T.C. Memo. 2002-314
UNITED STATES TAX COURT
WILLIAM T. BUTLER, TRANSFEREE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
JOSEPH P. MCGRAW, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 2265-00, 2385-00. Filed December 27, 2002.
Gregory J. Klint and Douglas R. Boettge, for petitioner
William T. Butler.
Nicky R. Hay, for petitioner Joseph P. McGraw.
John C. Schmittdiel and Melissa J. Hedtke, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
FOLEY, Judge: By notices of liability dated November 30,
1999, respondent determined deficiencies, additions to tax, and
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penalties relating to Metro Refuse, Inc.’s (Metro) tax years
ending June 30, 1988 through 1990 (hereinafter tax years 1988
through 1990) as follows:
Metro Refuse, Inc.
Additions to tax and penalty
Year Deficiency Sec. 6653(b)(1)(A) Sec. 6653(b)(1)(B) Sec. 6653(b) Sec. 6661 Sec. 6663
1988 $112,324 $83,393.25 50% of the interest –- -– --
due on $111,191
1989 186,457 -- –- $136,207.50 $46,614.25 --
1990 160,854 -- –- –- –- $14,889.75
Unless otherwise indicated, 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.
The issue for decision is whether petitioners are liable as
transferees in equity for $1,946,292 relating to Metro’s Federal
income tax liability, additions to tax, penalties and interest,
as of December 31, 1999.
FINDINGS OF FACT
In 1964, William Butler (Butler) began working in the waste
disposal industry as a truck driver. In 1969, he incorporated
Metro, a waste disposal company servicing commercial customers in
the Minneapolis/St. Paul metropolitan area (Twin Cities area).
In 1983, Metro hired Joseph McGraw (McGraw) as its general
manager, and, in 1988, he became president and chief financial
officer. His duties related to personnel, financial management,
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accounting, equipment acquisition, marketing, sales, and tax
return preparation. On June 30, 1988, Butler transferred to
McGraw a minority interest in Metro.
In the 1970s, Metro began hauling waste to Burnsville
Sanitary Landfill (Burnsville), which was owned by Ed Kraemer &
Sons, Inc. (Kraemer & Sons) (i.e., Rudy, Victor, and David
Kraemer’s construction company). Burnsville sent Metro monthly
invoices, and Metro paid these invoices by check. Robert Miller
(Miller), Kraemer & Sons’ Minnesota division manager, negotiated
the prices for all Burnsville customers.
Sometime before the years in issue, Butler, Miller, and
Richard Wybierala began participating in two schemes that
diverted Metro funds to Butler. Richard and Alice Wybierala
owned Poor Richards, Inc. (Poor Richards), another Twin Cities
area waste disposal company. Poor Richards did not have the
equipment necessary to empty trash containers that required a
front-end loader. Butler agreed to have Metro service all of
Poor Richards’s front-end loader customers in exchange for a
portion of the fees Poor Richards collected on those accounts.
Butler periodically submitted to Poor Richards invoices
summarizing the front-end loading subcontract work performed by
Metro. Poor Richards wrote checks payable to Metro or Village
Sanitation, Inc. (a defunct waste hauler). But, rather than
deliver the checks to Metro, Richard Wybierala (Wybierala) cashed
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them and delivered most or all of the proceeds to Butler. McGraw
knew of this scheme and did not report these funds on Metro’s
corporate tax returns for the years in issue.
Under another scheme, which began in 1987, Butler directed
McGraw to issue weekly Metro checks to Poor Richards in amounts
less than $10,000. Although Poor Richards did not perform any
services, these checks were recorded on Metro’s general ledger as
subcontract work and deducted on Metro’s corporate tax returns.
Wybierala routinely cashed the checks and delivered the funds to
Butler, while McGraw generated vouchers and gave them to Metro’s
accounts payable staff.
Neither Metro nor Butler kept records detailing the cash
Butler received under these diversion schemes. Butler gave some
of the cash to Miller, a Kraemer & Sons employee, who, in turn,
lowered Metro’s dumping fees. Paying cash to landfill operators
in exchange for lower dumping fees was not a common practice in
the Twin Cities area, and other Burnsville customers did not make
such payments.1
Saliterman, Ltd. (Saliterman), a certified public accounting
practice owned by Mark Saliterman, performed, with McGraw’s
assistance, yearend reviews of Metro’s financial statements and
prepared Metro’s Federal and State income tax returns.
1
Pursuant to Minn. Stat. Ann. sec. 609.86 (West Supp.
2002), a generally enforced statute, commercial bribery is a
crime.
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Saliterman was not aware of, and McGraw and Butler did not inform
Saliterman about, the diversion schemes. During the years in
issue, McGraw supervised the preparation of Metro’s Forms W-2,
Wage and Tax Statement, and Forms 1099-MISC, Miscellaneous
Income, which he knew did not reflect the funds diverted to
Butler, and signed Metro’s tax returns, which he knew did not
accurately reflect Metro’s income and deductions. McGraw did not
know the total amount of cash Butler kept for himself or, with
the exception of Butler’s payments to Miller, how the diverted
cash was spent.
In 1990, respondent audited Metro’s 1988 and 1989 tax years.
McGraw failed to disclose to the auditor that there were income
omissions and fictitious subcontract expenses. McGraw
subsequently consulted with Attorney Peter Thompson (Thompson),
who insisted that Metro properly classify all its income and
expense items and not file another false tax return.
On September 14, 1990, Saliterman sent McGraw Metro’s 1990
Federal and State income tax returns. Shortly before Metro filed
its 1990 returns on March 19, 1991, McGraw, acting pursuant to
the advice of Thompson, called Saliterman and instructed them to
reduce the expense for subcontract services by $400,873 and
report that amount as officer’s compensation. Despite Thompson’s
advice, McGraw did not instruct Saliterman to include on the 1990
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return amounts Butler received from Poor Richards for front-
loading subcontract services.
Metro’s 1990 tax returns reflect that Butler and McGraw
received compensation of $1,006,330 and $156,900, respectively.
Metro did not report the reclassified $400,873 on Butler’s Forms
1099 or W-2 or on Metro’s employment tax returns and did not pay
or withhold employment taxes on it. Butler did not report that
amount on his individual income tax returns.
In early 1990, Butler and McGraw began negotiations to sell
Metro to Browning Ferris Industries, Inc. (BFI). On August 31,
1990, Browning Ferris Industries of Minnesota, Inc. (BFIM),
agreed to purchase Metro. BFIM exchanged 212,233 common shares
of BFI, BFIM’s parent, for Metro’s assets in a transaction
intended to be a tax-free merger pursuant to section 368.
The merger agreement provided that Metro could not transfer
the BFI stock to Butler and McGraw until BFI issued financial
statements showing the combined operations of Metro and BFI. On
December 4, 1990, BFI transferred 141,489 shares of its stock to
Butler and 70,744 shares to McGraw, consistent with their
respective 67- and 33-percent interests in Metro. BFI stock was
traded publicly on the New York Stock Exchange, and on December
4, 1990, BFI stock’s mean sale price was $21.875.2
2
See Meyer v. Commissioner, 46 T.C. 65, 106 (1966)
(holding that “Where stock is listed * * * on a recognized
(continued...)
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In 1991, the State of Minnesota audited Metro. McGraw did
not disclose to the State auditor, and the auditor did not
discover, the income omissions or fictitious expenses. Metro was
dissolved on December 11, 1991.
In 1995, David Kraemer discovered that Miller had received
kickbacks from Metro and filed suit, on behalf of Kraemer & Sons,
against Wybierala and Butler for unpaid dumping fees.
On June 28, 1995, Butler pled guilty to violating section
7206(2) relating to Metro’s 1988 return (i.e., aiding and
abetting the filing of a false corporate return), and section
7206(1) relating to his 1988 individual return (i.e., filing a
false personal income tax return). Butler admitted knowing that
Metro’s 1988 return did not include all of Metro’s taxable income
and agreed to pay $1.5 million toward his individual, and
Metro’s, tax liabilities. In 1997, Miller pled guilty to
violating section 7201 for failing to report cash received from
Butler (i.e., presenting a false or fraudulent return).
On November 30, 1999, respondent issued petitioners notices
of liability in which respondent determined that petitioners, as
transferees of Metro, are liable for $1,946,292.38 of corporate
2
(...continued)
exchange, the mean price between the * * * [high and low] trading
prices on a given date is * * * the fair market value for that
date.”), revd. on other grounds 383 F.2d 883 (8th Cir. 1967).
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income tax, statutory additions, and interest relating to Metro’s
tax years 1988 through 1990.
When they filed their petitions, Butler resided in Cape
Coral, Florida, and McGraw resided in Mahtomedi, Minnesota.
OPINION
Respondent contends that Metro underpaid its tax liability
for tax years 1988 through 1990; the underpayments were due to
petitioners’ fraudulent actions as officers of Metro; and
petitioners, as transferees of Metro’s assets, are liable for
Metro’s tax liabilities pursuant to section 6901. Petitioners
contend that there was no underpayment of tax attributable to the
conduct of Metro officers, and that the period of limitations
relating to Metro’s tax years 1988 through 1990 expired.
I. Statute of Limitations, Deficiency Determination, and Fraud
Penalty
“In the case of a false or fraudulent return with the intent
to evade tax, the tax may be assessed, or a proceeding in court
for collection of such tax may be begun without assessment, at
any time.” Sec. 6501(c)(1); see also sec. 6901(c)(1).
Respondent must establish by clear and convincing evidence that
for each year in issue an underpayment of tax exists and some
portion of the underpayment is due to fraud. See Rule 142(b);
Ballard v. Commissioner, 740 F.2d 659 (8th Cir. 1984), affg. in
part and revg. in part T.C. Memo. 1982-466; Petzoldt v.
Commissioner, 92 T.C. 661, 699 (1989).
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A. Underpayment of Tax
1. Metro’s Omitted Income
Respondent determined the amount of Metro’s omitted income
by compiling checks written by Poor Richards to Metro and Village
Sanitation. See sec. 446(b) (authorizing the Commissioner to
reconstruct a taxpayer’s income where the taxpayer fails to
maintain adequate records). Petitioners contend that the
worksheets used to bill Poor Richards, as summarized by McGraw,
more accurately reflect income to Metro.
The worksheets were incomplete and not compiled
contemporaneously with Butler’s receipt of the diverted funds.
Accordingly, we sustain respondent’s determinations relating to
the amounts of income omitted from Metro’s returns.
2. Metro’s Alleged Deductions
Petitioners concede that Metro underreported subcontract
income during the years in issue, Metro overstated its
subcontract expense in 1988 and 1989, and all of the funds
related to the underreporting and overstatement were diverted to
Butler. Petitioners contend, without supplying any
contemporaneous documentary evidence or third-party testimony,
that all funds diverted to Butler were used to pay Metro’s
ordinary and necessary business expenses (e.g., cash payments for
lower dumping fees, black-market truck parts, compensation to
Butler and other Metro employees, etc.). See Franklin v.
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Commissioner, T.C. Memo. 1993-184 (placing the burden of
production on the taxpayer insofar as the taxpayer’s defense to
fraud is premised on offsetting deductions).
a. Cash Payments to Miller
The cash payments to Miller were not ordinary expenses
because they were not “normal, usual, or customary”, and the
transactions which gave rise to these expenses were not “of
common or frequent occurrence in the type of business involved.”
See Deputy v. Dupont, 308 U.S. 488, 495 (1940); United Draperies
v. Commissioner, 41 T.C. 457, 463 (1964), affd. 340 F.2d 936 (7th
Cir. 1964). Petitioners have not established that other
Burnsville customers paid cash in exchange for lower dumping
fees, or that such payments were a common practice in the Twin
Cities area. Thus, the cash payments are not deductible. See
Welch v. Helvering, 290 U.S. 111, 115 (1933). Moreover, section
162(c)(2) disallows deductions for payments that constitute “an
illegal bribe, illegal kickback, or other illegal payment” under
a “generally enforced” State law. Minn. Stat. Ann. sec. 609.86
(West Supp. 2002), a generally enforced State law, prohibits
commercial bribery. See sec. 1.162-18(b)(3), Income Tax Regs.
Thus, pursuant to section 162(c)(2), no deduction is permitted
for the cash payments to Miller.
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b. Miscellaneous Expenses
Petitioners contend that Butler, after paying Miller, spent
the remaining funds on Metro-related expenses. Petitioners,
however, give no specific account as to why, when, or how much of
the diverted funds were used to pay Metro expenses. Accordingly,
Metro is not entitled to deductions for these alleged expenses.
c. Officer’s Compensation
Petitioners’ alternative contention is that all funds
diverted to Butler are deductible by Metro as officer’s
compensation. Payments are deductible, however, only when they
are intended as compensation. See King’s Court Mobile Home Park,
Inc. v. Commissioner, 98 T.C. 511, 514 (1992). The testimony and
documentary evidence establish, and we conclude, that Metro did
not intend these payments to be compensation.
Petitioners’ concessions, that Metro omitted income and
overstated deductions, and our holding that Metro is not entitled
to offsetting deductions establish Metro’s underpayment of tax
for tax years 1988 through 1990.
B. Fraud
Fraud is established by proof of intent to evade tax
believed to be owing. See Clayton v. Commissioner, 102 T.C. 632
(1994). A corporation is liable for fraud if its officer has the
fraudulent intent to evade the corporation’s taxes. DiLeo v.
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Commissioner, 96 T.C. 858, 875 (1991), affd. 959 F.2d 16 (2d Cir.
1992); Beck v. Commissioner, T.C. Memo. 2001-270.
Metro’s two officers, Butler and McGraw, both concede their
participation in the two schemes that led to the
misrepresentations on Metro’s tax returns, which McGraw signed.
Metro’s accounting department, under Butler’s orders and McGraw’s
supervision, did not keep books and records relating to the funds
diverted to Butler. McGraw caused Metro to file an incorrect
return even after his attorney told him to report the income
accurately. During Metro’s 1990 and 1991 tax audits, neither
Butler nor McGraw informed the Federal or State taxing
authorities about the income omissions and deduction
overstatements. Participants in the schemes primarily dealt in
cash, and any checks used to facilitate the schemes were written
for less than $10,000 to avoid Internal Revenue Service scrutiny.
Petitioners contend that they believed Metro’s returns did
not reflect an underpayment because Butler used the diverted
funds to pay Metro’s expenses. We disagree. McGraw, Metro’s
chief financial officer, readily acknowledged that, when Metro’s
return was filed, he did not know how much Butler was receiving
nor what he was doing with the money. McGraw knowingly
participated in both schemes by accounting for, and causing Metro
to deduct, fictitious subcontract expenses. In addition, Butler
pled guilty to violating section 7206 for aiding and abetting the
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filing of a false corporate return and willfully underreporting
income relating to his 1988 and 1989 tax returns.
The evidence is clear and convincing that Metro’s
underpayment of tax was attributable to the fraudulent actions of
its officers, McGraw and Butler. See Davis v. Commissioner, T.C.
Memo. 1991-603 (holding that the Commissioner may prove intent to
evade tax by circumstantial evidence); see also, e.g.,
Niedringhaus v. Commissioner, 99 T.C. 202, 211 (1992) (evidence
of fraud may include substantial understatement of income,
inadequate books and records, failure to cooperate with tax
authorities, dealing in cash, implausible explanations of conduct
given at trial, and participation in or concealment of illegal
activities).
We reject petitioners’ contention that, in filing Metro’s
returns, petitioners relied in good faith on the advice of
Metro’s outside accountants. There is no evidence that Metro’s
outside accountants knew that Butler and McGraw conspired to omit
income and deduct fictitious subcontract expenses. Even if
Metro’s outside accountants, having knowledge of all the relevant
facts, had instructed petitioners to omit Metro’s income and
deduct fictitious subcontract expenses, such advice would have
been so clearly wrong that we could not find that petitioners
relied upon the advice in good faith. See LaVerne v.
Commissioner, 94 T.C. 637, 652-653 (1990), affd. without
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published opinion 956 F.2d 274 (9th Cir. 1992), affd. without
published opinion sub nom. Cowles v. Commissioner, 949 F.2d 401
(10th Cir. 1991); Cordes Fin. Corp. v. Commissioner, T.C. Memo.
1997-162, affd. without published opinion 162 F.3d 1172 (10th
Cir. 1998). Accordingly, the period of limitations has not
expired, and Metro is liable for the deficiencies in its income
taxes, the section 6653 additions to tax for fraud, and the
section 6663 fraud penalty.
II. Transferee Liability
Stockholders who have received the assets of a dissolved
corporation may be held liable for unpaid corporate taxes. Sec.
6901; Phillips v. Commissioner, 283 U.S. 589, 593 (1931).
Respondent has the burden of establishing transferee liability.
Rule 142(d); sec. 6902. Pursuant to section 6901(a), respondent
may establish petitioners’ liability in equity if a basis exists
under applicable Minnesota law for holding petitioners (i.e., the
transferees) liable. See Commissioner v. Stern, 357 U.S. 39, 42-
47 (1958).
A. Respondent Established a Prima Facie Case in Equity
Respondent established that, on December 4, 1990,
petitioners knew Metro underpaid its tax liabilities for tax
years 1988, 1989, and 1990, and petitioners received, without
consideration, liquidating distributions from Metro totaling
$4,642,597 (i.e., Butler’s 141,489 BFI shares plus McGraw’s
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70,744, multiplied by the $21.875 share price). Thus, the debtor
made the transfer without receiving a reasonably equivalent value
in exchange, and the debtor became insolvent as a result of the
transfer. See Minn. Stat. Ann. secs. 513.45 (West 2002),
302A.557 (West 1985). Metro’s tax liability for those years
remains unpaid. Accordingly, respondent has established a prima
facie case of equitable transferee liability. See Gumm v.
Commissioner, 93 T.C. 475 (1989).
Respondent relied on section 513.45 of Minnesota’s Uniform
Fraudulent Transfer Act (UFTA), Minn. Stat. Ann. sec. 513.45, to
establish that Metro was rendered insolvent by the distribution
of BFI stock, and accordingly, the distribution was fraudulent.
Petitioners contend that respondent erred by relying on the UFTA
to determine whether the transfer was fraudulent rather than
section 302A.551 of the Minnesota Model Business Corporation Act
(MBCA), Minn. Stat. Ann. sec. 302A.551 (West 1985), to determine
whether the distribution was illegal.
Section 513.45 of UFTA provides that a transfer is
fraudulent as to a present creditor if the debtor made the
transfer without receiving a reasonably equivalent value in
exchange for the transfer, and the debtor became insolvent as a
result of the transfer. Minn. Stat. Ann. sec. 513.45. Similarly
section 302A.551, subdivision 1, of the MBCA provides that a
distribution is illegal if the corporation is unable “to pay its
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debts in the ordinary course of business after making the
distribution”. Minn Stat. Ann. sec. 302A.551, subdiv. 1.
Respondent has established that Butler and McGraw caused
Metro to avoid paying taxes they knew to be owing. Scott v.
Commissioner, 117 F.2d 36 (8th Cir. 1941); Hagaman v.
Commissioner, 100 T.C. 180, 183 (1993). The liquidating
distribution to petitioners, for which Metro did not receive
anything in exchange from petitioners, rendered Metro insolvent
(i.e., unable to pay those taxes in the ordinary course of
business). Accordingly, the distribution was a fraudulent
transfer pursuant to section 513.45 of the UFTA, and illegal
pursuant to section 302A.551 of the MBCA. We conclude that
petitioners’ liability is established pursuant to either statute.
Petitioners also contend that several Minnesota statutes of
limitation (Minn. Stat. Ann. secs. 541.05 (West Supp. 2002),
302A.557, and 302A.7291 (West Supp. 2002)) bar respondent’s tax
claims. We disagree. Minnesota statutes of limitations are
inapplicable to transferee proceedings governed by section 6901.
See Phillips v. Commissioner, supra; see also Dillman v.
Commissioner, 64 T.C. 797 (1975).
B. Petitioners’ Rebuttal of Respondent’s Prima Facie Case
Petitioners contend that, pursuant to section 302A.557,
subdivision 1, of the MBCA, petitioners’ liability is limited to
$459,635 of tax, $323,000 of penalties, and interest accrued as
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of December 4, 1990. Petitioners contend that they are not
liable for any interest accruing after the date of the transfer
of assets (i.e., December 4, 1990). We disagree. There is no
authority for petitioners’ position. On December 4, 1990, Butler
and McGraw received BFI stock worth $3,095,072 and $1,547,525,
respectively. These amounts were obviously in excess of Metro’s
tax liability on that date (i.e., est. $1,100,000). “In cases
where the transferred assets exceed the total liability of the
transferor, the interest being charged is upon the deficiency,
and is therefore a right created by the Internal Revenue Code.”
Estate of Stein v. Commissioner, 37 T.C. 945, 961 (1962); Lowy v.
Commissioner, 35 T.C. 393, 397 (1960). Accordingly, petitioners’
liability with respect to interest on Metro’s tax liability is
determined pursuant to Federal law (i.e., section 6601).
Petitioners contend, without citing any authority, that the
BFI stock they received should be valued at a 40-percent discount
because the tax-free characterization of Metro’s merger with BFIM
would have been destroyed had they sold their stock on December
4, 1990. This contention is unpersuasive. A willing buyer would
not be concerned whether the seller recognizes gain as a result
of the exchange. See Stanko v. Commissioner, 209 F.3d 1082, 1086
(8th Cir. 2000) (holding that the proper approach to valuation is
to determine what a willing buyer would have paid for the
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property (citing United States v. Cartwright, 411 U.S. 546, 551
(1973))).
Petitioners contend that their liability should be reduced
because they allegedly paid $538,883 of Metro’s liabilities after
Metro’s BFI stock was distributed to them. Petitioners’
testimony, however, was devoid of any particulars relating to the
allegedly paid expenses. In addition, petitioners have not
established that the allegedly paid liabilities had priority over
respondent’s claim relating to tax liabilities. See Hutton v.
Commissioner, 59 F.2d 66 (9th Cir. 1932), affg. 21 B.T.A. 101
(1930); Gobins v. Commissioner, 18 T.C. 1159, 1174 (1952), affd.
per curiam 217 F.2d 952 (9th Cir. 1954). Accordingly, we reject
petitioners’ contention. McGraw contends that his transferee
liability should be reduced because Butler, in his 1995 criminal
plea, agreed to pay Butler’s and Metro’s tax liabilities. Each
transferee, however, is liable to the extent he received property
without adequate consideration. Phillips v. Commissioner, 283
U.S. at 603; Scott v. Commissioner, supra. McGraw also contends
respondent did not take reasonable steps to collect the tax
liability from Metro. We reject this contention also. Metro was
dissolved in 1991. The Commissioner is not required to proceed
against a dissolved corporation before asserting transferee
liability against its stockholders. Maher v. Commissioner, 469
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F.2d 225 (8th Cir. 1972), affg. in part and remanding in part 56
T.C. 763 (1970).
Contentions we have not addressed are irrelevant, moot, or
meritless.
To reflect the foregoing,
Decisions will be entered
for respondent.