                          T.C. Memo. 2000-325



                        UNITED STATES TAX COURT



         R. GEORGE AND PENNEY GREGERSEN, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 18076-97.                   Filed October 19, 2000.


     John M. Bradley and Thomas R. Barton, for petitioners.

     Mark H. Howard, for respondent.



                MEMORANDUM FINDINGS OF FACT AND OPINION


     FOLEY, Judge:     By notice dated June 13, 1997, respondent

determined a deficiency of $18,504 and a section 6662 accuracy-

related penalty of $3,701 relating to petitioners’ 1994 Federal

income taxes.     All section references are to the Internal Revenue

Code in effect for the year in issue, and all Rule references are

to the Tax Court Rules of Practice and Procedure.
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     After concessions, the issues remaining for decision are

whether petitioners are:    (1) Entitled to a deduction for accrued

interest; (2) entitled to a net operating loss carryover; (3)

entitled to deductions claimed by petitioner’s wholly owned S

corporation; and (4) liable for accuracy-related penalties.

                           FINDINGS OF FACT

     When the petition was filed, petitioners resided in Salt

Lake City, Utah, where Mr. Gregersen has been engaged in the

newspaper publishing business for nearly 30 years.    In 1983, Mr.

Gregersen began operating and managing his weekly business

publication, the Enterprise Business Newspaper (EBN), through the

Enterprise Newspaper Group (ENG), his sole proprietorship.       On

July 10, 1987, Mr. Gregersen incorporated Enterprise Business

Newspaper, Inc. (EBNI), an S corporation, of which he was the

sole shareholder.

     Neuman Petty was a longtime personal friend and financial

backer of Mr. Gregersen.    They transacted business with each

other over numerous years through a variety of controlled

entities.   Because of their close personal and business

relationship, Mr. Petty readily and frequently advanced money to

Mr. Gregersen.   Mr. Petty and Mr. Gregersen generally did not

distinguish between themselves and their respective controlled

entities.   In addition to funds lent for other purposes, Mr.

Petty lent approximately $900,000 to finance the expansion of Mr.
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Gregersen’s newspaper businesses.    Mr. Petty subsequently wrote

off many of these loans as bad debts.

     On November 30, 1988, Mr. Gregersen executed a $386,000

promissory note (the note) in favor of Claims, Inc. Employee

Pension Benefit Plan Trust (trust).      Mr. Petty was trustee and

sole beneficiary of the trust.    The note consolidated several

outstanding loans between Mr. Petty and Mr. Gregersen, was

payable 60 days after demand, accrued interest at 18 percent, and

was secured by “All of the Stock of the Enterprise” (i.e., the

stock of EBNI).    EBN, ENG, and Mr. Gregersen signed the note.

Mr. Gregersen signed for EBN and ENG.      Both Mr. Petty and Mr.

Gregersen believed that the note would be paid from the proceeds

of Mr. Gregersen’s newspaper business.      The proceeds of the

consolidated loans were used to finance EBN’s operations.

     Mr. Gregersen, in 1989, transferred EBN, its assets, and its

liabilities from ENG to EBNI.     On July 30, 1992, EBNI filed for

bankruptcy protection under Chapter 11 of the Bankruptcy Code.

In the schedules accompanying the bankruptcy petition, Mr.

Gregersen listed a $115,000 obligation owed to Nupetco (Nupetco

loan) one of Mr. Petty’s wholly owned entities but did not list

the note.   The trust did not demand payment from any of the

signers.    From 1988 through 1994, Mr. Gregersen made one payment

of $1,000 (i.e., in 1994).

     Petitioners did not file tax returns for 1987 and 1988.        On
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their amended 1993 and their 1994 tax returns, petitioners

claimed a deduction for accrued interest relating to the note.

On their 1994 tax return, petitioners claimed an interest

deduction and a net operating loss carryover.     A portion of the

claimed carryover (i.e., $121,284) related to:     (1) Deductions

for accrued interest claimed on petitioners’ 1993 tax return; (2)

legal expense deductions, purportedly related to Mr. Gregersen’s

Schedule C business, claimed in 1990 through 1993; and (3) a net

operating loss carryover from 1989.     On their 1989 tax return,

petitioners reported a net operating loss, and petitioners did

not file a statement waiving carryback of this loss.     Petitioners

were accrual basis taxpayers during the years in issue.

                              OPINION

I.   Accrued Interest Deduction

     Respondent determined that, because EBNI was the primary

obligor and Mr. Gregersen merely a guarantor, petitioners are not

entitled to a deduction relating to accrued interest on the note.

Petitioners contend that Mr. Gregersen was the obligor and is

entitled to the related deductions.

     Section 163(a) allows as a deduction “all interest paid or

accrued within the taxable year on indebtedness.”     A guarantor

who becomes the primary obligor on the liability is entitled to

deduct accrued interest.   See Tolzman v. Commissioner, T.C. Memo.

1981-689.   In addition, a taxpayer no longer in business may take
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deductions that result from the operation of a trade or business

previously engaged in.    See Schwarcz v. Commissioner, 24 T.C.

733, 740 (1955).

     Mr. Gregersen and Mr. Petty testified that the parties

expected that Mr. Gregersen’s newspaper business would be

primarily responsible for paying the note.   See Union Bank v.

Swenson, 707 P.2d 663, 665 (Utah 1985) (stating that “parol

evidence is admissible to show the circumstances under which the

contract was made or the purpose for which the writing was

executed.”).   Mr. Petty further testified that he viewed Mr.

Gregersen as a guarantor.   At the time the note was executed

EBNI’s stock was collateral for the note.    Moreover, the assets

and liabilities relating to EBN were transferred to EBNI in 1989.

Thus, EBNI was EBN’s successor in interest to the note.   See

Macris & Associates, Inc. v. Neways, Inc., 986 P.2d 748, 752

(Utah Ct. App. 1999)(quoting Florom v. Elliot Manufacturing Co.,

867 F.2d 570, 575 n.2 (10th Cir. 1989)).

     The note was not listed on EBNI’s bankruptcy schedules, and

EBNI’s reorganization plan did not provide for payment of the

note.   Mr. Petty testified that he did not object to the omission

of the note because he knew that the other signers (i.e., Mr.

Gregersen) were liable.   On May 28, 1993, the U.S. Bankruptcy

Court for the District of Utah entered an order confirming EBNI’s

Chapter 11 reorganization plan.   This order confirming EBNI’s
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plan also discharged the note and other debts arising before

confirmation of the plan.    See 11 U.S.C. sec. 1141(c) (1994).    As

guarantor, Mr. Gregersen then became primarily liable for the

note’s payments.    Accordingly, petitioners are entitled to a

deduction for interest accrued after the date of confirmation of

the bankruptcy plan.

II.    Net Operating Loss Carryover

       Respondent determined petitioners were not entitled to a

deduction for the portion of the 1994 net operating loss

carryover resulting from the 1993 interest deduction, 1990

through 1993 legal expense deductions, and a 1989 net operating

loss carryover.    Petitioners were entitled to an accrued interest

deduction.    The legal expenses, however, did not relate to Mr.

Gregersen’s Schedule C business, and, because petitioners did not

file 1987 or 1988 returns, or elect to waive carryback of the

1989 loss pursuant to section 172(b)(3), they could not establish

a carryover from 1989.    Accordingly, petitioners are entitled to

a net operating loss relating to petitioners’ deduction of

interest accruing from May 28 through December 31, 1993, on the

note.

III.    S Corporation Deductions

       Respondent disallowed a portion of the 1994 interest

deductions claimed by EBNI.    Petitioners, as the sole

shareholders, were required to take into account all of EBNI’s
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items of income, loss, deduction, or credit.        See sec. 1366(a).

Petitioners presented no credible evidence relating to this

issue.   Accordingly, we sustain respondent’s adjustment of

petitioners’ 1994 income.

IV.   Accuracy-Related Penalty

      Respondent determined that petitioners were negligent in

determining their 1994 tax liability and are liable for a section

6662 penalty.   The penalty applies to the portion of petitioners’

underpayment that is attributable to negligence or disregard of

rules or regulations.   Sec. 6662(b)(1).       Petitioners did not make

a reasonable attempt to report accurately some of their

deductions.   As a result, petitioners are liable for the

accuracy-related penalty.

      Contentions we have not addressed are moot, irrelevant, or

meritless.

      To reflect the foregoing,


                                               Decision will be entered

                                          under Rule 155.
