                       T.C. Memo. 1997-545



                     UNITED STATES TAX COURT



     FRENCH E. HICKMAN AND JANICE C. HICKMAN, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 3689-96.                Filed December 11, 1997.



     Dee A. Replogle, Jr., and Jennifer Henderson Callahan, for

petitioners.1

     Edith F. Moates, for respondent.




1
   James H. Rice (Mr. Rice) represented petitioners at the trial
in this case. Thereafter, but before the briefs in this case
were filed, Dee A. Replogle, Jr., and Jennifer Henderson Callahan
entered appearances on behalf of petitioners, and the Court
granted Mr. Rice's motion to withdraw as their counsel.
                                   - 2 -


                  MEMORANDUM FINDINGS OF FACT AND OPINION

     CHIECHI, Judge:       Respondent determined the following defi-

ciencies in, and accuracy-related penalties on, petitioners'

Federal income tax:

                                        Section 6662(a)2
           Year      Deficiency     Accuracy-Related Penalty

           1991        $46,801                  $9,360
           1992        104,743                  20,949
           1993         37,149                   7,430

     The issues remaining for decision are:

     (1)    Does $268,027.48 of interest paid by petitioners during

1991 to the F.E. Hickman, DDS Orthodontics, Inc., Profit-Sharing

Plan (Hickman corporation profit-sharing plan) qualify as invest-

ment interest within the meaning of section 163(d) for which

petitioners are entitled for the years at issue to deductions

under section 163(a), as limited by section 163(d)?         We hold that

it does.

     (2)    Are petitioners liable for each of the years at issue

for the accuracy-related penalty under section 6662(a)?        We hold

that they are to the extent stated herein.

                             FINDINGS OF FACT

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

     At the time the petition was filed, petitioner French E.


2
   Unless otherwise indicated, all section references are to the
Internal Revenue Code (Code) in effect for the years at issue.
All Rule references are to the Tax Court Rules of Practice and
Procedure.
                                - 3 -


Hickman3 and petitioner Janice C. Hickman, who divorced sometime

after the years at issue, lived in Oklahoma City and Edmond,

Oklahoma, respectively.   Petitioners timely filed a joint Federal

income tax return (return) for each of the years 1991, 1992, and

1993.

     During the years at issue, petitioner, an orthodontist, was

the sole shareholder of F.E. Hickman, DDS Orthodontics, Inc.

(Hickman corporation).    During those years, petitioner, who also

owned substantial interests in banks in and around the Oklahoma

City area, was (1) the director and the chairman of the board of

directors of Midwest National Bank (Midwest Bank), (2) a director

of The National Bank of Harrah (National Bank of Harrah), Harrah

National Bancshares, Inc. (Harrah Bancshares), and Midwest

National Bancshares, Inc. (Midwest Bancshares), and (3) the

director and chairman of the board of directors of Nichols Hills

Bank and Trust.   As such, petitioner was aware of the financial

and business circumstances of those organizations.

     The Hickman corporation maintained the F.E. Hickman, DDS,

Orthodontics, Inc., Retirement Plan and the Hickman corporation

profit-sharing plan until they were terminated on December 31,

1991, and January 31, 1992, respectively.




3
   Hereinafter, references to petitioner in the singular are to
petitioner French E. Hickman.
                                - 4 -


     On June 4, 1982, petitioner borrowed $130,000 from the

Hickman corporation profit-sharing plan (1982 plan loan).    That

loan, which was unsecured, was evidenced by a note payable to

that plan and signed by petitioner (1982 note).    The 1982 note

provided that interest on the 1982 plan loan was to be paid

annually at the rate of 15 percent per year, but it did not

specify a repayment date for that loan.

     On January 4, 1984, petitioner purchased 20,000 shares of

stock of National Bank of Harrah at $12 a share.    During 1984,

petitioner sold 200 shares of that stock.    In July 1984, the

National Bank of Harrah stock was converted to common stock

(Harrah Bancshares stock) in Harrah Bancshares, a holding com-

pany.    At the time of conversion, petitioner owned 19,800 shares

of Harrah Bancshares stock, or 20.43 percent of its outstanding

stock.    From July 1984 through about April 6, 1993, petitioner

held varying amounts of Harrah Bancshares stock.

     In an attempt to repay the 1982 plan loan, on August 19,

1985, petitioner transferred to the Hickman corporation profit-

sharing plan 5,000 shares of Harrah Bancshares stock (Harrah

Bancshares profit-sharing plan stock) and certain real property

located in Oklahoma County, Oklahoma (Hickman real property).

(Those transfers of 5,000 shares of Harrah Bancshares stock and

the Hickman real property shall be referred to collectively as

the 1985 stock and real property transfer.)
                               - 5 -


     During 1991, the Hickman corporation profit-sharing plan was

audited (1991 audit) by the Internal Revenue Service (IRS).     As

a result of that audit, the IRS made the following determina-

tions:   (1) The 1982 plan loan was a prohibited transaction under

section 4975(c)(1)(B) (1982 plan loan prohibited transaction);

and (2) the 1985 stock and real property transfer was a prohib-

ited transaction under section 4975(c)(1)(A) (1985 stock and real

property transfer prohibited transaction).

     Harold D. Hines (Mr. Hines), an authorized representative of

petitioners and the Hickman corporation profit-sharing plan, sent

respondent's Appeals Officer who was handling the 1991 audit a

letter dated October 18, 1991, which set forth the final resolu-

tion of that audit (1991 settlement).   The 1991 settlement

provided, inter alia, that petitioner was to correct

     the alleged prohibitive [sic] transactions [the 1982
     plan loan prohibited transaction and the 1985 stock and
     real property transfer prohibited transaction] through
     repayment of the outstanding loan balance, principal
     plus interest, and a conveyance of the real property
     and stock in the Harrah National Bancshares, Inc. from
     the Profit Sharing Plan to The French Hickman Trust
     (this Trust is a revocable trust established by F.E.
     Hickman for estate tax purposes).

     Attached to the 1991 settlement was, inter alia, peti-

tioner's check dated October 4, 1991, payable to the Hickman

corporation profit-sharing plan in the amount of $398,027.48,

representing payment of the $130,000 principal balance of the

1982 plan loan (1991 principal payment) and interest of
                               - 6 -


$268,027.48 (1991 interest payment).   The 1991 interest payment

was calculated based on 15-percent simple interest and 9-percent

interest compounded annually on the 15-percent simple interest.

The 1991 settlement indicated that other documentation was

enclosed therewith, including (1) a copy of a quitclaim deed

dated October 17, 1991, whereby the Hickman corporation profit-

sharing plan transferred the Hickman real property to The French

Hickman Trust (Hickman revocable trust), (2) a copy of an assign-

ment by the Hickman corporation profit-sharing plan to the

Hickman revocable trust of the Harrah Bancshares profit-sharing

plan stock, (3) Form 870, Waiver of Restrictions on Assessment

and Collection of Deficiency in Tax and Acceptance of

Overassessment, that was executed by petitioner on October 18,

1991, and (4) petitioner's check to cover the excise tax under

section 4975(a) that, pursuant to that Form 870, was to be

imposed on petitioner as part of the 1991 settlement.

     At the end of 1991, National Bank of Harrah and Harrah

Bancshares had a combined net operating loss carryforward of

$1,236,093.   At the end of 1992, National Bank of Harrah was an

operating bank.   On April 6, 1993, Harrah Bancshares, which owned

approximately 96 percent of the stock of National Bank of Harrah,

merged with Midwest Bancshares, and the common stock of Harrah

Bancshares was canceled.   On April 16, 1993, National Bank of

Harrah merged with and into Midwest Bank, each share of Midwest
                               - 7 -


Bank's common stock remained as one share of common stock of the

resulting national bank, and each share of National Bank of

Harrah's common stock was exchanged for one-seventh of a share of

Midwest Bancshares common stock.

      In their returns for 1991, 1992, and 1993, petitioners

claimed total investment interest expenses of $330,581, $221,697,

and $149,034, respectively.   Of those total amounts, petitioners

reported in the Forms 4952 (Investment Interest Expense Deduc-

tion), which they included with their returns for 1991, 1992, and

1993, respectively, that (1) $323,088 was "Investment interest

expense paid or accrued in 1991", and $7,493 was "Disallowed

investment interest expense from 1990 Form 4952, line 23";

(2) $47,824 was "Investment interest expense paid or accrued in

1992", and $173,873 was "Disallowed investment interest expense

from 1991 Form 4952, line 5"; and (3) $49,445 was "Investment

interest expense paid or accrued in 1993", and $99,589 was

"Disallowed investment interest expense from 1992 Form 4952, line

5".   Included in the $323,088 of investment interest expense

which petitioners claimed in their 1991 Form 4952 they paid or

accrued during 1991 was the 1991 interest payment of $268,027.48

that petitioner made as part of the 1991 settlement to correct

the 1982 plan loan prohibited transaction.

      Because of limitations prescribed by section 163(d)(1) on

the deductible amount of investment interest, petitioners de-
                                  - 8 -


ducted in their respective returns for 1991, 1992, and 1993 only

a portion of the total amounts of investment interest claimed in

their respective Forms 4952 for those years.     Pursuant to section

163(d)(2), they treated the balance of the total amount of

investment interest claimed in Forms 4952 for each of the years

1991 and 1992 as disallowed investment interest to be carried

over to the succeeding taxable year.

     In Schedules A, Itemized Deductions (Schedule A), of their

returns for 1991, 1992, and 1993, petitioners claimed total

interest deductions of $179,235, $141,388, and $96,901, respec-

tively.    Those deductions consisted of the following claimed

amounts of interest for the taxable years indicated:

                        Claimed
      Taxable        Home Mortgage              Claimed
        Year      Interest and Points     Investment Interest

          1991          $22,527                $156,708
          1992           19,280                 122,108
          1993           15,744                  81,157


     In Schedule D, Capital Gains and Losses (Schedule D), of

their 1992 return, petitioners claimed a net long-term capital

loss of $194,118.    Included in the computation of that loss was a

claimed long-term capital loss of $289,316 (claimed 1992 worth-

less stock loss) that petitioners explained in a statement

attached to their 1992 return as follows:     "The National Bank of

Harrah Common Stock was evaluated in June, 1992 and determined to

be worthless in accordance with Internal Revenue Code Section
                                - 9 -


165(g)(1).    The bank was in a failing condition and has since

been merged into another bank."    Because of the $3,000 limitation

imposed by section 1211(b) for each taxable year on the amount of

net capital loss by which an individual may reduce income,

petitioners reduced the income reported in their 1992 return by

$3,000 of the claimed 1992 worthless stock loss reported in their

1992 Schedule D.    Petitioners carried over the remainder of that

claimed loss to their 1993 Schedule D and reduced the income

reported in their 1993 return by $3,000 of that claimed loss

carryover.

     Respondent issued a notice of deficiency (notice) to peti-

tioners for the years at issue.    Respondent determined in the

notice, inter alia, that for 1991, 1992, and 1993 petitioners are

not entitled to $96,737, $81,165, and $31,712, respectively, of

the interest deductions that they claimed in Schedules A of their

returns for those years.    The following explanation was set forth

in the notice for the disallowance of those claimed interest

deductions:

     It is determined that your deduction for investment
     interest expenses is limited to your net investment
     income. It is determined that your deduction for home
     mortgage interest excess [sic] the $100,000 limit.

     Respondent determined in the notice that for 1992 petition-

ers had a net long-term capital gain of $98,198, rather than a

net long-term capital loss of $194,118, and that petitioners had

no capital loss carryover to 1993.      Consequently, respondent
                              - 10 -


disallowed petitioners' 1992 and 1993 deductions relating to

their claimed 1992 worthless stock loss.

     Respondent also determined in the notice that petitioners

are liable under section 6662(a) for each of the years at issue

on the entire amount of the underpayment that respondent deter-

mined for each of those years (1) because of their negligence or

intentional disregard of rules or regulations under section

6662(b)(1) and (2) alternatively because of their substantial

understatement of income tax under section 6662(b)(2).

                              OPINION

     Petitioners have the burden of proving that respondent's

determinations in the notice are erroneous.   Rule 142(a); Welch

v. Helvering, 290 U.S. 111, 115 (1933).    Respondent has the

burden of proving any new matter that was not raised in the

notice.   Rule 142(a); Achiro v. Commissioner, 77 T.C. 881, 890

(1981).

1991 Interest Payment

     Section 163(a) generally permits a deduction for all inter-

est paid or accrued within the taxable year on indebtedness.    In

the case of a taxpayer other than a corporation, the amount

allowed as a deduction for investment interest for any taxable

year is not to exceed the net investment income of the taxpayer

for that year.   Sec. 163(d)(1).   Except for certain interest not

involved here, the term "investment interest" means any interest
                              - 11 -


allowable as a deduction, determined without regard to section

163(d)(1), that is paid or accrued on indebtedness properly

allocable to property held for investment.   Sec. 163(d)(3)(A).

     In general, interest expense on a debt is allocated in the

same manner as the debt to which such interest expense relates is

allocated.   Debt is allocated by tracing disbursements of the

debt proceeds to specific expenditures.   Sec. 1.163-8T(a)(3),

Temporary Income Tax Regs., 52 Fed. Reg. 24999 (July 2, 1987).

Interest expense allocated to an investment expenditure is

treated for purposes of section 163(d) as investment interest.

Sec. 1.163-8T(a)(4)(i)(C), Temporary Income Tax Regs., 52 Fed.

Reg. 25000 (July 2, 1987).   The term "investment expenditure"

means an expenditure (other than a passive activity expenditure)

properly chargeable to capital account with respect to property

held for investment within the meaning of section 163(d)(5)(A) or

an expenditure in connection with the holding of such property.

Sec. 1.163-8T(b)(3), Temporary Income Tax Regs., 52 Fed. Reg.

25000 (July 2, 1987).   Section 163(d)(5)(A) provides that in

general the term "property held for investment" includes any

property which produces income of a type described in section

469(e)(1) (i.e., gross income from interest, dividends, annu-

ities, or royalties not derived in the ordinary course of a trade

or business and gain or loss not derived in the ordinary course

of a trade or business that is attributable to the disposition of
                              - 12 -


property producing income of a type just described or held for

investment) and any interest held by a taxpayer in an activity

involving the conduct of a trade or business which is not a

passive activity and with respect to which the taxpayer does not

materially participate.

     Debt is allocated to expenditures in accordance with the use

of the debt proceeds, and, with certain exceptions not pertinent

here, interest expense accruing on a debt during any period is

allocated to expenditures in the same manner as the debt is

allocated from time to time during such period.   Sec. 1.163-

8T(c)(1), Temporary Income Tax Regs., 52 Fed. Reg. 25000 (July 2,

1987).   Debt is allocated to an expenditure for the period

beginning on the date on which the proceeds for the debt are used

or treated as used under the rules of section 1.163-8T, Temporary

Income Tax Regs., 52 Fed. Reg. 24999 (July 2, 1987), to make the

expenditure and ending on the earlier of the date on which the

debt is repaid or the date on which the debt is reallocated in

accordance with, inter alia, section 1.163-8T(c)(4) and (j),

Temporary Income Tax Regs., 52 Fed. Reg. 25001, 25004 (July 2,

1987).   Sec. 1.163-8T(c)(2)(i), Temporary Income Tax Regs., 52

Fed. Reg. 25000 (July 2, 1987).   Generally, debt allocated to an

expenditure properly chargeable to capital account with respect

to an asset (first expenditure) is reallocated to another expen-

diture on the earlier of the date on which proceeds from a
                              - 13 -


disposition of such asset are used for another expenditure or the

date on which the character of the first expenditure changes by

reason of a change in the use of the asset with respect to which

the first expenditure was capitalized.   Sec. 1.163-8T(j)(1)(i),

Temporary Income Tax Regs., 52 Fed. Reg. 25004 (July 2, 1987).

     Petitioners contend that the 1991 interest payment of

$268,027.48 is investment interest within the meaning of section

163(d)(3) that is deductible under section 163(a) subject to the

limitations of section 163(d).   Respondent contends that the 1991

interest payment is not investment interest because petitioner

repaid the 1982 plan loan during 1985 when he made the 1985 stock

and real property transfer.   Respondent further contends that,

assuming arguendo that the Court were to find that the 1982 plan

loan was not repaid during 1985, petitioners have failed to show

that the 1991 interest payment constitutes investment interest

because they failed to establish that the $130,000 of proceeds

from that loan are traceable to an investment expenditure from

June 4, 1982, the date on which the 1982 plan loan was made,

through October 4, 1991, the date on which petitioner made the

1991 principal payment and the 1991 interest payment.   In the

alternative, respondent contends that, even if the Court were to

find that the 1991 interest payment constitutes investment

interest, either section 72(e) or section 72(p)(3) prohibits the

deduction of that interest.
                              - 14 -


     With respect to respondent's contention that the 1991

interest payment is not investment interest because the 1985

stock and real property transfer constituted repayment of the

1982 plan loan, the parties to the 1991 settlement (viz., respon-

dent, the Hickman corporation profit-sharing plan, and petition-

ers) agreed in that settlement that the 1982 plan loan had an

"outstanding loan balance" and that that loan, which the IRS

determined was a prohibited transaction, was to be corrected

"through repayment of the outstanding loan balance, principal

plus interest".   On the record before us, we shall not allow

respondent to abandon the agreement reflected in the 1991 settle-

ment that there was an outstanding loan balance during 1991 with

respect to the 1982 plan loan and that the principal of that

loan, plus interest, was paid by petitioner on October 4, 1991.

Consequently, we reject respondent's argument that the 1985 stock

and real property transfer constituted repayment of the 1982 plan

loan.

     We now address respondent's contention that, assuming

arguendo that the Court were to determine that the 1982 plan loan

was not repaid during 1985 by the 1985 stock and real property

transfer, the 1991 interest payment is not investment interest

because petitioners have failed to show that the $130,000 of

proceeds from that loan are traceable to an investment expendi-

ture from June 4, 1982, when the 1982 plan loan was made, through
                               - 15 -


October 4, 1991, when petitioner made the 1991 principal payment

and the 1991 interest payment.      Petitioners counter that respon-

dent stipulated at trial that those proceeds were invested, and

therefore are traceable to an investment expenditure, throughout

that period.   We agree with petitioners.

     During the direct examination of petitioners' accountant,

David B. Harbison (Mr. Harbison), by petitioners' counsel, Mr.

Rice, the following exchanges took place:

     BY MR. RICE:

     Q    Mr. Harbison, it has been previously testified
     while you were out of the courtroom that in June 1982
     Dr. Hickman [petitioner] borrowed $130,000 from a
     retirement plan.

     A    That is correct.

     Q    That -- several years later, during a year at
     issue, he repaid it with interest. Could you tell us,
     as succinctly as possible, referring to that document,
     the manner in which the proceeds of this loan were
     invested and held during the intervening years?

     A    Certainly.   I will try.

          MS. MOATES: Excuse me, Your Honor. The Respon-
     dent is willing to stipulate, and has expressed a
     willingness to stipulate, that the $130,000 that was
     borrowed from the pension plan in 1982 was, in fact,
     invested.

          MR. RICE:    Thank you.

          THE COURT:    What more do you need?

          MR. RICE:    We need nothing more.   [Emphasis
     added.]
                               - 16 -


     In her closing statement after the trial in this case,

respondent's counsel stated the position of respondent regarding

the investment interest issue presented here, as follows:

     The issue as to the interest paid -- there has been
     stipulation that the interest paid to correct the
     prohibited transaction in excess of $268,000 -- it was
     paid in 1991.

           The facts are rather clear. I believe that it is
     the Petitioner's argument -- I don't believe there is
     any discussion about the facts -- that it is Peti-
     tioner's legal argument that Code Section 72(p)(3)
     simply does not apply to the repayment of interest in
     1991.

          That is a legal issue that the Respondent will be
     happy to argue, but the facts on that issue are set
     forth and clear. [Emphasis added.]

     We construe the stipulation of respondent's counsel during

Mr. Harbison's direct testimony and her closing statement with

respect to the investment interest issue to mean that respondent

does not dispute (1) that the proceeds of the 1982 plan loan were

invested from June 4, 1982, when that loan was made, through

October 4, 1991, when petitioner made the 1991 principal payment

and the 1991 interest payment, and (2) that, consequently, the

1982 plan loan proceeds are traceable to an investment expendi-

ture throughout that period.   On the record before us, we shall

not allow respondent to abandon on brief the position taken at

trial that the $130,000 proceeds of the 1982 plan loan were

"invested" and that the facts regarding the investment interest

issue are "clear".   Consequently, we reject respondent's argument
                               - 17 -


that petitioners have failed to establish that the 1982 plan loan

proceeds were invested throughout the period June 4, 1982,

through October 4, 1991.

      Based on our examination of the entire record before us, we

find that the 1991 interest payment constitutes investment

interest within the meaning of section 163(d).

      We now turn to respondent's alternative contention that in

the event the Court were to determine that the 1991 interest

payment constitutes investment interest, which we have, either

section 72(e) or section 72(p)(3) bars petitioners from taking a

deduction for that interest.   The following explanation was set

forth in the notice for respondent's determination to disallow

certain investment interest expenses claimed by petitioners in

their returns for the years at issue: "It is determined that your

deduction for investment interest expenses is limited to your net

investment income."

      The Court ordered seriatim briefs in this case, and respon-

dent raised for the first time in the answering brief to peti-

tioners' opening brief that section 72(e) precludes the interest

deductions at issue because the Hickman corporation profit-

sharing plan is a plan described in section 72(e)(7).4   We con


4
    Sec. 72(e)(7) applies to any trust or contract

       (i) which is described in clause (i) or subclause (I),
    (II), or (III) of clause (ii) of paragraph (5)(D), and
                                                    (continued...)
                              - 18 -


clude that respondent raised the position under section 72(e) so

late as to prejudice petitioners.   Consequently, we shall not

allow respondent to advance that position in this case.5

      For the first time in the trial memorandum, respondent

contended that section 72(p)(3)6 disallows the interest deduc


4
 (...continued)
      (ii) with respect to which 85 percent or more of the
   total contributions during a representative period are
   derived from employee contributions. [Sec. 72(e)(7)(B).]
5
   Assuming arguendo that we were to have allowed respondent to
advance the position under sec. 72(e), that position would be a
new matter requiring the presentation of different evidence which
was not raised in the notice and on which respondent would have
the burden of proof. See Rule 142(a); Seagate Tech., Inc., &
Consol. Subs. v. Commissioner, 102 T.C. 149, 169 (1994); Achiro
v. Commissioner, 77 T.C. 881, 890 (1981). On the record before
us, we find that if the Court were to have permitted respondent
to advance the position under sec. 72(e), respondent has failed
to establish that the Hickman corporation profit-sharing plan is
a plan described in sec. 72(e)(7) and that sec. 72(e) precludes
the interest deductions at issue.
6
    Sec. 72(p)(3) provides:

       (A) In General.--No deduction otherwise allowable under
    this chapter shall be allowed under this chapter for any
    interest paid or accrued on any loan described in subpara-
    graph (B).

       (B) Loans to Which Subparagraph (A) Applies.-- For
    purposes of subparagraph (A), a loan is described in this
    subparagraph--

        (i) if paragraph (1) does not apply to such loan by
      reason of paragraph (2), and

         (ii) if--

            (I) such loan is made to a key employee (as de-
         fined in section 416(i)), or
                                                   (continued...)
                              - 19 -


tions at issue.   Petitioners did not claim at trial that they

were surprised by respondent's position under section 72(p)(3).

To the contrary, petitioners' counsel, Mr. Rice, made reference

to respondent's argument under section 72(p)(3) in his closing

statement after trial.   Although petitioners were not surprised

at trial by respondent's position under section 72(p)(3), that

position nonetheless constitutes a new matter requiring the

presentation of different evidence which was not raised in the

notice and on which respondent has the burden of proof.   See Rule

142(a); Seagate Tech., Inc., & Consol. Subs. v. Commissioner, 102

T.C. 149, 169 (1994); Achiro v. Commissioner, 77 T.C. at 890.

     The Tax Reform Act of 1986 (1986 Act), Pub. L. 99-514, sec.

1134(c), 100 Stat. 2484, amended the Code to add a new section

72(p)(3), effective for loans made, renewed, renegotiated,

modified, or extended after December 31, 1986, 1986 Act, sec.

1134(e), 100 Stat. 2484 (1986 Act effective date provisions).

Respondent contends that the 1982 plan loan was modified in 1991

by the 1991 settlement and that, consequently, the 1982 plan loan

falls within the 1986 effective date of section 72(p)(3).    In

support of that contention, respondent asserts:

          When the plan was examined in 1991, the settlement
     agreement called for the terms of the original [1982]


6
 (...continued)
           (II) such loan is secured by amounts attributable
        to elective 401(k) or 403(b) deferrals (as defined in
        section 402(g)(3)).
                              - 20 -


     note to be altered to correct prohibited transactions.
     The modification of the original note is evidenced by
     the amount of interest that was paid to correct the
     prohibited transactions. Interest on the original note
     was "at the rate of 15 percent per annum, payable
     annually." * * * Interest paid in connection with the
     correction of the prohibited transactions was "interest
     at fifteen percent (15%) simple and nine percent (9%)
     compounded annually on the fifteen percent (15%) simple
     interest." * * * The modification of the loan to cor-
     rect the prohibited transaction requires the applica-
     tion of I.R.C. § 72(p)(3) to determine the nature of
     the interest paid during 1991. The interest is simply
     not deductible pursuant to I.R.C. § 72(p)(3).

     On the record before us, we find that respondent has failed

to establish that the 1991 settlement modified the 1982 plan loan

within the meaning of the 1986 Act effective date provisions.

The 1982 note provided that interest on the 1982 plan loan was to

be paid annually at the rate of 15 percent per year, and the 1991

settlement provided for "repayment of the outstanding [1982 plan]

loan balance, principal plus interest," consisting of 15-percent

simple interest and 9-percent interest compounded annually on the

15-percent simple interest.   However, the provision in the 1991

settlement for 9-percent compound interest did not modify the

terms of the 1982 plan loan or the 1982 note evidencing that

loan; it merely effected the correction of the "prohibited" 1982

plan loan, which the parties to the 1991 settlement agreed was

required by section 4975(f)(5), by

     undoing the transaction [the 1982 plan loan] to the
     extent possible, but in any case placing the [Hickman
     corporation profit-sharing] plan in a financial posi-
     tion not worse than that in which it would be if the
                              - 21 -


      disqualified person [petitioner] were acting under the
      highest fiduciary standards. [Sec. 4975(f)(5).]

      Even assuming arguendo that we were to have found that the

1982 plan loan was modified within the meaning of the 1986 Act

effective date provisions, with the result that that loan may be

subjected to section 72(p)(3), on the instant record, we find

that section 72(p)(3) does not apply to that loan.   Section

72(p)(3) applies to a loan that is not subject to section

72(p)(1) because it satisfies the exception in section 72(p)(2).7


7
   Sec. 72(p)(1) provides that if during any taxable year a
participant or beneficiary receives any amount as a loan from a
qualified employer plan, that amount is to be treated as having
been received by such individual as a distribution under such
plan.

   Sec. 72(p)(2) provides the following exception to sec.
72(p)(1):

       (A) General Rule.--Paragraph (1) shall not apply to any
    loan to the extent that such loan (when added to the out-
    standing balance of all other loans from such plan whether
    made on, before, or after August 13, 1982), does not exceed
    the lesser of--

           (i)   $50,000, reduced by the excess (if any) of--

                 (I) the highest outstanding balance of loans
              from the plan during the 1-year period ending on
              the day before the date on which such loan was
              made, over

                 (II) the outstanding balance of loans from
              the plan on the date on which such loan was made,
              or

            (ii) the greater of (I) one-half of the present
         value of the nonforfeitable accrued benefit of the
         employee under the plan, or (II) $10,000.
                                                    (continued...)
                               - 22 -


In general, a loan fits within the exception in section 72(p)(2)

if it (1) is in an amount not exceeding a prescribed ceiling that

in no event may be more than $50,000, (2) is required by its

terms to be repaid within five years, and (3) requires substan-

tially level amortization, with payments made at least quarterly.


7
 (...continued)
      For purposes of clause (ii), the present value of the
      nonforfeitable accrued benefit shall be determined
      without regard to any accumulated deductible employee
      contributions (as defined in subsection (o)(5))(B)).

      (B)   Requirement That Loan Be Repayable Within 5 Years.--

            (i) In General.--Subparagraph (A) shall not apply
         to any loan unless such loan, by its terms, is re-
         quired to be repaid within 5 years.

            (ii) Exception for Home Loans.--Clause   (i) shall
         not apply to any loan used to acquire any   dwelling
         unit which within a reasonable time is to   be used
         (determined at the time the loan is made)   as the prin-
         cipal residence of the participant.

       (C) Requirement of Level Amortization.--Except as pro-
    vided in regulations, this paragraph shall not apply to any
    loan unless substantially level amortization of such loan
    (with payments not less frequently than quarterly) is
    required over the term of the loan.

               *     *     *     *      *    *       *

   The Tax Equity & Fiscal Responsibility Act of 1982 (TEFRA),
Pub. L. 97-248, sec. 236(a), 96 Stat. 509-510, amended the Code
to add sec. 72(p)(1) and (2), effective for loans, assignments,
and pledges made after Aug. 13, 1982, TEFRA, sec. 236(c), 96
Stat. 510-511 (TEFRA effective date provisions). In applying the
TEFRA effective date provisions governing sec. 72(p)(1) and (2),
the outstanding balance of any loan which is renegotiated,
extended, renewed, or revised after Aug. 13, 1982, is to be
treated as an amount received as a loan on the date of such
renegotiation, extension, renewal, or revision. TEFRA, sec.
236(c), 96 Stat. 510-511.
                               - 23 -


The terms of the 1982 note evidencing the 1982 plan loan provide

no specific repayment date for the $130,000 of principal and

require interest to be paid annually at the rate of 15 percent

per year.   Accordingly, the 1982 plan loan is not a loan de-

scribed in section 72(p)(2).   On the instant record, we reject

respondent's argument that section 72(p)(3) disallows the inter-

est deductions at issue relating to the 1991 interest payment on

the 1982 plan loan.

     Based on our examination of the entire record presented to

us, we reject respondent's determinations and find that petition-

ers are entitled for the years at issue to interest deductions

under section 163(a), as limited by section 163(d), that are

attributable to the 1991 interest payment on the 1982 plan loan.

Section 6662(a)

     Section 6662(a) imposes an addition to tax equal to 20

percent of the underpayment of tax attributable to, inter alia,

negligence or disregard of rules or regulations under section

6662(b)(1).8   For purposes of section 6662(a), the term "negli


8
   Respondent made alternative determinations in the notice that,
assuming arguendo that the Court were not to find petitioners
liable for the years at issue under sec. 6662(a) because of their
negligence or disregard of rules or regulations under sec.
6662(b)(1), they are liable under sec. 6662(a) for those years
because of substantial understatements of income tax under sec.
6662(b)(2). On brief, respondent does not advance any arguments
in support of the alternative determinations under sec. 6662(a)
that were based on sec. 6662(b)(2). We conclude that respondent
has abandoned the determinations under sec. 6662(a) that were
                                                   (continued...)
                              - 24 -


gence" includes any failure to make a reasonable attempt to

comply with the Code, and "disregard" includes any careless,

reckless, or intentional disregard.    Sec. 6662(c).   Negligence

has also been defined as a lack of due care or failure to do what

a reasonable person would do under the circumstances.      Leuhsler

v. Commissioner, 963 F.2d 907, 910 (6th Cir. 1992), affg. T.C.

Memo. 1991-179; Antonides v. Commissioner, 91 T.C. 686, 699

(1988), affd. 893 F.2d 656 (4th Cir. 1990); Neely v. Commis-

sioner, 85 T.C. 934, 947 (1985).

     The accuracy-related penalty under section 6662(a) does not

apply to any portion of an underpayment if it is shown that there

was reasonable cause for, and that the taxpayer acted in good

faith with respect to, such portion.    Sec. 6664(c)(1).   The

determination of whether a taxpayer acted with reasonable cause

and in good faith depends upon the pertinent facts and circum-

stances, including the taxpayer's efforts to assess his or her

proper tax liability and the knowledge and experience of the

taxpayer.   Sec. 1.6664-4(b)(1), Income Tax Regs.

     The parties address on brief, and we shall consider, respon-

dent's determinations under section 6662(a) for the years at

issue only insofar as they relate to the underpayment of tax




8
 (...continued)
premised upon substantial understatements of income tax within
the meaning of sec. 6662(b)(2).
                              - 25 -


(1) for each of the years at issue that is attributable to the

claimed investment interest deduction relating to the 1991

interest payment and (2) for each of the years 1992 and 1993 that

is attributable to the claimed deduction relating to their

claimed 1992 worthless stock loss.

     With respect to the investment interest deductions for 1991,

1992, and 1993 that are attributable to the 1991 interest payment

on the 1982 plan loan, we have rejected respondent's determina-

tions disallowing those deductions.    Consequently, there are no

underpayments of income tax for those years that are attributable

to those deductions on which the accuracy-related penalties under

section 6662(a) may be imposed.

     With respect to the 1992 and 1993 deductions relating to

petitioners' claimed 1992 worthless stock loss, petitioners

conceded at trial they are not entitled to those deductions.

However, they contend that they are not liable for 1992 and 1993

for the accuracy-related penalties under section 6662(a) that are

attributable to those deductions because they acted reasonably in

claiming them.   Respondent disagrees.   On the record before us,

we reject petitioners' contention.

     During 1991, 1992, and 1993, petitioner, an orthodontist and

the sole shareholder of the Hickman corporation, was (1) the

director and the chairman of the board of directors of Midwest

Bank, (2) a director of National Bank of Harrah, Harrah
                              - 26 -


Bancshares, and Midwest Bancshares, and (3) the director and

chairman of the board of directors of Nichols Hills Bank and

Trust.   As such, he was aware of the financial and business

circumstances of those organizations.

     To support their position that they acted reasonably in

claiming the 1992 and 1993 deductions relating to their claimed

1992 worthless stock loss, petitioners point to the following:

(1) The parties' stipulations (a) that at the end of 1991 Na-

tional Bank of Harrah and Harrah Bancshares had a combined net

operating loss carryforward of $1,236,093 and (b) that peti-

tioner's Harrah Bancshares stock was canceled on April 6, 1993,

when Harrah Bancshares merged with Midwest Bancshares, and

(2) petitioner's testimony that "Harrah had become insolvent".

Petitioners presented no documentary or other evidence corrobo-

rating petitioner's testimony that "Harrah had become insolvent"

or clarifying the date on which petitioners claim "Harrah had

become insolvent".   In addition, petitioners disregard peti-

tioner's testimony that National Bank of Harrah was an operating

bank at the end of 1992.

     Based on our examination of the entire record before us, we

find that petitioners have failed to show that they acted with

reasonable cause and in good faith, or that they otherwise

exercised due care or made a reasonable attempt to comply with

the Code, when they claimed the 1992 and 1993 deductions relating
                             - 27 -


to their claimed 1992 worthless stock loss.   Accordingly, we

sustain respondent's determinations imposing the accuracy-related

penalties under section 6662(a) for 1992 and 1993 to the extent

that they are attributable to those deductions.

     To reflect the foregoing and the concessions of the parties,



                                        Decision will be entered

                                   under Rule 155.
