                            T.C. Memo. 1996-507



                          UNITED STATES TAX COURT



            SAMUEL C. STONE AND SUSAN C. STONE, Petitioners v.
               COMMISSIONER OF INTERNAL REVENUE, Respondent



        Docket No. 26039-93.                 Filed November 13, 1996.



        Samuel C. Stone, pro se.

        Ann L. Baker, for respondent.



                  MEMORANDUM FINDINGS OF FACT AND OPINION

        CARLUZZO, Special Trial Judge:    This case was heard pursuant

to the provisions of section 7443A(b)(3) and Rules 180, 181, and

182.1       Respondent determined a deficiency in petitioners' 1991


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

Federal income tax in the amount of $9,687.    Following

concessions, the issues for decision are:   (1) Whether

petitioners are entitled to an interest expense deduction claimed

as a miscellaneous itemized deduction on their 1991 Federal

income tax return (the 1991 return); (2) whether petitioners are

entitled to an additional interest deduction not claimed on their

1991 return; (3) whether petitioners are entitled to various

employee business expense deductions claimed for the year 1991;

and (4) whether petitioners are entitled to a deduction for

credit life insurance premiums paid in 1991.

                         FINDINGS OF FACT

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

Petitioners filed a joint Federal income tax return for the year

1991.   They computed their 1991 Federal income tax liability in

accordance with the cash receipts and disbursements method of

accounting.   At the time the petition was filed, petitioners

resided in Tulsa, Oklahoma.   References to petitioner are to

Samuel C. Stone.

     Petitioner is, and was during the year in issue, a

practicing attorney specializing in the issuance of municipal

securities.   Petitioner conducted his law practice as a sole

proprietor from 1972 until 1981.

     In June of 1981, petitioner and two other attorneys, James

R. Jessup (Jessup) and Robyn Owens (Owens), incorporated Samuel

C. Stone & Associates, P.C., which was a professional corporation
                               - 3 -

organized pursuant to Oklahoma law for the purpose of providing

legal services.   Petitioner, Jessup, and Owens were the initial

shareholders and directors of this corporation.    In January of

1985, the corporation's articles were amended to eliminate Owens

as a shareholder and director, and the corporation's name was

changed to Stone, Jessup & Styron, P.C.   In January of 1986, the

corporation's articles were amended again, this time changing the

corporation's name to Stone Jessup, P.C. (Stone Jessup).    Jessup

remained a shareholder and director of Stone Jessup until his

death in February of 1991.   Thereafter, petitioner was the sole

shareholder, director, and officer of the corporation.

      During 1991, petitioner practiced law as an employee of

Stone Jessup, but was not compensated as such.    In addition to

petitioner, Stone Jessup employed 4 or 5 other individuals on a

full-time basis during that year.   As an employee of Stone

Jessup, petitioner was required to travel for various business-

related reasons and to entertain clients of Stone Jessup.     On

some occasions, Stone Jessup would directly pay for petitioner's

travel and client entertainment expenses.   On other occasions

petitioner would pay his own travel expenses and the expenses he

incurred in entertaining Stone Jessup's clients.    Stone Jessup

only paid petitioner's travel expenses and the client

entertainment expenses when corporate funds were available to do

so.   In prior years, Stone Jessup usually reimbursed petitioner

for expenses he incurred on its behalf.   Petitioner was not
                                - 4 -

reimbursed for all of the expenses he incurred in 1991 as an

employee of Stone Jessup because the corporation did not have

sufficient funds to do so.    As a director and officer of Stone

Jessup, petitioner had the authority to set corporate policy and

determine how corporate funds were spent.

     During 1991 petitioner incurred the following expenses in

connection with his employment with Stone Jessup:

            Vehicle                                 $2,673.06
            Parking fees, tolls, etc.                  270.00
            Travel                                   1,242.21
            Meals and entertainment                  2,603.23
            Workshops, forums                           90.86

Respondent disallowed petitioners' deduction attributable to the

above categories of expenses, explaining in the notice of

deficiency that "these expenses are not deductible because they

relate to the production of corporate income".

     In 1972, in connection with his practice of law as a sole

proprietor, petitioner arranged a revolving line of credit with

Walnut Valley State Bank of El Dorado, Kansas (the bank).    The

line of credit was used for payroll and other general operating

expenses incurred by petitioner in connection with his law

practice.    This line of credit was ultimately assumed and used by

Stone Jessup.    The bank required the line of credit to be secured

by accounts receivable and other assets of Stone Jessup, as well

as certain business assets owned and used by petitioner in

connection with his law practice.
                                - 5 -

     By December of 1987, Stone Jessup's debt to the bank

exceeded $400,000.   Notes evidencing the debt were due and had to

be paid or refinanced.   Because of Stone Jessup's financial

situation at the time, the bank was unwilling to renew Stone

Jessup's loans or grant the corporation further extensions of

credit unless:    (1) Petitioner assumed personal liability for any

existing or future debt by acting as a comaker with Stone Jessup

on various debt instruments; (2) petitioners agreed to

collateralize the debt by placing a mortgage on their residence

in favor of the bank; (3) certain stock owned by petitioner was

pledged to the bank; and (4) petitioner obtained, at his expense,

certain minimum levels of credit life insurance naming the bank

as beneficiary.   Beginning in 1988, Stone Jessup's and

petitioner's credit arrangements with the bank were restructured

in accordance with the above terms.

     On a Schedule A filed with their 1991 return, petitioners

claimed a miscellaneous itemized deduction in the amount of

$41,906.55 for interest payments made to the bank during that

year on account of loans made under the above-discussed credit

arrangements.    Of the amount deducted, $41,496.98 was "paid" to

the bank by notes co-made by Stone Jessup and petitioner (the

relevant notes were signed by petitioner, individually, and in

his capacity as president of Stone Jessup), and $409.57 was paid

directly to the bank on petitioner's behalf as a gift from

petitioner's father, who was a director of the bank.   In
                               - 6 -

addition, petitioner's father made a $10,521.57 interest payment

to the bank on petitioner's behalf, which payment forms the basis

for the additional interest deduction claimed by petitioners in

this case.   All of the interest involved with respect to the

interest deductions in dispute in this proceeding; i.e.

$52,428.12, is attributable to the indebtedness incurred by Stone

Jessup and petitioner pursuant to the above-described line of

credit with the bank.

     Respondent disallowed the interest deduction claimed as a

miscellaneous itemized deduction upon the ground that "a note

issued as 'payment' for interest is not the equivalent of cash".2

     During 1991, petitioners claimed deductions amounting to

$1,142.88 for the premiums paid for the credit life insurance

policies petitioner was required to obtain pursuant to the above-

discussed credit arrangement with the bank.   The bank was the

named beneficiary with respect to each of the relevant life

insurance policies.   Respondent disallowed the deductions,

explaining in the notice of deficiency that the "expense related

to the production of corporate income".

                              OPINION

Deductions for Interest


     2
      Respondent's explanation does not address the portion of
the interest expense deduction attributable to the payment of
interest by petitioner's father on petitioner's behalf. We
consider the different ways in which the interest was "paid" in
separate sections of this opinion.
                                - 7 -

1. Use of Notes To Satisfy Interest Liability

     Although limited elsewhere in the statute, in general,

section 163(a) permits a taxpayer to deduct "all interest paid or

accrued within the taxable year on indebtedness."   For cash basis

taxpayers, like petitioners, the interest must be paid in cash or

its equivalent.    Don E. Williams Co. v. Commissioner, 429 U.S.

569, 578-579 (1977); Eckert v. Burnet, 283 U.S. 140, 141 (1931);

Menz v. Commissioner, 80 T.C. 1174, 1185 (1983).    A promissory

note is generally not considered the equivalent of cash, but

merely a promise to pay.    Helvering v. Price, 309 U.S. 409, 413

(1940); Nat Harrison Associates, Inc. v. Commissioner, 42 T.C.

601, 624 (1964).   If the interest obligation is satisfied through

the issuance of notes to the same lender to whom the interest

obligation is owed, as in this case, there has been no payment of

interest; rather, payment has merely been postponed.    Davison v.

Commissioner, 107 T.C. 35 (1996).   Accordingly, petitioners,

being cash basis taxpayers, are not entitled to an interest

deduction for the interest obligations satisfied by the issuance

of notes to the bank because the interest has not been paid

within the meaning of section 163(a).3

2. Interest Paid to Bank by Petitioner's Father

     In 1991, petitioner's father made interest payments of

$409.57 and $10,521.57 to the bank on petitioner's behalf as


     3
      See infra note 4.
                                - 8 -

gifts to him.   The former payment was included in the

miscellaneous itemized interest deduction claimed on petitioners'

1991 return.    The latter payment is the basis for the additional

interest deduction petitioners are claiming in this proceeding.

     We have previously made reference to section 163(a), which

generally allows a deduction for all interest paid or accrued

within the taxable year.   However, section 163(a) is limited by

section 163(h)(1), which provides that in the case of a taxpayer

other than a corporation, no deduction shall be allowed for

personal interest.   Section 163(h)(2) defines personal interest

to include any interest other than interest which arises in

connection with five specified situations, none of which is

applicable to this case.

     Petitioners argue that the interest is attributable to

petitioner's trade or business, and we agree.     But petitioner's

trade or business during 1991 was as an employee of Stone Jessup;

consequently, the interest is considered personal interest.     Sec.

163(h)(2)(A).   No doubt in petitioner's view the distinction

between Stone Jessup's trade or business and his own is less

apparent than real. (For a discussion on this point see Souris v.

Commissioner, T.C. Memo. 1996-450.)      Nevertheless, petitioner

chose the form of business through which he pursued his

profession, and he is bound by the Federal income tax

consequences of his choice.   See Moline Properties, Inc. v.

Commissioner, 319 U.S. 436 (1943).      Accordingly, the interest
                                - 9 -

paid on petitioner's behalf by petitioner's father constitutes

nondeductible personal interest as that term is used in section

163(h)(1).4

     We have also considered, and reject, petitioners'

alternative argument that the interest deductions should be

allowed under the provisions of section 166.     That section

generally allows a deduction for any bad debt that becomes

worthless during the taxable year.      In order to be entitled to a

section 166 deduction, petitioners must establish that petitioner

was owed a bona fide debt by Stone Jessup on account of the

interest payments made, and that such debt became worthless in

1991.    Rule 142(a); Crown v. Commissioner, 77 T.C. 582, 598

(1981); Rude v. Commissioner, 48 T.C. 165, 172 (1967).      This they

have failed to do.   Even assuming that petitioner's status as a

comaker on the notes with Stone Jessup resulted in a debtor-

creditor relationship between the two because it was petitioner

rather than Stone Jessup who satisfied the obligations created by

the notes, there is nothing in the record to indicate that any

debt that would have resulted was worthless as of the close of

1991.    Accordingly, petitioners have not established that they

are entitled to a bad debt deduction pursuant to section 166 on

account of the interest payments made to the bank.


     4
      As an aside, we note that the provisions of sec. 163(h)(1)
also prohibit petitioners from deducting the interest paid by the
notes.
                               - 10 -

Employee Business Expense Deductions

     During 1991 petitioner paid the following expenses in

connection with his employment with Stone Jessup:

            Vehicle                                 $2,673.06
            Parking fees, tolls, other trans.          270.80
            Travel                                   1,242.21
            Meals and entertainment                  2,603.23
            Workshops, forums                           90.86

Petitioners argue that the expenses are deductible as employee

business expenses pursuant to section 162(a).

     In general, a taxpayer is entitled to deductions pursuant to

section 162(a) for all ordinary and necessary expenses paid or

incurred during the taxable year in carrying on a trade or

business.    The term "trade or business" as used in section 162(a)

includes the trade or business of being an employee.    Primuth v.

Commissioner, 54 T.C. 374, 377 (1970); Christensen v.

Commissioner, 17 T.C. 1456 (1952); Abraham v. Commissioner,

9 T.C. 222 (1947).    An expense is ordinary if it is considered to

be "normal, usual, or customary" in the context of the particular

business out of which it arose.    Deputy v. du Pont, 308 U.S. 488,

495 (1940).    An expense is necessary if it is appropriate and

helpful to the operation of the taxpayer's trade or business.

Commissioner v. Tellier, 383 U.S. 687, 689 (1966); Carbine v.

Commissioner, 83 T.C. 356, 363 (1984), affd. 777 F.2d 662 (11th

Cir. 1985).    Corporate officers, employees, and shareholders who

voluntarily incur corporate expenses are generally not entitled

to deductions for these expenditures because such expenditures
                                - 11 -

are not considered necessary.    Deputy v. du Pont, supra; Noland

v. Commissioner, 269 F.2d 108, 109 (4th Cir. 1959); Westerman v.

Commissioner, 55 T.C. 478, 482 (1970); Stolk v. Commissioner, 40

T.C. 345, 357 (1963), affd. 326 F.2d 760 (2d Cir. 1964); Jergens

v. Commissioner, 17 T.C. 806, 811 (1951); Harding v.

Commissioner, T.C. Memo. 1970-179.       Merely because an employer is

financially unable to reimburse an employee for expenses paid by

the employee on the employer's behalf does not necessarily

entitle the employee to a deduction.       Thomas v. Commissioner,

T.C. Memo. 1988-505.

     On the other hand, if, as a condition of employment, an

employee is required to incur expenses on behalf of his or her

employer, the employee is entitled to a deduction for those

expenses that are ordinary and necessary to his or her business

as an employee to the extent such expenses are not subject to

reimbursement.   Schmidlapp v. Commissioner, 96 F.2d 680 (2d Cir.

1938); Eder v. Commissioner, T.C. Memo. 1981-408.

     Respondent argues that the expenses do not constitute

ordinary and necessary employee business expenses within the

meaning of section 162(a) because petitioner, as a corporate

officer and employee of Stone Jessup, incurred the expenses

voluntarily and not because Stone Jessup required him to do so as

a condition of his employment.    We do not agree.

     As the only director and officer of Stone Jessup, it would

have been petitioner who would have established the conditions of
                              - 12 -

his own employment.   We find that as an officer and director of

Stone Jessup petitioner established the requisite corporate

policy that would allow him, as an employee of the corporation,

to deduct any unreimbursed employee business expenses he incurred

in connection with his employment.     See Theodore Souris, P.C. v.

Commissioner, T.C. Memo. 1996-450.     We therefore find that as a

condition of petitioner's employment with Stone Jessup he was

required personally to pay expenses that he incurred in

connection with such employment.   We further find that petitioner

was only entitled to reimbursement from Stone Jessup for such

expenses if Stone Jessup was financially able to do so, which

during the year in issue, was not the case.    Accordingly, we hold

that petitioners are entitled to a deduction for the employee

business expenses specifically listed above in this section of

the opinion.

Credit Life Insurance Premiums

     Pursuant to the previously discussed line of credit with the

bank, petitioner obtained several credit life insurance policies,

each naming the bank as beneficiary, and paid $1,142.88 in

premiums.   The manner in which petitioners deducted the expenses

for the premiums on their 1991 return, partly on a Form 2106 and

partly as a miscellaneous itemized deduction, leads us to

conclude that they rely upon section 162(a), section 212(2), or

both, in support of the deductions.    However, we need not

consider whether the deductions should be allowed under either of
                              - 13 -

those sections because of section 264(a)(1).    That section

disallows any deduction for life insurance premiums paid if the

insured is an employee, officer, or is otherwise financially

interested in the trade or business carried on by the taxpayer,

and is directly or indirectly a beneficiary under the policy.

Obviously, petitioner had a financial interest in his own trade

or business.   Furthermore he directly or indirectly was a

beneficiary of the policies, even though the bank was the named

beneficiary.   A taxpayer who is required, as a condition of

obtaining a loan, to purchase a life insurance policy which names

the creditor as beneficiary, is "directly or indirectly"

benefited within the meaning of section 264 and therefore

precluded by the operation of that section from deducting the

premiums under sections 162 or 212.    See Jefferson v. Helvering,

121 F.2d 16, 17 (D.C. Cir. 1941), affg. 40 B.T.A. 274 (1939);

Klein v. Commissioner, 84 F.2d 310 (7th Cir. 1936), affg. 31

B.T.A. 910 (1934); Rieck v. Heiner, 25 F.2d 453 (3d Cir. 1928);

Glassner v. Commissioner, 43 T.C. 713 (1965), affd. per curiam

360 F.2d 33 (3d Cir. 1966); Ragan v. Commissioner, T.C. Memo.

1980-94; King v. Commissioner, T.C. Memo. 1963-267.    Accordingly,

petitioners are not entitled to deductions for the premiums

petitioner paid to obtain the life insurance required in

connection with the loans from the bank.

     To reflect the foregoing,

                                           Decision will be entered
- 14 -

     under Rule 155.
