                        T.C. Memo. 1998-377



                      UNITED STATES TAX COURT



              ROBERT C. COBORN, SR., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 16842-94.                    Filed October 19, 1998.



     Mark A. Pridgeon, for petitioner.

     David L. Zoss, for respondent.



                        MEMORANDUM OPINION


     SWIFT, Judge:   Respondent determined deficiencies of

$249,919, $96,478, $5,627, and $16,300, respectively, in

petitioner's Federal income taxes for 1988, 1989, 1990, and 1991.
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     The issue for decision is whether petitioner is entitled to

a claimed $1.6 million nonbusiness bad debt deduction relating to

funds transferred to a closely held corporation.


                            Background

     Petitioner resided in St. Cloud, Minnesota, at the time the

petition was filed.

     On June 16, 1972, petitioner became holder of stock in

Environmental Protection Laboratories, Inc. (EPL), a newly formed

Minnesota corporation established, among other things, to develop

products relating to laboratory testing and to environmental

monitoring equipment.

     Beginning in 1983 and through January of 1990, petitioner

was the controlling shareholder of EPL.   One of petitioner's

business objectives for EPL was for EPL to become sufficiently

successful and profitable so that the stock in EPL could be sold

to a third party at a large profit.

     In 1983, petitioner's son, Robert C. Coborn, Jr., became

EPL's president.   Over the years, petitioner invested heavily in

EPL, in part, to financially support the corporation of which his

son was president.

     In the early 1980's, it was estimated that EPL would need

$1.5 to $1.9 million in additional capital funds to implement for

EPL the business plan that petitioner, his son, and others had

developed.
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     Between 1972 and 1988, petitioner transferred at least

$1,571,429 to EPL.

     Over the years, EPL obtained a number of loans from banks.

These loans were personally guaranteed by petitioner.   Funds that

petitioner individually transferred to EPL were not secured and

were subordinated to bank loans EPL obtained.

     Not until September of 1990 did petitioner take steps to

secure funds he alleges to have loaned to EPL.

     Between 1973 and 1984, a series of purported promissory

notes were executed on behalf of EPL and in favor of petitioner

that apparently related to some of the funds petitioner

transferred to EPL.   Neither petitioner nor EPL, however,

maintained adequate, current documentation and accounting records

reflecting funds petitioner transferred to EPL.   Certain

documentation relating to the funds petitioner transferred to EPL

appears to have been originated not at the time the funds were

transferred but in later years.

     Of the $1,571,429 that petitioner alleges constituted funds

he loaned to EPL, $729,248 thereof is not reflected by any

purported promissory notes.

     At some point in time, an undated document was executed on

behalf of EPL and in favor of petitioner indicating that

petitioner agreed to loan over an unspecified period of time an
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unspecified amount of funds to EPL and that EPL would repay the

funds on demand with interest at a rate of 14 percent per annum.

     On petitioner's Federal income tax returns for the years in

issue, the reporting of interest income by petitioner relating to

funds petitioner received from EPL and relating to the alleged

loans petitioner purportedly made to EPL is erratic and

inconsistent.     In some years, petitioner received no funds from

EPL, but petitioner reported on his income tax returns interest

income received from EPL.     In other years, petitioner reported on

his income tax returns more or less in interest income than the

total funds he received from EPL.     In some years, petitioner

reported none of the funds he received from EPL as interest

income.     The schedule below indicates, for some years, the

amounts of funds petitioner apparently received from EPL and the

amounts petitioner reported on his respective Federal income tax

returns as interest income received from EPL:


                  Funds Petitioner Received     Funds Reported As
     Year                 From EPL               Interest Income
     1979                    -0-                     $ 4,965
     1984                 $ 2,400                      6,286
     1985                    -0-                      14,125
     1986                  52,469                       -0-
     1987                  45,267                      3,600
     1988                  48,454                      6,000


     On a final decree of divorce between petitioner and his wife

dated January 12, 1987, it is stated that petitioner is awarded

debt owed by EPL to him in the amount of $591,606.
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     In July of 1988, apparently before petitioner made any claim

that the debt purportedly owed to him by EPL was worthless, EPL's

financial statements for 1986 were prepared and reflected total

assets of $3,029,877 and total stockholder equity of $552,097.

Included among the reported assets was an asset with a stated

value of $2,369,810 that was described as "Fair Market Value of

Product Rights".   In September of 1990, apparently after

petitioner made the claim that purported debt owed to him by EPL

was worthless, EPL’s financial statements for 1987 and 1988 were

prepared, and the above asset was omitted from the financial

statements.

     EPL experienced some degree of success.   Between 1983 and

1987, EPL’s gross receipts increased by over 400 percent.

According to EPL’s books, however, from 1984 through 1987, no net

profits were realized by EPL, and EPL had a negative net worth.

In 1988, EPL became delinquent in the payment of employment

taxes, and EPL’s board of directors considered filing a

bankruptcy petition.

     Petitioner and his son, however, decided not to file a

bankruptcy petition on behalf of EPL because such a step would

disrupt EPL’s employee, vendor, banking, and customer

relationships and would damage EPL’s trade name.   Further, in

1988, petitioner and his son still considered EPL's business
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prospects good, and petitioner anticipated the possible private

or public sale of the stock of EPL.

       In 1988, no appraisals relating to the value of EPL as a

business were obtained.

       The evidence does not indicate that petitioner ever made

demand on EPL for repayment of his purported loans to EPL, nor

does the evidence indicate that petitioner ever undertook steps

to otherwise collect from EPL the purported loans.

       In 1988, in anticipation of, among other things, a possible

sale of EPL’s stock and in an effort to enhance the financial

statements of EPL, petitioner went through the exercise of

“forgiving” $1.6 million in purported debt of EPL to petitioner

relating to funds that petitioner over the years had transferred

to EPL.

       After 1988, EPL continued to operate as a business.

Petitioner and his son attempted to sell the stock of EPL in a

public offering, and petitioner continued to transfer funds to

EPL.    In 1989, 1990, and 1991, petitioner transferred to EPL

funds totaling $616,169, and petitioner received from EPL funds

totaling $573,282.    The evidence does not indicate the existence

of any promissory notes or other debt instruments relating to the

funds that petitioner, after 1988, transferred to EPL.

       In 1989, in seeking outside investment capital, a new

comprehensive business plan for EPL was adopted.
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     By 1992, EPL had changed its name to Micro Bio Logics, Inc.

(MBL), and in 1992 MBL conducted an unsuccessful public offering

of its common stock and warrants.

     On EPL’s original and amended 1988 corporate Federal income

tax returns, $1.6 million in forgiveness of indebtedness income

was reported relating to the $1.6 million in purported debt to

petitioner that petitioner in 1988 allegedly forgave.

     Based on EPL's 1988 corporate Federal income tax return, but

for the $1.6 million in forgiveness of indebtedness income that

was reported, EPL would have reported on its 1988 corporate

Federal income tax return a net operating loss for 1988 in the

amount of $717,119.

     As a result of its 1988 operations and its net operating

loss carryforward from prior years, the $1.6 million in

forgiveness of indebtedness income that EPL reported for 1988 did

not result in any reported tax liability for EPL.

     Further, in January of 1988, petitioner sold his stock in

Coborn's, Inc. (Coborn), another closely held corporation in

which petitioner had an interest, and petitioner realized from

this sale a long-term capital gain of $2,044,988.   In 1988, 1989,

1990, and 1991, petitioner recognized and reported $855,089,

$451,494, $30,786 and $34,730, respectively, of this capital

gain.
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     On petitioner's 1988, 1989, 1990, and 1991 Federal income

tax returns, the $1.6 million claimed nonbusiness bad debt

deduction (and the carryovers thereof) relating to petitioner’s

purported loans to EPL significantly offset the capital gains

reported from the sale of petitioner’s stock in Coborn.


                              Discussion

     Losses on nonbusiness bad debts are treated as sustained in

a particular year only if the entire debt becomes totally

worthless during the year.     Riss v. Commissioner, 478 F.2d 1160,

1165-1166 (8th Cir. 1973), affg. in part and remanding 56 T.C.

388 (1971); sec. 1.166-5(a)(2), Income Tax Regs.    The taxpayer

must show some identifiable event or group of facts that proves

worthlessness.   American Offshore, Inc. v. Commissioner, 97 T.C.

579, 593-594 (1991).   A debt does not become worthless merely

because a creditor decides not to enforce the debt.     Southwestern

Life Ins. Co. v. United States, 560 F.2d 627, 644 (5th Cir.

1977).   Declining business, lack of profits, or poor financial

condition do not necessarily establish worthlessness of a debt.

Intergraph Corp. v. Commissioner, 106 T.C. 312, 323 (1996), affd.

per curiam without published opinion 121 F.3d 723 (11th Cir.

1997).   This is particularly true where a debtor continues to

operate as a going concern and where the creditor continues to

extend funds to the debtor.     Id. and cases cited therein.
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     The evidence establishes that, after 1988, EPL continued to

operate as a business.   Petitioner continued to seek a sale of

the stock of EPL, and EPL conducted ongoing business activity.

In 1989, a new business plan for EPL was formulated, and in 1992

a public offering of EPL stock occurred.       Significantly, after

1988, petitioner continued to transfer funds to EPL.       The

evidence does not demonstrate that EPL's purported debt to

petitioner became worthless in 1988.

       For the reasons stated,

                                         Decision will be entered for

                                 respondent.
