Joseph P. and Marilyn Schneller - Page 5

          James Luscombe,2 that interest-bearing notes should be prepared to                 
          evidence the loans, advances, and investments.  Petitioner did not                 
          follow this advice although petitioners did agree to the accrual of                
          interest for the year 1984.                                                        
                Petitioners’ 1982, 1983, and 1984 individual tax returns and                 
          Delivery’s related corporate returns were selected for examination                 
          by respondent’s Wichita, Kansas, district office.3  The examination                
          included an analysis of Delivery’s shareholder loan accounts.  The                 
          balances in the accounts increased by $14,995 in 1982, $75,404 in                  
          1983, and $42,502 in 1984, for a 3-year total increase of $132,901.                
          Throughout the examination, petitioners (through their                             
          representatives)4 insisted that their withdrawals from Delivery                    
          were loans.  The examining agent concluded that a portion ($51,065)                
          of the increase in the account balances for the 1982-84 years                      
          ($132,901) should be taxed as dividend income to petitioners; he                   

                2    From 1963 through 1987, Mr. Luscombe prepared all of                    
          the financial statements and corporate tax returns for Delivery,                   
          as well as petitioners’ individual tax returns.  The financial                     
          statements were prepared monthly from records delivered to Mr.                     
          Luscombe by Mrs. Schneller.  Following petitioners’ move from                      
          Kansas City to Kentucky, petitioners retained William B. Arthur,                   
          Jr. to perform the accounting and tax work for Delivery and                        
          themselves.  The first return Mr. Arthur prepared in 1990 was the                  
          1988 corporate return for Delivery.                                                
                3    The examination centered around the examiner’s                          
          determination that the Schnellers underreported their income for                   
          years 1982-84, as well as the examiner’s proposal to assert the                    
          fraud addition to tax.                                                             
                4    James Baker, an attorney, and Mr. Arthur represented                    
          petitioners with respect to the 1982-84 tax examination.                           

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