1 The proceedings herein were automatically stayed after the

trial herein when petitioners filed a petition for bankruptcy

with the U.S. Bankruptcy Court for the Northern District of

California on Sept. 30, 1993. On Oct. 18, 1995, after petitioners' bankruptcy proceeding was discharged, the Court lifted

the automatic stay and ordered the parties to file simultaneous

opening briefs by Dec. 18, 1995, and simultaneous answering

briefs by Jan. 12, 1996. Petitioners did not file an opening

brief. On Jan. 17, 1996, petitioners submitted a document that

the Court had filed as their answering brief. On Jan. 18, 1996,

the Court ordered that petitioners were not allowed to file any

additional briefs in this case and that respondent was allowed to

file a reply to petitioners' answering brief, which she did on

Feb. 16, 1996.

T.C. Memo. 1996-296

UNITED STATES TAX COURT

TERRY R. HARDTKE AND NANCY HARDTKE, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 13669-92.1 Filed June 26, 1996.

Terry R. Hardtke, pro se.

Allan D. Hill, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

CHIECHI, Judge: Respondent determined the following defi-
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2 All section references are to the Internal Revenue Code in

effect for 1987. All Rule references are to the Tax Court Rules

of Practice and Procedure.

ciency in, and additions to, petitioners' Federal income tax:

 Section Section Section 

Year Deficiency 6653(a)(1)(A)2 6653(a)(1)(B) 6661(a)

1987 $13,912.00 $695.60 * $3,478.00

* 50 percent of the interest due on the portion of the underpayment due to negligence. Respondent determined that the entire

underpayment was attributable to negligence.

The issues for decision are:

(1) Did petitioners have unreported income for 1987 attributable to services provided by petitioner Terry R. Hardtke (Mr.

Hardtke) to T.R. Hardtke Insurance Agency, Inc. (Agency)? We

hold that they did.

(2) Are petitioners liable for self-employment tax for

1987? We hold that they are.

(3) Are petitioners liable for 1987 for the additions to

tax for negligence under section 6653(a)? We hold that they are. 

(4) Are petitioners liable for 1987 for the addition to tax

for a substantial understatement of income tax under section

6661(a)? We hold that they are.

FINDINGS OF FACT

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

Petitioners resided in New Almaden, California, at the time

the petition was filed.

During 1987, Agency was a California corporation that
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operated a general agency specializing in brokering small group

medical insurance plans. Throughout 1987, Mr. Hardtke owned 75

percent of the common stock of Agency, and Stuart Michell (Mr.

Michell) owned the remaining 25 percent of the common stock of

Agency. During 1987, Mr. Hardtke, who already was serving as

Agency's chief executive officer (CEO), was elected its president

during a special meeting of its board of directors (board of

directors) held on March 3, 1987 (March 3, 1987 Agency board

meeting).

During 1987, Dinan, Inc. (Dinan) was a California corporation that specialized in pension administration and in the

production and marketing of computer software that compared the

costs and benefits of various group medical plans. Mr. Hardtke,

who served as CEO of Dinan during 1987, owned 42 percent of the

common stock of Dinan throughout that year until December 8,

1987, when he purchased an additional 33 percent of that stock

from Russell M. Meusy (Mr. Meusy), thereby increasing his common

stock ownership of Dinan to 75 percent. In addition to that

common stock ownership of Mr. Hardtke and Mr. Meusy, during 1987,

Mr. Hardtke's mother owned three percent, Mr. Michell owned 15

percent, and an unidentified individual owned seven percent of

Dinan's common stock.

The minutes of the March 3, 1987 Agency board meeting

provided in pertinent part:

Compensation will be earned by Mr. Hardtke and Mr.
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3 It is not clear from the record whether all of those payments

were made during 1987.

4 Although during all relevant times Dinan used a fiscal year

that ended on the last day of February, the parties stipulated to

Dinan's books and records for the period Jan. 1, 1987, through

Dec. 31, 1987, when agreeing that those books and records do not

show any compensation paid to Mr. Hardtke during that year.

Michell and shall be paid directly to Dinan, Inc. as

follows:

$7,000.00 each month is payable to Dinan, Inc. as

a consulting fee for the services of Mr. Hardtke

and Mr. Michell. It will be accounted as $4,000

for Mr. Hardtke and $3,000 for Mr. Michell.

The only persons present at the March 3, 1987 Agency board

meeting were Mr. Hardtke, Mr. Michell, and petitioner Nancy

Hardtke (Ms. Hardtke).

Agency's books of account for the period February 28, 1987,

through February 28, 1988, show entries reflecting that Agency

paid a total of $74,000 to Dinan as "consulting fees".3 Its

books of account for the period January 1, 1987, through December

31, 1987, do not contain any entries showing that compensation

was paid to Mr. Hardtke during 1987.

The books and records of Dinan for the period January 1,

1987, through December 31, 1987, do not contain any entries

showing that compensation was paid to Mr. Hardtke during 1987.4

Mr. Hardtke received the following compensation from Agency

and Dinan for the years 1986 and 1988:

Year Agency Dinan

 1986 $3,000 $56,500

 1988 65,600 38,535
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OPINION

Petitioners bear the burden of proving that respondent's

determinations in the notice of deficiency are erroneous. Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).

Unreported Income

Respondent determined that Mr. Hardtke had $44,000 of

unreported compensation income from Agency during 1987. Although

Agency made no payments to Mr. Hardtke during that year, respondent argues that the amounts that Agency paid to Dinan during

1987 with respect to services provided by Mr. Hardtke were income

earned by Mr. Hardtke that is includible in petitioners' income

for that year. Petitioners argue that during 1987 Mr. Hardtke

provided services to Agency as an employee of Dinan pursuant to a

consulting agreement between Agency and Dinan and that he did not

provide services to Agency in any other capacity.

It is well established that income must be taxed to the

actual earner of that income. Lucas v. Earl, 281 U.S. 111

(1930). "In the corporate context, however, the actual earner

test may be inadequate because a corporation can earn income only

through the personal services of its employees and agents." Haag

v. Commissioner, 88 T.C. 604, 611 (1987), affd. without published

opinion 855 F.2d 855 (8th Cir. 1988). "In numerous instances, a

corporation is hired solely in order to obtain the services of a

specific corporate employee." Johnson v. Commissioner, 78 T.C.

882, 891 (1982), affd. without published opinion 734 F.2d 20 (9th
- 6 -

Cir. 1984). As a result, this Court applies a two-prong test to

determine whether a corporation or its employee is the actual

earner of the income in question:

First, the service-performer employee must be just

that--an employee of the corporation whom the corporation has the right to direct or control in some meaningful sense. Second, there must exist between the

corporation and the person or entity using the services

a contract or similar indicium recognizing the corporation's controlling position. [Id.; citations omitted.]

With respect to the first prong of the foregoing test,

although Mr. Hardtke was an employee of Dinan during 1987, he

also was an employee of Agency during that year. Thus, not only

Dinan, but also Agency, had the right to control or direct Mr.

Hardtke in some meaningful sense as its employee.

With respect to the second prong of the test set forth in

the Johnson case, we find that petitioners failed to prove that a

contract existed between Dinan and Agency during 1987 under which

Dinan was to provide its services to Agency through its employee,

Mr. Hardtke. Except possibly for the minutes of the March 3,

1987 Agency board meeting, the only evidence of the existence of

such an agreement between Dinan and Agency is the self-serving

testimony of Mr. Hardtke on which we are unwilling to rely.

With respect to the March 3, 1987 Agency board minutes, they

provide in pertinent part:

Compensation will be earned by Mr. Hardtke and Mr.

Michell and shall be paid directly to Dinan, Inc. as

follows:

$7,000.00 each month is payable to Dinan, Inc. as

a consulting fee for the services of Mr. Hardtke
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and Mr. Michell. It will be accounted as $4,000

for Mr. Hardtke and $3,000 for Mr. Michell.

The first clause of the March 3, 1987 Agency board minutes quoted

above unequivocally provides that Mr. Hardtke was to earn compensation and that that compensation was to be paid by Agency to

Dinan. Although those minutes further provide that Agency was to

pay Dinan for Mr. Hardtke's services, they do not establish that

a contractual relationship existed during 1987 for Dinan to

provide its services to Agency through its employee, Mr. Hardtke. 

Even assuming arguendo that we were to read the second

clause of the March 3, 1987 Agency board minutes quoted above as

providing that Dinan was to earn compensation for rendering its

services to Agency through its employee, Mr. Hardtke, --a reading

that we find to be quite strained--we would be left in equipoise

as to the intended meaning of those minutes. This is because, on

the one hand, they provide that Mr. Hardtke was to earn compensation and that that compensation was to be paid to Dinan, and, on

the other hand, under that assumed reading, they provide inconsistently that Dinan was to earn compensation for rendering its

services to Agency through its employee, Mr. Hardtke. Consequently, petitioners would have failed to establish that Dinan,

and not Mr. Hardtke, was to earn the compensation in question.

Based on the entire record before us, we find that petitioners failed to prove that Mr. Hardtke did not earn the income that

Agency paid to Dinan with respect to Mr. Hardtke's services to
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5 Although respondent argues that certain amounts that Mr.

Hardtke received during 1987 from Dinan that were characterized

on the books and records of Dinan as "Loan Payable-Officers"

actually represented, at least in part, indirect payments of

compensation from Agency and petitioners argue that those amounts

were in fact repayments of loans, and not compensation, we need

not decide that dispute. This is because resolution of that

dispute is not necessary to our conclusions herein. All that is

necessary is whether the compensation that Agency paid during

1987 to Dinan for services performed by Mr. Hardtke was earned by

Mr. Hardtke, rather than by Dinan, under the two-prong test

enunciated in Johnson v. Commissioner, 78 T.C. 882, 891 (1982),

affd. without published opinion 734 F.2d 20 (9th Cir. 1984).

Agency during 1987. We therefore sustain respondent's determination on that issue.5

Self-Employment Tax

Respondent determined that petitioners are liable for selfemployment tax of $5,387 for 1987. In order to refute that

determination, petitioners rely on the evidence they presented

and the argument they make with respect to whether Mr. Hardtke

had compensation income from Agency for 1987. We have found that

petitioners failed to satisfy their burden of proof on the

compensation issue. Consequently, they have failed to meet their

burden of proving error in respondent's determination regarding

petitioners' liability for self-employment tax for 1987. See

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

we sustain that determination.

Additions to Tax

Respondent determined that petitioners are liable for 1987

for the additions to tax for negligence under section
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6653(a)(1)(A) and (B) and the addition to tax for a substantial

understatement of income tax under section 6661(a). Petitioners

presented no evidence and make no argument regarding the additions to tax under section 6653(a)(1)(A) and (B) and section

6661(a) for 1987. Consequently, petitioners have failed to

satisfy their burden of proof on those issues. See Rule 142(a);

Niedringhaus v. Commissioner, 99 T.C. 202, 220-222 (1992); Crown

Income Charitable Fund v. Commissioner, 98 T.C. 327, 339 (1992),

affd. 8 F.3d 571 (7th Cir. 1993). Accordingly, we sustain

respondent's determinations that petitioners are liable for 1987

for the additions to tax under section 6653(a)(1)(A) and (B) and

section 6661(a).

To reflect the foregoing,

Decision will be entered

for respondent.