                        T.C. Memo. 2000-212



                      UNITED STATES TAX COURT



                 RICHARD D. NELSON, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 14125-98.                       Filed July 11, 2000.



     Stanley Hagendorf and Wayne Hagendorf, for petitioner.

     William R. McCants, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     GERBER, Judge:   Respondent determined deficiencies in

petitioner’s Federal income tax and accuracy-related penalties

under section 66621 for the 1991, 1992, and 1993 taxable years as

follows:


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

                                           Penalty
     Year              Deficiency         Sec. 6662
     1991             $125,883.04        $25,176.61
     1992              142,707.58         28,541.52
     1993              197,963.79         39,592.76

     We consider the following issues:   (1) Whether petitioner

has established a passthrough loss by showing his S corporation’s

entitlement: (a) to accrue and deduct a $1.5 million legal fee

for 1991; (b) to deduct $5,500 monthly payments made in

connection with a bingo business; and (c) to deduct claimed

supplies expenses for the 1991, 1992, and 1993 taxable years; (2)

if petitioner establishes a passthrough loss, whether petitioner

had basis in his wholly owned S corporation so as to allow

passthrough losses for his individual taxable years;2 and (3)

whether petitioner is liable for a negligence penalty under

section 6662(a) for 1991, 1992, and/or 1993.

                          FINDINGS OF FACT

     At the time his petition was filed, petitioner resided in

Florida.    Petitioner’s wholly owned corporation November, Inc.

(November), was incorporated in Virginia on December 19, 1988,

and for its 1989 through 1997 taxable years, reported, as an S

corporation, income and deductions under the accrual method of

accounting.    In the late 1980’s petitioner became involved with



     2
       Respondent bears the burden of showing that petitioner did
not have basis because respondent raised the question of basis in
his trial memorandum and assumed the burden in accord with this
Court’s rules.
                               - 3 -

Sherman and Elaine Lichty (the Lichtys) and Hilton Enterprises,

Inc. (Hilton), in connection with a bingo operation.

     Leonard Morrison (Morrison) and the Lichtys established a

successful bingo operation during the early 1980’s at a location

on Warwick Boulevard in Newport News, Virginia (Warwick

location), but they were prosecuted for fraud, and they were

required to divest their interest in the bingo operation as a

requirement of probation.   Initially, the divestment was

accomplished by interposing Michael Anderson (Anderson),

Morrison’s son-in-law, to serve the Lichtys’ and Morrison’s

interests.   Anderson, due to personal problems, did not

effectively operate the bingo operation, and late in 1988, the

Lichtys and Morrison were referred to petitioner by Mark Gilbert

(Gilbert), a mutual friend.

     Gilbert placed petitioner into the bingo business

opportunity as a straw for the Lichtys.   In accord with a

December 18, 1988, purchase agreement, it appeared that November

had purchased the assets of Hilton Enterprises, Inc. (Hilton), in

order to operate the bingo business at the Warwick location, a

property leased by the Lichtys.   Gilbert also became involved in

the bingo operation and received a salary.   In addition, Gilbert

owned an adjacent parking lot used in conjunction with the bingo

business operations.   Petitioner was to receive a $50,000 salary

that was to be increased after 1 year.    Prior to his involvement
                                 - 4 -

in the bingo operation, petitioner had reported annual earnings

to respondent of about $5,000.    Petitioner’s involvement in the

bingo business, however, was expected to generate $150,000 per

year for petitioner.

     Petitioner and November jointly executed a $450,000

promissory note, dated January 5, 1989, in favor of the Lichtys

and a sublease for the Warwick property.    The note was secured by

petitioner’s stock in November and all of the assets used in the

bingo business and called for $5,000 monthly payments to the

Lichtys.   The transaction was, in part, structured to appear to

be a sale and also to permit the monthly note payments to be

reflected as rent so as to be deducted by November and/or

petitioner from the bingo-related income.

     In substance, petitioner was acting as a shill for the

Lichtys and Morrison because of their probation requirements.

The note and “lease” were intended as a contrivance that

permitted the Lichtys and Morrison to remain financially involved

in the bingo business and to maintain some control over

petitioner’s involvement.   In that regard, Gilbert assisted the

Lichtys and Morrison by overseeing petitioner’s involvement in

the bingo operation.   The Lichtys’ lease on the Warwick property

expired January 31, 1991, and during 1990 they found a new bingo

location, owned by Lockwood Brothers, Inc., on Chestnut Avenue

(the Chestnut property).
                                - 5 -

     The Chestnut property had been used as a fish processing

factory, and November expended approximately $400,000 to improve

and make the Chestnut property suitable for the bingo operations.

November expended $222,171, $166,553, and $25,915 during 1990,

1991, and 1992, respectively, to convert it into a bingo

operation.    Based on those expenditures, November claimed

depreciation on a 10-year basis equal to the term of the Chestnut

property lease in the respective amounts of $30,545, $40,168, and

$41,464 for the 1991 through 1993 tax years.

     The Lichtys and November, during October 1991, jointly

entered into a lease of the Chestnut property.    The Lichtys’

involvement was through their corporate entity, EDL Properties,

Inc. (EDL).    Under the terms of the lease, the Lichtys’ entity

was obligated for a $6,793.36 monthly rental payment for the

Chestnut property, beginning February 10, 1991.

     Disagreements arose between petitioner/November and the

Lichtys and Gilbert concerning the bingo operation, and the

Lichtys advised petitioner that it was not likely that he would

be allowed to continue as the bingo operator.    On February 1,

1991, petitioner and November filed suit against the Lichtys and

others, treating the sublease of the property and note for

$450,000 as rightful and seeking specific performance and a

temporary injunction.    Petitioner sought exclusive use of the

Chestnut property for the bingo operation and to keep the Lichtys
                                - 6 -

and others from interfering.    In May 1991, the suit was settled

with petitioner and November emerging with the right to continue

the operation of the bingo business.     Under the settlement, EDL

entered into a 10-year sublease of the Chestnut property with

November.

     Petitioner/November had hired attorney William M. Krieger

(Krieger) on a contingent fee basis to represent them in the

above-described lawsuit.   As a result of the successful

settlement of the suit, it was determined that the value of the

bingo business was approximately $4.5 million and that Krieger

was entitled to a $1.5 million fee.     November and petitioner,

during June 1991, executed a promissory note to Krieger for $1.5

million that was payable from bingo income and wholly dependent

on the success of the bingo operations.     The note did not have a

maturity date and was payable in monthly amounts computed in

accord with a separate agreement between the parties.     The

agreement limited petitioner’s salary to an amount not exceeding

$65,000 until such time as Krieger’s $1.5 million note, including

interest, was paid in full.    The note was non-negotiable and

could not be discounted, transferred, assigned, or owned by

anyone other than Krieger and his immediate heirs.     Under the

agreement and note, November was obligated for and did pay to

Krieger one-third of the pretax profit, which amounted to
                                - 7 -

$56,409.11, $110,317.07, $130,739.49, $75,636.22, and $56,492.60

for the years 1991, 1992, 1993, 1994, and 1995, respectively.

     As an accrual basis reporter, November claimed a $1 million

deduction for Krieger’s fee for its 1991 reporting period, but

petitioner now claims the entire $1.5 million.    November paid the

$6,793.36 rent for the Chestnut property for March 1991 and paid

amounts for rent and other items into the court during the

pendency of the lawsuit.    After the lawsuit and pursuant to the

settlement between November/petitioner and the Lichtys and

others, November made monthly payments of $12,293.36 (the

equivalent of $6,793.36 rent on the Chestnut property plus

$5,500) to the Lichtys’ entity.    For the 1991, 1992, and 1993

reporting periods, November paid $147,235.49, $145,962.73, and

$147,520, consisting of the above-described payments.

     Respondent disallowed the $1 million deduction that had been

claimed for legal fees.    The deduction was disallowed on the

alternative grounds that economic performance had not occurred or

that the fee was a capital, nonamortizable expenditure.

Respondent also determined that the improvements to the Chestnut

property were not currently deductible and that they should be

capitalized and depreciated during a 31.5-year recovery period

under the modified accelerated cost recovery system (MACRS).

Under respondent’s determination, November would be entitled to

depreciation deductions of $7,274, $12,376, and $13,165 for 1991,
                                - 8 -

1992, and 1993, respectively.   Respondent also disallowed about

$5,500 of the $12,293 monthly payments that November had claimed

as rent on the basis that those amounts were capital payments

that were being paid to acquire the bingo business.

     Petitioner, on his 1991 income tax return, claimed a

$753,728 flowthrough loss from November, his S corporation.

Respondent, due to his determination denying certain of

November’s claimed deductions, in turn, disallowed petitioner’s

claimed loss.    Petitioner claimed a carryover of the 1991 loss to

his 1992 and 1993 income tax returns.   Respondent did not make

the determination, in the deficiency notice, that petitioner had

insufficient basis in his S corporation (November) to claim the

loss.

     November’s capital stock was issued for $1,000 and did not

increase.   Loans from shareholders, at one time, approached

$4,500 but decreased to zero by the time of the years under

consideration.   Petitioner recognized $79,768 and $20,099 of

passthrough income from November, as reflected on Forms 1120S,

Schedules K, Shareholders’ Shares of Income, Credits, Deductions,

Etc. (Form 1120S) for the 1989 and 1990 tax years.    November’s

balance sheets reflect $1,000 in equity, and the loans to

shareholders on November’s balance sheets reflected $96,007 as of

December 31, 1990, $143,548 as of December 31, 1991, $332,029 as
                                 - 9 -

of December 31, 1992, $578,231 as of December 31, 1993, and

$768,223 as of December 31, 1994.

                                OPINION

     The parties agree that, prior to his bringing suit against

the Lichtys, petitioner was a shill for others and that his

apparent ownership of the bingo operation was, most likely, a

sham.    In addition, petitioner asserts that the existence of his

S corporation should be disregarded and that he should be

permitted to report the income or claim the losses directly,

instead of passing them through the entity.    As an alternative,

petitioner argues that he “was not the beneficial owner of the

equity interest in November or the Bingo operations during the

years in issue, but was merely a ‘front man’, a ‘straw’, or

‘shill’”.    Under the alternative argument, petitioner asks us to

hold that he was not entitled to any income from November.3

Finally, petitioner counters respondent’s position by contending

that the disputed adjustments to his S corporation were in error

and that he had basis to claim a passthrough loss.

        Petitioner’s argument that we disregard his wholly owned

corporate entity (November) must fail.     Petitioner first raised

this argument on brief, in a posttrial setting.     Although



     3
       We summarily dispense with petitioner’s argument that no
income should be attributable to him because he received varying
amounts of money and/or benefits from and/or through his S
corporation’s bingo activities.
                              - 10 -

respondent argues that petitioner did not have ownership in the

bingo operation prior to the settlement of the lawsuit, neither

party, prior to the submission of the briefs, contended that

November should be disregarded as an entity.     Under these

circumstances, petitioner’s attempt, for the first time on brief,

to disavow the existence of November would be most prejudicial to

respondent and will not be permitted.     See, e.g., Estate of

Horvath v. Commissioner, 59 T.C. 551, 556 (1973).

     Even if petitioner had been permitted to pursue his

contention that the corporate entity be disregarded, on the

record here he would have failed.4     Petitioner created this

corporate entity, caused it to file returns, and reported

passthrough losses from the entity on his individual return.     In

addition, the existence and form of the S corporation had not

been questioned by respondent.   Importantly, the existence of

November is in no way dependent upon whether it or petitioner had

an ownership interest in the bingo operation.     November was the

financial conduit for petitioner’s involvement in the bingo

business, whether or not he or November had an ownership interest

in the bingo business.   Additionally, the deficiencies under



     4
       A party seeking to disavow the form of its own transaction
may be required to present “strong proof” that the substance
differs from the form. Ullman v. Commissioner, 264 F.2d 305, 308
(2d Cir. 1959), affg. 29 T.C. 129 (1957); Coleman v.
Commissioner, 87 T.C. 178, 202 (1986), affd. without published
opinion 833 F.2d 303 (3d Cir. 1987).
                                - 11 -

consideration arose, in great part, after petitioner had settled

the litigation and was entitled to continue operating the bingo

business.   Finally, where there has been substantial business

activity by a corporation, it would be difficult to show that the

corporation is a taxpayer’s alter ego or merely a nominee for

purposes of Federal taxation.    See Moline Properties, Inc. v.

Commissioner, 319 U.S. 436, 438-439 (1943); National Carbide

Corp. v. Commissioner, 336 U.S. 422 (1949); Commissioner v.

State-Adams Corp., 283 F.2d 395 (2d Cir. 1960).   Although

petitioner was a shill or front for the Lichtys and others,

November was an active and operating entity that, in the course

of conducting the bingo business, received income and issued

checks for bingo business expenditures.   Moreover, November was a

named plaintiff in the legal proceeding with the Lichtys.

November played too large and vital a role to be disregarded.

     We proceed to consider whether petitioner has shown that

respondent’s determination disallowing certain of November’s

deductions was in error.   We first consider the 1991 legal fee

that was incurred in connection with litigation involving the

bingo operation.   November originally claimed a $1 million

deduction with respect to the $1.5 million fee for which an

agreement and note were executed with/to Attorney Krieger.

Petitioner contends that the entire $1.5 million fee should be

deductible by an accrual basis taxpayer because it was an
                               - 12 -

ordinary and necessary business expense.5    Conversely, respondent

contends that the legal fee was a capital expenditure and,

accordingly, not deductible.   Alternatively, respondent contends

that if the attorney’s fee is not a capital expenditure, November

would not be entitled to deduct the entire amount for failure to

meet the all events test.

Should the $1.5 Million Legal Fee Be Capitalized?

     Respondent, relying on INDOPCO, Inc. v. Commissioner, 503

U.S. 79 (1992), argues that the $1.5 million legal fee is a

nonamortizable capital expenditure.     Petitioner, however,

contends that under section 162 the legal fee was an ordinary and

necessary expense that was incurred in carrying on a trade or

business.   Respondent counters that section 263 provides that no

deduction is allowable for amounts paid for permanent

improvements or betterments made to increase the value of any

property or estate.   Respondent, in support of his determination,

contends that petitioner instituted suit for the purpose of

asserting ownership over the bingo operation, and, ultimately, he

emerged as the owner, subject to his making certain payments to

the Lichtys and others, including Kreiger, petitioner’s attorney.




     5
       Petitioner also points out that respondent did not allow
the amounts actually paid by November to the attorney during
1991, 1992, and 1993. In that regard, respondent’s determination
that the expenditure should be capitalized would not depend on
the method of accounting or when the amounts were actually paid.
                              - 13 -

     The situation we consider is quite novel.    Initially,

petitioner acted as a front for others who were constrained not

to reveal their ownership interests.    Under his agreement with

the true owners, petitioner was to receive a $50,000 salary (ten

times more than he had reported as income in the past), with the

potential to make $150,000 in exchange for acting as owner and

for operating the bingo business.    It was not until the Lichtys

advised petitioner that they were going to remove him from that

position that petitioner hired Krieger and sought to protect his

income stream under the agreement.     Petitioner’s lawyer advised

him to approach the litigation by attempting to perfect the

ostensible ownership that he had been permitted by the true

owners.   Petitioner’s attorney believed that it was the Lichtys’

inability to assert their ownership that was the main reason for

petitioner’s success in arriving at a settlement under which he

was able to continue receiving income from the bingo operation.

     Respondent’s position that the legal fees were not

deductible in the ordinary course of business and constitute a

capital expenditure does not fit the unique factual circumstances

here.   In substance, petitioner was not seeking to perfect

control and/or ownership of the bingo operation.    Instead, he

knew that he was merely a shill or front for others with a

promise of income for acting in that capacity and managing the

business.   In effect, he was seeking to keep the true owners from
                              - 14 -

removing him from his position and from stopping the flow of his

earnings or income stream.

     By seeking to enforce the ostensible terms with the true

owners, petitioner protected his income earning position and kept

the true owners from asserting their authority in the future.

Petitioner already owned the capital entity (November) that was

permitted to continue the operation of the bingo business.   He

did not perfect his ownership in November, and he did not acquire

the lease to either of the locations where the bingo business was

operated.   Accordingly, respondent’s reliance on INDOPCO Inc. v.

Commissioner, supra, is in apropos.    Petitioner had entered into

an agreement with the Lichtys, et al. for a position where he

would receive $50,000 to $150,000 per annum in exchange for his

services, including serving as a shill or front for the Lichtys.

Under that agreement, petitioner would also have been entitled to

some equity at a future time.6   When the Lichtys attempted to

default on their part of the agreement by attempting to remove

petitioner from his position, he sued.   Accordingly, petitioner

did not incur the legal fee to produce a long-term benefit, he

incurred it to protect his existing right to an income stream.

Such expenditures are ordinary and necessary business expenses


     6
       We note that petitioner’s situation after the settlement
was substantially similar to his situation before. He operated a
bingo business and paid the Lichtys $5,000 before and $5,500 per
month after the settlement. In form and substance nothing else
changed.
                             - 15 -

within the meaning of section 162, and we so hold.   See

Commissioner v. Heininger, 320 U.S. 467 (1943).

     Respondent also argues that petitioner is not entitled to

deduct the face amount of the note to Krieger on the ground that

all of the events had not occurred which determine the fact of

liability and because the value of the note could not have been

determined with reasonable accuracy (the “all events test”).

Respondent also relies on section 461(h)(1), arguing that it

would apply to limit the deductible amount, even if the all

events test is met, to an amount for which economic performance

has been met.7

     There is no dispute that petitioner and November were

obligated to Krieger on a note in the face amount of $1.5 million

and that Krieger had successfully prosecuted petitioner’s

litigation to a conclusion (settlement) during the taxable year.

There was no performance left on the part of Krieger, and

petitioner and November were obligated to make payment.

Petitioner and November, however, were not required to make

payments on the note unless the bingo operation was profitable.

Further, the note did not have a fixed payment date and could


     7
       In addition, respondent argues that sec. 1.461-1(a)(1),
Income Tax Regs., prohibits the deduction of any expenditure
which results in the creation of an asset having a useful life
extending beyond the close of the taxable year. Because we have
decided that the litigation did not result in the creation of an
new asset, we need not address the effect of the cited
regulation.
                             - 16 -

have remained unsatisfied for an indefinite period of time.    In

accord with the note and the terms of an accompanying agreement,

Krieger was paid $429,594.49 during the first 5 years after the

settlement ($56,409.11, $110,317.07, $130,739.49, $75,636.22, and

$56,492.60 for the years 1991, 1992, 1993, 1994, and 1995,

respectively).

     Accordingly, although it was agreed that Krieger was

entitled to $1.5 million, there was no assurance that the bingo

operation would generate income sufficient to satisfy the note.

The conditional nature of the note and its indefinite term

prevent the all events test from being satisfied.   See, e.g.,

Restore, Inc. v. Commissioner, T.C. Memo. 1997-571, affd. per

curiam 174 F.3d 203 (11th Cir. 1999).   Even if these

circumstances did facially comply with the all events test, the

allowance of a $1.5 million deduction for November’s 1991 year

when payments on the note are conditional and extend over an

indefinite period of time would result in a distortion and fail

to match November’s income and deductions.   Cf. Ford Motor Co. v.

Commissioner, 102 T.C. 87 (1994), affd. 71 F.3d 209 (6th Cir.

1995).

     Accordingly, we hold that November was not entitled to

deduct $1.5 million for legal fees for its 1991 year, but that it

is entitled to deduct the payments to Krieger in the year of each

payment.
                              - 17 -

Whether November Is Entitled To Write Off or Depreciate Over the
10-year Term of the Lease The Improvements Made to the Chestnut
Property

     The Chestnut property had been used for processing fish and

needed substantial improvements before bingo operations could

commence.8   November expended $222,171, $166,553, and $25,915

during 1990, 1991, and 1992, respectively, to convert it into a

bingo operation.   Based on those expenditures, November claimed

depreciation on a 10-year basis (equal to the 10-year term of the

lease) in the respective amounts of $30,545, $40,168, and $41,464

for the 1991 through 1993 tax years.   Respondent determined that

petitioner was entitled to use a 31.5-year recovery period under

the MACRS, resulting in allowances of $7,274, $12,376, and

$13,165, respectively.   On brief, petitioner also claimed that

November would, alternatively, be entitled to deduct the entire

expenditure (about $400,000) as lease acquisition cost that would

not be subject to the MACRS requirements.

     Petitioner had relied on section 1.162-11(b), Income Tax

Regs., which held that lessees may be entitled to use the length

of the lease as the recovery period for leasehold improvements.

Respondent correctly points out that section 168(i)(8) (added by

the Tax Reform Act of 1986) made the above-referenced regulation



     8
       Because bingo is a game of chance where the bingo operator
is the only participant who always “wins”, it might be said that
the Chestnut property was to continue being used for the
“processing of fish”.
                                - 18 -

obsolete and, instead, required that leasehold improvements be

subject to the MACRS-prescribed recovery periods.    With respect

to petitioner’s claim that the expenditures to convert the

facility to a bingo operation were lease acquisition costs,

respondent contends that most of the expenditures were made

subsequent to the time that the lease was in effect.

Furthermore, petitioner has not shown, as he is required to, that

the expenditures were for lease acquisition costs, as opposed to

leasehold improvements, as reported by November and determined by

respondent.

     Accordingly, we hold that respondent’s determination that

petitioner is not entitled to a 10-year recovery period is

sustained.    Further, we hold that petitioner has failed to show

that November is entitled to deduct any portion of the

expenditure as a lease acquisition cost.

Is November Entitled To Deduct the $5,500 Portion of the
$12,293.36 Monthly Payment to the Lichtys’ Entity?

     Prior to and after the settlement of the lawsuit, November

and the Lichtys’ entity were obligated to pay $6,793.36 rent for

use of the Chestnut property.    The note executed from petitioner

and/or November to the Lichtys also called for a $5,000 monthly

payment for a period of years.    After the settlement, November

was required to pay to the Lichtys’ entity $12,293.36, which

amount was $5,500 more than the $6,793.36 rental payment.

November claimed the $12,293.36 monthly payments as rent.
                              - 19 -

Respondent allowed the portion attributable to the rental of the

Chestnut property but disallowed the $5,500 portion.   Respondent

argues that the $5,500 portion is a payment to the Lichtys in

exchange for their interest in the operation.   Under the

circumstances here, the $5,500 portion of the monthly payment is

not deductible rent, but it would be deductible under section 162

as an expense incurred in the operation of the bingo business.

Respondent contends that the $5,500 monthly payments to the

Lichtys are merely a continuation of the $5,000 monthly payments

that were made on the note prior to the litigation and

settlement.   Again, respondent’s argument rests on the premise

that petitioner was acquiring capital assets under the

settlement.

     In these circumstances, we are not convinced that the $5,500

should be classified as capital in nature and nondeductible.    As

discussed in detail above, petitioner and/or November was the

owner of the bingo operations on paper prior to the litigation

and settlement but had an underlying agreement with the Lichtys

to receive income for appearing as the owner and managing the

business.   The terms of the settlement do not delineate whether

the $5,500 payment is in exchange for the Lichtys’ capital

interest or for the Lichtys’ forbearance from interfering with

petitioner’s operation of the bingo business.   The Lichtys were

prohibited from having an interest in the bingo operation and
                              - 20 -

appeared, at least on paper, as not directly involved.   It is

difficult to tell from the settlement the nature of the $5,500

portion of the monthly payments.   At the very least and in

essence, petitioner had the right to earn income in connection

with the bingo operation, and he was successful in protecting

that right from the interference of the Lichtys and perhaps

others.   The $5,500 monthly payments were not in exchange for an

equity interest but instead were a cost of continuing the bingo

business operation.   Accordingly, we hold that November is

entitled to deduct the $5,500 portion of the payments made to the

Lichtys through their corporate entity for the years under

consideration.

Has Petitioner Shown That $10,350, $35,436, and $35,436 Were
Incurred for Supplies for the 1991, 1992, and 1993 Tax Years,
Respectively?

     Respondent disallowed the above-listed amounts due to

petitioner’s failure to substantiate that the amounts were

expended for deductible business supplies.   Petitioner did not

offer any evidence at trial regarding these amounts.

Accordingly, respondent’s determination on these items is

sustained.
                               - 21 -

Does Petitioner Have Basis in His S Corporation so as To Be
Entitled To Deduct Any of the Passthrough Losses That May Be
Finally Redetermined for the Years Under Consideration?

     We now turn to a critical9 question of whether petitioner

has sufficient basis in November so as to be able to deduct any

passthrough losses.    In accord with the Form K-1 petitioner

received from November, he claimed a $753,728 passthrough loss.

Respondent determined that petitioner was not entitled to the

claimed loss on the grounds that petitioner had a passthrough

gain in each year due to the disallowance of various deductions

claimed by November.    Some of the disallowed deductions are the

subject of this opinion, and our holding with respect to them may

result in a passthrough and/or carryover loss for the taxable

years under consideration.    Respondent did not determine, in the

notice of deficiency, that petitioner lacked sufficient basis to

receive the “benefit” of any loss.

     Respondent has shown that November’s balance sheets reflect

$1,000 in equity, and the loans to shareholders on November’s

balance sheets reflected $96,007 as of December 31, 1990,

$143,548 as of December 31, 1991, $332,029 as of December 31,

1992, $578,231 as of December 31, 1993, and $768,223 as of

December 31, 1994.    No loans from shareholders were reflected for



     9
       If petitioner is without basis in his S corporation, his
success with respect to November’s deduction items would, to the
extent that November’s expenses exceed its income, be a Pyrrhic
victory.
                               - 22 -

the years under consideration.    So there was a decidedly large

flow of capital to petitioner from November, rather than the

opposite.   Petitioner did, however, recognize $79,768 and $20,099

of passthrough income from November, as reflected in Forms 1120S

for 1989 and 1990 tax years.

     Petitioner does not rely on contributions made directly to

November to counter respondent’s argument.    Petitioner contends

that the $1.5 million note to Krieger, on which both petitioner

and November were shown as obligors, made him personally liable

and would therefore constitute basis in November.    Respondent

contends that petitioner is merely a guarantor and, under the

circumstances of this case, should not be permitted S corporation

basis attributable to the note.    The note to Attorney Krieger

cannot be fully understood without reference to the integral

accompanying agreement between the parties.    In that agreement it

is made clear that but for the success in settlement of the

lawsuit, petitioner and November would have been “bankrupt”.

Significantly, the note is only to be paid from income of

November’s bingo business.   For example, it was agreed if the

laws change to prohibit bingo, Krieger would “receive no

payments” on the note.   More particularly, the payment on the

note to Krieger was dependent on November and the profitability

of its bingo business, and Krieger did not look to petitioner,

individually, for payment.   Accordingly, in this setting,
                              - 23 -

petitioner was a guarantor who had not pledged any individual

assets and who, but for November’s business, was without means to

pay the $1.5 million note to Krieger.

      This Court and several U.S. Courts of Appeals have held

that, absent an economic outlay by a taxpayer, guaranties of

loans do not increase basis in S corporation stock.   See Estate

of Leavitt v. Commissioner, 90 T.C. 206 (1988), affd. 875 F.2d

420 (4th Cir. 1989) (and cases cited therein).   The Court of

Appeals for the Eleventh Circuit held in particular circumstances

that some guaranties may be sufficient to constitute basis where

the facts show that, in substance, the shareholder has borrowed

funds and subsequently advanced them to the corporation.   See

Selfe v. United States, 778 F.2d 769, 774 (11th Cir. 1985).      The

key factor emphasized by the Court of Appeals was that the

“lender [looked] to [the] shareholder as the primary obligor.”

Id.

      Any appeal of our decision here will lie in the Court of

Appeals for the Eleventh Circuit, and, accordingly, we must

decide whether Selfe v. United States would compel our holding

for petitioner on this issue.10   The Selfe v. United States

holding would permit a stepped-up basis where the facts show



      10
       Under our holding in Golsen v. Commissioner, 54 T.C. 742
(1970), affd. 445 F.2d 985 (10th Cir. 1971), we follow, if it is
directly on point, a holding by the Court of Appeals to which our
decision would be appealable.
                               - 24 -

that, in substance, the shareholder has borrowed funds from a

third party and subsequently advanced them to the corporation.

In particular, the Court of Appeals emphasized that it would be

relevant whether the creditor looked to the shareholder as the

primary obligor in the circumstances of Selfe v. United States,

supra.    The circumstances here are factually distinguishable from

Selfe.    See Spencer v. Commissioner, 110 T.C. 62, 83-87 (1998),

affd. without published opinion 194 F.3d 1324 (11th Cir. 1999).

Petitioner had no individual assets and did not put up any

security.    More significantly, November’s bingo business income

was the sole source available and one which had been specifically

designated for payment of the debt to Krieger.

     Accordingly, we do not feel compelled to follow Selfe in

this instance and, instead, hold that petitioner is not entitled

to increase his basis in his S corporation with respect to any

part of the $1.5 million debt to Krieger.11

Should Respondent’s Determination of a Negligence Penalty Under
Section 6662(a) Be Sustained for 1991, 1992, or 1993?

     Respondent, for each of the 3 taxable years, determined an

accuracy-related penalty, based on negligence, under section

6662(a).    That section imposes an addition to tax in the amount

of 20 percent of any portion of the underpayment attributable to



     11
       The Court leaves the parties to the task of computing
petitioner’s correct basis in their Rule 155 computation(s) in
accord with our findings and holdings.
                               - 25 -

negligence.   To avoid this penalty, petitioner must show that his

actions were reasonable and not careless, reckless, or made with

intentional disregard of rules or regulations.    See Delaney v.

Commissioner, 743 F.2d 670 (9th Cir. 1984), affg. T.C. Memo.

1982-666.

     Respondent determined that petitioner was liable for the

penalty on the entire underpayment in each of the 3 years under

consideration.    Accordingly, we must consider each adjustment to

decide whether the portion of the underpayment attributable to it

is due to negligence.   We recognize that petitioner had no

particular business or tax expertise and became involved in the

bingo operation merely as a front for others.    He relied on

advisers (accountants and lawyers) for establishing business

entities and for the preparation of his and his S corporation’s

returns.    On the seminal return (the one in which the S

corporation claimed the loss) the deductions were taken in accord

with petitioner’s advisers’ judgment.    Petitioner was successful

with respect to two significant items in this litigation--the

legal fee and the $5,500 monthly payments.    He was unsuccessful

on the amortization and substantiation issues.

     With respect to the amortization issue, that involved a

technical interpretation of regulations, and petitioner’s tax

return preparer and adviser counseled petitioner to amortize the

property based on a 10-year life.    Considering petitioner’s
                              - 26 -

background and reliance, we hold that his actions with respect to

that item were reasonable and are not subject to the section 6662

penalty.

    With respect to the substantiation items and any items

conceded, petitioner has failed to show that his actions were

reasonable and not careless, reckless, or made with intentional

disregard of rules or regulations.     Even considering petitioner’s

background, his inability to substantiate claimed expenditures is

not reasonable.   Under these circumstances, we hold that

petitioner is liable, in each of the 3 taxable years, for the

accuracy-related penalty under section 6662(a) on the portion of

any underpayment attributable to the substantiation issues

decided and on the adjustment items that he conceded.

     To reflect the foregoing and due to concessions,

                                     Decision will be entered under

                               Rule 155.
