pulsar Components Intl., Inc. v. Commissioner, T.C.

Memo. 1996-129.

Rogers had sole discretion of whether to pay a

dividend, and the amount thereof.

dividends in the year at issue.

Petitioner paid $1,500 in

Although the amount of this

dividend is a 150-percent return on the capital invested, it is

insignificant in comparison to petitioner's earnings.

A corporation's dividend policies should not, however, be

viewed in a vacuum.

Owensby & Kritikos, Inc. v. Commissioner,

supra at 1326-1327.

The Court should look at the total return

the corporation is earning for its shareholders, the prime

indicator of which is the return on shareholders' equity.

Id.

If, * * * the company's earnings on equity remain at a

level that would satisfy an independent investor, there

is a strong indication that management is providing

compensable services and that profits are not being

siphoned out of the company disguised as salary.

[Elliotts, Inc. v. Commissioner, 716 F.2d 1241, 1247

(9th Cir. 1983), revg. T.C. Memo. 1980-282; fn. ref.

omitted.]

Petitioner's shareholder's equity grew from $97,623 at

yearend 1986 to $1,708,137 at yearend 1989 to $3,389,705 at

yearend 1990.7

Petitioner's total return on equity for the year

at issue was 98.65 percent.8

This return is impressive, and an

7

In this case, shareholder's equity is the sum of Rogers'

original capital investment, $1,000, plus retained earnings.

8

Return on equity is calculated after deducting all

amounts paid as compensation. Thus, total return on equity is

the sum of the increase in shareholder's equity from yearend 1989

to yearend 1990 plus dividends paid in 1990, divided by

shareholder's equity at yearend 1989.

- 28 independent investor would undoubtedly be satisfied with such a

return.

7.

This factor favors petitioner.

Prevailing Rates of Compensation for Comparable

Positions in Comparable Concerns

Respondent's regulations provide that "It is, in general,

just to assume that reasonable and true compensation is only such

amount as would ordinarily be paid for like services by like

enterprises under like circumstances."

Sec. 1.162-7(b)(3),

Income Tax Regs.

Petitioner relied on its expert witnesses' testimony and

reports for evidence on this factor.

Petitioner submitted a

report written by Joe T. Fisher (Fisher), in addition to the one

coauthored by Hughes and Benesh.

Petitioner's Experts' Reports

Although Fisher does not specialize in executive

compensation, he is a member of the American College of Health

Care Executives and has held various executive positions in the

health care industry since 1977.

In his professional capacity

Fisher has become familiar with the various incentive plans that

have been administered through various health care companies, he

has conducted studies and surveys of executive compensation, and

he has participated in the design of executive compensation

plans.

In his report, Fisher concluded that the amount of

compensation paid Rogers in 1990 was reasonable.

Fisher's

report, however, contains several inaccuracies that cause this

- 29 Court to discount his opinion.

For instance, in his report

Fisher stated that "Rogers personally designed and implemented a

computer system for * * * [petitioner]", and that "Rogers was

personally involved * * * in the day-to-day operations of

* * * [petitioner] from the period of 1986 through 1990."

Rogers, however, testified to the contrary.

Furthermore, although Fisher testified that he compared

Rogers' compensation to that paid to others in comparable

positions, he did not cite the sources for those comparisons in

either his testimony or his report.

Fisher's opinion does not

appear to be based on verified factual data.

Fisher's opinion little weight.

Thus, we accord

See Diverse Indus., Inc. v.

Commissioner, T.C. Memo. 1986-84.

Petitioner's other experts, Hughes and Benesh, also

submitted a written report.

The report coauthored by Hughes and

Benesh states, however, that they "were unable to locate any

comparable survey data on home health care agency managers

similar to * * * [petitioner]."

Hughes and Benesh, therefore,

were unable to perform a direct comparison.

Nor were they able

to identify individuals in a similar employment position, with

similar experience, qualifications, knowledge, and

responsibilities to those of Rogers.

Despite these obstacles,

Hughes and Benesh were able to create, in their opinion, a

reasonable comparison by examining the specific functions

- 30 performed by Rogers and then comparing the compensation paid to

Rogers with that paid to the person performing functions similar

to those performed by Rogers.

Thus, Hughes and Benesh first

compared Rogers to a physician.

In comparing the compensation paid to Rogers to the

compensation paid to a physician, Hughes and Benesh determined

that Rogers' average annual compensation was approximately 18

percent of petitioner's total revenue, whereas for a physician

the average median compensation-to-production ratio is 40

percent; and the compensation for a physician in the 90th

percentile is 59 percent, which exceeds the percentage paid to

Rogers in 1990.

In the alternative, Hughes and Benesh compared Rogers'

position and compensation to that of a real estate sales agent.

For this comparison, Hughes and Benesh relied upon data provided

in a report entitled "Real Estate Profitability 1992", which was

published by the National Association of Realtors.

Hughes and

Benesh found that the median compensation for real estate agents

who are paid on a sliding scale starts at 55 percent of the

commission paid by the sellers to the real estate broker and

increases to 63 percent.9

9

On the basis of these comparisons,

Compensation on a sliding scale is based upon the notion

that a salesperson will receive a larger portion of the

commission as her total dollar volume of sales increases.

- 31 Hughes and Benesh determined that Rogers' compensation as a

percentage of gross revenue was low.

We do not find Hughes and Benesh's opinion persuasive.

For

the evidence of comparable salaries to be accorded any weight, it

must be shown that the salaried positions are actually

comparable.

Work responsibility, nature of operations, years in

which the salary is paid, and even the local cost of living may

be taken into account.

See, e.g., Thomas A. Curtis, M.D., Inc.

v. Commissioner, T.C. Memo. 1994-15; Diverse Indus., Inc. v.

Commissioner, T.C. Memo. 1986-84; Snyder Bros. Co. v.

Commissioner, T.C. Memo. 1980-275; Townsend v. Commissioner, T.C.

Memo. 1980-264.

The similarity Hughes and Benesh found between a physician

and Rogers was that both are in the health care business, and

that Rogers performed his duties well with the support of several

office professionals and nurses.

Thus, they concluded that just

as a medical practice cannot exist without a physician, without

Rogers petitioner's supporting staff would not perform their

duties and petitioner would not exist.

This superficial

comparison is specious and is accorded no weight.

Hughes' and Benesh's comparison of Rogers' compensation to

that of a real estate agent is equally unpersuasive.

In their

report, Hughes and Benesh state that although real estate agents

and Rogers perform similar functions in their jobs, e.g.,

- 32 research the market for prospective buyers and sellers, solicit

business, provide consulting expertise, negotiate agreements with

prospective clients, and assist with paperwork, Rogers'

compensation as a percentage of petitioner's gross revenue is

"much lower than the [real estate] agents' median commission",

which is 55 to 63 percent of the commission paid by the seller to

the real estate broker.

Petitioner's experts, however, ignore the fact that the

industry publication that they relied upon for their data reports

that the median amount of the net compensation paid to real

estate sales agents in the South in 1992, who are compensated on

a sliding scale, is approximately $31,000.10

The amount of

Rogers' compensation in 1990 was $4,439,180.

Thus, although the

amount of Rogers' compensation is more than 140 times greater

than the median amount paid to persons who, according to Hughes

and Benesh, perform comparable functions, Hughes and Benesh

conclude that Rogers' level of compensation is comparatively low.

Previously, we stated that the absolute probative value of

measuring compensation as a percentage of income is often minimal

when used as an isolated factor.

10

We do not find that the data

The report also states that the typical established real

estate salesperson is a 49-year-old female who derives 67 percent

of her household income from the practice of residential real

estate brokerage. We have not given any weight to these

differences between the typical real estate salesperson and

Rogers.

- 33 relied upon by Hughes' and Benesh's report supports their

conclusion.

Hughes' and Benesh's total disregard of the actual

amounts paid to those who, in their opinion, perform jobs

requiring functions comparable to those required of Rogers is

suspect.

Thus, we find petitioner's experts' opinions of dubious

value.

Respondent's Witness

Respondent chose not to rely upon an expert witness for an

opinion and chose instead to rely upon Revenue Agent Horton to

explain how he determined $400,000 was the reasonable amount of

compensation for petitioner to pay Rogers.

expert on compensation.

Horton is not an

Horton based his determination of the

compensation that would be reasonable upon his experience as an

IRS agent, and some general statistics on the average

compensation paid to an officer of a business of approximately

the same size as petitioner.

There is no evidence that Horton

based his determination on the prevailing rates of compensation

for comparable positions in comparable concerns.

Therefore, we

accord Horton's testimony regarding this factor no weight.

factor favors neither party.

8.

This

We consider it neutral.

Salary Policy of Petitioner as to All Employees

Courts have considered salaries paid to other employees of a

business in deciding whether compensation is reasonable.

Kennedy

v. Commissioner, 671 F.2d at 173; Home Interiors & Gifts, Inc. v.

- 34 Commissioner, 73 T.C. at 1159.

We look to this factor to

determine whether Rogers was compensated differently than

petitioner's other employees solely because of his status as a

shareholder.

Petitioner deducted total compensation of $6,075,444 in

1990.

As a percentage of total compensation paid, Rogers

received 73 percent, even though he constituted less than 2

percent of petitioner's employees.11

Furthermore, of the total

compensation paid to petitioner's seven key employees (including

Rogers), $5,162,018, or 85.99 percent, was paid to Rogers.12

Moreover, the compensation of the highest paid nonshareholder,

Worley, was 5.1 percent of the amount paid to Rogers.

The

disparity between the compensation paid to the nonshareholders

and that paid to the shareholder--Rogers--is patent.

Further

exploration of this situation is required.

Contingent compensation paid under a longstanding arm'slength agreement will usually be upheld even if an incentive

formula results in greater compensation than the parties

anticipated at the time they entered into the contract.

Owensby

& Kritikos, Inc. v. Commissioner, 819 F.2d at 1327, 1328;

11

Thus, Rogers' compensation was almost three times

greater than the total compensation paid to all of the other

employees.

12

Thus, Rogers' compensation was more than six times the

total amount paid the other key employees.

- 35 Elliotts, Inc. v. Commissioner, 716 F.2d at 1248; Kennedy v.

Commissioner, supra at 174.

Rogers' bonus formula was

established in the corporate minutes at the beginning of 1989.13

Thus, the bonus formula was not longstanding.

Cf. Mayson

Manufacturing Co. v. Commissioner, 178 F.2d at 120 (bonus

contracts basically unchanged since they were negotiated in 1929,

held reasonable for taxable year 1943).

Rogers is the 100-

percent shareholder of petitioner, its director, and its

president.

Rogers alone determined the salary and bonus

compensation of every employee, including himself.

and petitioner were not dealing at arm's length.

Thus, Rogers

See Estate of

Wallace v. Commissioner, 95 T.C. at 555; cf. Mayson Manufacturing

Co. v. Commissioner, supra at 121 (bonus plan established by

board of directors for minority shareholders was an arm's-length

transaction).

Where an employer and employee are not dealing at

arm's length, the amount of compensation may be unreasonable.

Owensby & Kritikos, Inc. v. Commissioner, supra at 1324;

Elliotts, Inc. v. Commissioner, supra at 1246.

Petitioner notes on brief that respondent previously

reviewed the bonus formula in the examination of petitioner's

1989 return.

The result of that examination was a $211 refund,

and no adjustment was proposed to the deduction for compensation

13

In 1989, Rogers' base salary was $500,000; in 1990 it

was $1 million. In both years, the bonus formula was 50 percent

of pretax profit.

- 36 by petitioner.

Petitioner contends this fact is of particular

importance in this case.

Contrary to the position of petitioner, we do not find that

the fact respondent chose not to assert deficiencies in the prior

examination is necessarily important, or that it indicates that

the IRS accepted the manner in which compensation was determined.

See Owensby & Kritikos, Inc. v. Commissioner, supra at 1329; cf.

Mayson Manufacturing Co. v. Commissioner, supra at 121

(commission contract approved and accepted by the Commissioner

over a period of a number of years).

We note that Rogers was

paid total compensation of $928,883 in 1989, compared to

$4,439,180 in 1990.

The dramatic increase raised the stakes

involved and thereby increased respondent's incentive to

challenge the payments.

Owensby & Kritikos, Inc. v.

Commissioner, supra at 1329 n.57.

The great disparity between the amounts paid to the

nonshareholders and the sole shareholder--Rogers--and the fact

that Rogers' compensation plan was not the result of a

longstanding arm's-length agreement point to the conclusion that

the compensation paid Rogers in 1990 was in part unreasonable.

9.

Amount of Compensation Paid to Rogers in Previous Years

We note at the outset that respondent concedes on brief that

the maximum reasonable compensation for Rogers in 1990 is

$1,837,821.

Respondent arrived at this amount by calculating the

- 37 percentage of gross receipts that Rogers received as compensation

in 1989--18.6009 percent--and applying that percentage to

petitioner's 1990 gross receipts.

Petitioner contends that,

although Rogers' compensation in 1990 was 44.9 percent of that

year's gross receipts, it is reasonable because when the 1990

percentage is averaged with the prior years' percentages, the

average percentage is 18.84 percent, which is almost the same

percentage as the compensation respondent allowed in 1989.14

Thus, petitioner argues that the compensation paid Rogers in

1990 was, in part, paid to compensate him for undercompensation

in earlier years.

Respondent counters that in making this

argument petitioner, in effect, is seeking to deduct in 1990

compensation for services performed by Rogers in prior years.

14

Rogers' compensation in 1986, 1987, 1988, 1989, and 1990

measured as a percentage of petitioner's gross receipts in each

of those years is 7.8, 6.0, 16.9, 18.6, and 44.9 percent,

respectively. The average of the percentages is 18.84 percent.

We find, however, that petitioner's argument on this point

is flawed. From 1986 through 1990, petitioner paid Rogers

$5,942,622, and petitioner's total gross receipts for the same

period were $19,462,685. Thus, the total compensation paid to

Rogers as a percentage of petitioner's total gross revenue is

30.53 percent.

If it was actually petitioner's intent to compensate Rogers

in 1990 for his service in the prior years by paying him 18.6

percent of the gross receipts it earned in those years,

petitioner would have paid Rogers $2,116,618. This amount is the

total of 18.6 percent of each prior year's gross receipts less

the amounts petitioner actually paid to him for each of those

years, plus 18.6 percent of petitioner's 1990 gross receipts.

((18.6% x $848,403) - $66,943) + ((18.6% x $1,196,849) - $75,914)

+ ((18.6% x $2,542,912) - $431,702) + ((18.6% x $4,993,761) $928,883) + (18.6% x $9,880,760).

- 38 Respondent correctly acknowledges that it is well settled

that under some circumstances, reasonable additional compensation

of officers for services rendered in prior years is deductible

from the corporation's income for the year in which paid.

v. Ox Fibre Brush Co., 281 U.S. 115 (1930).

Lucas

However, a taxpayer

claiming that part of the payment to an officer in the current

year is for services rendered for prior periods must show:

(1)

The insufficiency of the officer's compensation in the previous

year, and (2) the amount of the current year's compensation that

was intended as compensation for that underpayment.

Pacific

Grains, Inc. v. Commissioner, 399 F.2d at 606; Estate of Wallace

v. Commissioner, supra at 554; Pulsar Components Intl., Inc. v.

Commissioner, T.C. Memo. 1996-129.

We have found as a fact that

the $500,000 increase in Rogers' base salary was intended to

compensate him for service in prior years.

Therefore, it is only

the first prong that is at issue.

Respondent denies that Rogers was undercompensated in prior

years.

In support of his position, respondent notes that in

1986, Rogers' compensation was very nearly one-half of

petitioner's taxable income, and that in 1988 and 1989, it was

more than one-half.

Moreover, respondent argues that as

petitioner paid Rogers more than $1.5 million over those 4 years,

Rogers could not have been undercompensated.

- 39 In 1984, Rogers rejected a job that offered to pay him in

excess of $1 million a year to manage a home health care

division.

Instead, Rogers went to work for petitioner in 1986,

managing its home health care business.

Petitioner paid Rogers

$66,943, $75,914, $431,702, and $928,883 in 1986, 1987, 1988, and

1989, respectively.

It is evident, therefore, that Rogers was

underpaid in each of those 4 years.

Thus, we find that petitioner has met its burden of proving

that part of the compensation paid Rogers in 1990 was intended to

compensate him for services he performed prior to 1990.

Conclusion

We come to the point where we must use our best judgment,

after weighing the evidence, to reconcile and integrate the

factors discussed above and reach our ultimate conclusion.

Because of all the factors and circumstances here present, we

have given the issue herein a close scrutiny with the result that

we agree with neither petitioner nor respondent.

On the basis of

our examination of the entire record we hold that $2.3 million

constituted reasonable compensation to Rogers for personal

services rendered to petitioner in 1990 and prior years.

Issue 2. Accuracy-Related Penalty Under Section 6662

Respondent determined an accuracy-related penalty under

section 6662 against petitioner for 1990 equal to 20 percent of

the tax deficiency.

- 40 Section 6662(a) provides that if any portion of an

underpayment of tax is attributable to any one of the factors

listed in section 6662(b), then there shall be added to the tax

an amount equal to 20 percent of the amount of the underpayment

to which it is so attributable.

Petitioner has the burden of

proving that respondent's determination of the penalty is

erroneous.

Rule 142(a); Welch v. Helvering, 290 U.S. at 115.

Petitioner did not address the section 6662 penalty issue at

trial or on brief.

Therefore, it failed to carry its burden of

proof, and we sustain respondent's determination of the penalty

for 1990.

To reflect the foregoing,

Decision will be entered

under Rule 155.