                          T.C. Memo. 2002-21



                        UNITED STATES TAX COURT



           GARRY D. ACUNCIUS AND DANALENE L. ACUNCIUS,
   Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 3752-00.              Filed January 22, 2002.


     Lawrence R. Jones, Jr., and Henry J. Lischer, Jr., for

petitioners.1

     James F. Prothro, for respondent.



                MEMORANDUM FINDINGS OF FACT AND OPINION

     VASQUEZ, Judge:     Respondent determined a $9,290 deficiency

and a $1,858 accuracy-related penalty pursuant to section 6662(a)




     1
        Petitioners were pro se during the trial and for the
opening brief.
                               - 2 -

with respect to petitioners’ Federal income tax for 1997.2

     The issues for decision are:   (1) Whether petitioners had

income from discharge of indebtedness of $32,000 in 1997;3 and

(2) whether petitioners are liable for an accuracy-related

penalty pursuant to section 6662(a) and (d)(1).

                         FINDINGS OF FACT

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

The stipulation of facts and the attached exhibits are

incorporated herein by this reference.   At the time they filed

their petition, petitioners resided in Cresson, Texas.

     On October 22, 1992, petitioners signed a promissory note

with BankTEXAS, N.A. (BankTEXAS), for a loan in the amount of

$32,000.   With regard to this loan, on March 26, 1992,

petitioners had signed a commercial security agreement with

BankTEXAS.   This agreement gave BankTEXAS a security interest in

the listed collateral, which included boats and horses.4

     Petitioners took out the loan in order to start a business,

Southwest Concepts, which consisted of an art gallery and a horse

training facility.   In 1992, because of problems with the



     2
        Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue.
     3
        Respondent conceded on brief the portion of the
adjustment attributable to the canceled commercial loan interest
in the amount of $14,395, pursuant to sec. 108(e)(2).
     4
        In 1993, petitioners sold the boats in violation of the
security agreement.
                                - 3 -

facility, a bank officer advised petitioners to move.

Petitioners moved and closed the business in 1992.    As a result,

petitioners lost their investment in the venture.

     When the business closed, petitioners returned the items

that artists had brought to the gallery on consignment and sold

other business assets at wholesale prices to pay off expenses.

In addition, petitioners sold their livestock at cost.   Mrs.

Acuncius took a job as office help in a furniture company at a

lower income than her income from Southwest Concepts, and Mr.

Acuncius was unable to find steady work.

     As a result, petitioners were unable to make payments on

their house.   Their house was foreclosed on in 1993 or 1994.

After the house was foreclosed on, petitioners moved in with

their daughter, then to an apartment in Granbury, Texas, and then

to a ranch in Oklahoma, where they worked as caretakers.   By

1997, petitioners were renting a modular home near Cresson,

Texas.   Petitioners did not have their mail forwarded each time

they moved.

     On April 15, 1993, BankTEXAS sent petitioners a notice that

the note of $32,000 would be due on April 20, 1993.   Petitioners

did not receive this notice because they were no longer residing

at the address on the notice.   BankTEXAS continued to mail

notices to petitioners at its address of record--the address on

the loan application.
                               - 4 -

     Prior to 1997, BankTEXAS made efforts to collect the loan

from petitioners by renewing the note several times, making the

repayment structure easier, collecting interest only, and

unsuccessfully attempting to collect the collateral.    On April

20, 1997, BankTEXAS deemed the loan to be uncollectible and

discharged the loan in the amount of $32,000 and $14,395 in

accrued interest.   Thereafter, BankTEXAS reported the debt

forgiven to the Internal Revenue Service on a Form 1099-C for

1997.

     During 1997, Mrs. Acuncius was an art teacher in a public

school and Mr. Acuncius was a horse trainer.     In addition, Mrs.

Acuncius pursued a Master’s degree in education, and Mr. Acuncius

pursued a Master’s degree in agricultural development in the hope

of increasing their earning potential and obtaining better jobs.

In 1997, petitioners owned the following assets:

        Asset                                  Value

     Livestock                             Less than $5,000
     1979 Jeep                             500
     1986 Ford truck                       500
     Household goods                       1,000 to 1,500
     Jewelry                               Less than 1,000

In 1997, petitioners owed the following liabilities:

     Liability                                            Amount

     BankTEXAS loan                                      $32,000
     Accrued interest on loan                             14,396
     Teaching certification                                4,000
     Master’s degree student loan:     Mrs. Acuncius       8,751
     Master’s degree student loan:     Mr. Acuncius       17,269
     1991 Income taxes                                       700
                                - 5 -

     1992 Income taxes                                     2,000
     1994 Income taxes                                     5,000

     Respondent determined that petitioners were liable for

income from discharge of indebtedness of $32,000 in 1997 and an

accuracy-related penalty of $1,858 due to a substantial

understatement of tax.    When petitioners received the notice of

deficiency, this was the first time that they were aware that the

loan had been discharged in 1997 because they had not received

any of the notices from BankTEXAS.

                               OPINION

I.   Income from the Discharge of Indebtedness

     A.     Burden of Proof

     Section 7491 applies to this case because the examination in

this case began after July 22, 1998.     Internal Revenue Service

Restructuring & Reform Act of 1998, Pub. L. 105-206, sec.

3001(c), 112 Stat. 685, 727.    We do not find, however, that the

resolution of this case depends on which party has the burden of

proof.    We resolve the issue on the basis of a preponderance of

evidence in the record.    Assuming arguendo that petitioners do

have the burden of proof under section 7491, we still conclude,

on the basis of evidence in the record, that petitioners

recognized no discharge of indebtedness income with regard to the

BankTEXAS loan in 1997.
                                - 6 -

B.   Did the Insolvency Exception Apply in 1997?

     Petitioners concede that BankTEXAS forgave their loan of

$32,000 in 1997.    The parties agree that resolution of the issue

as to whether petitioners must include this income in 1997

depends on whether, immediately before BankTEXAS forgave their

loan on April 20, 1997, petitioners were insolvent within the

meaning of sections 108(a)(1)(B) and (d)(3) (insolvency

exception).

     Petitioners contend that the evidence demonstrates that

their liabilities exceeded the fair market value (FMV) of their

assets in 1997.    Additionally, petitioners argue that further

evidence, such as the foreclosure on their house and BankTEXAS’s

unsuccessful attempts to collect on the loan, support a

conclusion that they were insolvent.    Respondent argues that

petitioners were not insolvent and that section 108(a)(1)(B) does

not apply.    Respondent contends that petitioners’ proof of the

FMV of their assets in 1997 was “incomplete and highly

questionable” because it was based on petitioners’ memory.

     Section 61(a) defines the term “gross income” broadly to

mean all income from whatever source derived, including income

from discharge of indebtedness.    Sec. 61(a)(12).   Section 108(a)

provides certain exceptions to section 61(a)(12).    See Gitlitz v.

Commissioner, 531 U.S. 206, 213 (2001).    Section 108(a)(1)(B)

excludes from gross income any amount that otherwise would be
                                - 7 -

includable in gross income by reason of the discharge of

indebtedness of the taxpayer if the discharge occurs when the

taxpayer is insolvent.    The amount of this income excluded under

section 108(a)(1)(B) is not to exceed the amount by which the

taxpayer is insolvent.    Sec. 108(a)(3).   The term “insolvent” is

defined in section 108(d)(3) as:

          Insolvent.--For purposes of this section, the term
     “insolvent” means the excess of liabilities over the
     fair market value of assets. With respect to any
     discharge, whether or not the taxpayer is insolvent,
     and the amount by which the taxpayer is insolvent,
     shall be determined on the basis of the taxpayer’s
     assets and liabilities immediately before the
     discharge.

A taxpayer claiming the benefit of the insolvency exception must

prove:    (1) With respect to any obligation claimed to be a

liability, that, as of the calculation date, it is more probable

than not that he will be called upon to pay that obligation in

the amount claimed; and (2) that the total liabilities so proved

exceed the FMV of his assets.    Merkel v. Commissioner, 109 T.C.

463, 484 (1997), affd. 192 F.3d 844 (9th Cir. 1999).

     We note section 108(e)(1) provides that, “there shall be no

insolvency exception from the general rule that gross income

includes income from the discharge of indebtedness” except as

provided in section 108, eliminating any judicially created

exceptions to the general rule of income from discharge of

indebtedness.    See Carlson v. Commissioner, 116 T.C. 87, 100

(2001).
                                 - 8 -

      Petitioners relied upon their oral testimony as evidence of

the FMV of assets owned and liabilities owed in 1997 immediately

prior to the discharge.   Having observed petitioners’ appearances

and demeanors at trial, we find their testimony to be honest,

forthright, and credible.   Based upon this testimony, we find

that petitioners owned approximately $8,500 in assets and owed

$84,116 in liabilities.   See Diaz v. Commissioner, 58 T.C. 560,

565 (1972) (basing analysis upon evaluation of the entire record

and credibility of witnesses).    Based on the entire record, we

find that petitioners’ liabilities exceeded the FMV of their

assets when their loan was discharged to such an extent that no

discharge of indebtedness income is recognized.

II.   Accuracy-Related Tax Penalty

      Respondent determined that petitioners are liable for the

accuracy-related penalty under section 6662(a) due to a

substantial understatement of tax.       Section 6662(a) imposes a

penalty in the amount of 20 percent on the portion of the

underpayment to which the section applies.       Relevant to this

case, the penalty applies to any portion of the underpayment that

is attributable to any substantial understatement of tax under

section 6662(b)(2).   As outlined in the above discussion, we hold

that petitioners did not have $32,000 of income from discharge of

indebtedness.   Accordingly, we find that no understatement of tax
                                 - 9 -

occurred.   We hold, therefore, that petitioners are not liable

for the accuracy-related penalty.

     In reaching our holdings herein, we have considered all

arguments made, and to the extent not mentioned above, we find

them to be moot, irrelevant, or without merit.

     To reflect the foregoing,

                                              Decision will be

                                         entered for petitioners.
