                            T.C. Memo. 1996-199



                          UNITED STATES TAX COURT



   JOHN T. BARRETT, JR. AND JANE W. A. BARRETT, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



       Docket No. 12895-93.              Filed April 24, 1996.



       William S. Barrett, for petitioners.

       Carmino J. Santaniello, Jr., for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


       WELLS, Judge:     Respondent determined deficiencies and

penalties in petitioners’ Federal income taxes as follows:

Year        Deficiency        Penalty Pursuant to Section 6662(a)

1989         $3,800                        $760
1990         10,080                       2,016
                                 - 2 -

Unless otherwise indicated, all section references are to the

Internal Revenue Code (Code) in effect for the taxable years in

issue, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

     The issues we must decide in the instant case are:    (1)

Whether petitioners, for taxable year 1989, must recognize a

capital gain pursuant to the installment sale provisions of

section 453 on petitioner John T. Barrett, Jr.’s (petitioner)

disposition of shares (shares) of stock in Drexel Burnham Lambert

Group, Inc. (Drexel); (2) whether petitioners are entitled to a

bad debt deduction for taxable year 1990 for the alleged

worthlessness of a certain note issued by Drexel to petitioner as

partial consideration for the purchase of the shares; and (3)

whether petitioners are liable for the accuracy-related penalty

pursuant to section 6662(a).

                          FINDINGS OF FACT

     Some of the facts and certain exhibits have been stipulated

for trial pursuant to Rule 91.    The parties’ stipulations are

incorporated in this Memorandum Opinion by reference and are

found accordingly except as noted below.

General Background

     Petitioners resided in Providence, Rhode Island, when they

filed their petition in the instant case.    Petitioners reported

their income and deductions for the years in issue on the basis

of the cash receipts and disbursements method of accounting.
                                - 3 -

     Beginning in January 1985 and until May 26, 1989, petitioner

was employed by Drexel as a stockbroker in its retail securities

operation.   During petitioner’s employment, Drexel and its

subsidiaries were engaged in the business of providing

investment, banking, securities brokerage, trading, merchant

banking, and other financial services.    During his employment

with Drexel, petitioner was primarily engaged in the trading of

corporate bonds for Drexel’s individual and corporate clients and

was not involved in the high-yield, or “junk bond” underwriting

facet of Drexel’s business.

Petitioner’s Acquisition and Sale of the Shares

     During 1985 and 1986, Drexel privately sold its common stock

to certain employees and Drexel insiders.    By letter dated April

25, 1985, Drexel offered to sell to petitioner, as part of its

employee stock purchase plan, 700 shares of its common stock at

the December 31, 1984, book value of $67.04 per share.    On that

date, petitioner acquired the 700 shares for a total purchase

price of $46,928.   By letter dated April 30, 1986, Drexel offered

to sell to petitioner an additional 600 shares of its common

stock at the fixed price of $115.96 per share.    On that date,

petitioner acquired the additional 600 shares for a total

purchase price of $69,576.    On two occasions after April 1986,

petitioner’s 1,300 shares of Drexel stock split 2-for-1, giving
                                - 4 -

petitioner a total of 5,200 shares.1    Petitioner’s original cost

basis in the shares was $116,504.

     Petitioner never physically possessed the shares, which were

held in “street” name in petitioner’s security account with

Drexel.   Petitioner’s shares were not registered pursuant to the

Securities Act of 1933, and there was no market on which they

could be traded.   In accordance with the “buy-back provision”

contained in Drexel’s Restated Certificate of Incorporation

(certificate), the shares were nontransferable and generally

could only be sold to Drexel upon an employee’s termination from

Drexel.   Pursuant to the certificate, the price Drexel would pay

for the shares was set at their aggregate net book value.

     Pursuant to the recommendation of a consultant that its

retail securities operation be sold, Drexel announced on or about

April 18, 1989, that it was disposing of the operation, of which

petitioner was an employee, to Smith Barney Harris Upham, Inc.,

and the sale occurred on May 19, 1989.    As a consequence of the

sale, petitioner’s employment with Drexel was terminated, which

precipitated the mandatory redemption of the shares pursuant to

the terms of the certificate.   Drexel notified petitioner by

letter dated August 11, 1989, that pursuant to the “buy-back



1

     We accordingly do not accept the suggestion in the parties'
stipulation that petitioner owned only 1,300 shares of Drexel
stock throughout the period that he held the shares. Cal-Maine
Foods, Inc. v. Commissioner, 93 T.C. 181, 185 (1989).
                               - 5 -

provision” in the certificate, it intended to purchase the shares

because of the cessation of his employment with Drexel.    The per-

share purchase price was set at the adjusted book value on May

26, 1989, which was $45.06.   Pursuant to the terms of the

certificate, petitioner was entitled to contest Drexel’s

determination of the book value of the shares.

     In August 1989 (effective May 26, 1989), Drexel redeemed the

shares in exchange for a cash payment of $67,950 and a

subordinated note (note) dated May 26, 1989, in the principal

amount of $166,361.   The note was nonnegotiable and could not be

encumbered or disposed of without the consent of Drexel.     The

note provided for two principal payments:   The first, in the

amount of $142,930, was payable on November 26, 1990, and the

second, in the amount of $23,431, was payable on May 24, 1994.

Interest accrued on the unpaid principal balance and was payable

semiannually on June and December 15.   On August 23 and December

19, 1989, Drexel paid petitioner interest on the principal amount

of the note pursuant to its terms.

Events Preceding the Bankruptcy of Drexel

     In November 1986, the Securities Exchange Commission (SEC)

and the U.S. Department of Justice (Justice Department) commenced

investigations (investigations) of alleged violations of the

Securities Exchange Act by Ivan Boesky and Drexel insiders and/or

employees.
                               - 6 -

     As a result of the investigations, in December 1988, the SEC

commenced a civil action against Drexel, members of its High

Yield Bond Department, and other related persons alleging that

those persons engaged in fraudulent conduct with respect to

various securities transactions.   Subsequently, the Justice

Department informed Drexel that it intended to seek an indictment

against Drexel unless Drexel agreed to settle the proposed

charges.   During that time, Drexel made frequent disclosures to

its employees regarding the potential criminal charges, denying

that it was guilty of any wrongdoing.

     In December 1988, as a result of the investigations and

potential indictment, Drexel agreed to pay $650 million in fines

and restitution, $350 million of which was to provide a civil

disgorgement fund to be distributed in accordance with a court-

approved plan.

     In January 1989, Drexel entered into a formal plea agreement

with the Justice Department, agreeing to plead guilty to six

criminal charges.   Thereafter, during April 1989, Michael Milken,

head of Drexel’s High Yield Bond Department, was indicted on 98

counts of securities fraud and related charges.   Mr. Milken

resigned all positions that he held with Drexel on June 15, 1989.

In September 1989, Drexel paid $500 million of the fines and

restitution.

     The investigations and related negative publicity, market

developments, and the cost associated with the sale of its retail
                                - 7 -

securities operation had a negative effect on Drexel’s financial

position during 1989.    Drexel, however, continued to engage in

business throughout 1989 and into 1990.    Drexel responded to the

difficulties facing it by (1) increasing efforts to reduce its

securities positions, especially in high-yield securities and

bridge loans, (2) pursuing alternative sources of financing, and

(3) developing and considering different strategic options for

its lines of business.    Drexel developed a 1990 business plan

that projected significant cuts in operating costs, which were in

addition to a large reduction of expenses in 1989 from 1988

levels.    Drexel also completed a series of management changes

that were designed to provide new leadership in key business

areas.    Despite the adverse developments affecting Drexel, it

projected a profit for 1990.

     During January 1990, Drexel’s cash flow from operations was

depressed, and Drexel experienced continuing difficulties in

financing its operations, relying upon the assets of subsidiaries

to fund shortfalls.    Drexel also sought new sources of financing

to replace its commercial paper, which was unattractive to buyers

because of a lowered rating.    Although Drexel believed that it

could utilize the excess net regulatory capital of its

subsidiaries to finance its operations, it was informed by the

SEC on February 7, 1990, that it could not borrow any of the

subsidiaries' funds without prior SEC approval.    Although the SEC

agreed to permit Drexel to borrow funds from a subsidiary to pay
                              - 8 -

off commercial paper maturing on February 12, 1990, word of

Drexel’s liquidity problem spread through the market, and some

entities refused to trade with Drexel.

Drexel’s Bankruptcy Proceedings

     On February 13, 1990, Drexel was advised by the SEC and the

Federal Reserve Bank of New York to file a petition pursuant to

Chapter ll of the Bankruptcy Code (chapter 11).    Drexel’s board

of directors agreed to commence a chapter 11 case and, on that

date, Drexel filed a voluntary petition for relief pursuant to

chapter 11 in the U.S. Bankruptcy Court for the Southern District

of New York (bankruptcy court).

     Beginning on the date of the bankruptcy filing, Drexel began

to wind down certain of its affairs and operations and

significantly reduced its operating expenses.    After the petition

was filed, Drexel began to consider alternatives for the ultimate

resolution of its chapter 11 case.    Financial projections for

Drexel and its subsidiaries were prepared, including sales values

for assets and an analysis of liabilities.    The problems

presented by (1) growing litigation against Drexel, including

many suits pursuant to the securities laws, (2) the need to

resolve that litigation, (3) potential claims against Drexel by

the Internal Revenue Service (IRS), and (4) the difficulty of

quickly disposing of many of Drexel’s assets at amounts near

their book value weighed against liquidation of Drexel and

indicated the need for a reorganization of Drexel and an entity
                                - 9 -

to manage Drexel’s assets.    During April 1990, a committee of

Drexel’s creditors began an examination of Drexel with a view to

establishing bases for possible asset and claim recoveries.

     The bankruptcy court set a deadline of November 15, 1990,

for filing proofs of claim against Drexel, but allowed the IRS

until February 13, 1991, to file its proof of claim on account of

all Federal income and other taxes allegedly owed by Drexel and

its subsidiaries.    During 1991, a settlement agreement was

reached between Drexel, its subsidiaries, and the IRS with

respect to the IRS' Federal tax claims.    Also during 1991, Drexel

reached a settlement with respect to the securities litigation

claims made against it.

     Petitioner filed a timely proof of claim against Drexel’s

bankruptcy estate.    Petitioner’s claim was based on, and was

equal to, the full face amount of the note.    Petitioner and other

former Drexel employees who had received notes in redemption of

Drexel shares were represented in the bankruptcy proceeding by a

committee known as the Equity Committee.    During 1990, petitioner

was informed by the Equity Committee that Drexel might have

committed technical violations of the Employee Retirement Income

Security Act (ERISA) with respect to the shares and the note.     A

claim pursuant to ERISA was made against Drexel’s bankruptcy

estate in connection with the subordinated notes held by

petitioner and approximately 1,000 others, and, after

negotiations, the claims filed by petitioner and other former
                              - 10 -

Drexel employees similarly situated were treated as ERISA claims.

As a result, the priority of the claims of petitioner and other

former Drexel employees against Drexel’s bankruptcy estate was

elevated.

     Drexel’s plan of reorganization (plan) assigned petitioner

and other former Drexel employees to DBL Group Class 6B.

Pursuant to the plan, members of that class were to receive

marketable securities known as certificates of beneficial

interest (CBI’s) in the DBL Liquidating Trust (trust) and limited

partnership interests known as DPI-A’s.   The distributions to be

made to members of Group Class 6B were based on the face amount

of each noteholder’s note.   In exchange for the distributions,

members of the class were to release their ERISA claims.

Petitioner voted to approve the plan.

     On April 30, 1992, the plan was confirmed by the bankruptcy

court.   Pursuant to the plan, on that date, petitioner received

certain CBI’s and DPI-A’s, all of which were valued at $8,455.54.

On September 30, 1993, petitioner received certain additional

CBI’s and a DPI-A, all of which were valued at $2,089.69.

Pursuant to a closing agreement between Drexel and the IRS, the

distributions were treated as wage income for withholding and

information reporting purposes.   A letter dated August 29, 1992,

sent to petitioner by the trust stated:

          Pursuant to the order of the Bankruptcy Court
     confirming the plan, holders of securities issued under
     the plan are required to take positions on their tax
                               - 11 -

     returns consistent with the tax information provided by
     the Trust and the other plan entities in accordance
     with the Closing Agreement between Drexel and the
     Internal Revenue Service.

Petitioner was issued Forms W-2 reporting the 1992 and 1993

distributions as wages.   Petitioners reported the distributions

as ordinary income on, respectively, their 1992 and 1993 Federal

income tax returns.

Petitioners’ 1989 and 1990 Federal Income Tax Returns

     Petitioners’ 1989 and 1990 Federal income tax returns were

prepared by a return preparer.

     On their 1989 return, petitioners reported a long-term

capital gain with respect to the sale of the shares in the amount

of $22,950, claiming an amount realized on the sale of $67,950

and a basis of $45,000.   Petitioners did not mention the note on

the return.   Because petitioner did not have adequate records

with respect to the shares, he incorrectly estimated the basis

claimed on the return.    Petitioners did not elect to report the

sale of the shares on the installment method on their 1989

return.

     On their 1990 Federal income tax return, petitioners

reported a long-term capital loss with respect to the note in the

amount of $29,945, claiming an amount realized of $166,361 and a

basis of $196,306.

     On April 14, 1993, petitioners mailed to the IRS an amended

1989 Federal income tax return reporting a capital loss with
                                - 12 -

respect to the sale of the shares by increasing the basis claimed

for the shares from $45,000 to $116,528.   Petitioners

subsequently filed an amendment to the amended return claiming a

basis of $116,504 for the shares.

                                OPINION

     The first issue we must decide is whether petitioners, for

taxable year 1989, must recognize a capital gain2 pursuant to the

installment sale provisions of section 453 on the disposition of

the shares.   As a general matter, an installment sale is a

disposition of property where one payment is to be received after

the close of the year in which the disposition occurs.    Sec.

453(b)(1).3   Income from an installment sale is to be taken into

account using the installment method, unless a taxpayer elects

not to have the method apply.    Sec. 453(a), (d).   The installment

method requires gain from the disposition to be recognized for

payments received in a taxable year in the same proportion that

the gross profit (realized or to be realized when payment is

completed) bears to the total contract price.    Sec. 453(c).



2

     Respondent does not contest petitioners' characterization of
their gain as capital gain.
3

     Sec. 453(b)(1) provides:

          (1) In general.--The term “installment sale” means a
     disposition of property where at least 1 payment is to
     be received after the close of the taxable year in
     which the disposition occurs.
                              - 13 -

Generally, the election not to report a disposition of property

on the installment method is made by the due date of the

taxpayer’s return for the year in which the disposition occurs

and in the manner prescribed by the appropriate tax forms for

that return.   Sec. 15A.453-1(d)(3), Temporary Income Tax Regs.,

46 Fed. Reg. 10718 (Feb. 4, 1981); see also Bolton v.

Commissioner, 92 T.C. 303, 305-306 (1989).

     Respondent contends that petitioner’s disposition of the

shares falls squarely within the definition of an installment

sale, and, therefore, petitioners must report gain pursuant to

the installment method on the disposition of the shares for the

year of the sale, to wit, 1989.   Petitioners contend that the

sale was not an installment sale because no payment was to be

received after the close of the year in which the disposition of

the shares occurred, as required by section 453(b)(1).

Petitioners contend that the note was not a “payment” as that

term is used in section 453(b)(1), because section 453(f)(3)4

excludes from the definition of “payment” the receipt of an

evidence of indebtedness of the person acquiring the property

unless the purchaser’s evidence of indebtedness is payable on

4

     Sec. 453(f)(3) states:

          (3) Payment.--Except as provided in paragraph (4),
     the term “payment” does not include the receipt of
     evidences of indebtedness of the person acquiring the
     property (whether or not payment of such indebtedness
     is guaranteed by another person).
                                - 14 -

demand or is issued by, inter alia, a corporation and is readily

tradable, sec. 453(f)(4),5 and the note was neither payable on

demand nor readily tradable.    Petitioners argue that the only

“payment” received with respect to the shares was the cash that

they received from Drexel during 1989.    Accordingly, petitioners

argue that they were not required to elect out6 of the

installment method in order to preclude its application to

petitioner’s disposition of the shares.

     Although petitioners are correct in their contention that

the note was not a “payment” within the meaning of the relevant

sections because it was neither payable on demand nor readily

tradable, petitioners simply misinterpret the Code when they

conclude that the transaction was not an installment sale because

the note was not a “payment”.    By excluding the receipt of a

nondemand, nonreadily tradable evidence of indebtedness from the

definition of “payment”, the installment sale provisions treat



5

     Sec. 453(f)(4) states:

          (4) Purchaser evidences of indebtedness payable on
     demand or readily tradable.--Receipt of a bond or other
     evidence of indebtedness which--
             (A) is payable on demand, or
             (B) is issued by a corporation or a
          government or political subdivision thereof and is
          readily tradable,
     shall be treated as receipt of payment.
6

     Petitioners do not argue that they elected out of the
installment method as provided by sec. 453(d).
                               - 15 -

the actual payments made in satisfaction of such an obligation as

“payments” when made.   Consequently, because the note provided

for payments to be made after the close of 1989, the taxable year

during which the disposition of the shares occurred, the

transaction is an “installment sale” within the meaning of

section 453(b)(1).

     Petitioners argue that the note became worthless during 1989

and for that reason the installment sale provisions of section

453 do not apply.    Petitioners, however, have not shown that the

note became worthless during 1989.7

     The worthlessness of a debt is a question of fact.     Crown v.

Commissioner, 77 T.C. 582, 598 (1981).    A debt is considered

worthless when there are reasonable grounds for abandoning any

hope that the debt will be paid in the future.    Estate of Mann v.

United States, 731 F.2d 267, 276 (5th Cir. 1984).    Although a

taxpayer is not required to be an “incorrigible optimist” with

respect to the collection of debts owed to him, United States v.

S.S. White Dental Manufacturing Co., 274 U.S. 398, 403 (1927),

neither must a taxpayer be a “stygian pessimist”, Riss v.



7

     We also are not persuaded by petitioners' contention that
requiring them to report the sale of the shares on the
installment method causes them to recognize income for taxable
year 1989 when the sale actually produced a loss. As we discuss
below, to the extent they suffer an allowable loss, petitioners
may avail themselves of the provisions of sec. 166 in the year
that the note becomes worthless. American Offshore, Inc. v.
Commissioner, 97 T.C. 579, 592-597 (1991).
                              - 16 -

Commissioner, 478 F.2d 1160, 1166 (8th Cir. 1973), affg. on this

issue and remanding on another issue 56 T.C. 388 (1971).    “The

decision must be made in the exercise of sound business judgment,

based upon as complete information as is reasonably obtainable.”

Andrew v. Commissioner, 54 T.C. 239, 248 (1970) (citing Blair v.

Commissioner, 91 F.2d 992, 994 (2d Cir. 1937)).   Generally, the

taxpayer must show one or more “identifiable events” that

demonstrate the worthlessness of the debt.   American Offshore,

Inc. v. Commissioner, 97 T.C. 579, 593 (1991).

     If the debtor is solvent in the sense that its assets exceed

its liabilities, ordinarily no bad debt deduction is allowable to

the creditor.   Perry v. Commissioner, 22 T.C. 968, 973-975

(1954); Bennett v. Commissioner, 20 B.T.A. 171, 173-174 (1930).

Although evidence demonstrating that the debtor is insolvent

points to the conclusion that the debt is worthless, see Gorman

Lumber Sales Co. v. Commissioner, 12 T.C. 1184, 1192 (1949),

insolvency is not conclusive evidence that a debt is worthless.

Cimarron Trust Estate v. Commissioner, 59 T.C. 195, 200 (1972).

The fact that the credit of a debtor is not good, and that it

does not have sufficient cash or other quick assets to pay its

debts immediately, does not necessarily make a debt worthless.

Bennett v. Commissioner, supra at 173-174; Ernst v. Commissioner,

18 B.T.A. 928, 929 (1930).   Even if a debtor is shown to be

insolvent, if it is still actively engaged in business, its

insolvency does not necessarily establish the worthlessness of
                                - 17 -

the debt.     Trinco Indus., Inc. v. Commissioner, 22 T.C. 959, 965

(1954).     Consideration must be given to the debtor’s potential

for improving its financial position.     Dustin v. Commissioner, 53

T.C. 491, 502 (1969), affd. 467 F.2d 47 (9th Cir. 1972).

     The mere belief of the creditor that the debtor is in bad

financial condition is not adequate evidence that the debt is

worthless.     Bryan v. Commissioner, 32 T.C. 104, 131 (1959), affd.

in part and remanded on another issue 281 F.2d 238 (4th Cir.

1960).    Moreover, the subjective, good faith opinion of the

taxpayer that the debt is uncollectible, standing alone, is not

sufficient evidence that the debt is worthless.     Fox v.

Commissioner, 50 T.C. 813, 822 (1968), affd. per curiam by an

unreported order (9th Cir. March 9, 1970).

     Applying the foregoing cases, we hold that the record in the

instant case fails to establish that the note was worthless

during 1989.     Several considerations support our conclusion.   We

begin with the fact that Drexel continued to engage in business

throughout 1989 and into 1990.     Petitioner admitted at trial

that, based on its continued operations, Drexel seemed viable as

a going concern.     Drexel’s continued business operations through

and beyond 1989, even though it may have been faltering, indicate

that the note did not become worthless during 1989.     Riss v.

Commissioner, 56 T.C. at 408.     Where a financially troubled

company remains actively engaged in business, the potential

ability to pay some of its debts may exist.     Pierson v.
                               - 18 -

Commissioner, 27 T.C. 330, 339 (1956), affd. 253 F.2d 928 (3d

Cir. 1958).

     We also consider the fact that Drexel was current on its

interest obligations throughout 1989.     On August 23 and December

19, 1989, Drexel made interest payments on the note, a factor

that weighs against worthlessness.      Cole v. Commissioner, 871

F.2d 64, 67 (7th Cir. 1989), affg. T.C. Memo. 1987-228.

     Additionally, we consider the fact that the record is devoid

of any direct evidence of the worthlessness of the note.

Although petitioner testified at trial that he observed certain

events which he believed “could have impaired Drexel’s capital or

its ability to do business”, such as the resignation of Michael

Milken during June 1989, Drexel’s payment of $500 million in

fines and restitution during September 1989, and a 216-point drop

in the Dow Jones Industrial Average on October 13, 1989,

petitioner’s negative perceptions of Drexel’s condition, without

more, are inadequate to support a finding of worthlessness.         Fox

v. Commissioner, supra at 822.    Moreover, general unfavorable

circumstances have less to do with establishing worthlessness

than specific facts regarding the debtor’s assets and the amount

and validity of claims against it.      Dallmeyer v. Commissioner, 14

T.C. 1282, 1292-1293 (1950).

     Petitioners argue that Drexel itself viewed the note as

worthless.    Petitioners rely on the fact that the notation “N/A”

appears beneath the words “Market Value” in monthly statements
                              - 19 -

dated September and December 29, 1989, as evidence of Drexel’s

affirmation that the note was worthless.    Respondent contends

that the notation does not establish worthlessness because there

is no conclusive evidence of its meaning.    Respondent posits that

the notation might simply have meant that the market value was

“not available” because the note was not marketable.    We agree.

Petitioners did not offer the testimony of a Drexel employee or

other credible evidence as to the meaning of the notation.

Consequently, we do not find the notation to be persuasive

evidence that the note was worthless.

     Petitioners also contend that Drexel's insolvency during

1989 is shown by the allegations of Drexel’s insolvency made in a

complaint filed in a 1992 defendant class action by Drexel

against its employees for recovery of alleged preferential and/or

fraudulent transfers.   However, that complaint was admitted into

evidence, subject to respondent’s objection to its relevance,

solely for the purpose of showing that the complaint was filed,

not for the purpose of allowing the hearsay statements made in

the complaint to be admitted for the truth of the matters

asserted in the complaint.   Consequently, we do not find that it

has any bearing on the question of the worthlessness of the

note.8




8

     We accordingly sustain respondent’s relevance objection.
                              - 20 -

     Petitioners’ brief makes the following statement about

Drexel’s financial condition on December 31, 1989:   “Drexel’s

true financial condition as of December 31 was -- and still is --

anyone’s guess.”   However, worthlessness is determined on the

basis of objective standards, Dustin v. Commissioner, 53 T.C. at

501, and a guess as to the debtor’s financial condition does not

establish reasonable grounds for abandoning any hope that the

debt will be paid in the future.   See Estate of Mann v. United

States, 731 F.2d at 276.   Petitioners cannot satisfy their burden

of proof by simply showing that petitioner had a good faith

subjective belief that the note was worthless.   Fox v.

Commissioner, supra at 822.   We accordingly sustain respondent’s

determination for petitioners’ 1989 taxable year.9

     Petitioners alternatively argue that the note became

worthless during 1990 and that they are therefore entitled to a

bad debt deduction pursuant to section 166 for that year.

Petitioners argue that Drexel’s filing for protection pursuant to

chapter 11 on February 13, 1990, was the “single identifiable

event” upon which the determination of the worthlessness of the

note should be made.   Petitioners argue that the size of the



9

     Respondent determined the 1989 deficiency in petitioners’
Federal income tax using a basis for the shares of $116,528,
which was also the amount claimed in petitioners’ initial amended
return for 1989. Respondent, however, does not seek to modify
that determination to take account of the basis of $116,504 for
the shares as reflected in a later amendment to the return.
                              - 21 -

claims made against Drexel in relation to its assets shows that

there was no hope that the note would be paid.

     As respondent points out, however, a debtor’s petition in

bankruptcy is not conclusive of a debt’s total worthlessness.

Estate of Mann v. United States, supra at 276; Dallmeyer v.

Commissioner, supra at 1292-1293; sec. 1.166-2(c), Income Tax

Regs.   The debtor may have assets remaining that will permit some

amount to be paid to creditors.   Patten & Davies Lumber Co. v.

Commissioner, 45 F.2d 556, 558 (9th Cir. 1930), revg. a

Memorandum Opinion of this Court dated July 29, 1929.    The

question whether any of Drexel’s assets would be available to pay

the note depends upon the value of Drexel’s assets, the amount

and validity of secured and priority claims filed, and the cost

of the bankruptcy administration, and not solely on Drexel’s

financial history which ultimately led to its bankruptcy

petition.   Dallmeyer v. Commissioner, supra at 1292-1293; see

also Patten & Davies Lumber Co. v. Commissioner, supra at 558.

     Petitioners have failed to show the value of Drexel’s

assets, the amount and validity of secured and priority claims

filed, and the cost of the bankruptcy administration.     Indeed,

the record indicates to us that those factors could not be

determined with any degree of certainty during 1990.    Such

uncertainty precludes a conclusion that the note became worthless

in that year.   Dallmeyer v. Commissioner, supra at 1293.      During

1990, the process of making and evaluating claims against Drexel
                                - 22 -

was ongoing, and the final deadline for claims was extended until

the following year so that the IRS could file its proof of claim.

Many of the claims against Drexel arose from securities

litigation, and the amount of Drexel’s liability in connection

with those claims could not be known until the litigation was

settled or proceeded to judgment.     Contrary to petitioners’

contention, the size of the claims made against Drexel are not

necessarily probative of the state of its financial condition in

1990.    For instance, we note that the IRS filed a Federal tax

claim against Drexel in the amount of $5.3 billion, which

apparently was settled for, inter alia, a payment of $183 million

in 1992 and a payment of $106 million in interest over the next 6

years.    Finally, Drexel filed a petition for reorganization

pursuant to chapter 11, which, absent evidence that the creditors

have suggested dismissal, often carries a strong presumption that

the reorganization was not hopeless.     Mayer Tank Manufacturing

Co. v. Commissioner, 126 F.2d 588, 592 (2d Cir. 1942); see Simon

v. Commissioner, T.C. Memo. 1978-485.     The record in the instant

case indicates to us that the events that occurred in 1990 do not

require a conclusion that all reasonable hope that the note would

be paid, at least in part, could be abandoned in that year.

Estate of Mann v. United States, supra at 276.

        Petitioner’s subjective perceptions of Drexel’s financial

condition on February 13, 1990, are insufficient to support

petitioners’ claim that the note became worthless during 1990.
                               - 23 -

Fox v. Commissioner, 50 T.C. at 822.      We have considered

petitioners' remaining arguments and find them to be without

merit.   Accordingly, we hold that petitioners have failed to

prove that the note became worthless during 1990.

     The final issue we consider is whether petitioners are

liable for the accuracy-related penalty provided by section

6662(a).    Section 6662(a) imposes a 20-percent penalty on the

portion of an underpayment of tax that is attributable to, inter

alia, negligence or disregard of rules or regulations.     The term

“negligence” includes any failure to make a reasonable attempt to

comply with the provisions of the Code, including failure to

exercise due care, failure to do what a reasonable person would

do under the circumstances, or failure to keep adequate books and

records.    Sec. 6662(a); sec. 1.6662-3(b)(1), Income Tax Regs.

The term “disregard” includes any careless, reckless, or

intentional disregard of the Code or the temporary and final

regulations issued pursuant to the Code.     Sec. 6662(c); sec.

1.6662-3(b)(2), Income Tax Regs.

     The accuracy-related penalty does not apply to any portion

of an underpayment with respect to which it is shown that there

was a reasonable cause and that the taxpayer acted in good faith.

Sec. 6664(c)(1).    The decision as to whether the taxpayer acted

with reasonable cause and in good faith depends upon all

pertinent facts and circumstances.      Sec. 1.6664-4(b)(1), Income

Tax Regs.    Generally, the most important factor is the extent of
                              - 24 -

the taxpayer’s efforts to assess the proper tax liability.        Id.

An honest misunderstanding of fact or law that is reasonable in

light of all of the facts and circumstances, including the

knowledge and experience of the taxpayer, may also indicate

reasonable cause and good faith.   Id.    Petitioners must establish

error in respondent’s determination that they are liable for the

penalty provided by section 6662(a).     Rule 142(a); Estate of

Monroe v. Commissioner, 104 T.C. 352, 366 (1995).

     We conclude, however, that petitioners are liable for the

penalty.   Although petitioners employed a tax return preparer to

complete the return, they admit that they did not give complete

information to the preparer concerning the sale of the shares and

acknowledge their responsibility for the errors in the return.

In reporting the sale on their 1989 return, petitioners included

only the cash received, $67,950, and claimed a basis of $45,000,

which petitioner admitted at trial was incorrect.    Petitioners

also admit that they did not correctly report the basis of the

shares because petitioner did not have adequate records.

Petitioner testified that he considered the basis claimed on the

return to be the basis in the first group of shares that he had

purchased in 1985.   Petitioner thus apparently reported the sale

of the shares as involving only a portion of the shares, even

though all 5,200 of the shares were redeemed by Drexel in 1989.

Petitioners contend that they eventually were able to correct the

erroneous basis claim in their 1989 return by filing an amended
                              - 25 -

return in 1993, but petitioners concede that the amended return

was not filed until after respondent issued the statutory notice

determining the deficiencies in the instant case.

     Furthermore, petitioners did not properly elect out of the

installment method for purposes of reporting the sale of the

shares, nor did they properly report the sale on that method.

Petitioners claim that petitioner made a good faith effort to

ascertain the worthlessness of the note and that his effort

should be sufficient to show that he was not negligent.    However,

petitioner’s conclusion as to the worthlessness of the note was

based on little other than his subjective opinion, which is

insufficient to sustain a deduction.    Fox v. Commissioner, 50

T.C. at 822.

     On Schedule D of their 1990 return, petitioners reported a

long-term capital loss with respect to the note in the amount of

$29,945, calculated by subtracting the face amount of the note,

$166,361, from a basis of $196,306.    Petitioners’ basis in the

shares was only $116,504.   Petitioners have not attempted to

explain how they established the claimed basis in the note or to

otherwise justify the amount and nature10 of the loss claimed.



10

     Petitioners argue that the note became worthless during
1990; however, the Code provides for the treatment of a worthless
debt as a deduction, sec. 166(a), or, in the case of a
nonbusiness bad debt, as a short-term capital loss, sec. 166(d).
Petitioners have not attempted to reconcile their argument with
the position taken on their 1990 return.
                               - 26 -

     Based on the foregoing, we sustain respondent’s

determination that petitioners are liable for the penalty

provided by section 6662(a).

     To reflect the foregoing,

                                         Decision will be entered

                                    for respondent.
