                  T.C. Memo. 1997-113



                UNITED STATES TAX COURT



  WALLACE R. NOEL AND ROBINETTE NOEL, Petitioners v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 18000-94.           Filed March 5, 1997.



     P owned stock in Corp. A. Corp. A operated numerous
restaurants under a franchise arrangement with Corp. B. P
sued both Corp. A and Corp. B, alleging two contract claims
and a tort claim. Corp. B and P entered into a settlement
agreement, whereby Corp. B purchased P's stock in Corp. A
and, in return, P released his claims against Corp. B. P
used some of the proceeds received as a result of the
agreement with Corp. B to settle a loan made to P by Bank X.
The loan balance consisted of both principal and accrued
interest. P also wrote off an investment in Company Y.
     Held: $295,461 of the proceeds P received from Corp. B
is excludable under sec. 104(a)(2).
     Held, further: Except for $219,000 of the fees that P
paid to his lawyers, P failed to substantiate his additions
to basis in Corp. A stock.
                                - 2 -

          Held, further: P failed to substantiate a part of his
     basis in Company Y.
          Held, further: R's calculation of the interest portion
     on the loan from Bank X is sustained.
          Held, further: P failed to substantiate $19,975 of
     attorney's fees.
          Held, further: P is not liable for the accuracy-
     related penalty under sec. 6662(a).



     David M. Berrett, for petitioners.

     William R. Davis, Jr., for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION

     FAY, Judge:    Respondent determined deficiencies in peti-

tioners' Federal income taxes and penalties as follows:

                                                    Penalty
        Year                 Deficiency            Sec. 66631

        1990                  $815,589              $611,692
        1991                     1,069                   802
               1
               Prior to trial, respondent conceded that
        no amounts were due to fraud. In her answer to
        the petition, respondent asserted an accuracy-
        related penalty against petitioners pursuant to
        sec. 6662(a).

     All section references are to the Internal Revenue Code in

effect for the taxable years in issue, and all Rule references

are to the Tax Court Rules of Practice and Procedure, unless

otherwise indicated.

     A trial was held to resolve the following issues for

decision:
                                 - 3 -

     (1)    Whether any of the amount received from PepsiCo, Inc.

(PepsiCo), on the sale of petitioner's1 stock in Pizza Manage-

ment, Inc., is excludable from petitioners' income under section

104(a)(2).     We hold that $295,461 is excludable.

     (2)     Whether legal fees and other expenses should have been

included in the basis of petitioner's stock in Pizza Management,

Inc., sold in 1990.     We hold that $219,000 of the fees should

have been so included.

     (3)    Whether petitioner substantiated amounts included in

the basis of his failed investment in a T.J. Cinnamons Bakery

franchise.     We hold that the amounts have not been substantiated.

     (4)    Whether petitioners are entitled to deduct the invest-

ment interest expense claimed on their 1990 Federal income tax

return related to loans from the United Bank of Fort Collins (the

bank).     We hold that they are, in the amounts set out herein.

     (5)    Whether 1991 deductions claimed for attorney's fees

have been substantiated by petitioners.     We hold that the fees

have not been substantiated.

     (6)    Whether petitioners are subject to the accuracy-related

penalty under section 6662(a) in connection with the filing of

their 1990 and 1991 Federal income tax returns.       We hold that

they are not.




     1
      All references to petitioner are to Wallace R. Noel.
                                - 4 -

                          FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

The stipulation of facts and the attached exhibits are incorpo-

rated herein by this reference.

     At the time the petition was filed, petitioners resided in

Fort Collins, Colorado.   At all times relevant, petitioners used

the cash receipts and disbursements method of accounting.

Investment in Pizza Management, Inc.

     In the 1960's and early 1970's, petitioner owned a number of

Pizza Hut, Inc. (Pizza Hut), restaurants as a sole proprietor

under a franchise arrangement between petitioner and Pizza Hut.

In 1975, petitioner was approached by several other individual

Pizza Hut franchisees who had formed a corporation called Pizza

Management, Inc. (PMI).   Petitioner transferred his restaurants

to PMI in exchange for stock in the PMI corporation.    Petitioner

believed that PMI had a special contractual right to issue its

shares to the public notwithstanding any terms or limitations of

the Pizza Hut franchise agreements.     As a result of petitioner's

transferring his restaurants to PMI, petitioner received approxi-

mately 11 percent of the stock in PMI.    By the mid-1980's, PMI

was the franchisee of approximately 200 Pizza Hut restaurants.

     In the spring of 1986, PMI developed plans for a public

offering of PMI stock.    Pizza Hut successfully prevented PMI from

issuing shares in PMI to the public.    Pizza Hut asserted that a
                                - 5 -

public offering of PMI stock would violate the terms of the fran-

chise agreements between Pizza Hut and PMI.

     PepsiCo's actions2 in preventing the public offering

adversely affected the value of petitioner's PMI stock.     Also,

petitioner suffered personal emotional distress as a consequence

of PepsiCo's actions.    Further, the damages to petitioner's

business reputation caused by PepsiCo resulted in petitioner's

suffering personal financial setbacks in ventures unrelated to

his investment in PMI.

     In May 1988, petitioner, as a shareholder of PMI, and his

children, as shareholders of PMI, brought a civil action against

PepsiCo,Pizza Hut, PMI, and other PMI shareholders.    Petitioner

alleged that he suffered damages as a result of Pizza Hut's

refusal to allow the public offering to go forward.    Specifi-

cally, petitioner made three claims against Pizza Hut and

PepsiCo.   First, petitioner alleged that PMI and PepsiCo had

entered into agreements, after petitioner had transferred his

sole proprietorship restaurants to PMI, which restricted PMI's

right to "go public" and that the agreements between PepsiCo and

PMI constituted a breach of obligations owed to petitioner as a

third-party beneficiary under the original agreements between

Pizza Hut and PMI.   Second, petitioner urged that Pizza Hut be


     2
      By the spring of 1986, PepsiCo had purchased all of the
stock of Pizza Hut, and Pizza Hut became a wholly owned
subsidiary of PepsiCo.
                               - 6 -

estopped from claiming that the PMI shareholders' rights had been

modified by the later agreements between PMI and PepsiCo.

Finally, petitioner alleged that the conduct by Pizza Hut in

preventing the public offering constituted a tortious

interference with petitioner's contractual rights and prospective

business advantages.

     In 1990, petitioner and Lawrence F. Dickie, a representative

of PepsiCo, entered into settlement negotiations, resulting in an

agreement whereby PepsiCo would acquire all of petitioner's PMI

stock, and petitioner would release his claims against PepsiCo

and Pizza Hut.   During these negotiations, petitioner and

Mr. Dickie discussed the damages suffered by petitioner as a

result of PepsiCo's actions, including the damage to his rela-

tionship with the bank and the harm to his business reputation

through adverse publicity in the press.    On March 28, 1990, in

compliance with the settlement agreement, petitioner transferred

393,9483 shares of PMI stock to PepsiCo.   On the same date, peti-

tioner signed documents releasing all claims against PepsiCo and

Pizza Hut.   In consideration of the stock transfer and peti-

tioner's release of claims, PepsiCo paid petitioner $3,250,071.




     3
      Petitioner owned 386,448 shares of Pizza Management, Inc.
(PMI). Additionally, petitioner controlled 7,500 shares that
were beneficially owned by his wife and children. The total of
these two amounts constitutes the 393,948 shares transferred to
PepsiCo, Inc. (PepsiCo).
                               - 7 -

Of this amount, petitioner paid $300,000 to the attorneys

handling the lawsuit against PepsiCo.

     In preparing his 1990 Federal income tax return, petitioner

allocated the $3,250,071 payment between two amounts.   Petitioner

treated $1,969,7404 as the amount received for his shares of PMI

and $1,280,331 as the amount received in exchange for the release

of his claims against PepsiCo and Pizza Hut.

     Petitioner's C.P.A., Wayne Hoover, advised petitioner in

connection with the preparation of petitioner's 1990 Federal

income tax return that the $1,280,331 was excludable from income

under section 104(a)(2) as damages received on account of per-

sonal injuries.   Petitioner did not report this amount as income

on his 1990 Federal income tax return.   Petitioner claimed on his

return a basis of $1,469,309 in his PMI stock, consisting of the

following:

     Original basis                        $200,000
     Miscellaneous expenses                  100,000
                                             1
     Received from children                    61,875
     Travel expenses                            5,797
     Misc. legal fees                           1,637
     Legal fees paid                         300,000
                                           2
     Contingent legal fees                   800,000
         Total                            1,469,309
             1
            Petitioner, in his 1990 Federal income tax
     return, reduced his gain by $61,875, which represents
     the amount received which is attributable to his wife's
     and children's stock. Respondent concedes that this
     amount is not taxable to petitioner.


     4
      Petitioner's allocation comports to the $5 per share book
value reflected in the 1990 financial statements of PMI.
                               - 8 -
            2
           In his 1990 Federal income tax return, petitioner
     included $800,000 in contingent legal fees in the basis
     of his stock. In the brief, petitioners admit that
     this was in error, and that the contingent portion of
     the fees amounted to only $500,000; thus, the $300,000
     actually paid by petitioner was reported twice on his
     Federal income tax return. Accordingly, we will
     discuss this issue using the $500,000 amount as
     conceded by petitioner.


     The difference between $1,969,740 (amount received for

shares of PMI stock) and $1,469,309 was reported in petitioner's

1990 Federal income tax return as a long-term capital gain of

$500,431.

     Respondent, in her notice of deficiency, determined that the

$3,250,071 received from PepsiCo was paid as consideration for

petitioner's PMI stock, and no amounts were excludable under

section 104(a)(2).   Further, respondent limited petitioner's

basis in the PMI stock to the $200,000 initially invested by

petitioner.

Investment Interest Expense

     Petitioner deducted $156,441 as investment interest expense

in his 1990 Federal income tax return and reported $1,224,395 as

an investment interest expense carryforward.   These amounts

related to petitioner's various loans from the bank.

     Petitioner borrowed money from the bank on various dates

throughout the 1980's.   In return, petitioner executed promissory

notes in favor of the bank, secured by petitioner's PMI stock and

the assets of several other business ventures controlled by him.
                                - 9 -

One of these entities operated a restaurant and was called Out of

Bounds, Inc.    Another entity was Noel Exploration, Inc., a

corporation engaged in the oil and gas business.    The bank used

separate customer numbers for Noel Exploration, Inc. (Cust.

No. 10408), Out of Bounds, Inc. (Cust. No. 10626), and petitioner

(Cust. No. 10398).    Typically, the loans from the bank were for

terms of 1 year.    At the end of the term, petitioner typically

rolled the outstanding principal and accrued interest into a new

1-year loan.

     On December 3, 1984, the bank lent petitioner $549,312 from

an unsecured line of credit (loan No. 10398/100160),5 $497,620 of

which was used to pay off a prior unsecured line of credit for

Out of Bounds, Inc., and $51,692 was used to pay off the accrued

interest.

     On September 4, 1985, the bank lent petitioner $1,100,000

(loan No. 10398/102971).    Of this amount, $650,000 was used to

purchase 283 acres of land called the "Overland Trail" property,

and $439,323 was used to satisfy the outstanding principal

balance on loan No. 10398/100160.    The record is silent with

regard to the application of the remaining $10,677.    Also, on

December 18, 1985, a $125,000 unsecured line of credit was

established between the bank and petitioner with loan No.

10398/105886.

     5
      The number preceding the slash identifies the customer, and
the number following the slash identifies the specific loan.
                                - 10 -

     On December 19, 1986, the bank lent petitioner $1,570,000

(loan No. 10398/111752).    The bank applied $102,155 to pay off

loan No. 10398/105886, the balance owed on the unsecured line of

credit ($97,779 principal and $4,376 interest).      The bank applied

$168,978 to pay off loan No. 10626/68956, an outstanding loan to

Out of Bounds, Inc.    The bank disbursed $30,000 to petitioner,

and the bank charged petitioner $681 in fees.      Finally,

$1,154,545 was applied to pay off loan No. 10398/102971

($1,107,123 for principal and $47,422 for interest).      The

remaining available balance of the note was to be used as a

reserve for future interest accruals.

     On September 8, 1987, the bank renewed loan No. 10398/111752

in the amount of $1,750,000.    The increase of $180,000 was desig-

nated to satisfy accrued interest.

     On August 15, 1988, the bank renewed loan No. 10398/111752,

in the amount of $2 million with a maturity date of August 15,

1989.   Again, the increase in the amount of the note represents

accrued interest on the note.    The note was secured by 160,000

shares of PMI stock.

     By August 23, 1989, the bank began demanding payment of the

$2 million note of August 15, 1988.      As of March 22, 1990, the

amount due on the note was $2,204,210, inclusive of principal and

interest.   On March 28, 1990, petitioner and the bank entered

into a settlement agreement.    Pursuant to the agreement, peti-

tioner agreed to pay the bank $1,800,000 in full satisfaction of
                               - 11 -

principal and interest due on loan No. 10398/111752.    No amount

was separately designated for principal or interest.    As of

March 28, 1990, the principal portion of the note was as follows:

   Principal balance from loan No. 10398/100160           $439,323
   Amount advanced for Overland Trail property             650,000
   Payoff of loan No. 10626/68956                          168,978
   Payoff of principal of loan No. 10398/105886             97,779
   Funds advanced to petitioner                             30,000
   Loan fees                                                   681
     Total                                              1,386,761

     Petitioner, in his 1990 Federal income tax return, deducted

investment interest expense in the amount of $156,441.6    Respon-

dent disallowed this deduction.    Additionally, respondent deter-

mined that petitioner realized income of $404,210, the difference

between the outstanding balance of $2,204,210 and the $1,800,000

actually paid by petitioner.

The T.J. Cinnamons Bakery Franchise

     On November 30, 1987, petitioner entered into an agreement

to purchase the assets of a T.J. Cinnamons Bakery franchise

located in San Antonio, Texas.    T.J. Cinnamons Bakery is a

company that specializes in bakery products.    Petitioner paid

$60,000 to acquire the business and assumed a note in the amount

of $181,058.

     Shortly after the transaction was consummated, petitioner

discovered that the seller had given him inaccurate financial



     6
      The amount of the deduction was limited to petitioner's net
investment income.
                                - 12 -

information and that the seller was unable to transfer certain

business assets to petitioner.    After petitioner initiated steps

to rescind the transaction, the seller filed for bankruptcy.     In

1990, the bankruptcy court discharged petitioner's claims against

the seller.   As a result of the bankruptcy court's decision,

petitioner claimed a long-term capital loss of $357,356 in his

1990 Federal income tax return related to the T.J. Cinnamons

Bakery franchise.    The items that constitute the $357,356 were

not separately identified in petitioner's Federal income tax

return.   Respondent limited the loss to petitioner's original

basis of $241,058.

                                OPINION

Exclusions Under Section 104(a)(2)

     Petitioner did not report $1,280,331 of the $3,250,071

received from PepsiCo as income on his 1990 Federal income tax

return.   Petitioner's C.P.A. advised him that the amount was

excludable, pursuant to section 104(a)(2), as damages received on

account of personal injuries.    Respondent argues that petitioner

has failed to establish that any portion of the amount received

is excludable under section 104(a)(2).     We disagree with

respondent.

     Section 61 provides that "gross income means all income from

whatever source derived".    Sec. 61(a).   Unless the Internal

Revenue Code specifically provides otherwise, all accessions to

wealth must be included in gross income.     Commissioner v. Glen-
                              - 13 -

shaw Glass Co., 348 U.S. 426 (1955).   Exclusions from gross

income have been narrowly construed.    United States v. Centennial

Sav. Bank, 499 U.S. 573 (1991).

     Section 104(a)(2) provides an exclusion from income for "the

amount of any damages received * * * on account of personal

injuries or sickness".   The term "damages" in section 104(a)(2)

encompasses amounts received pursuant to settlement agreements.

Sec. 1.104-1(c), Income Tax Regs.   To be excludable, the under-

lying claim must be based on tort type rights, and the damages

must be received on account of personal injuries.    O'Gilvie v.

United States, 519 U.S. __, 117 S. Ct. 459 (1996); Commissioner

v. Schleier, 515 U.S. __, 115 S. Ct. 2159, 2167 (1995).

     The tax consequences of a settlement agreement depend on the

nature of the litigation and on the origin of the claim but not

on the validity of those claims.    Woodward v. Commissioner, 397

U.S. 572 (1970).   Where a settlement agreement lacks specific

language, the intent of the payor is the most important factor in

determining the nature of the claim being settled.    Knuckles v.

Commissioner, 349 F.2d 610 (10th Cir. 1965), affg. T.C. Memo.

1964-33.

     In his 1990 Federal income tax return, petitioner allocated

some of the proceeds received from PepsiCo to nontaxable amounts

received in settlement of a lawsuit under section 104(a)(2).

Petitioner, in connection with the transfer of PMI stock to

PepsiCo, signed a release which discharged his claims against
                              - 14 -

Pizza Hut and PepsiCo (release).   The release states, in perti-

nent part:

          The undersigned, Wallace R. Noel, does hereby
     release and forever discharge Pizza Hut, Inc., PepsiCo,
     Inc., and all of their subsidiaries, divisions and
     related companies, and all of their employees, officers
     and agents, from any and all claims, actions, and
     causes of action, now existing or that may arise here-
     after, known and unknown, and including, in particular
     but without limitation, all claims that have been
     asserted or that could be asserted in that certain
     action pending in Sedgwick County District Court,
     Sedgwick County, Kansas, captioned:

          Wallace R. Noel, Larry D. Noel, Michael L. Noel
          and Cathy R. Noel vs. Pizza Hut, Inc., a corpora-
          tion, PepsiCo, Inc., a corporation, Pizza Manage-
          ment, Inc., a corporation, and Arturo G. Torres,
          Case No. 88 C 1652.

          The undersigned agrees that, as a part of this
     Release, the referenced action, as it relates to Pizza
     Hut, Inc. and PepsiCo, Inc., shall be dismissed, with
     prejudice, forthwith and agrees further that he shall
     take whatever action is necessary to bring about such a
     dismissal. * * *

     The release lacks any language concerning the amount of

money petitioner received, if any, as consideration for signing

this release.   Further, the stock transfer agreement states:

     Upon delivery to me or my designee of (i) $3,250,071 in
     immediately available funds and (ii) your release of
     claims against me, I will transfer to Pizza Hut, Inc.
     (by delivery of the Shares and the Powers) good, valid
     and marketable title to all of the Shares * * *.

The stock transfer agreement does not specify what portion of the

proceeds, if any, was paid to petitioner for his release of

claims.   Since the documents presented by petitioner lack any

language concerning what, if any, portion of PepsiCo's payment
                              - 15 -

represents consideration for petitioner's signing the release, we

will look to the intent of the payor (PepsiCo) to determine what

portion was paid for petitioner's release of his claims.

     At trial, Mr. Dickie, PepsiCo's representative in the

transaction, testified that the amount paid to petitioner was

based solely on PepsiCo's valuation of the PMI corporation.7

Mr. Dickie testified that the amounts paid to petitioner related

only to the value of the PMI stock, and no amounts were paid for

the release of claims obtained by PepsiCo.   Mr. Dickie indicated

that it was a normal business practice to obtain a general

release from all sellers in these types of situations.

     We cannot accept this testimony at face value.   The evidence

before the Court belies Mr. Dickie's assertion that no amounts

were paid for the settlement of claims.   First, the release is

not merely a general release of claims.   Rather, the release

specifically identifies petitioner's claims asserted against

PepsiCo and Pizza Hut in the action pending in Sedgwick County

District Court.   Second, it is evident from the documents

presented at trial that PepsiCo would not have purchased peti-

tioner's stock in PMI without also receiving his release of

claims.   It is apparent that PepsiCo paid petitioner $3,250,071,

     7
      In his testimony Mr. Dickie explained that a retail food
franchise is usually valued based on either a percentage of sales
income or a multiplier of income before depreciation and taxes.
According to Mr. Dickie, these methods were applied to PMI in
order for PepsiCo to arrive at the $8.25 per share price paid by
PepsiCo to petitioner.
                              - 16 -

both to purchase his stock and to settle his claims.   Accord-

ingly, we must allocate the $3,250,071 between the value of the

stock in PMI and the value of settling petitioner's claims.

     It would serve no purpose to delve into detailed discussions

concerning the weight of specific testimony or the credibility of

certain evidence.   We make this allocation based on the totality

of the evidence before the Court, while allowing for a certain

amount of overstatement, or understatement, in the assertions

contained in the testimony before us.    See Eisler v. Commis-

sioner, 59 T.C. 634 (1973).   Therefore, based on the evidence, we

conclude that PepsiCo paid $2,363,688 for the PMI stock, or $6

per share.   Consequently, we find that the remainder of the

amount paid to petitioner by PepsiCo, an amount equal to

$886,383, was paid to settle petitioner's claims in contract and

in tort.

     To exclude under section 104(a)(2) the proceeds from the

settlement of a claim, the claim (1) must be based on tortlike

rights and (2) must be "on account of" personal injuries.      Com-

missioner v. Schleier, 515 U.S. __, 115 S. Ct. 2159 (1995).

Petitioner's first two claims against PepsiCo constitute contract

claims not covered by section 104(a)(2).   Petitioner's third

claim is an action in tort.   See Maxwell v. Southwest Natl. Bank,

593 F. Supp. 250, 253 (D. Kan. 1984); Turner v. Halliburton Co.,

722 P.2d 1106, 1115 (Kan. 1986).   Further, we are satisfied that

petitioner suffered personal injuries.   The phrase "on account of
                              - 17 -

personal injuries" includes both nonphysical and physical

injuries.   United States v. Burke, 504 U.S. 229, 235 n.6 (1992);

Threlkeld v. Commissioner, 848 F.2d 81, 84 (6th Cir. 1988), affg.

87 T.C. 1294, 1308 (1986).   Section 104(a)(2) has been held to

apply to several types of nonphysical personal injuries, such as

emotional distress, United States v. Burke, supra; mental pain

and suffering, Bent v. Commissioner, 835 F.2d 67 (3d Cir. 1987),

affg. 87 T.C. 236 (1986); indignity, humiliation, inconvenience,

pain and distress of mind, and prevention from attending usual

pursuits, Threlkeld v. Commissioner, supra at 81-82; and injury

to personal, professional, and credit reputation, Church v.

Commissioner, 80 T.C. 1104 (1983).     The evidence before the Court

is that PepsiCo's actions caused petitioner to suffer emotional

distress and resulted in damage to petitioner's business

reputation.8   Petitioner discussed these damages with Mr. Dickie

during the settlement negotiations.    The payment made by PepsiCo

was intended to settle both the contract claims and the tort

claim.   Thus, we conclude that part of the settlement payment was

excludable, and part was not excludable under section 104(a)(2).

     If a settlement payment covers both contract claims and

excludable tort claims, then we may allocate amounts to each

claim.   Stocks v. Commissioner, 98 T.C. 1, 14 (1992); Eisler v.

     8
      When contracts are interfered with in a tortious manner, a
litigant may recover damages for emotional distress. McLoughlin
v. Golf Course Superintendents Association of Am., No. 85-4499-R
(D. Kan., Apr. 8, 1991).
                              - 18 -

Commissioner, supra at 640.   The record does not contain a great

deal of evidence to help this Court in making an allocation.    As

we stated in Eisler v. Commissioner, supra at 641, under these

circumstances, "the most that can be expected of us is the

exercise of our best judgment based upon the entire record."

Therefore, we conclude that, of the $886,383 in settlement pro-

ceeds apportionable to the release of petitioner's claims in

contract and in tort, one-third was paid to settle the tort

claim.   Accordingly, one-third of the $886,383, or $295,461, is

excludable under section 104(a)(2).

Basis of Petitioner's PMI Stock

     In his 1990 Federal income tax return, petitioner included

the following amounts in the basis of his PMI stock:   $100,000 of

miscellaneous expenses, $5,797 in additional travel costs, $1,637

in miscellaneous legal fees, and $800,000 in legal costs related

to the PepsiCo litigation ($300,000 actually paid and $500,000 in

contingent fees; see supra p. 8 table note 2).   Respondent, in

her notice of deficiency, determined that none of these amounts

should have been included in petitioner's PMI stock basis.    We

will deal with each of these items in turn.

     The Commissioner's determinations are presumed correct.

Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).     Peti-

tioner has the burden of establishing the correct basis of his

PMI stock.   Burnet v. Houston, 283 U.S. 223, 228 (1931).
                               - 19 -

     At trial, petitioner and his C.P.A. testified that the

$100,000 in miscellaneous expenses and the $5,797 in travel

expenses were paid by petitioner as a stockholder of PMI.

However, petitioner did not produce any records at trial to

substantiate these claimed expenses.    A determination of basis is

a factual one, for which the burden of proof rests with peti-

tioner.   Hinckley v. Commissioner, 410 F.2d 937 (8th Cir. 1969),

affg. T.C. Memo. 1967-180.   Petitioner's self-serving testimony,

without any additional proof, fails to meet this burden.    Because

petitioner failed to substantiate his expenses, the miscellaneous

and travel expenses are not allowable items in computing peti-

tioner's basis in his PMI stock.

     Petitioner argues on brief that $8,800 in accounting fees

should be included in the basis of his PMI stock.9   Petitioner

has failed to demonstrate that the accounting firm did any work

related to the PMI stock.    In her notice of deficiency, respon-

dent has allowed this $8,800 in fees as miscellaneous deductions.

Respondent's notice of deficiency is presumed correct.     Welch v.

Helvering, supra at 115.    Since petitioner failed to put on any

evidence, outside of his own testimony, as to the nature of the

accounting work, we find for respondent.


     9
      Petitioner reported $1,637 of miscellaneous legal fees in
the basis of his PMI stock. Respondent, in her notice of
deficiency, allowed these expenses as miscellaneous itemized
deductions. Petitioner, in his reply brief, agreed that these
fees were properly accounted for in the notice of deficiency.
                                - 20 -

     Petitioner paid $300,000 to his lawyers upon the settlement

of claims against PepsiCo and increased the basis of his PMI

stock.   Again, respondent, in her notice of deficiency, allowed

petitioner these fees as a miscellaneous itemized deduction.      For

the reasons set out below, we hold that $219,000 of these fees is

a proper addition to the basis of petitioner's stock, $54,000 of

the fees is deductible as a miscellaneous itemized deduction, and

$27,000 of the fees is nondeductible.    Section 265 precludes a

deduction for legal expenses attributable to a class of income

that is exempt from taxation.    Section 1.265-1(c), Income Tax

Regs., provides as follows:

     Expenses and amounts otherwise allowable which are
     directly allocable to any class or classes of exempt
     income shall be allocated thereto; and expenses and
     amounts directly allocable to any class or classes of
     nonexempt income shall be allocated thereto. If an
     expense or amount otherwise allowable is indirectly
     allocable to both a class of nonexempt income and a
     class of exempt income, a reasonable proportion thereof
     determined in the light of all the facts and circum-
     stances in each case shall be allocated to each.

     Ordinarily, we allocate the legal expenses in the same

proportion as the settlement payment.    See Stocks v. Commis-

sioner, supra at 18; Metzger v. Commissioner, 88 T.C. 834, 860

(1987), affd. 845 F.2d 1013 (3d Cir. 1988); Church v. Commis-

sioner, supra at 1110-1111.     But see Eisler v. Commissioner,

supra at 642.   Based on the evidence, a proportionate allocation

is appropriate in this case.    We have held that 73 percent of the

settlement payment was paid for petitioner's stock, 18 percent
                                - 21 -

was paid to settle petitioner's two contract claims, and 9 per-

cent was paid to settle his tort claim.     We, therefore, conclude

that 9 percent of the legal expenses, or $27,000, is not deduct-

ible.     Also, $54,000 of the legal fees, the amount related to

petitioner's two contract claims, is deductible as a miscel-

laneous itemized deduction.

     Next, we must decide whether the legal fees allocated to the

sale of petitioner's stock, or $219,000, were properly added to

the basis in petitioner's stock, as argued by petitioner, or

whether the fees are deductible as miscellaneous itemized

deductions, as respondent contends.      In litigation involving the

acquisition or disposition of capital assets, the origin and

character of the claim control in deciding whether or not legal

expenses should be capitalized.     Woodward v. Commissioner, 397

U.S. 572 (1970).     This Court has applied the same rule to cases

involving the defense or perfection of title to property.     See

Boagni v. Commissioner, 59 T.C. 708 (1973).      Consideration must

be given to the issues involved, the nature and objectives of the

litigation, and the background and the facts surrounding the

controversy.     Id. at 713.

        Petitioner transferred his Pizza Hut franchises in exchange

for PMI stock because he was under the impression that PMI

possessed the right to issue its stock in a public offering

without restrictions from Pizza Hut.     When PepsiCo contested

PMI's public offering, petitioner instituted a lawsuit to enforce
                               - 22 -

these rights.   The litigation involved the transferability of

PMI's stock, thereby implicating the "perfection of title" by

petitioner, and the litigation culminated in the sale of the

stock to PepsiCo.   Thus, 73 percent of the legal expenses, or

$219,000 of the $300,000 legal fees paid, was properly included

in the basis of petitioner's stock and treated as an offset

against the sale price.   See Reed v. Commissioner, 55 T.C. 32

(1970) (legal expenditures to remove restrictions on the trans-

ferability of a partnership interest are capital in nature).

      In addition to the $300,000 of legal fees paid to the

attorneys, petitioner included $500,000 in the basis of his PMI

stock.    The $500,000 related to a contingent note, executed by

petitioner, payable to the law firm involved in the litigation.

Payment on the note was contingent upon any future awards from

the PMI litigation.

     Generally, a contingent liability may not be added to basis.

Albany Car Wheel Co. v. Commissioner, 40 T.C. 831, 839 (1963),

affd. per curiam 333 F.2d 653 (2d Cir. 1964).    Petitioner,

however, relies on Roberts Co. v. Commissioner, a Memorandum

Opinion of this Court dated June 15, 1945, to support his claim

of propriety of this addition to basis.    This reliance is

misplaced.    The taxpayers in Roberts capitalized contingent

attorney's fees paid for defense of claims against their father's

estate.    The fees were paid out of the estate, because the

defense was successful.    Thus, the contingency had been met, and
                                - 23 -

the legal expenses paid, prior to being capitalized into the

basis of the property.   Here, the contingency had not been met,

and the fees had not been paid.    Accordingly, the contingent fees

cannot be treated as an addition to basis in petitioner's stock

in PMI.

Deductions in Connection With T.J. Cinnamons Bakery

     In his 1990 Federal income tax return, petitioner deducted

$357,356 as a long-term capital loss from his failed investment

in a T.J. Cinnamons Bakery franchise.    On brief, however, peti-

tioner argues that the basis of the franchise consisted of the

following amounts:

     Cash paid by petitioner                      $60,000
     Note assumed by petitioner                   181,058
     Capitalized expenses                          86,175
                                              1
          Total                                   327,233
             1
           Petitioner's counsel, in his trial brief, admits
     that petitioner was not able to reconstruct the
     $357,356 amount reported in the 1990 Federal income
     tax return. Therefore, our discussion will focus on
     the $327,233 amount testified to by petitioner's
     accountant, Mr. Hoover.

Respondent contends that the basis is limited to the amount

allowed in the notice of deficiency, $241,058, representing the

cash paid and the note assumed by petitioner.      Thus, the expenses

of $86,175 remain in dispute.    For the reasons set forth herein,

we conclude that the basis is $241,058.

     Petitioner included $86,175 of expenses in the basis of his

T.J. Cinnamons Bakery investment.    A taxpayer is responsible for
                               - 24 -

maintaining sufficient records to substantiate the propriety of a

deduction.    Sec. 1.6001-1(a), Income Tax Regs.   At trial, no

reliable evidence was produced by petitioner.      A photocopy of a

handwritten note made by Mr. Hoover listing various expenses was

produced.    Many of the items in the handwritten note were

illegible, the descriptions were ambiguous, and no amounts were

supported by documentation.    Petitioner also produced a letter

from his lawyers, listing expenses incurred by petitioner.10      The

letter does not assist petitioner in substantiating his expenses.

Accordingly, we find petitioner's evidence insufficient to

substantiate his claimed expenses involving the T.J. Cinnamons

Bakery franchise.

Investment Interest Expense Deduction

     Respondent, in her notice of deficiency, disallowed

petitioner's claimed investment interest expense deduction of

$156,441 and determined that petitioner realized $404,210 of

income from debt forgiveness.11   On brief, respondent abandoned

     10
      The letter from petitioner's attorneys was sent to the
sellers of the T.J. Cinnamons Bakery franchise. It was written
as part of petitioner's attempts to rescind the transaction and
recover his money.
     11
      Petitioner, in his 1990 Federal income tax return,
reported $1,224,395 as investment interest expense carry forward.
This amount was also disallowed by respondent in her notice of
deficiency. This disallowance affected the deficiency determined
for 1991. Petitioner concedes on brief that the 1990 Federal
income tax return inaccurately reported interest accrued in prior
years, because none of that interest was actually paid until
1990. Accordingly, the interest carried forward will consist
                                                   (continued...)
                                - 25 -

this argument because she calculated that the principal balance

of petitioner's borrowings was something less than the $1,800,000

he ultimately paid to the bank.    Respondent therefore concluded

that the remaining balance of petitioner's payment represented

interest accrued by the bank.    Specifically, respondent deter-

mined that $1,386,761 of petitioner's $1,800,000 payment to the

bank constituted payment of principal, and $413,239 related to

interest.   Respondent calculated the principal balance by tracing

payments through the bank's "Loan Commitment" sheets to determine

how the funds were actually disbursed.    This analysis was

detailed, credible, and persuasive.

     Petitioner relies on "Interest Paid" statements he received

from the bank to support his contention that more than $413,239

of the $1,800,000 payment to the bank related to interest.

Included in these statements was a $71,321.97 amount of interest

"paid" for 1990.   However, a bank "Charge Off Authorization" form

indicates that the $71,321.97 amount was actually written off by

the bank.   Therefore, the Court finds that the bank's "Interest

Paid" statements do not reflect interest actually "paid" by

petitioner.   Petitioner failed to introduce any other evidence at

trial concerning the principal balance on the notes or the

interest paid to the bank.   Accordingly, we sustain respondent's

     11
      (...continued)
only of the interest expense the Court determines has been "paid"
in 1990 but not deducted by petitioner due to sec. 163(d)
limitations.
                               - 26 -

determination that petitioner paid $413,239 in interest charges

for 1990.

Legal Expenses

     In her notice of deficiency, respondent disallowed $19,975

in legal expenses claimed as a deduction in 1991.    Since peti-

tioner failed to address this issue either at trial or in his

brief, we treat this as a concession by petitioner and find for

respondent.

Penalties

     In her notice of deficiency, respondent determined that

petitioners were liable for penalties for fraud pursuant to

section 6663.    Prior to trial, respondent conceded that no

amounts were due for fraud.    In her answer to the petition,

respondent asserted an accuracy-related penalty against peti-

tioners pursuant to section 6662(a) for their 1990 and 1991

Federal income tax returns.    Since the accuracy-related penalty

was first raised in her answer to the petition, respondent has

the burden of proof on this issue.

     An accuracy-related penalty equaling 20 percent of the

underpayment may be imposed for any one of five reasons.     Sec.

6662(a).    One such reason exists where the taxpayer is negligent

in completing his return.    Sec. 6662(b)(1).   Negligence includes

"any failure to make a reasonable attempt to comply with the

provisions" of the Internal Revenue Code.    Sec. 6662(c).   This

Court has defined negligence as the "lack of due care or failure
                                - 27 -

to do what a reasonable and ordinarily prudent person would do

under the circumstances."     Neely v. Commissioner, 85 T.C. 934,

947 (1985) (quoting Marcello v. Commissioner, 380 F.2d 499, 506

(5th Cir. 1967)).

     A taxpayer can avoid liability for the accuracy-related

penalty if he engages a competent professional to prepare his

return, and he reasonably relies on the advice of that

professional.    Freytag v. Commissioner, 89 T.C. 849, 888 (1987),

affd. 904 F.2d 1011, 1017 (5th Cir. 1990), affd. 501 U.S. 868

(1991).    The taxpayer must show that he provided all relevant

information to the professional.     Pessin v. Commissioner, 59 T.C.

473, 489 (1972).

     Petitioner engaged Wayne Hoover, a C.P.A. with over 20 years

of experience, to prepare his 1990 and 1991 Federal income tax

returns.    Petitioner was a longtime client of Mr. Hoover's and

heavily relied on Mr. Hoover's advice.       After discussing the

facts with petitioner, Mr. Hoover advised petitioner to exclude

income under section 104(a)(2) and include the contingent legal

fees in his PMI stock basis.    Since the burden of proof is on

respondent, she must prove that petitioner failed to provide

relevant information to Mr. Hoover and that petitioner's reliance

on Mr. Hoover was improper.    Respondent has failed to meet this

burden.    The penalties for 1990 and 1991 are not sustained.

                                      Decision will be entered under

                                 Rule 155.
