                          T.C. Memo. 1997-326


                      UNITED STATES TAX COURT



          TIMOTHY L. AND JANE WILLIAMS, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 557-95.                         Filed July 16, 1997.



     Timothy L. Williams, pro se.

     Julie M.T. Foster, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     BEGHE, Judge:   Respondent determined deficiencies in

petitioners’ Federal income tax and accuracy-related penalties

for substantial understatements of income tax as follows:1




     1
       Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the years in issue. All Rule
references are to the Tax Court Rules of Practice and Procedure.
                                - 2 -


                                              Penalty
     Year          Deficiency           Sec. 6662(a) and (d)
     1991           $4,024                      - 0 -
     1992           14,645                     $2,929
     1993            8,013                      1,603

     All references to petitioner are to Timothy L. Williams.

All numbers are rounded to the nearest dollar.    After

concessions,2 the issue for decision is whether petitioners are

entitled to deduct losses attributable to certain S corporations

in excess of the amounts allowed by respondent.    Disposition of

this issue turns on the amount of petitioner’s basis in his stock


     2
       The deficiencies and penalties reflect, in part,
adjustments for unreported income. At trial and on brief
petitioners specifically contested only the adjustments relating
to disallowance of S corporation losses. All uncontested
adjustments and liability for accuracy-related penalties with
respect to any substantial understatements of tax are deemed to
be conceded. Rule 149(b); Murphy v. Commissioner, 103 T.C. 111,
119 (1994); Rothstein v. Commissioner, 90 T.C. 488, 497 (1988).

     Petitioners in their petition raised an issue relating to
their tax liability for a year not covered by the notice of
deficiency. They alleged that, owing to a return preparer’s
error, a net loss incurred for 1989 by petitioner’s wholly owned
S corporation was not claimed on petitioners’ tax return for that
year. Petitioners subsequently filed a claim for refund of
$12,988, which the Internal Revenue Service denied by letter
dated April 22, 1993. With respect to this issue, we can only
observe that the jurisdiction of this Court to redetermine
petitioners’ correct tax liability is limited to the years
covered by the notice of deficiency, 1991 through 1993. Sec.
6214(b). Petitioners did not claim an NOL carryover from 1989 on
their returns for any of the years in issue, and they have not
shown that they would be entitled to carry forward any NOL that
may have arisen in 1989 without first carrying it back to the
preceding 3 years. Sec. 172(b)(2) and (3). Consequently, the
alleged overpayment of tax for 1989 has no relevance to the
issues that are properly before us. Cf. Lone Manor Farms, Inc.
v. Commissioner, 61 T.C. 436, 440-442 (1974), affd. without
published opinion 510 F.2d 970 (3d Cir. 1975).
                               - 3 -


in and loans to the S corporations and the extent, if any, to

which petitioner recognized income upon the acquisition by one of

these corporations of assets from the other.

                         FINDINGS OF FACT

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

The stipulations of fact and attached exhibits are incorporated

by this reference.   At the time the petition was filed,

petitioners resided in Columbia, South Carolina.

     In 1987 petitioner founded Williams Investigative & Security

Services, Inc. (WIS).   Petitioner was the operator and sole

shareholder of WIS throughout its existence.    WIS was primarily

engaged in the business of insurance investigations; it also

provided security services.

     Throughout 1990 WIS was in a dispute with a client over a

major security services contract.   The client unilaterally cut

back the amount of services required, then terminated the

contract prematurely and disavowed representations it had made to

WIS concerning future work engagements.     At the end of the year,

WIS filed suit for fraud, breach of contract and promissory

estoppel, seeking recovery of compensatory and punitive damages

arising from the loss of the contract and the valuable

engagements.   See Kemira, Inc. v. Williams Investigative & Sec.

Serv., Inc., 450 S.E.2d 427 (Ga. Ct. App. 1994).

     As WIS’s financial situation deteriorated, it was compelled

to borrow.   Third-party loans were not sufficient, however, to
                                 - 4 -


keep WIS afloat.   During 1990 petitioner provided additional

capital, both through contributions and loans.         In January 1990

petitioner made two deposits totaling $29,000 into the WIS

payroll account maintained at the Citizens & Southern National

Bank.   On February 28, petitioner executed a promissory note and

security agreement in favor of Navy Federal Credit Union in

exchange for a personal loan of $14,000.          He then deposited the

loan proceeds into the WIS account at Palmetto Federal.         The

deposit slip identifies the amount deposited as “Loan”.         On

March 1 petitioner entered into a sale-leaseback agreement with

Palmetto Rental & Leasing, Inc. (PR&L), with respect to five

motor vehicles.    PR&L purchased the vehicles and agreed to lease

them to WIS for a stated term.    All proceeds of the sale were

deposited into WIS’s account at Palmetto Federal on March 5.          The

proceeds attributable to each vehicle were as follow:

           Ford Aerostar                 $3,330
           Toyota Pickup                  2,050
           Toyota Pickup                  4,800
           Toyota Cressida                4,000
           Ford Bronco                    8,000
                                         22,180

For each vehicle except the Ford Aerostar, an Affidavit &

Notification of Sale of Motor Vehicle identifies the seller as

either petitioner alone or petitioners jointly.         In the case of

the Ford Aerostar, the seller is listed as “WMS Invest Sec & T.

Williams”.   In each case the seller(s) correspond to the owner(s)

identified on the vehicle’s Certificate of Title.
                                - 5 -


     On January 5, February 5, and May 30, 1990, petitioner used

his personal credit cards to obtain cash advances on WIS’s behalf

totaling $19,500.   On August 24, petitioner deposited a personal

check in the amount of $15,000 into WIS’s account at Palmetto

Federal.   The deposit slip identifies the amount as “Loan”.

     At some point in 1991, WIS filed a petition for

reorganization under chapter 11 of the Bankruptcy Code.

Petitioner continued to operate the corporation in bankruptcy

while it endeavored to pay its debts.    By the end of the year

petitioner had formulated a plan of reorganization (the business

reincorporation transaction).   The insurance investigation

business would be continued through a newly formed entity called

Southeast Professional Services, Inc. (SPS), and the security

services business discontinued.   WIS would transfer assets to SPS

to provide the new company’s initial capital and would also lease

to SPS its equipment and furniture.     As an inducement to help him

manage the business, petitioner would share ownership of SPS with

two associates named Lewis and Tate.    Each would hold an equal

one-third share of SPS’s newly issued stock, but only petitioner

 among the three holders would be responsible for an initial

contribution of property, which would be supplied by WIS.3

     3
       Petitioner’s uncorroborated testimony is the source of
most of the evidence in the record concerning the terms of the
business reincorporation transaction outlined above. Under the
Bankruptcy Code, in general any transfer of an interest in
property of the bankruptcy estate after the filing of the
                                                   (continued...)
                               - 6 -


     SPS was organized on December 31, 1991.     Its opening balance

sheet as of that date shows current assets of $23,509, consisting

of $5,000 in cash and $18,509 in accounts receivable.     Deposit

slips show three separate deposits in the total amount of $5,000

were made into SPS’s account at NCNB National Bank during

December 1991.   Two of these deposits are traceable to a check

for $3,000 drawn on WIS’s account.     Transfer of the accounts

receivable reflected on SPS’s opening balance sheet is

substantially confirmed by payments made to SPS on these accounts

in the total amount of $17,911 in January and February 1992.      The

parties have stipulated that WIS transferred additional accounts

receivable to SPS in 1992.   These receivables represent work for

which WIS issued invoices during January 1992.     Although the

stipulated amount of the receivables transferred in 1992 is

$8,141, comparison of the invoices evidencing these additional


     3
      (...continued)
petition is voidable unless authorized by the bankruptcy court or
by some provision of the Bankruptcy Code. 11 U.S.C. sec. 549
(1988). Any plan for the rehabilitation of the debtor must be
submitted to the creditors for approval and confirmed by the
bankruptcy court. 11 U.S.C. secs. 1125, 1126, 1128, 1129 (1988).
It is not entirely clear from petitioner’s testimony what would
have persuaded the bankruptcy court and WIS’s creditors that
WIS’s transfer of property to another corporation partly owned by
its sole shareholder served the creditors’ interests. However,
inasmuch as respondent did not challenge the plausibility of
petitioner’s account of the business reincorporation transaction
on this ground, there is no evidence contradicting his account,
and the tax consequences of his account are not necessarily more
favorable to him than other conceivable explanations of the few
facts relating to the transaction for which documentation exists,
we accept petitioner’s account.
                               - 7 -


receivables with the checks evidencing the initial $18,509 of

receivables reveals an overlap of $1,003.   Accordingly, a total

of $7,138 of accounts receivable was transferred by WIS to SPS at

the beginning of 1992.

     There is no evidence that any liabilities of WIS to

petitioner or third-party creditors were assumed by SPS or

otherwise satisfied or discharged as part of the business

reincorporation transaction.   There is no evidence that Lewis and

Tate received their stock in SPS in exchange for any contribution

of property or preincorporation services on SPS’s behalf.    Nor is

any indebtedness of the corporation to a shareholder or of a

shareholder to the corporation reflected on SPS’s opening balance

sheet.

     The record contains no direct evidence establishing when

petitioner actually received his stock in SPS.   If SPS issued its

stock in December 1991 before receiving full payment of the

consideration, then the unpaid balance would presumably have

appeared as an asset on the corporate balance sheet as of

December 31, 1991.   The absence of any such entry suggests that

the stock was more likely issued when fully paid, following the

transfer of the $7,138 of additional receivables at the beginning

of 1992.

     Following the aforesaid transfers of property, WIS ceased

active business but remained in existence to collect rental

income from the lease of its fixed assets and any damages that it
                                - 8 -


might be awarded in the lawsuit filed in 1990 (presumably for the

benefit of its creditors).    The WIS chapter 11 proceedings

concluded in 1992.    Petitioner’s attempt to revive the insurance

investigation business through SPS was short lived.    Lewis and

Tate left the venture in 1992 and 1993, respectively, and SPS

ceased business in 1994.

       For all relevant years, WIS and SPS qualified as S

corporations within the meaning of section 1361(a)(1).      It

appears that WIS had no accumulated earnings and profits from

prior years in which it may have been a C corporation.      Each

corporation maintained its books and records and filed its

returns using the cash method of accounting.    In the absence of

any evidence to the contrary, we assume that each corporation

computed its income on the basis of a calendar year.    See sec.

1378.

       On their joint Federal income tax return for 1991,

petitioners reported income attributable to WIS in the amount of

$1,541.    They also claimed a deduction for “other losses” in the

amount of $136,748, which petitioners claim is attributable to

WIS.    The computation of the loss was disclosed in an attachment

to the return.    The attachment purports to be a balance sheet for

WIS as of December 31, 1991, prepared for purposes of the chapter

11 reorganization.    The balance sheet lists corporate assets,

“pre-petition liabilities” and “post-petition liabilities”, and

reflects a deficit in shareholder’s equity of $136,748.
                              - 9 -


     On their joint Federal income tax return for 1992,

petitioners reported income attributable to WIS in the amount of

$6,777 and a loss attributable to SPS in the amount of $40,560.

They also claimed a $129,972 deduction for “other losses”.     The

copy of petitioners’ return for 1992 that was submitted in

evidence does not disclose how the “other losses” were computed.

It appears, however, that this figure simply represents the

$136,748 deficit in shareholder’s equity of WIS reported for 1991

reduced by $6,777 of income earned by WIS in 1992.

     On their joint Federal income tax return for 1993,

petitioners reported a $36,464 loss attributable to SPS.

     The notice of deficiency explained respondent’s

determination regarding the losses claimed from WIS for 1991 and

1992 as follows:

     1.e. The deductions of $136,748.00 and $129,972.00
     shown on your returns for the respective taxable years
     ended December 31, 1991, and 1992, as “other losses”
     are not allowable because no basis in fact for such
     “other losses” exists (See explanation 1.f.). * * *

     1.f. S corporation losses are limited by section 1366
     of the Internal Revenue Code to the extent of your
     basis in stock in the S corporation and your adjusted
     basis of any indebtedness of the S corporation to you.
     Accordingly, it is determined that losses in the
     amounts of $136,748.00 and $129,972.00[4] from Williams
     Investigative and Security Services, Inc., are
     allowable only to the extent of $12,331.00 for the
     taxable year ended December 31, 1991. * * *




     4
       At trial and on brief, respondent’s counsel mistakenly
treated this amount as attributable to SPS.
                                - 10 -


Respondent computed the basis of petitioner’s investment in WIS

and the allowable loss for 1991 as follows:



Contributions or loans, 1990
            Personal credit card advances      $19,500
            Proceeds of personal loan           14,000
            Check drawn on own account          15,000
            Own funds                           29,000
          Basis in WIS, 1990                    77,500
          Loss claimed from WIS, 1990           65,169
          Basis in WIS, 1991                    12,331
          Allowable portion of loss
            claimed from WIS, 1991              12,331
          Basis in WIS, 1992                     - 0 -
          Allowable portion of loss
            claimed from WIS, 1992               - 0 -

     The record does not disclose why, after concluding that

there was “no basis in fact” for claiming a loss that represented

a deficit in shareholder’s equity, respondent nevertheless

allowed $12,331 of that loss.    At trial, respondent’s counsel

conceded that the pass-through loss from WIS for 1991 was

allowable in excess of $12,331 to the extent that petitioners

could document any additional adjusted basis of petitioner’s

investment in WIS.

     With respect to SPS losses of $40,560 and $36,464 claimed as

deductions on petitioners’ returns for 1992 and 1993, respondent

determined that $879 was allowable for 1992, and no amount was

allowable for 1993.   The notice of deficiency does not identify

the source of the $879 of stock or loan basis implied by

respondent’s determination for 1992, and respondent did not offer

clarification at any time in these proceedings.    At trial, the
                                 - 11 -


Court deemed respondent to have conceded any grounds for

disallowance of the deductions claimed for SPS losses other than

the limitation of the deductions to the extent of petitioner’s

stock and loan bases in SPS.

                        ULTIMATE FINDINGS OF FACT

       The combined total of the adjusted bases of petitioner’s

stock in WIS and of WIS’s indebtedness to petitioner was $32,846

for 1991, before taking account of pass-through losses for the

year, and zero for 1992.     The adjusted basis of petitioner’s

stock in SPS was $31,526 for 1992, before taking account of pass-

through losses for the year, and zero for 1993.     Petitioner

recognized additional income in the business reincorporation

transaction in the amount of $30,647 for 1992.

                                 OPINION

1.   Petitioner’s Basis in WIS

       In general an S corporation is not subject to Federal income

tax.    Sec. 1363(a).   The S corporation’s items of income, loss,

deduction, and credit for the taxable year are taken into account

currently by the shareholders on their individual returns.       Sec.

1366(a).    The aggregate amount of corporate losses and deductions

taken into account by a shareholder cannot exceed the sum of the

adjusted bases of the shareholder’s stock in the S corporation

and the indebtedness of the S corporation to the shareholder.

Sec. 1366(d)(1).
                                - 12 -


       The parties dispute the cumulative amount of petitioner’s

contributions and loans to WIS through the end of the taxable

year 1991.     In computing petitioner’s basis in WIS for 1991,

respondent gave petitioner credit for contributions and loans

during 1990 in the total amount of $77,500.     Petitioners bear the

burden of proving that petitioner’s investment in WIS exceeded

the amount determined by respondent.     Rule 142(a).

       The evidence indicates that in 1990, in addition to the

amounts allowed by respondent, petitioner contributed to WIS the

proceeds realized from the sale of personally owned vehicles to

PR&L.     Of the five vehicles sold, one, the Ford Aerostar, was

owned in part by WIS.     The record does not disclose the

respective ownership shares of WIS and petitioner in this

vehicle.     We estimate petitioner’s share as one-half;

accordingly, petitioner is entitled to have one-half of the

proceeds from the sale of this vehicle applied to his basis in

WIS.     See Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930); Rudd

v. Commissioner, 79 T.C. 225, 236-238 (1982).

        At trial, respondent’s counsel asserted that since the

income tax returns of WIS showed that the corporation had claimed

depreciation with respect to three of the five vehicles prior to

the sale, it was respondent’s position that WIS was the owner of

these three vehicles for tax purposes, regardless of who held

title.     However, WIS’s tax returns were not introduced in

evidence, and petitioner’s testimony contradicted counsel’s
                              - 13 -


assertions.   Accordingly, petitioner is entitled to an additional

$20,515 of basis in WIS for 1990, corresponding to the sum of the

sale prices of the two Toyota pickups, the Toyota Cressida, and

the Ford Bronco as well as one-half the sale price of the Ford

Aerostar.

     There is no persuasive evidence of any further investments

in WIS by petitioner before or during the years at issue.

Although petitioners did introduce personal credit card

statements reflecting cash advances in the total amount of $7,300

during 1990, there is no evidence in the record that any of these

advances were used on behalf of WIS rather than for petitioner’s

personal consumption.   For this reason respondent properly denied

petitioner basis credit for any portion of this amount.

Petitioners also introduced deposit slips evidencing three

deposits into WIS’s account at Palmetto Federal during 1990 in

the total amount of $2,250.   The deposit slips identify the

amounts as loans.   However, petitioners failed to prove that

petitioner was the source of the loans.

     Petitioners urge the Court, in the absence of direct

evidence, to infer that petitioner’s investment in WIS was

sufficient to deduct the full amount of the losses claimed on

their individual returns.   First, they argue that, although

petitioner possessed documentation necessary to substantiate the

amount of his basis in WIS, the revenue agents neglected to

request it.   Three months before trial, in August 1995, “since
                              - 14 -


the audit was over and no one had asked any questions, it was

ASSUMED that the files and records were no longer needed, they

were destroyed.”   If there is insufficient evidence in the trial

record to establish the amount of petitioner’s basis, they argue,

the perfunctory handling of the audit is to blame, and it would

be unfair to make petitioners bear the consequences.   “In a

criminal proceedings [sic] had the investigators failed to

complete the investigation * * * ruling in favor of the defendant

would be appropriate.”

     Petitioners misunderstand the nature of this proceeding.     A

petition for redetermination of a deficiency is a request for a

trial on a clean slate of all disputed issues relating to the

taxpayer’s liability for the taxable year.   The factual record

assembled at the audit stage as a basis for the Commissioner’s

determinations is generally irrelevant; unlike a criminal

proceeding in which the Government bears the burden of

persuasion, generally the Commissioner is not required to come

forward with any evidence.   Potts, Davis & Co. v. Commissioner,

431 F.2d 1222, 1225 (9th Cir. 1970), affg. T.C. Memo. 1968-257;

Greenberg’s Express, Inc. v. Commissioner, 62 T.C. 324, 327-328

(1974); Wisconsin Butter & Cheese Co. v. Commissioner, 10 B.T.A.

852, 854 (1928); Lyon v. Commissioner, 1 B.T.A. 378, 379-380

(1925).   Petitioners are not entitled to claim any more basis

than they have proven with the few pertinent documents they

retained and presented at trial.
                                - 15 -


     Petitioners’ second argument is that since petitioner was

the sole shareholder of WIS, any loss sustained by WIS

represented a loss of his investment.      “It only makes sense that

the losses had to come from somewhere and since TW was the only

stockholder the losses had to come out of his pockets in some

form”.   Considering the way in which petitioners computed these

losses, the fallacy in their argument is obvious.      The $136,748

loss they claimed on their 1991 return represented the excess of

WIS’s liabilities over its assets.       This is precisely the extent

to which the company’s losses came out of the pockets of its

creditors.   In all likelihood, most of these losses were borne by

third-party creditors.   There is no necessary relationship

between the extent of WIS’s insolvency in 1991 and the amount of

petitioner’s investment loss.

     Of the total proven investment of $98,015 as of the end of

1990, a deposit into WIS’s bank account in February 1990 in the

amount of $14,000 and a deposit into WIS’s account in August 1990

in the amount of $15,000 are designated on the deposit slips as

loans.   Consequently, we are satisfied that as of the end of 1990

the basis of WIS’s indebtedness to petitioner was $29,000 and the

basis of petitioner’s stock in WIS was $69,015.

2.   Effect of Business Reincorporation Transaction on
     Petitioner’s Basis in and Allowable Losses Respecting SPS

     Petitioners contend that petitioner acquired an initial

basis in SPS stock of $34,309.    This amount represents the sum of
                              - 16 -


$5,000 cash, $18,509 accounts receivable, and work in process

valued at $10,800, which they claim were transferred by WIS to

SPS at the time of SPS’s formation.    There is adequate evidence

in the record to confirm that WIS transferred $23,509 of cash and

accounts receivable to SPS in December 1991, and transferred an

additional $7,138 of accounts receivable at the beginning of

1992, for a total investment of $30,647.

     Petitioners claim the total value of the WIS contribution to

SPS as the basis of petitioner’s SPS stock, on the ground that

his wholly owned corporation was the source of all property

contributed and the contributions were made on his behalf.

Respondent, on the other hand, contends that petitioner acquired

no basis in SPS by reason of any transfers from WIS.   Although

respondent does not articulate the legal theory behind this

position, the reason respondent gives is that petitioner failed

to demonstrate that he had any remaining basis in WIS at the

times of the alleged transfers from WIS to SPS.

     Based largely on petitioner’s uncontroverted testimony, the

salient facts of the business reincorporation transaction may be

summarized as follows:   All the stock of SPS was issued in 1992

in exchange for property transferred by WIS during December 1991

and January 1992; petitioner’s business associates, Lewis and

Tate, received two-thirds of SPS’s stock; the transfers of

property by WIS to SPS were made on petitioner’s behalf and not

made in satisfaction of any liabilities of WIS to Lewis and Tate.
                             - 17 -


Petitioner granted Lewis and Tate an ownership interest in SPS as

an inducement to assist petitioner in managing the business.

     For tax purposes, the transaction structure implied by the

facts consists of three steps:    (1) The transfers of assets by

WIS to SPS in exchange for SPS stock; (2) the distribution by WIS

of SPS stock to petitioner;5 and (3) the transfer by petitioner

to Lewis and Tate of two-thirds of the SPS stock in consideration

of their agreement to render services to SPS.    Petitioner’s basis

in the one-third of the SPS stock he retained depends upon

whether he received the stock in a distribution governed by

section 301 or, pursuant to a reorganization, in a distribution

governed by section 354 or 355.    If steps 1 and 2 constituted a

reorganization, then petitioner’s basis in the SPS stock

distributed to him would be determined under section 358 by

reference to his basis in WIS stock.    If steps 1 and 2 did not

constitute a reorganization, then petitioner’s basis in the SPS

stock distributed to him would be equal to the fair market value

of the stock under section 301(d).    In either case, petitioner’s

disposition of two-thirds of the SPS stock in step 3 did not


     5
       Since the parties agree that both WIS and SPS were S
corporations for all taxable years at issue, there is no need to
consider what effect, if any, WIS’s transitory ownership of SPS
stock in the course of the business reincorporation transaction
would have had on each corporation’s eligibility for S
corporation status. See secs. 1361(b)(1)(B), (2)(A), (c)(6),
1362(d)(2), (f); see also Haley Bros. Constr. Corp. v.
Commissioner, 87 T.C. 498, 516-517 (1986); Rev. Rul. 72-320,
1972-1 C.B. 270.
                              - 18 -


reduce his aggregate stock basis, since the basis of the shares

he transferred is added to the basis of the shares he retained,

in accordance with the treatment of his transfer of the shares as

a contribution to the capital of SPS.6

     We are satisfied that the business reincorporation

transaction did not qualify as a reorganization for income tax

purposes.   Since WIS did not transfer substantially all of its

assets to SPS and distribute all of its remaining properties, the

transaction does not satisfy the requirements of a C

reorganization or an acquisitive D or G reorganization.   Secs.

368(a)(1)(C), (D), (G), (2)(G), 354(b).   Since WIS ceased active

business following the formation of SPS, the requirements of a

divisive D or G reorganization are not satisfied.   Secs. 368(a)

(1)(D), (G), 355(b)(1).   As a result, petitioner did not receive

the stock of SPS in an exchange to which either section 354 or


     6
       If a shareholder of a corporation transfers stock to a
corporate employee in consideration of the performance of
services for the corporation, the shareholder is treated as
having contributed the stock to the capital of the corporation
and the corporation is treated as having transferred the stock to
the employee immediately thereafter. Tilford v. Commissioner,
705 F.2d 828 (6th Cir. 1983), revg. 75 T.C. 134 (1980); Estate of
Foster v. Commissioner, 9 T.C. 930, 936 (1947); Webb v. United
States, 560 F. Supp. 150, 155, 157 (S.D. Miss. 1982); sec. 1.83-
6(d)(1), Income Tax Regs.; see Commissioner v. Fink, 483 U.S. 89,
98 n.14 (1987); Frantz v. Commissioner, 83 T.C. 162, 174-181
(1984), affd. 784 F.2d 119 (2d Cir. 1986). The shareholder’s
basis in the transferred shares is reallocated to the shares he
retains. Estate of Foster v. Commissioner, supra; sec.
1016(a)(1); sec. 1.263(a)-2(f), Income Tax Regs. Cf. Rev. Rul.
80-76, 1980-1 C.B. 15.
                              - 19 -


355 applies, and therefore he did not take an exchanged basis in

that stock pursuant to section 358.    Sec. 358(a)(1), (c); see

sec. 7701(a)(44).   It therefore follows that petitioner received

the SPS stock in a distribution governed by section 301, at a

basis equal to the fair market value of the stock.    Sec. 301(d).



     On the limited record before us, we conclude that the fair

market value of SPS’s issued capital stock was equal to the value

of the net assets transferred to SPS in the exchange, viz,

$30,647.   See United States v. Davis, 370 U.S. 65, 72 (1962);

Philadelphia Park Amusement Co. v. United States, 130 Ct. Cl.

166, 126 F. Supp. 184, 189 (1954).     Although the most important

asset of SPS would have been the “human capital” that petitioner

and his associates brought to the business, and although the

inauspicious circumstances under which SPS was organized might

well have raised doubts about its ultimate success, the effect of

these factors upon the value of the corporation’s stock cannot be

determined from the record.   Therefore, petitioner’s initial

basis in the portion of the SPS stock he retained was $30,647.7




     7
       We observe that the tax results to petitioner of our
determination of the value of SPS stock received by him would be
the same if we determined that value to be zero or some other
figure. This is because the amount includable in petitioner’s
income as a result of his receipt of the SPS stock would in all
likelihood exactly equal his additional basis in the stock for
the purpose of computing his share of the allowable loss incurred
by SPS for 1992. See text infra pp. 20-21.
                               - 20 -


     In the notice of deficiency respondent allowed petitioner a

loss attributable to SPS in the amount of $879 for 1992.    This

determination necessarily implies that petitioner acquired at

least $879 of basis in his stock of or loans to SPS during that

year.   Neither the record nor the arguments on brief disclose how

this amount was determined.    However, in view of the position

taken by respondent during these proceedings that petitioner

acquired no basis in SPS as a result of transfers of property

from WIS pursuant to the business reincorporation transaction, we

construe the determination in the notice of deficiency as a

concession that petitioner made an additional investment of $879

at some time during 1992 in an unrelated transaction.

Consequently, by the close of 1992, petitioner’s combined basis

in SPS stock and debt was $31,526, before taking account of pass-

through losses for the year.

     The transfer by WIS of cash and accounts receivable to SPS

during December 1991 and January 1992 in exchange for all of

SPS’s stock constituted a transaction described in section 351.

Sec. 351(a), (c).   Neither corporation recognized gain on the

exchange, and WIS took a basis in the SPS stock equal to the sum

of its bases in the cash and accounts receivable.    Sec.

358(a)(1).   As a cash method taxpayer, WIS had no basis in the

unrealized receivables.   Consequently, its exchanged basis in the

SPS stock preserved the unrealized gain in respect of the

receivables for later taxation.    On the distribution of the SPS
                                  - 21 -


stock to petitioner upon its receipt in 1992, WIS recognized this

built-in gain in full.      Sec. 311(b).    Since the character of the

gain is ordinary, it is taken into account in determining WIS’s

nonseparately computed loss for 1992.        Secs. 1221(4), 1366(a).

     The amount of WIS’s nonseparately computed loss for 1991

greatly exceeded petitioner’s basis in WIS stock.            As a result,

on the distribution of the SPS stock to him at the beginning of

1992, petitioner had no remaining basis in WIS stock and

recognized capital gain to the full extent of the amount of the

distribution.       Secs. 1367(a)(2), 1368(b)(2).     The amount of the

distribution, and the gain recognized to petitioner, was the fair

market value of the SPS stock distributed, viz, $30,647.           Secs.

301(b)(1), 1371(a)(1).      This income fully offsets the pass-

through losses from SPS to which petitioner is entitled for 1992

by reason of the investment made in SPS pursuant to the business

reincorporation transaction.

     Based on the foregoing analysis, we redetermine the

adjustments to petitioners’ income attributable to WIS and SPS as

follows:

Taxable Year 1990

Adjustments Attributable to WIS

  Total of bases in WIS stock and debt
    (investment basis)                             $98,015
  WIS loss per return                               65,169
  Pass-through loss allowed per notice of
     deficiency                                     65,169
  Investment basis after pass-through adjustment    32,846
                                          - 22 -


Taxable Year 1991

Adjustments Attributable to WIS

     Investment basis                                  32,846
     WIS income per return                              1,541
     WIS “other losses” per return                    136,748
     WIS nonseparately computed loss
       (as conceded by respondent)                    135,207
     Pass-through loss allowable                       32,846
     Pass-through loss suspended                      102,361
     Investment basis after pass-through adjustment     - 0 -


                   - - - - - -
     Loss allowable                                   32,846
     Loss allowed per notice of deficiency            12,331
     Reduction in taxable income                      20,515

Taxable Year 1992

1.     Adjustments Attributable to WIS

     Investment basis                                   - 0 -
     WIS income per return                              6,777
     WIS gain on distribution                          25,647
     WIS suspended loss treated as incurred in 1992   102,361
     WIS nonseparately computed loss                   69,937
     Pass-through loss allowable                        - 0 -
     Pass-through loss suspended                       69,937
     Investment basis after pass-through adjustment     - 0 -
     Petitioner’s gain on excess distribution          30,647

2.     Adjustments Attributable to SPS

     Investment basis                                 31,526
     Allocable share of SPS loss per return           40,560
     Allocable share of SPS nonseparately
       computed loss (as conceded by respondent)      40,560
     Pass-through loss allowable (as conceded by
       respondent)                                    31,526
     Pass-through loss suspended                       9,034
     Investment basis after pass-through adjustment    - 0 -

                  -   -   -   -   -   -

     Net loss allowable (31,526- 30,647)                 879
     Loss allowed per notice of deficiency               879
     Additional loss allowable                         - 0 -
                              - 23 -


Taxable Year 1993

     Since the foregoing computations confirm respondent’s

determination that petitioner had no investment basis remaining

in SPS after the pass-through adjustments for 1992, we sustain

respondent’s disallowance of the $36,464 deduction claimed for

petitioner’s share of losses attributable to SPS for 1993.

3.   Conclusion

     We have concluded that petitioners’ taxable income for 1991

was $20,515 lower than the amount determined by respondent.

Petitioners are entitled to the resulting reduction of the

deficiency for that year, to be determined in a Rule 155

computation.

     Petitioners have not persuaded us that the deficiency

determinations for 1992 and 1993 are erroneous.   Neither party

provided a coherent analysis of the tax consequences of the

business reincorporation transaction:   Respondent’s position

seems to be either that there was in fact no such transaction or

that it had no effect on petitioners’ tax liability; petitioners

contended that the transaction created basis in petitioner’s SPS

stock, but did not acknowledge the tax cost of acquiring that

basis.   Consequently, in sustaining respondent’s determinations

for 1992 and 1993, we have necessarily relied upon a legal

analysis that was neither pleaded nor argued by the parties.

     A deficiency determination may be sustained upon any legal

ground that supports it, even though the grounds relied upon by
                             - 24 -


the Commissioner may have been different or unsound.       Blansett v.

United States, 283 F.2d 474, 478 (8th Cir. 1960); Smith v.

Commissioner, 56 T.C. 263, 291 n.17 (1971); Wilkes-Barre Carriage

Co. v. Commissioner, 39 T.C. 839, 845-846 (1963), affd. 332 F.2d

421 (2d Cir. 1964).

     It is the Court’s right and obligation to decide the
     case upon what it considers to be the correct
     application of the law, based upon the record
     presented, whether the parties have properly pleaded
     the controlling issues or not. * * * if the Court
     feels that a full and fair opportunity to present the
     facts has been given, and the Court feels that no
     further briefing on the law is necessary, the Court can
     go forward and decide the case on the record presented.
     [Barnette v. Commissioner, T.C. Memo. 1992-595, affd.
     without published opinion sub nom. Allied Management
     Corp. v. Commissioner, 41 F.3d 667 (11th Cir. 1994).]

     There is no reason to believe that petitioners have been

prejudiced by our resolution of the case.    Considering

petitioners’ evidentiary showing at trial and arguments on brief,

we are satisfied that they had sufficient opportunity to prove

the relevant facts and would not have presented their case any

differently, even if they had been fully and correctly advised by

the notice of deficiency or respondent’s pleadings of the

intricate and interrelated provisions of the Code that govern the

tax consequences of the business reincorporation transaction.

     To reflect the foregoing,


                                            Decision will be entered

                                      under Rule 155.
