Hee v. Commissioner, T.C. Memo. 2026-53: When a Business Owner's Personal Expenses Become Taxable Dividends — and Civil Fraud

Overview: Constructive Dividends, Personal Expenses, and a 75% Civil Fraud Penalty

On June 23, 2026, the United States Tax Court issued its memorandum opinion in Hee v. Commissioner; Waimana Enterprises, Inc. v. Commissioner, T.C. Memo. 2026-53 — one of the most comprehensive recent decisions on the danger of blurring the line between personal expenditures and corporate business expenses in a closely held corporation. The court ruled entirely in favor of the IRS, sustaining substantial tax deficiencies for tax years 2003 through 2012 and imposing 75% civil fraud penalties under I.R.C. § 6663 against both the individual taxpayer, Albert S.N. Hee, and his corporation, Waimana Enterprises, Inc. For any business owner who uses a company credit card for personal items, employs family members, or treats family vacations as business travel, this case is required reading. If you are already under IRS examination for similar issues, visit our Tax Court practice overview to understand what is at stake.

Who Were the Taxpayers and What Did They Do?

Albert S.N. Hee is a graduate of the United States Naval Academy who incorporated Waimana Enterprises, Inc. in Hawaii in 1988. Waimana served as the holding company for several wholly owned subsidiaries in the telecommunications space, including Sandwich Isles Communications, Inc. and Clearcom, Inc. Mr. Hee was the sole shareholder and president of Waimana and each of its operating subsidiaries.

To pay for expenses, Mr. Hee routinely used personal credit cards, paying the monthly balances himself and then seeking reimbursement from Waimana or its subsidiaries. His administrative assistant categorized the charges — labeling them as travel, meals, or office expenses based on Mr. Hee's direction — and the costs flowed through the subsidiary books before being reimbursed to Mr. Hee at the parent company level. What Waimana and its subsidiaries maintained as a structured, documented reimbursement process for ordinary business travel applied to everyone except Mr. Hee and his family. His personal family trips were completely exempt from the standard corporate review procedures requiring receipts and documented business purpose.

Separately, an IRS examination eventually escalated to criminal prosecution. Mr. Hee was convicted in the parallel criminal case United States v. Hee of one count of corrupt interference with the administration of Internal Revenue laws under I.R.C. § 7212(a) and six counts of filing false tax returns under I.R.C. § 7206(1) for tax years 2007 through 2012. He was sentenced to 46 months in federal prison and ordered to pay restitution. Following the criminal conviction, the IRS issued Notices of Deficiency for the civil tax proceedings that produced this Tax Court opinion.

The Issues Before the Court

The consolidated Tax Court cases presented several distinct issues, each significant in its own right:

• Constructive dividends: Whether dozens of corporate expenditures — massages, college tuition, family salaries, luxury resort stays, international vacations — constituted ordinary and necessary business expenses under I.R.C. § 162(a) or personal expenses under I.R.C. § 262(a) that must be reclassified as taxable constructive dividends to Mr. Hee
• Shareholder loan vs. dividend: Whether over $1.1 million recorded on Waimana's books as "Loans to Shareholders" were bona fide debts or disguised taxable distributions
• Section 274(d) substantiation: Whether travel, meals, and entertainment expenses met the strict contemporaneous record-keeping requirements that override the general estimation rules available for other business deductions
• Civil fraud penalty — § 6663: Whether Mr. Hee and Waimana each had an underpayment attributable to fraud, triggering a 75% civil fraud penalty on the fraudulent portion
• Statute of limitations — § 6501(c)(1): Whether the fraud exception to the normal three-year assessment limitations period opened the IRS's ability to assess tax for years well outside the standard window
• Innocent spouse — § 6663(c): Whether Mrs. Wendy R. Hee shared liability for the civil fraud penalties assessed against her husband

The IRS's Position

The Commissioner argued that Waimana's deductions for Mr. Hee's personal expenses — massages, his daughter's MIT tuition, family airfare between Hawaii and mainland universities, luxury resort charges, and international vacation trips thinly disguised as business travel — lacked any legitimate business purpose under § 162(a). Because those payments inured to Mr. Hee's personal benefit as sole shareholder, they were constructive dividends taxable to him as ordinary income under I.R.C. § 61. The IRS further contended that Mr. Hee's prior criminal conviction — which covered the same fraudulent underreporting of income — established by collateral estoppel that he acted with fraudulent intent for those years, satisfying the Commissioner's burden of proving fraud by clear and convincing evidence under I.R.C. § 7454(a). Because fraud was established, the unlimited statute of limitations under § 6501(c)(1) applied to all years, defeating Mr. Hee's limitations defense.

The Taxpayers' Arguments

Mr. Hee and Waimana raised several defenses:

• Business purpose: He argued that twice-weekly massage therapy sessions were medically prescribed for his chronic asthma and were cheaper than replacing him as a key executive; that his daughter's MIT tuition was deductible educational assistance; that family trips to France, Tahiti, and Walt Disney World were primarily business in nature
• Bona fide loans: The $1.1 million in "shareholder loans" were legitimate debt obligations, evidenced by subsequent repayment and interest payments
• No deceptive intent: The accountants had access to all relevant records; any inconsistencies were attributable to the passage of time, not deliberate concealment
• Seventh Amendment: Mr. Hee contended the IRS's administrative imposition of the civil fraud penalty without a jury trial violated the Constitution
• Innocent spouse: Mrs. Hee sought complete relief from fraud penalty liability — a defense the IRS ultimately conceded

How the Tax Court Ruled — and Why Every Argument Failed

The Tax Court ruled entirely in favor of the Commissioner, sustaining all deficiencies and the § 6663 civil fraud penalties against Mr. Hee and Waimana. The court's reasoning on each category is instructive for any business owner.

Personal Expenses Reclassified as Constructive Dividends

The court applied the foundational rule that a closely held corporation's payment of a controlling shareholder's personal expenses generates a taxable constructive dividend to that shareholder equal to the benefit conferred — there is no requirement that the corporation formally declare a dividend or that cash actually change hands. The personal benefit alone triggers income. Each category of expenditure fell under this rule:

• Massages: Twice-weekly massage sessions at $6,000–$10,000 per year were "inherently personal" health maintenance costs that cannot qualify as § 162 business expenses regardless of any medical necessity argument
• MIT tuition: Paying $33,523 for a daughter who majored in architecture — unrelated to Waimana's telecommunications work — failed the requirement under Treas. Reg. § 1.162-5(a) that educational expenses maintain or improve skills required in the taxpayer's employment
• Family member salaries: Payments to children who were full-time out-of-state college students, with no documented hours or job duties, and to Mrs. Hee in a role that was uncorroborated and for which she maintained no physical office, were disallowed under the heightened scrutiny courts apply to intra-family employment arrangements
• Family vacations: A ski trip to France and Switzerland (with one day at an Alcatel cable factory), a Tahiti trip that spent two of seven days on nominal business activity, a trip to Walt Disney World justified by "building rapport" with a Raytheon executive on a public theme park ride, and a luxury resort stay billed as a "stockholder meeting" for a corporation with one stockholder — all were disallowed under § 274(d) for failure to maintain contemporaneous records of business purpose

Loans Were Actually Constructive Dividends

The court found the "Loans to Shareholders" entries on Waimana's general ledger were not bona fide debt. The analysis under Maguire v. Commissioner requires objective evidence of a genuine creditor-debtor relationship: formal loan documentation, established repayment schedules, consistent interest treatment, and meaningful ability and intent to repay. The entries here lacked adequate formality and reflected transfers of funds for personal benefit, not genuine corporate lending transactions. They were therefore taxable as constructive dividends.

The 75% Civil Fraud Penalty Under § 6663

Section 6663 imposes a penalty equal to 75% of the portion of any underpayment attributable to fraud. This is one of the most severe civil penalties in the tax code — and unlike the 20% accuracy-related penalty under § 6662, the burden of proof falls on the government, which must establish fraud by clear and convincing evidence. The court found that burden satisfied by multiple convergent "badges of fraud," including: a consistent multi-year pattern of claiming personal expenses as business deductions; deliberate exemption of the controlling shareholder's family travel from the standard corporate review process applied to all other employees; delivery of misleading records to the CPA preparers; implausible post-hoc business purpose explanations; and — most powerfully — the prior criminal convictions under § 7206(1), which by operation of collateral estoppel established fraudulent intent for the years covered by those counts. The Seventh Amendment argument was rejected without extended discussion; the Tax Court's civil determination of fraud penalties does not require a separate jury trial.

Statute of Limitations Remained Open Indefinitely

The fraud exception in § 6501(c)(1) provides that when a taxpayer files a false or fraudulent return with the intent to evade tax, the IRS may assess the resulting deficiency "at any time." Because the court sustained the fraud finding, all years at issue — some filed more than a decade before the Notices of Deficiency — remained open for assessment. The normal three-year period under § 6501(a) was completely superseded.

Mrs. Hee Was Not Liable

The IRS conceded that Wendy R. Hee was not liable for the § 6663 civil fraud penalties under the innocent spouse provisions of § 6663(c), which protect a spouse who can demonstrate they did not know of, or have reason to know of, the fraudulent items. That concession highlights that innocent spouse relief — while not available to the primary wrongdoer — can be a critical lifeline for a non-participating spouse caught in a civil fraud assessment. Our IRS audit representation team regularly evaluates innocent spouse claims alongside deficiency defense strategy.

What This Means for You: Practical Takeaways for Business Owners

Corporate Formalities Are Not Optional — They Are Your Defense

The single most important lesson from Hee is structural: the fact that Waimana maintained thorough travel reimbursement procedures for all employees but completely exempted Mr. Hee and his family from those procedures was, in the court's analysis, direct evidence that those family expenses were personal. If you own a closely held corporation, apply your own expense documentation standards to yourself with the same rigor you apply to employees. Keep receipts. Document business purpose contemporaneously. Use the same reimbursement forms everyone else uses. The corporate veil protects you from personal liability in a lawsuit; corporate formalities protect you in a tax examination. More detail on how these IRS audits unfold is at our audit representation page.

Section 274(d) Cannot Be Estimated Around — Document or Lose

For travel, meals, and entertainment, the Cohan rule — which allows the court to estimate deductible expenses from imprecise evidence — does not apply. Section 274(d) requires strict contemporaneous records showing the amount, date, place, and business purpose of each expense. No record, no deduction. Period. A trip that is genuinely 80% business is treated as 100% personal if the documentation does not exist. Build the habit of documenting in the moment, not at year-end or audit time.

Employing Family Members Requires Documentation — and Arm's-Length Terms

You can legitimately employ family members in your business, and reasonable compensation is deductible. But the Tax Court applies heightened scrutiny to intra-family employment, requiring evidence of a bona fide employer-employee relationship: documented job duties, records of hours worked, comparable market compensation, and actual services rendered. Paying a college student a corporate salary for unspecified "services" will be reclassified as a constructive dividend. Paying your spouse for a role she never actually performs will be reclassified as a constructive dividend. Structure family employment the same way you would structure employment for a non-family hire you expected to defend in an audit.

Civil Fraud Is Not Just a Criminal Case Problem

Many taxpayers assume that the 75% civil fraud penalty under § 6663 only follows a criminal conviction. In reality, the IRS asserts civil fraud penalties independently in civil examination proceedings, and the Tax Court can sustain them based on the totality of the circumstances — the "badges of fraud" — without any criminal charges ever having been filed. In the Hee case, however, the existing criminal convictions provided collateral estoppel that made the civil fraud finding even more straightforward. The civil fraud penalty also opens the unlimited statute of limitations under § 6501(c)(1), meaning the IRS can reach back decades if it can prove the intent to evade tax. If you are under civil examination and believe fraudulent underreporting may be an issue, you need criminal tax defense counsel involved from the outset — an eggshell audit that starts as a civil examination can become a criminal referral if the revenue agent discovers badges of fraud during the examination.

Proactive Resolution Before Examination Is Always Cheaper

The Hee cases involved tax years 2003 through 2012 — a decade of litigation, a criminal conviction, prison time, and now a Tax Court opinion sustaining multi-year deficiencies plus the 75% fraud penalty. Had voluntary disclosure been made in the early years, the outcome — civil penalties on the tax owed — would have been dramatically less damaging than the combination of criminal prosecution and protracted Tax Court litigation. If you are aware that past corporate deductions have included personal items and have not yet been contacted by the IRS, early engagement with experienced counsel to evaluate your options — including the IRS Voluntary Disclosure Practice, penalty abatement, or simply cleaning up filings going forward — is far less costly than waiting for a revenue agent to make the same discovery. Our penalty abatement team and full IRS resolution services can help you evaluate the right path.

Act Before Your 90-Day Window Closes

If you received a Notice of Deficiency, you have only 90 days to petition the Tax Court — missing that deadline means the IRS assesses the full deficiency automatically and collection begins immediately. Contact Brightside Tax Relief for a consultation before that deadline expires. Our attorneys understand both the civil deficiency framework and the criminal tax exposure that often runs alongside it. Call 914-214-9127 or visit brightsidetaxrelief.com/tax-court today.