Albert S.N. Hee and Wendy R. Hee v. Commissioner; Waimana Enterprises, Inc. v. Commissioner, T.C. Memo. 2026-53 (June 23, 2026)

In the realm of closely held corporations, the line between personal and business expenses is frequently a focal point of Internal Revenue Service examinations. When a controlling shareholder treats a corporate treasury as a personal pocketbook, the tax consequences can escalate from simple disallowances to civil fraud penalties under Internal Revenue Code Section 6663. The United States Tax Court decision in Hee v. Commissioner, T.C. Memo. 2026-53, serves as an instructive and sobering case study for Certified Public Accountants (CPAs) and Enrolled Agents (EAs) on the critical importance of corporate formalities, the strict substantiation requirements of Section 274(d), and the mechanics of the civil fraud penalty.

Background and Factual Matrix

The consolidated cases of Albert S.N. Hee and Wendy R. Hee v. Commissioner and Waimana Enterprises, Inc. v. Commissioner involved substantial tax deficiencies and civil fraud penalties determined by the IRS for tax years 2003 through 2012.

Albert S.N. Hee, a graduate of the United States Naval Academy, incorporated Waimana Enterprises, Inc. (Waimana) in 1988, serving as its sole shareholder and president. Waimana operated as a C corporation holding company for several wholly owned subsidiaries, including Sandwich Isles Communications, Inc. (Sandwich Isles), Clearcom, Inc., and Ho'opa'a Insurance Co. (a captive insurance company). Mr. Hee was also the president of each of these subsidiaries.

To fund various expenses, Mr. Hee routinely used his personal credit cards. He would pay the credit card balances personally each month and then seek reimbursement from Waimana or its subsidiaries. His administrative assistant would categorize these charges on the monthly statements based on his directions (e.g., travel, meals, or office expenses). The expenses were initially paid and deducted by Sandwich Isles or Clearcom, repaid to Waimana, and Waimana would then reimburse Mr. Hee. Waimana did not file consolidated returns with its subsidiaries for the tax years 2003 through 2008.

While Waimana and its subsidiaries maintained a structured travel reimbursement process—which included reviews by a travel coordinator, detailed receipts, and statements of business purpose—trips taken by Mr. Hee and his family were completely exempted from this standard corporate review.

The IRS examination eventually led to a criminal referral. In the parallel criminal case, United States v. Hee, No. 14CR00826-001, Mr. Hee was convicted by a jury of one count of corrupt interference with the administration of Internal Revenue laws under Section 7212(a) and six counts of filing false tax returns under Section 7206(1) for the tax years 2007 through 2012. He was sentenced to 46 months in prison and ordered to pay restitution. Following this conviction, the IRS issued Notices of Deficiency asserting civil fraud penalties under Section 6663 against Mr. Hee for the years 2004 through 2012, and against Waimana for the years 2003, 2004, and 2006 through 2008.

Taxpayers Request for Relief and Affirmative Defenses

The petitioners presented several arguments seeking relief from the asserted deficiencies and fraud penalties:

Statute of Limitations: The petitioners argued that because the Notices of Deficiency were issued more than three years after the returns were filed, the periods of limitation for the tax years at issue had expired under the general rule of Section 6501(a).
Bona Fide Debt Characterization: Mr. Hee contended that over $1.1 million in corporate distributions recorded on Waimana’s general ledger as "Loans to Shareholders" were bona fide shareholder loans rather than taxable constructive dividends, pointing to his subsequent repayments and interest payments.
Lack of Deceptive Intent: The petitioners argued that they did not deceive their CPA tax preparers (Chinaka & Siu and KMH, LLP), asserting that the accountants had all records at their disposal and that any discrepancies or inconsistencies in records or testimony were simply due to the passage of time.
Constitutional Defense: Mr. Hee asserted that the IRS’s administrative determination of civil fraud penalties violated his Seventh Amendment right to a jury trial.
Spouse Liability: Wendy R. Hee sought relief from liability, which the IRS conceded, determining she was not liable for the Section 6663 civil fraud penalties under the innocent spouse rules of Section 6663(c).

The Court's Analysis of the Law and Burden of Proof

The Tax Court began its analysis by establishing the governing legal standards and burdens of proof. Under Rule 142(a) and Welch v. Helvering, 290 U.S. 111 (1933), the Commissioner’s deficiency determinations are generally presumed correct, and the taxpayer bears the burden of proving them erroneous. However, in cases involving unreported income, the Commissioner must first establish a threshold "minimal evidentiary foundation" linking the taxpayer to an income-producing activity, after which the burden shifts back to the taxpayer (citing Walquist v. Commissioner, 152 T.C. 61, 67–68 (2019)).

For the Section 6663 civil fraud penalty and the fraud exception to the statute of limitations under Section 6501(c)(1), the burden of proof is fundamentally different. The Commissioner bears the burden of proving fraud by clear and convincing evidence under Section 7454(a) and Rule 142(b). To meet this burden, the Commissioner must show that:

An underpayment exists for each year; and
The taxpayer intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of taxes (citing Parks v. Commissioner, 94 T.C. 654 (1990)).

Under Section 6501(c)(1), if a taxpayer files a false or fraudulent return with the intent to evade tax, the tax may be assessed "at any time." In the context of joint individual returns, the court cited Vannaman v. Commissioner, 54 T.C. 1011 (1970) to establish that "fraud by either taxpayer suspends indefinitely the period of limitations for both taxpayers." Therefore, establishing fraud on the part of Mr. Hee would effectively open the statute of limitations for both Mr. and Mrs. Hee.

Application of the Law to the Questioned Corporate Expenditures

The Tax Court methodically evaluated each category of disputed corporate expenditures to determine whether they constituted ordinary and necessary business expenses under Section 162(a) or personal expenses under Section 262(a). If the corporation lacked a valid business deduction and the expenditure resulted in an "economic gain, benefit, or income to the owner-taxpayer," the payment was characterized as a constructive dividend to the extent of corporate Earnings and Profits (E&P) (citing P.R. Farms, Inc. v. Commissioner, 820 F.2d 1084 (9th Cir. 1987)).

Massage Therapy Expenses

Mr. Hee claimed deductions for twice-weekly, two-hour massage therapy sessions provided by Diane Doll, which cost Waimana between $6,000 and $10,000 annually. He argued these massages were prescribed by his chiropractor to treat his chronic asthma and were deductible because they were "cheaper than finding a replacement worker."

The court rejected this argument, distinguishing the case from Hutchison v. Commissioner, 13 B.T.A. 1187 (1928), where a stunt actor was permitted to deduct massages. The court explained:

"Because the cost of maintaining good health is one of those expenses which is so 'inherently personal' that it simply cannot qualify as a business expense within section 162, such cost is not deductible." (quoting Kelly v. Commissioner, T.C. Memo. 1991-605, citing Fred W. Amend Co. v. Commissioner, 55 T.C. 320 (1970)).

Because Waimana paid these personal expenses on behalf of Mr. Hee, they were reclassified as constructive dividends.

Educational Expenses and MIT Tuition

In 2004, Waimana paid $33,523 to the Massachusetts Institute of Technology (MIT) for Adrianne Hee's tuition, dormitory, and dining plan. The corporate books recorded these as "educational" and "travel" expenses.

Under Treasury Regulation Section 1.162-5(a), educational expenses must maintain or improve skills required in employment or meet an employer's express requirements. The court noted that Adrianne majored in architecture, which bore "no relationship to the telecommunication work that Waimana performed." Furthermore, the company did not have a general educational assistance program for other employees. Citing O'Connor v. Commissioner, T.C. Memo. 2015-155, the court held that:

"The taxpayer must show that the educational expense is directly and proximately related to the skills required in his trade or business."

The MIT expenditures represented a clear personal benefit and were sustained as constructive dividends.

Salaries and Employee Benefits Paid to Family Members

Waimana paid substantial salaries and retirement benefits to Mr. Hee's children and his wife, Mrs. Wendy Hee. The Tax Court applied heightened scrutiny to these intra-family arrangements, noting that:

"where a family relationship is involved, the facts require close scrutiny to determine whether a bona fide employer-employee relationship existed and whether the payments received were made on account of the employer-employee relationship or the family relationship." (quoting Haeder v. Commissioner, T.C. Memo. 2001-7).

Furthermore, the court cited Wycoff v. Commissioner, T.C. Memo. 2017-203, pointing out that:

"Special scrutiny is given in situations where a corporation is controlled by the employees to whom the compensation is paid because there is a lack of arm’s-length bargaining."

Applying this standard, the court disallowed the deductions for the children's salaries and benefits because Waimana did not document their hours or the type of work performed, and the children were full-time students residing out-of-state during the relevant periods. Under the assignment of income doctrine (citing P.R. Farms, Inc.), these corporate payments to the children were taxable to Mr. Hee as constructive dividends:

"Waimana’s transfers of employee benefits and salaries to Mr. Hee’s Children are benefits to Mr. Hee as its sole shareholder and president. We do not need to find that an actual distribution was made to Mr. Hee to find that he received a benefit by transferring money to his Children."

Similarly, the court disallowed Wendy Hee’s salary and benefits. Her role was uncorroborated, she lacked a physical office, and her son testified that she was a stay-at-home mother during a significant portion of the years in question. These payments were also reclassified as constructive dividends.

Miscellaneous and Travel Expenses Subject to Section 274(d)

The court methodically disallowed a slew of personal family trips and miscellaneous expenditures that Waimana and its subsidiary Clearcom claimed as business deductions. The court emphasized that Section 274(d) overrides the estimation rules of Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930), requiring strict contemporaneous records of the amount, time, place, and business purpose of travel, meals, and entertainment.

Children's Airfare: Reimbursed flights for the children between their out-of-state colleges and Hawaii lacked any documented business purpose and were reclassified as constructive dividends.
2008 Trip to France and Switzerland: Clearcom deducted $21,872 for a family trip. While the taxpayers claimed the France leg was to inspect an undersea fiber optic cable at an Alcatel factory, the visit lasted only a single day of a week-long spring break, and the rest of the time was spent on a ski trip in Switzerland. Citing Treasury Regulation Section 1.162-2(b)(1) and Section 274(d) standards, the court disallowed the entire deduction.
2009 Presidential Inauguration Trip: Waimana deducted travel expenses for a family trip to attend the inauguration of President Obama. Although Mrs. Hee met with Senator Daniel Inouye, the court disallowed the $2,878 deduction due to a complete failure to meet Section 274(d) substantiation standards.
2010 Tahiti Trip: Clearcom deducted a week-long trip to Tahiti for Mrs. Hee and the children. The family spent only two days looking for an undersea cable landing zone and trying to contact a local company, Honotua, without any prior coordination. Under Treasury Regulation Section 1.162-2(b)(1), if a trip is "primarily personal in nature," the travel costs are non-deductible. The court relied on Crawford v. Commissioner, T.C. Memo. 2014-156, to analyze the ratio of business to personal time, concluding the trip was primarily personal and thus a constructive dividend.
2010 Walt Disney World Trip: Waimana deducted $10,919 for a family trip to Disney World. Mr. Hee’s claimed business purpose of "building rapport" with the chairman of Raytheon by riding a public, Raytheon-sponsored ride was deemed entirely implausible and lacked any Section 162 business purpose.
2011 Mauna Lani Resort Stay: Waimana deducted $16,515 for a family stay at a luxury resort in Kona, Hawaii, which was labeled a "Stockholder's Meeting" for succession planning. Because Mr. Hee was the sole shareholder and the taxpayers failed to maintain contemporaneous meeting minutes or agendas, the deduction was disallowed under Section 274(d).
Sport Coat Purchase: Mr. Hee purchased a $1,246 sport coat from Saks Fifth Avenue for a dinner with Raytheon executives. Applying the three-pronged clothing deduction test from Barnes v. Commissioner, T.C. Memo. 2016-79, the court disallowed the deduction because the clothing was suitable for general, personal street wear (citing Ayria v. Commissioner).
Meals, Office Expenses, and Cash Withdrawals: Disallowed meal expenses, various personal retail purchases from Costco, Target, and Nordstrom (improperly classified as corporate "office expenses"), and undocumented personal ATM cash withdrawals were all reclassified as constructive dividends due to a lack of business purpose and failure to provide receipts.

The Santa Clara Residence

On May 28, 2008, Waimana purchased a five-bedroom residential property in Santa Clara, California, for $1,249,608. Mr. Hee asserted the home was purchased to provide a lodging option when visiting a biotech investment in Menlo Park.

However, the property was situated within walking distance of Santa Clara University, where two of Mr. Hee's children were enrolled. The children lived in the residence rent-free, rented out the remaining rooms to other students, and kept the rental income. Waimana failed to report any rental income for 2008 through 2010.

The court accepted the IRS's real estate expert witness, Paul Walker, who established the monthly fair market rental value of the property. The court held that Waimana had no ordinary and necessary business purpose for purchasing the home. Consequently, the fair market rental value of the lodging provided rent-free to Mr. Hee's children was reclassified as a constructive dividend to the Hees, totaling over $192,000 across the years at issue.

The Recharacterization of Disputed "Shareholder Loans"

A key battleground in the case was the characterization of over $1.1 million in corporate advances and payments made on behalf of Mr. Hee. Waimana recorded these amounts as "Loans to Shareholders."

To determine whether these advances were bona fide loans or constructive dividends, the Tax Court analyzed the nonexclusive factors outlined in Welch v. Commissioner, 204 F.3d 1228, 1230 (9th Cir. 2000). These factors include whether the debt is evidenced by a promissory note, whether interest was charged, whether a fixed repayment schedule was established, whether collateral was provided, and whether repayments were made.

The court carefully scrutinized the objective indicators of debt, stating:

"We carefully scrutinize this claim and give greater weight to the objective indicators of debt rather than to Mr. Hee’s self-serving statements. The question is whether Mr. Hee and Waimana intended to create a bona fide debtor/creditor relationship at the time of the distributions." (citing Estate of Chism v. Commissioner, 322 F.2d 956 (9th Cir. 1963)).

Applying the Welch factors, the court observed several fatal flaws:

No promissory notes or formal loan agreements were executed for any of the advances made to Mr. Hee from 2005 through 2012. Citing Teymourian v. Commissioner, T.C. Memo. 2005-232, the court noted that "The absence of a note or other loan documentation is indicative of a constructive dividend."
Waimana failed to accrue interest annually. It only recorded imputed interest on December 31, 2012, and August 1, 2013, after KMH, LLP raised inquiries during the audit.
No repayment schedule was established, and Mr. Hee offered no collateral to secure the debt.
Mr. Hee lacked a reasonable prospect of repaying the loans at the time they were advanced.

While Mr. Hee did make two substantial repayments—$298,856 in 2011 and $736,000 in 2012—the court found that these isolated repayments were insufficient to overcome the lack of corporate formalities. Notably, the $736,000 repayment was funded by a $1 million cash dividend that Waimana distributed to Mr. Hee, which originated from its captive insurance subsidiary.

Crucially, the court contrasted Mr. Hee’s undocumented advances with a loan that Sandwich Isles made to another employee, Harold Johnston. That loan was formalized in a signed employment agreement and secured by a promissory note. The court concluded that because Waimana did not follow these same procedures for its sole shareholder, the advances were not bona fide loans. Citing Estate of Chism, the court emphasized:

"the existence of a legal obligation to repay is not controlling; rather, the taxpayer’s intent to honor, and the corporation’s intent to enforce, the obligation is determinative."

Accordingly, the entire disputed shareholder loan balance was reclassified as taxable constructive dividends.

The Fraud Penalty and the Statute of Limitations Exception

Having established the existence of tax underpayments for all years at issue, the Tax Court turned to whether the underpayments were attributable to fraud. Under Section 6663(a), if any part of an underpayment is due to fraud, a 75% penalty is added to the tax. Under Section 6663(b), once the Commissioner proves that any portion of an underpayment is fraudulent, the entire underpayment is treated as such, unless the taxpayer can prove otherwise by a preponderance of the evidence.

To evaluate fraudulent intent, the court examined the "badges of fraud" established in Bradford v. Commissioner, 796 F.2d 303, 307 (9th Cir. 1986). The court found that Mr. Hee exhibited six prominent badges of fraud:

Understating Income: Mr. Hee consistently and substantially understated his income by over $2 million in the aggregate from 2004 to 2012. Citing Korecky v. Commissioner, 781 F.2d 1566 (11th Cir. 1986), the court noted that consistent and substantial understatement of income is "strong evidence of fraud."
Maintaining Inadequate Records: Mr. Hee failed to keep receipts, logs, or business purpose records for his reimbursed personal expenses and family trips, routinely processing his claims outside of Waimana's standard internal control policies.
Implausible or Inconsistent Explanations: The court deemed Mr. Hee's explanations regarding the business purpose of the Disney World trip, the Tahiti trip, and the Santa Clara residence to be entirely implausible.
Supplying Incomplete or Misleading Information to Tax Preparers: Mr. Hee actively concealed the true nature of his personal expenses. He did not disclose to Chinaka & Siu that corporate payments to Diane Doll were for massages (the preparers believed she was a corporate "consultant" until the 2011 IRS audit). He also failed to timely disclose the children's salaries and the rental of the Santa Clara Property to KMH, LLP, and directed his assistant to reclassify personal charges as business expenses.
Lack of Credibility in Testimony: The court found Mr. Hee's testimony at trial and in his prior criminal proceedings to lack credibility.
Filing False Documents: Before trial, the court ruled that Mr. Hee was collaterally estopped from denying that he filed false tax returns for the years 2007 through 2012 due to his criminal conviction under Section 7206(1).

With respect to Waimana, the Tax Court explained that a corporation can only act through its officers, and therefore:

"Corporate fraud necessarily depends upon the fraudulent intent of the corporate officer." (quoting Federbush v. Commissioner, 34 T.C. 740 (1960)).

Citing Benes v. Commissioner, 42 T.C. 358 (1964), the court noted:

"Where fraud is alleged against a corporate taxpayer, the requisite proof of fraudulent intent is to be found in the acts of its officers, inasmuch as the corporation, being an artificial person created by law, can have no separate intent of its own apart from those who direct its affairs."

Because Mr. Hee was the president and sole shareholder of Waimana, his fraudulent intent was attributed directly to the corporation. The court found that several badges of fraud also supported corporate-level fraud, including Waimana's failure to maintain adequate records, Mr. Hee's implausible explanations, and the delivery of misleading books to its CPAs.

Conclusions of the Tax Court and Key Takeaways

The Tax Court ruled entirely in favor of the Commissioner, sustaining the determined tax deficiencies and the Section 6663 civil fraud penalties against both Mr. Hee and Waimana Enterprises, Inc.

Because the underpayments were due to fraud, the court held that the period of limitations for assessing tax remained open indefinitely for all tax years at issue under Section 6501(c)(1). Consequently, the IRS was not barred from assessing the deficiencies and penalties. The court also sustained the Section 6651(a)(1) addition to tax against Waimana for its untimely filed 2003 return, and upheld the disallowance of net operating losses (NOLs) carried back from 2005 and 2006.

For tax professionals, Hee v. Commissioner highlights critical practice points:

Strict Adherence to Section 274(d): CPAs and EAs must advise clients that general assertions of business purpose cannot overcome the statutory substantiation requirements of Section 274(d). Without contemporaneous logs, receipts, and detailed business purpose records, travel, meals, and entertainment deductions will be summarily disallowed, and the Cohan estimation rule will provide no relief.
Formalize Shareholder Transactions: Any transfer of funds between a closely held corporation and its controlling shareholder must be formalized at its inception. To survive IRS scrutiny as a bona fide loan, the transaction must be supported by a signed promissory note, market-rate interest accrued and paid annually, a fixed repayment schedule, and collateral. Simple general ledger entries, retroactive interest imputations, and erratic repayments will not suffice.
Special Scrutiny of Family Compensation: Compensation and employee benefits paid to family members must be reasonable and purely for services actually rendered. Detailed contemporaneous records of hours worked and tasks performed are mandatory, particularly when the family members are full-time students residing away from the business's location.
The High Bar of Tax Preparer Reliance: The defense of good faith reliance on a tax professional is completely unavailable if the taxpayer provides incomplete, inaccurate, or misleading information to their preparer. Circumventing internal accounting controls and mischaracterizing personal expenditures as business consulting or office expenses represents affirmative behavior that supports a finding of civil tax fraud.

Prepared with assistance from NotebookLM.