                         T.C. Memo. 2006-55



                       UNITED STATES TAX COURT



             ERIC B. BENSON, ET AL.,1 Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent*



     Docket Nos.     585-98, 19416-98,    Filed March 27, 2006.
                   19417-98, 19421-98,
                   12967-00, 14171-01.


     John M. Youngquist, for petitioners.

     Michael E. Melone, for respondent.




     1
       Cases of the following petitioners are consolidated
herewith: Brad D. Benson, docket No. 19416-98; Mark D. Benson,
docket No. 19417-98; Eric B. Benson, docket No. 19421-98; and
Burton O. and Elizabeth C. Benson, docket Nos. 12967-00 and
14171-01.
     *
       This opinion supplements our previously filed opinion in
Benson v. Commissioner, T.C. Memo. 2004-272.
                                 - 2 -

                    SUPPLEMENTAL MEMORANDUM OPINION


     RUWE, Judge:    This case is before the Court on petitioners’

motion for reconsideration of findings and opinion.    On November

29, 2004, we issued a Memorandum Opinion holding that the Bensons

received constructive dividends in 1989, 1990, 1993, and 1994.

Benson v. Commissioner, T.C. Memo. 2004-272.     In that Memorandum

Opinion, we stated the detailed facts of this case, which we

incorporate herein by this reference.

     Section 6501(a)2 generally bars the assessment of a

deficiency after 3 years from the date the return was filed.

Section 6501(e) provides for a 6-year period of limitations if

the taxpayer omits more than 25 percent of the gross income

stated in the return.    In our prior opinion, we noted that the

parties agreed in their briefs that our opinion on the merits

would determine whether the section 6501(e) exception to the

period of limitations in section 6501(a) allows assessment of the

deficiencies for 1989, 1990, 1993, and 1994.

     As we noted in our prior opinion, section 6501(e)(1)(A)(ii)

provides that in determining the amount omitted from gross

income, there shall not be taken into account any amount omitted

if such amount is disclosed in the return, or in a statement


     2
       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.
                                 - 3 -

attached to the return in a manner adequate to apprise the

Secretary of the nature and amount of such item.         In the briefs

submitted before our opinion at T.C. Memo. 2004-272 was filed,

neither party raised the issue of adequate disclosure under

section 6501(e)(1)(A)(ii).

     After our opinion at T.C. Memo. 2004-272, petitioners filed

a motion for reconsideration.     Petitioners now for the first time

argue that the prior opinion did not provide a basis to resolve

the question of whether petitioners Burton O. and Elizabeth C.

Benson (the Bensons) disclosed the understatements of gross

income on their returns.   Petitioners argue that their failure to

make this argument before our previous opinion was due to the

complexities of the way the case was presented and briefed.              On

March 10, 2005, we granted petitioners’ motion for

reconsideration of findings and opinion pursuant to Rule 161 with

respect to the application of section 6501(e).

     In Benson v. Commissioner, supra, we found that the Bensons

received items of gross income in 1989, 1990, 1993, and 1994 that

were not reported on their Forms 1040, U.S. Individual Income Tax

Returns, as follows:

                                              Tax Year

   Description                  1989      1990       1993       1994

                                          1
ERG-Recreation acct.              –-        $686     $26,000    $2,698
ERG transfers to NPI         $483,098       –-     3,600,000   160,063
143 Alice Lane                    –-     336,500        –-        –-
Prop. taxes Alice Ln.             –-        –-         3,879     8,196
                              2
Check ref: Carroll              96,749       –-         –-        –-
Automobile deductions           10,624    23,676      28,308    14,723
                                    - 4 -
Charitable deduction                –-         –-        50,000      –-
Excess rent--Stanford               –-       40,067      46,560    63,444
Rent--Lowell                      29,400     29,400      31,020    41,736
Director’s fees                    6,000     23,000      42,000    49,000
Townsend check                      –-         –-          –-      15,000
Travel expenses                     –-         –-          –-       3,889
Legal expenses                      –-         –-          –-       4,033
Life insurance payments            2,404      2,480        --       4,781
Education payments                  --         --         2,599     9,166
Royalty income                       709       --           570       586
Franklin dividend income             193        691         987     1,072
Forgiveness of debt income          --         --          --      88,291
Employee relations expenses         --         --          --       3,035
    Total                         629,177   456,500   3,831,923   469,713
      1
        All figures are rounded to the nearest dollar.
      2
        Respondent conceded that the Bensons are entitled to a deduction of
$77,973 in 1989 with respect to legal expenses.

          The parties agree that the normal 3-year period of

limitations in section 6501(a) would bar assessment of

deficiencies for these years unless the exception in section

6501(e) applies.      Thus, we must decide whether the 6-year period

of limitations provided by section 6501(e)(1) applies to the

Bensons’ 1989, 1990, 1993, and 1994 returns.3

      Respondent argues that section 6501(e)(1)(A) extended the

period of limitations to 6 years because the Bensons omitted

gross income in excess of 25 percent of their reported gross

income in 1989, 1990, 1993, and 1994.          Respondent has the burden

of proving that the Bensons omitted more than 25 percent of gross

income.      See Harlan v. Commissioner, 116 T.C. 31, 39 (2001).




      3
       Respondent had also argued that the exception to the
statute of limitations for fraud applied. See sec. 6501(c). In
Benson v. Commissioner, T.C. Memo. 2004-272, we found that
respondent did not satisfy his burden of proving fraud by clear
and convincing evidence.
                                - 5 -

     Section 6501(a)4 provides that the Commissioner shall assess

any tax due within 3 years after the taxpayer files a return.

Section 6501(e)(1)(A)5 provides an exception to the general 3-


     4
         Specifically, sec. 6501(a) provides:

     the amount of any tax imposed by this title shall be
     assessed within 3 years after the return was filed
     (whether or not such return was filed on or after the
     date prescribed) * * * and no proceeding in court
     without assessment for the collection of such tax shall
     be begun after the expiration of such period.

     5
         Sec. 6501(e) provides in pertinent part:

          SEC. 6501(e). Substantial Omission of Items.--
     Except as otherwise provided in subsection (c)--

                 (1) Income taxes.--In the case of any tax
            imposed by subtitle A--

                      (A) General rule.--If the taxpayer omits
                 from gross income an amount properly
                 includible therein which is in excess of 25
                 percent of the amount of gross income stated
                 in the return, the tax may be assessed, or a
                 proceeding in court for the collection of
                 such tax may be begun without assessment, at
                 any time within 6 years after the return was
                 filed. For purposes of this subparagraph--

                           (i) In the case of a trade or
                      business, the term “gross income” means
                      the total of the amounts received or
                      accrued from the sale of goods or
                      services (if such amounts are required
                      to be shown on the return) prior to
                      diminution by the cost of such sales or
                      services; and

                           (ii) In determining the amount
                      omitted from gross income, there shall
                      not be taken into account any amount
                                                     (continued...)
                                 - 6 -

year period of limitations prescribed by section 6501(a).

Section 6501(e)(1)(A) extends the period of limitations to 6

years when the taxpayer omits amounts properly includable in

gross income and the omitted amounts exceed 25 percent of the

reported gross income.

     “The test for the extended limitations period under section

6501(e) may be expressed as a fraction.”     Harlan v. Commissioner,

supra at 40.   In that fraction, the numerator is the amount

properly includable in gross income that the taxpayer omitted

from the return.   The denominator is the amount of gross income

stated in the taxpayer’s return.    See sec. 6501(e)(1)(A); Harlan

v. Commissioner, supra.

     This Court has found that the section 61 definition of

“gross income” generally applies to section 6501(e)(1)(A).     E.g.,

Hoffman v. Commissioner, 119 T.C. 140, 148 (2002); Insulglass

Corp. v. Commissioner, 84 T.C. 203, 210 (1985).     In the case of a

trade or business, however, section 6501(e)(1)(A)(i) modifies the

term “gross income” to mean “the total of the amounts received or

accrued from the sale of goods or services (if such amounts are



     5
      (...continued)
                       which is omitted from gross income
                       stated in the return if such amount is
                       disclosed in the return, or in a
                       statement attached to the return, in a
                       manner adequate to apprise the Secretary
                       of the nature and amount of such item.
                               - 7 -

required to be shown on the return) prior to diminution by the

cost of such sales or services”.

     For a taxpayer who owns an interest in a partnership or an S

corporation, gross income under section 6501(e)(1)(A)(i) includes

the taxpayer’s share of the entity’s reported gross income.

“[W]e have interpreted * * * [section 6501(e)(1)(A)(i)] as

requiring that a taxpayer’s gross income include her share of the

partnership’s gross receipts from the sale of goods or services.”

Hoffman v. Commissioner, supra at 148 (citing Harlan v.

Commissioner, supra); accord Estate of Klein v. Commissioner, 63

T.C. 585, 591 n.6 (1975), affd. 537 F.2d 701 (2d Cir. 1976)).

With respect to S corporations, section 1366(c) provides:    “In

any case where it is necessary to determine the gross income of a

shareholder for purposes of this title, such gross income shall

include the shareholder’s pro rata share of the gross income of

the corporation.”   When calculating reported gross income under

section 6501(e), taxpayers include their portion of an S

corporation’s gross income.   Benderoff v. United States, 398 F.2d

132, 135 (8th Cir. 1968); Roschuni v. Commissioner, 44 T.C. 80,

85-86 (1965); Gmelin v. Commissioner, T.C. Memo. 1988-338, affd.

without published opinion 891 F.2d 280 (3d Cir. 1989).

     Furthermore, section 6501(e)(1)(A)(ii) provides that any

amount disclosed in the return, or in a statement attached to the

return, shall not be considered as omitted gross income.    These
                                 - 8 -

disclosures must adequately apprise the Commissioner of the

nature and amount of the relevant item.     Sec. 6501(e)(1)(A)(ii).

The question of whether the taxpayer adequately disclosed an item

on the return is a factual question.     Whitesell v. Commissioner,

90 T.C. 702, 707-708 (1988).

     The purpose of extending the period of limitations under

section 6501(e) is to level the playing field when the taxpayer’s

omission of income places the Commissioner at a disadvantage in

discovering errors.     Colony, Inc. v. Commissioner, 357 U.S. 28,

36 (1958).   Interpreting a prior version of section 6501(e), the

Supreme Court stated that Congress extended the period of

limitations to allow the Commissioner additional time “to

investigate tax returns in cases where, because of a taxpayer’s

omission to report some taxable item, the Commissioner is at a

special disadvantage in detecting errors.     In such instances the

return on its face provides no clue to the existence of the

omitted item.”   Id.    To adequately apprise the Commissioner, “The

statement must be sufficiently detailed to alert the Commissioner

and his agents as to the nature of the transaction so that the

decision as to whether to select the return for audit may be a

reasonably informed one.”     Estate of Fry v. Commissioner, 88 T.C.

1020, 1023 (1987).     While a taxpayer’s disclosure must be more

substantial than supplying the Commissioner with “a ‘clue’ which

would be sufficient to intrigue a Sherlock Holmes”, the
                               - 9 -

disclosure need not recite every underlying fact.     Quick’s Trust

v. Commissioner, 54 T.C. 1336, 1347 (1970), affd. 444 F.2d 90

(8th Cir. 1971).   Although a misleading statement may provide a

“clue” to omitted gross income, it does not adequately apprise

the Commissioner of the nature and amount of an item.     Phinney v.

Chambers, 392 F.2d 680, 685 (5th Cir. 1968); Estate of Fry v.

Commissioner, supra.

     When taxpayers’ individual returns contain references to

other documents or returns, those references provide a clue or

serve as notice to the Commissioner.     Reuter v. Commissioner,

T.C. Memo. 1985-607.   Specifically, when a return includes a

reference to a partnership return, “partnership returns are

considered together with individual returns to determine the

amount omitted from gross income.”     White v. Commissioner, 991

F.2d 657, 661 (10th Cir. 1993), affg. T.C. Memo. 1991-552; see

also Hoffman v. Commissioner, supra at 147.    Similarly, when

taxpayers’ returns include a reference to an S corporation, “the

corporate information return on Form 1120-S must be considered

along with taxpayers’ individual returns in resolving the issue

of adequate disclosure.”   Benderoff v. United States, supra at

135; see also Roschuni v. Commissioner, supra.

     In section 6501(e)(1)(A), the word “return” does not include

amended returns.   See Houston v. Commissioner, 38 T.C. 486, 489

(1962); Goldring v. Commissioner, 20 T.C. 79, 81 (1953)
                              - 10 -

(interpreting similar language in section 275(c), the predecessor

to section 6501(e)).   The period of limitations starts to run

with the filing of the original return, and the filing of an

amended return does not affect the period of limitations.

Insulglass Corp. v. Commissioner, 84 T.C. at 207; Goldring v.

Commissioner, supra at 82.

I.   Disclosures Under Section 6501(e)(1)(A)(ii)

     ERG was a subchapter C corporation that was a taxable

entity.   NPI was a subchapter S corporation and as such was a

passthrough entity that was not taxable.   Burton Benson

controlled the operations of both of these entities.

     The Bensons first argue that the determinations sustained in

our prior opinion were not omissions of gross income but

reallocations of reported corporate income and expenses to Burton

Benson as the controlling shareholder of ERG.   In particular, the

Bensons argue that NPI’s Forms 1120S, U.S. Income Tax Return for

an S Corporation, including amended Forms 1120S, disclosed

royalties, engineering services,6 and rents7 that NPI received


     6
       In our prior opinion, we found that transfers made by ERG
to NPI of $483,098 in 1989, $3.6 million in 1993, and $160,063 in
1994 constituted constructive dividends to the Bensons. Benson
v. Commissioner, T.C. Memo. 2004-272.
     7
       In our prior opinion, we held that the Bensons received
constructive dividend income of $40,067 in 1990, $46,560 in 1993,
and $63,444 in 1994 from excess rent paid by ERG for its use of
the Stanford plant. Id. We also held that the Bensons received
constructive dividend income of $29,400 in 1989, $29,400 in 1990,
                                                   (continued...)
                              - 11 -

from ERG that we found to be constructive dividends to the

Bensons.   The Bensons also assert that ERG’s Forms 1120 disclosed

deductions for payments, which were found to be constructive

dividends to the Bensons.

     Respondent argues that the returns of NPI did not adequately

disclose the nature and amount of the Bensons’ constructive

dividend income.   Respondent also argues that disclosures on

amended returns are not relevant to the question of adequate

disclosure.   Respondent also argues that the corporate returns of

ERG are not relevant to whether the Bensons made adequate

disclosures on their individual tax returns because ERG was a

taxable entity.

     A.    Disclosures on Amended Returns and ERG Corporate
           Tax Returns Are Not Relevant to the Application of
           Section 6501(e)(1)(A)(ii)

     The Bensons argue that the amended returns of NPI disclose

items of gross income for purposes of section 6501(e)(1)(A)(ii).

Amended returns do not correct the omission of income from an

original return.   Houston v. Commissioner, supra; Goldring v.

Commissioner, supra.   Section 6501(e)(1)(A)(ii) requires

respondent to examine only the Bensons’ original returns and the

original returns of the passthrough entities listed on their

returns.   Any “clues” to omitted gross income on the amended


     7
      (...continued)
$31,020 in 1993, and $41,736 in 1994 from ERG’s so-called rent
payments for the Lowell plant. Id.
                              - 12 -

returns of NPI will not prevent the 6-year period of limitations

of section 6501(e) from applying to the Bensons’ 1989, 1990,

1993, and 1994 tax years.

     Neither section 6501(e)(1)(A)(ii) nor the caselaw

interpreting that section requires respondent to examine the

corporate returns of ERG in search of “clues” that disclose

income.   The Bensons have not cited any authority to support

their contention that the returns of a taxable subchapter C

corporation serve as an adjunct to an individual taxpayer’s

return for purposes of section 6501(e)(1)(A)(ii).   Instead, the

Bensons rely on Benderoff v. United States, 398 F.2d 132 (8th

Cir. 1968), and Roschuni v. Commissioner, 44 T.C. 80 (1965),

which involve the returns of subchapter S corporations.   This

Court has explained that the returns of subchapter S corporations

and partnerships should be examined in conjunction with the

individual taxpayer’s return because these entities are

passthrough entities.   See Harlan v. Commissioner, 116 T.C. at 54

(“when the taxpayers’ tax returns stated taxable income from

partnerships or S corporations, we declared that the information

returns of these pass-through entities would be treated as

adjuncts to, and part of, the taxpayers’ tax returns”); Roschuni

v. Commissioner, supra at 85-86.   As a subchapter C corporation,

ERG is a taxable entity, it does not have the passthrough aspects

of an S corporation, and it files income tax returns, not
                              - 13 -

information returns.   Therefore, the rationale for treating the

returns of passthrough entities as adjuncts to an individual’s

returns is not present in the case of a subchapter C

corporation’s income tax return.   Respondent was not required to

examine the returns of ERG, a subchapter C corporation, to

determine whether the Bensons disclosed items of gross income.

     B.    Disclosures on Returns Were Not Adequate to Apprise the
           Secretary of the Nature and Amount of Omitted Income

           1.   Royalties and Engineering Services

     The Bensons argue that the returns of NPI disclosed royalty

and engineering service payments from ERG that we previously

found to be constructive dividends to the Bensons.    Quoting

Colony v. Commissioner, 357 U.S. 28 (1958), the Bensons argue

that respondent had “no ‘special disadvantage in detecting

errors’” because these items were disclosed on the corporate

returns.   Respondent argues that the returns do not adequately

disclose the transfers and mischaracterized the transfers.

     A misleading disclosure on a return is insufficient to

apprise the Commissioner of the nature and amount of an item for

purposes of section 6501(e)(1)(A)(ii).     Estate of Fry v.

Commissioner, 88 T.C. 1020 (1987).     In our prior opinion, we

stated:

     On or about March 10, 1990, Burton executed as
     president of both NPI and ERG, a document entitled
     “Agreement of Sale and Exclusive License” (exclusive
     license agreement). The document had a retroactive
     effective date of July 1, 1987, and a 40-year term.
                              - 14 -

      The document purports to sell certain “patent rights”
      owned by ERG to NPI and simultaneously grants ERG an
      exclusive license to use the patent rights transferred.
      * * * [Benson v. Commissioner, T.C. Memo. 2004-272;
      fn. refs. omitted.].

We found that “the exclusive licensing agreement was merely a tax

planning tool, completely lacking in economic substance.   * * *

As the arbitrators found, the pattern of payment demonstrates

that Burton [Benson] was merely funneling ERG’s profits to NPI.”

Id.

      We find that the disclosures of royalties on NPI’s returns

were misleading.   The returns of NPI failed to disclose that it

received the royalties from a related corporation, ERG, or that

Burton Benson acted on behalf of both corporations involved in

the transaction.   The returns of NPI failed to disclose that ERG

sold patent rights to NPI and simultaneously licensed those

rights back from NPI in the exclusive licensing agreement.      Also,

the “royalties” label listed on the returns of NPI was misleading

and inadequate to apprise respondent that the transactions

constituted a tax planning tool completely lacking in economic

substance.8   Because the royalties disclosures in the returns of

NPI were misleading, they fail to satisfy section

6501(e)(1)(A)(ii).


      8
       With respect to the 1993 royalty payments, Burton Benson
prepared invoices in response to a meeting with a revenue agent--
“these invoices were not created contemporaneously with payment
and/or the receipt of services.” Benson v. Commissioner, T.C.
Memo. 2004-272.
                             - 15 -

     Similarly, the Bensons argue that the NPI returns disclosed

engineering services paid by ERG to NPI.   In our prior opinion,

we found:

     ERG transferred millions of dollars to NPI for payment
     of supposed “engineering services”. However, there is
     no evidence of what services Burton performed on behalf
     of NPI other than his testimony that he provided ERG
     with engineering “know how”. No third party testified
     as to what Burton specifically did. There is no
     evidence of how much time he devoted to this endeavor
     and whether the amounts charged were reasonable and
     customary. In fact, we infer from the evidence that in
     conjunction with the exclusive licensing agreement, the
     label “engineering services” was created to achieve
     Burton’s goal of having ERG show a consistent paper
     profit of approximately $75,000. * * *

After reviewing the NPI returns, we find that these returns lack

any specific reference to engineering services.     Additionally,

like the royalties that NPI purportedly received from ERG, we

find that any characterization of the ERG transfers to NPI as

payments for engineering services was misleading.     Burton Benson

caused ERG to make these transfers to NPI for the purpose of

maintaining ERG’s profits at $75,000.   He used the “engineering

services” explanation to justify these payments.9    We find that




     9
       Like the royalty invoices, the 1993 invoices for
engineering services were not created contemporaneously with the
alleged performance of these services: “Burton admitted * * *
that these invoices were created shortly before an audit meeting
with a revenue agent.” Benson v. Commissioner, supra.
                                 - 16 -

this label does not reflect the true nature of these transfers.

For purposes of section 6501(e)(1)(A)(ii), we hold that the NPI

returns failed to adequately disclose the nature and amounts of

these transfers.

          2.     Rental Income

     The Bensons also argue that the returns of NPI disclose the

rents received by NPI, and that the Bensons’ constructive

dividends related to the Lowell and Stanford plants were

adequately disclosed on their returns.     Respondent contends that

the disclosures of gross rental income reported on the returns of

NPI did not give respondent a clue as to the nature and amounts

of these payments that we found to be constructive dividends.

     We agree with respondent.     The returns of NPI reported gross

rental income from “MFG Facilities”; however, these returns do

not specifically identify the properties that generated the

rental income.     The Stanford and Lowell plants were identified

only in NPI’s depreciation schedules.

     With respect to the Lowell plant, in our prior opinion we

stated:

     ERG had no contractual obligation to pay Aker’s rent
     obligations. Indeed, it was, as the arbitrators
     concluded, Aker’s responsibility to pay NPI for the use
     of the Lowell plant, which Glendon ultimately paid by
     virtue of the final arbitration decision. This, of
     course, is in accord with what the brothers agreed in
     the unbundling agreement. Given that these funds were
     transferred to NPI, which the Bensons used for their
     personal benefit * * * we find and hold that the
     Bensons received constructive dividends in the amounts
                               - 17 -

     of the excess rents that ERG paid.   [Benson v.
     Commissioner, supra].

     We found that the Lowell rent payments constituted

constructive dividends to the Bensons because ERG made payments

that it had no contractual obligation to make.   We further found

that the payment of “rents” by ERG constituted constructive

dividends to the Bensons.   The returns of NPI do not provide any

clues that suggest that ERG’s payments for the Lowell plant

exceeded ERG’s legal obligation to make those payments.   These

disclosures did not adequately reveal the nature of these

transfers.   Therefore, we hold that the Bensons failed to

disclose the constructive dividends received in the form of

purported rent payments for the Lowell plant.

     While the returns of NPI disclosed the receipt of rent for

the Stanford plant, these disclosures were misleading because

they did not inform respondent that the payments exceeded ERG’s

contractual rent obligation.   In Benson v. Commissioner, supra,

we stated:

          The maximum monthly lease amount listed in the
     unbundling agreement apparently reflected the product
     of an arm’s-length negotiation between the two warring
     brothers. Under these circumstances, this is the best
     indication of the intent of the parties and the value
     of the use of the property at that time. * * * [Fn.
     ref. omitted.]

The actual payments exceeded the monthly lease payments as agreed

upon in the unbundling agreement.   We think that the disclosure

of the rental payments is misleading because an examiner would
                               - 18 -

expect that these payments reflected the monthly payments agreed

to during the arm’s-length negotiation.    Nothing in the returns

of NPI informed respondent that NPI received rent payments from

ERG that exceeded the amounts that the parties agreed upon in the

unbundling agreement.    We hold that the Bensons did not

adequately apprise respondent of the nature of these transactions

for purposes of section 6501(e)(1)(A)(ii).

      We hold that the amended returns of NPI and the corporate

returns of ERG are not adjunct returns for purposes of section

6501(e)(1)(A)(ii).    We also hold that the Bensons did not

adequately apprise respondent of the nature and amount of the

transfers from ERG to NPI.10

II.   Section 6501(e)--Substantial Omissions

      In light of our holding on petitioners’ first argument, the

Bensons concede that the 6-year period of limitations applies to

the 1990 and 1993 tax years.    The Bensons argue that they did not

omit in excess of 25 percent of reported income in the 1989 and

1994 taxable years.    The Bensons and respondent each offered

calculations for the amounts of gross income omitted and reported

on the Bensons’ returns.




      10
       Even if we considered the amended returns of NPI and the
ERG returns we would draw the same conclusion since the
characterizations of the payments from ERG to NPI were misleading
for the same reasons.
                                - 19 -

     A.    1989

     The parties calculated the Bensons’ 1989 omitted gross

income as follows:

   Items of omitted              Amounts asserted   Amounts asserted
     gross income                 by the Bensons     by respondent

Payments from ERG to NPI              --               $483,098
Check ref: Carroll                 $96,749               96,749
Automobile expenses                 10,624               10,624
Life insurance                       2,404                2,404
ERG payment related to                --                 29,400
  Lowell plant
Director’s fees                      6,000                 6,000
Franklin dividends                     193                   193
Interest/dividend (NPI)               --                     861
Royalty income (1099)                  709                   709
                                                       1
Reverse royalty income                --                 (165,481)
  recharacterized as
  constructive dividends
                                                        2
Reverse NPI rental income             --                 (19,610)
  recharacterized as
  constructive dividends
     Total                          116,679                 444,947
     1
       This amount represents a negative number. Respondent
appears to have reduced the $483,098 payment from ERG to NPI by
the amount of NPI’s royalty income reported by the Bensons on
their 1989 return.
     2
       This amount represents a negative number. NPI’s 1989 Form
1120S reported its income from gross rental real estate
activities and listed Burton O. Benson as a 66.7-percent
shareholder. Respondent appears to have reduced the $29,400 of
omitted gross income from the Lowell plant rent by the Bensons’
pro rata share of the Lowell plant rent ($29,400 x 66.7% =
19,609.8).

The parties assert that the Bensons reported gross income in 1989

as follows:

   Items of gross           Amounts asserted        Amounts asserted
       income                by the Bensons          by respondent

Wages                           $103,372                $103,372
Interest                           2,505                   2,505
                                - 20 -

Rents:
 3341 Lucile                        --                   12,900
 3 Arroyo                           --                    8,550
 189 Ivy                            --                    3,500
 Total gross rents                24,950                 24,950
Royalties:
 Occidental                         --                      785
 Permain                            --                      124
 Texaco                             --                      355
 Phillips                           --                       59
 Exxon                              --                        5
 Walter L. Johnson                  --                       63
 NPI                                --                  165,481
 Total royalties                 166,872                166,872
Other income (NPI)               100,000                100,000
Evelyn C. Hermsmeir              137,341                137,342
 partnership
1120-S return of NPI:
 ERG Hercules payment            483,098                   --
 Gross rents                     119,508                 79,712
 Total                           602,606                 79,712
Baden Spiel Haus                    --                      625
 partnership
     Total                     1,137,646                615,378

The parties calculated the percentage of omitted gross income in

1989 as follows:

                           The Bensons’              Respondent’s
                           calculation               calculation

Omitted gross income         $116,679                  $444,947
Reported gross income      $1,137,646                  $615,377
Percent understated           10.26                       72


          1.   Omitted Gross Income

     The parties agree that the Bensons omitted gross income of

$116,679, which consists of:    (1) Constructive dividends of

$96,749 from ERG’s payment of legal expenses (Check ref:

Carroll); (2) constructive dividends of $10,624 from automobile

expenses paid by ERG; (3) constructive dividends of $2,404 from
                              - 21 -

life insurance payments made by ERG; (4) constructive dividends

of $6,000 from director’s fees; (5) Franklin dividends of $193;

and (6) royalty income of $709.

      The parties dispute whether the payments of $483,098 from

ERG to NPI (Hercules payment) constitute omitted gross income.

On their original 1989 return, the Bensons reported royalty

income of $165,48111 received from NPI.   Benson v. Commissioner,

T.C. Memo. 2004-272.   In our prior opinion, we stated:

           On or about November 22, 1989, Hercules and ERG
      entered into a memorandum of agreement (MOA), whereby
      Hercules agreed to pay $483,098 as an add-on cost to
      increase production of the baffle sets delivered by
      ERG. The MOA was unique because it called for Hercules
      to “facilitize” or fund ERG’s plant and equipment,
      the cost of which is normally paid for by the owner of
      the plant and equipment. Attached to the MOA is
      “schedule 1”, which lists the equipment and their
      associated prices as contemplated by the MOA. [Id.;
      fn. ref. omitted.]

We also stated that “Burton testified that the ‘engineering

services’ for which ERG compensated NPI were consulting design

services that he performed to make the Hercules contract ‘work’.”

Id.

      However, the Bensons’ return does not refer to the Hercules

payment.   The Bensons assert that the Hercules payment is

disclosed on the 1989 amended return of NPI.   As we held supra,

the 1989 amended return of NPI is not to be considered as a


      11
       It appears that respondent has factored this disclosure
into his calculation as the “Reverse Royalty income
recharacterized as constructive dividends”.
                              - 22 -

disclosure for purposes of section 6501(e).   Therefore, we find

that the Hercules payment is omitted gross income for purposes of

section 6501(e).

     The parties also dispute whether the Bensons omitted from

their 1989 income tax return $29,400 in constructive dividends

from the ERG payments related to the Lowell plant.   As we found

supra, the 1989 return of NPI provided a misleading disclosure

because the return did not reveal that NPI paid rent for the

Lowell plant even though it did not have a contractual obligation

to make any rent payments.   NPI’s return failed to adequately

apprise respondent of the nature of this income for purposes of

section 6501(e)(1)(A)(ii); therefore, the $29,400 of constructive

dividends is omitted gross income.12

     Respondent’s calculation of the Bensons’ omitted gross

income included “Interest/Dividend (NPI)” income of $861.    In his

brief, respondent failed to explain why this amount constituted

omitted gross income.   We will not include the $861 of

“interest/dividend (NPI)” income in our calculation of the

Bensons’ omitted gross income.

     For purposes of applying section 6501(e), we hold that the

Bensons omitted gross income of $444,086, itemized as follows:



     12
       In the “reverse rental income recharacterized as
constructive dividends”, it appears that respondent reduced the
omitted gross income in an amount equal to the Bensons’ pro rata
share of the Lowell plant rent.
                                   - 23 -

     Items of omitted                        Amounts omitted
       gross income                           by the Bensons

     Payments from ERG to NPI                     $483,098
     Check ref: Carroll                             96,749
     Automobile expenses                            10,624
     Life insurance                                  2,404
     ERG payment related to                         29,400
       Lowell plant
     Director’s fees                                  6,000
     Franklin dividends                                 193
     Royalty income (1099)                              709
                                                  1
     Reverse royalty income                         (165,481)
       recharacterized as
       constructive dividends
                                                  1
     Reverse NPI rental income                     (19,610)
       recharacterized as
       constructive dividends
         Total                                        444,086
     1
          This amount represents a negative number.

             2.     Reported Gross Income

     The parties agree that the Bensons reported gross income of

$535,041, which consists of:       (1) Wages of $103,372; (2) interest

income of $2,505; (3) rental income totaling $24,950; (4) royalty

income totaling $166,872; (5) other income from NPI of $100,000;

and (6) income from the Evelyn C. Hermsmeir partnership of

$137,342.13       Additionally, respondent concedes that the Bensons

reported income of $625 from the Baden Spiel Haus partnership.




     13
       The Bensons assert that their 1989 return reported income
of $137,341 from the Evelyn C. Hermsmeir partnership. Respondent
argues that the Bensons reported $137,342 on their return from
the Evelyn C. Hermsmeir partnership. We will calculate the
Bensons’ reported gross income using respondent’s figure, as it
is more favorable to the Bensons than their own calculation.
                              - 24 -

     The parties disagree as to the amount of the Bensons’

reported gross income from NPI’s 1989 Form 1120S.    The Bensons

argue that the Hercules payment of $483,098 was reported on NPI’s

amended 1989 Form 1120S, and that the entire $119,508 of gross

rental income reported on the 1989 return of NPI should be

included in the Bensons’ reported gross income.   Respondent

argues the Bensons reported only their pro rata share of NPI’s

reported gross income on its original 1989 return.

     As we found supra, the Hercules payment was disclosed only

on the amended return of NPI, not the original return.    Because

“return” in section 6501(e)(1)(A) does not include amended

returns, see Houston v. Commissioner, 38 T.C. at 489; Goldring v.

Commissioner, 20 T.C. at 81, the Hercules payment is not included

in the Bensons’ reported gross income.

     We also disagree with the Bensons that the entire $119,508

of NPI’s reported income from real estate activities is included

in their reported gross income.   For purposes of section

6501(e)(1)(A), taxpayers’ reported gross income includes their

pro rata share of gross income from passthrough entities, such as

an S corporation.   Benderoff v. United States, 398 F.2d at 135;

Roschuni v. Commissioner, 44 T.C. at 85-86.   On its original 1989

Form 1120-S, NPI reported gross income from real estate

activities of $119,508, and listed Burton O. Benson as a 66.7-

percent shareholder of NPI.   Therefore, we find that the Bensons’
                                - 25 -

1989 reported gross income includes their pro rata share of NPI’s

reported gross income, which equals $79,712 (66.7 percent of

$119,508).

     For purposes of applying section 6501(e), we hold that the

Bensons’ reported gross income of $615,378 on their 1989 return,

which is itemized as follows:

            Items of gross                Amounts reported
                income                     by the Bensons

            Wages                             $103,372
            Interest                             2,505
            Rental income                       24,950
            Royalties                          166,872
            Other income (NPI Salary)          100,000
            Evelyn C. Hermsmeir                137,342
             partnership
            1120-S return of NPI                79,712
            Baden Spiel Haus                       625
             partnership
               Total                           615,378

            3. 25-Percent Omission

     We hold that the Bensons omitted 72 percent14 of their

reported gross income in 1989; therefore, the 6-year period of

limitations applies to their 1989 tax year as provided by section

6501(e)(1)(A).

     B.     1994

     The parties contend that the Bensons omitted gross income in

1994 as follows:




     14
          $444,086 / $615,378 equals 71.641 percent.
                             - 26 -
                                                 1
    Items of omitted          Amounts asserted    Amounts asserted
      gross income             by the Bensons      by respondent

ERG recreation account             $2,698                  --
Alice Lane--property taxes           8,196                 --
Automobile expenses                14,723                  --
Director’s fees                    37,000                  --
Esther Benson check                12,000                  --
Townsend check                     15,000                  --
                                   2
Travel expenses                      6,690                 --
                                    3
Legal expenses                        4,159                --
                                   4
Employee relation’s fund             4,027                 --
Education expenses                   9,166                 --
Life insurance                       4,781                 --
Additional dividends                    586                --
  Total                           119,026               $399,826
     1
       On brief, respondent failed to itemize the Bensons’ 1994
omitted gross income and provided only the total amount of the
Bensons’ omitted gross income.
     2
       In Benson v. Commissioner, T.C. Memo. 2004-272, we held
that Burton Benson received constructive dividend income of
$3,889 from travel expenses. We will use this amount to
calculate the Bensons’ omitted gross income.
     3
       In Benson v. Commissioner, supra, we held that Burton
Benson received constructive dividend income of $4,033 from legal
expenses paid by ERG. We will use this amount to calculate the
Bensons’ omitted gross income.
     4
       In Benson v. Commissioner, supra, we held that the Bensons
received constructive dividend income of $3,035 from amounts paid
by ERG for the employee relation fund. We will use this amount
to calculate the Bensons’ omitted gross income.

The parties argue that the Bensons reported gross income in 1994

as follows:

    Items of gross       Amounts asserted            Amounts asserted
        income            by the Bensons              by respondent

Wages                       $196,000                     $196,000
Interest                       7,105                        7,105
                                                              1
Less: Baden Spiel Haus          --                              (4)
 flowthrough interest
                                                             1
Less: Hermsmeir partnership     --                            (411)
 flowthrough interest
Dividends                     29,327                       62,748
                                                         1
Less: NPI flowthrough           --                        (62,735)
                               - 27 -

 dividend income
Capital gain                       492                       492
 distributions
Taxable refunds                  --                      29,327
Rents:
 3341 Lucile                     --                      14,976
 3 Arroyo                        --                      12,480
 266 Elsie Drive                 --                       8,700
 Total rents                   36,156                    36,156
Royalties:
 Occidental                      --                         785
 Sun                             --                         363
 Scurlock                        --                         192
                             2
 Total royalties               81,372                     1,340
Other income (NPI Salary)    200,000                    200,000
Evelyn Hermsmeir             100,620                    100,620
 partnership
1120-S return of NPI:
 Gross sales                     --                          50
 Royalties                  160,063                     160,063
 Gross rents                200,605                     200,605
 Dividends                      --                      125,470
   Total NPI income         360,668                     486,188
   Bensons’ share of            --                      243,094
     NPI income
Bensons’ share of               --                           579
 Baden Spiel Haus
 partnership
   Total                  1,011,740                     814,311
     1
         This amount represents a negative number.
     2
         This amount includes royalties received from NPI.

The parties calculated the percentage of omitted gross income in

1994 as follows:

                           The Bensons’              Respondent’s
                           calculation               calculation
Omitted gross income         $119,026                  $399,826
Reported gross income      $1,011,740                  $814,310
Percent understated           11.76                       49
                                - 28 -

          1.    Omitted Gross Income

     We disagree with the Bensons’ calculation of 1994 omitted

gross income.   The Bensons concede that they omitted gross income

of $119,026 from their 1994 return.      For the reasons discussed

supra, we also find that the Bensons’ omitted gross income

includes the $160,063 transferred from ERG to NPI, the excess

rent of $63,444 received for the Stanford plant, and the rent of

$41,736 received for the Lowell plant.

     Respondent provided only the total figure for the Bensons’

omitted gross income in 1994.    In his calculations of omitted

gross income in 1989, 1990, and 1993, respondent reduced the

total omitted gross income by amounts described as “Reverse * * *

income recharacterized as constructive dividends”.      In our

calculation, we credit the Bensons with a “reverse” of the

payment from ERG to NPI that is recharacterized as constructive

dividends of $80,032 because the Bensons reported this amount on

their 1994 return.

     The 1994 return of NPI included gross rents of $200,605.

Because the return does not itemize the properties that generated

this income, we assume that the rents received from the Lowell

and Stanford plants are included in NPI’s total gross rents.      In

calculating omitted gross income, we will credit, or “reverse”,

the Bensons’ pro rata shares of rental income from the Lowell and

Stanford plants.   In other words, the “reverse” ensures that the
                                - 29 -

rental income recharacterized as constructive dividends counts as

omitted gross income of the Bensons only to the extent that this

income exceeds their pro rata share, which was disclosed on the

Bensons’ return.    We credit the Bensons with a “reverse” of

$20,868 for the Lowell plant rent15 and $31,722 for the Stanford

plant rent16 that has been recharacterized as a constructive

dividend.

     In our prior opinion, we held that the Bensons had

cancellation of indebtedness income of $88,291 in 1994.     Benson

v. Commissioner, T.C. Memo. 2004-272.     On brief, the Bensons make

no argument that this cancellation of indebtedness income was

disclosed on their 1994 return.     Furthermore, in our examination

of the Bensons’ 1994 return, we have not found any statement that

provides a clue to or discloses the cancellation of indebtedness.

For purposes of section 6501(e)(1)(A), we find that the

cancellation of indebtedness income of $88,291 constitutes

omitted gross income to the Bensons in 1994.

     Next, we find that the Bensons omitted from gross income

constructive dividends of $1,072 received from the Franklin

account.    In our prior opinion, we stated that “on his 1994

return [the Bensons’ son] Eric reported dividend income from

Franklin account #1 of $1,072.”     Benson v. Commissioner, supra.


     15
          $41,736 x 50% = $20,868
     16
          $63,444 x 50% = $31,722
                               - 30 -

We held that the Bensons received additional dividend income of

$1,072 in 1994 because “Despite the fact that Eric reported the

amount credited on his 1994 return, the dividends are clearly

attributable to the Bensons and should have been reported by

them.”   Id.   We find that the disclosure of the 1994 Franklin

dividend on the return of Eric Benson, the Bensons’ son, does not

satisfy the disclosure requirement of section 6501(e)(1)(A)(ii).

See Greenway v. Commissioner, T.C. Memo. 1987-4 (“Reporting of

that income on their children’s returns, and petitioners payment

of taxes owed on it, does not satisfy the section

6501(e)(1)(A)(ii) requirement that the omission be ‘disclosed in

the return, or in a statement attached to the return, in a manner

adequate to apprise the Secretary of the nature and amount of

such item.’”).

     For purposes of applying section 6501(e), we hold that the

Bensons’ omitted gross income in 1994 equals $337,092, which is

itemized as follows:

           Items of omitted               Amounts omitted
             gross income                  by the Bensons

     ERG recreation fund payments              $2,698
     Alice Lane--property taxes                 8,196
     Automobile expenses                       14,723
     Director’s fees                           37,000
     Esther Benson check                       12,000
     Townsend check                            15,000
     Travel expenses                            3,889
     Legal expenses                             4,033
     Employee relation’s expenses               3,035
     Education expenses                         9,166
     Life insurance                             4,781
                                - 31 -

     Additional dividends                            586
     ERG transfers to NPI                       160,063
                                               1
     Reverse of payments from ERG                (80,032)
       to NPI income recharacterized as
       constructive dividends
     ERG payment related to                        41,736
       Lowell plant
                                              1
     Reverse Lowell plant rental               (20,868)
       income recharacterized as a
       constructive dividend
     ERG payment related to                        63,444
       Stanford plant
                                              1
     Reverse Stanford plant rental                (31,722)
       income recharacterized as a
       constructive dividend
     Cancellation of indebtedness                  88,291
       income
     Franklin account                               1,072
       Total                                      337,092
     1
         This amount represents a negative number.

            2.   Reported Gross Income and 25-Percent Omission

     The parties agree that the Bensons reported gross income of

$533,268 in 1994, which consists of:     (1) Wages of $196,000; (2)

capital gain distributions of $492; (3) rental income of $36,156;

(4) $200,000 of “other income” or salary from NPI; and (5) income

of $100,620 from the Evelyn Hermsmeir partnership.           In addition,

respondent concedes that the Bensons’ reported a taxable refund

of $29,327 and $579 from their share of Baden Spiel Haus

partnership income.    The parties dispute the following items of

reported gross income:    (1) Interest income; (2) dividend income;

(3) royalty income; and (4) NPI income.

     The parties agree that the Bensons reported interest income

of $7,105 on their 1994 return.    However, respondent’s
                               - 32 -

calculation of the Bensons’ interest income reduces the total

interest income by $4 of interest received from Baden Spiel Haus

and $411 of interest received from the Evelyn Hermsmeir

partnership.   We agree with respondent’s calculation.   The

Bensons’ reported gross income includes income that they received

from the Baden Spiel Haus and Evelyn Hermsmeir partnerships.    If

their interest income were not reduced by the amount of interest

income received from these two partnerships, the Bensons’

reported gross income would include this interest income twice.

We find that the Bensons’ reported interest income of $6,690 for

1994.

     On brief, the Bensons assert that they reported dividend

income of $29,327 in 1994.17   Respondent calculated the Bensons’

reported dividend income as totaling $62,748 and reduced this

amount by $62,735, which represents the amount of dividend income

that the Bensons received from NPI.     Because their share of NPI

income will be calculated separately, including the NPI dividend

income as a portion of the Bensons’ dividend income would include

this item twice.   We agree with respondent and find that the

Bensons reported dividend income of $13 in 1994.

     As with the dividend income, the parties dispute the

Bensons’ reported royalty income.   The Bensons calculated their


     17
       The Bensons’ 1994 return reports a taxable refund of
$29,327. It appears that they mistakenly listed the reported
taxable refund as a dividend.
                               - 33 -

reported royalty income as $81,372, which includes $80,032 of

royalties received from NPI.   Respondent asserted that the

Bensons reported royalty income of $1,340; the calculation does

not include the royalties received from NPI.   As with the

dividend income, we agree that the NPI royalties should not be

included in the Bensons’ royalty income to avoid the inclusion of

this income twice.   We find that the Bensons reported royalty

income of $1,340 in 1994.

     With respect to the Bensons’ share of NPI income, we agree

with respondent’s calculation.   As we discussed supra, the

Bensons’ reported gross income includes their pro rata share of

gross income from NPI.   The 1994 return of NPI reports total

income of $486,188, which consists of:   (1) Gross receipts or

sales of $50; (2) royalties of $160,063; (3) gross rents of

$200,605; and (4) dividend income of $125,470.   That return also

lists Burton O. Benson as a 50-percent shareholder.   Therefore,

we agree with respondent that the Bensons’ reported gross income

includes their share of NPI’s income, which is $243,094.

     For purposes of applying section 6501(e), we hold that the

Bensons reported gross income of $814,311 in 1994, which is

itemized as follows:

     Items of reported                      Amount of reported
       gross income                            gross income

     Wages                                       $196,000
     Interest income                                6,690
     Dividends                                         13
                                - 34 -

     Capital gain                                        492
      distributions
     Taxable refunds                                29,327
     Rents                                          36,156
     Royalties                                       1,340
     Other income (NPI Salary)                     200,000
     Evelyn Hermsmeir                              100,620
      partnership
     Bensons’ share of                             243,094
      NPI income
     Bensons’ share of                                   579
      Baden Spiel Haus
      partnership
        Total                                      814,311


The Bensons have omitted more than 25 percent of their reported

gross income in 1994.18

     Even assuming that the Bensons correctly calculated the

amount of reported gross income as $1,011,740, they have omitted

more than 25 percent of the reported gross income in 1994.19    We

hold that the 6-year period of limitations applies to the

Bensons’ 1994 tax year as provided by section 6501(e)(1)(A).

III. Conclusion

     In conclusion, we hold that the Bensons omitted from gross

income amounts that exceed 25 percent of their reported gross




     18
          $337,092 / $814,311 equals 41.396 percent.
     19
          $337,092 / $1,011,740 equals 33.318 percent.
                             - 35 -

income in 1989, 1990, 1993, and 1994.   Therefore, the 6-year

period of limitations provided by section 6501(e)(1)(A) applies

in each of these years.

     To reflect the foregoing,

                                         Decisions will be entered

                                   under Rule 155.
