                         T.C. Memo. 2010-17



                      UNITED STATES TAX COURT



  MARC VIANELLO AND MICHELLE MULLARKEY VIANELLO, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 15967-07.             Filed February 1, 2010.



     John A. Beam III and J. Matthew Sharp, for petitioners.

     Dennis R. Onnen, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     HAINES, Judge:   Respondent determined deficiencies in

petitioners’ Federal income taxes of $9,013 and $157,486 and

penalties under section 6662(a) of $1,803 and $31,497 for 2002

and 2003, respectively.1    The issues for decision are:   (1)


     1
      Unless otherwise indicated, section references are to the
                                                   (continued...)
                               -2-

Whether Mr. Vianello (petitioner) was in the trade or business of

farming; (2) Whether petitioner was in the trade or business of

acquiring loans; (3) whether a debt for which a bad debt

deduction was claimed in 2003 became worthless in that year; and

(4) whether petitioners are liable for accuracy-related penalties

under section 6662(a).

                         FINDINGS OF FACT

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

The stipulation of facts and the exhibits attached thereto are

incorporated herein by this reference.    At the time they filed

their petition, petitioners resided in Kansas.

Notice of Deficiency and Procedural Background

     On May 3, 2007, respondent issued a notice of deficiency to

petitioners determining deficiencies for 2002 and 2003 (years at

issue) of $9,013 and $157,486, respectively.2    Respondent also

determined penalties under section 6662(a) for 2002 and 2003 of

$1,803 and $31,497, respectively.    The dispute arises over the

disallowance of petitioners’ farm losses for 2002 and 2003 of

$34,741 and $134,941, respectively; business expense “loan


     1
      (...continued)
Internal Revenue Code as amended. Rule references are to the Tax
Court Rules of Practice and Procedure. Amounts are rounded to
the nearest dollar.
     2
      Petitioners’ 2002 joint Form 1040X, Amended U.S. Individual
Income Tax Return, was filed on July 23, 2004. Petitioners’ 2003
joint Form 1040, U.S. Individual Income Tax Return, was filed on
Aug. 3, 2004.
                                -3-

acquisition” losses for 2002 and 2003 of $18,723 and $302,007,

respectively; and a $269,622 bad debt deduction for 2003.

Personal Background

     Both Mr. and Ms. Vianello are certified public accountants

(C.P.A.s).   In 1997 petitioner formed Vianello & Leonard, L.L.C.,

(Vianello & Leonard), a two-member accounting firm that dissolved

in 2007.   Petitioner specializes in forensic accounting and was

heavily involved in the business of forensic consulting during

the years at issue, billing 911 hours in 2002 and 1,409 hours in

2003.   Ms. Vianello specializes in taxation and prepared

petitioners’ Federal income tax returns for the years at issue.

Ms. Vianello has been a CPA since 1980 and started her own

practice 25 years ago.

Conflicts With the DuPonts

     As a member of Vianello & Leonard, petitioner was hired by

Robert J. DuPont (Mr. DuPont) to serve as an expert witness.    Mr.

DuPont refused to pay the $75,000 he owed for petitioner’s

services, leading Vianello & Leonard to sue and obtain a judgment

against him that was later transferred to petitioner.   Mr.

DuPont’s nonpayment was the first dispute in a series of

conflicts between petitioner and the DuPonts that form the

factual basis for the action at hand.

     Although the DuPonts ultimately satisfied the Vianello &

Leonard judgment in 2001, petitioner wanted to put Mr. DuPont out
                                -4-

of business because he was a “crook”.   To that end, in December

2000 petitioner purchased another judgment (Dean judgment)

against the DuPonts from a third party and executed on it by

forcing a sheriff’s sale of the DuPonts’ residence and land at

22457 Mahogany Lane (Mahogany Lane property).   On July 26, 2001,

using the Marc Vianello Revocable Trust (trust), petitioner won

the bid on the Mahogany Lane property and subsequently filed an

action against the DuPonts for unlawful detainer and other relief

on account of the DuPonts’ frustration of petitioner’s attempts

to take possession of the property.

     The Mahogany Lane property was subject to a deed of trust

with a principal balance of $252,000 in favor of Bank of America

evidenced by a promissory note (note) executed by Mr. and Mrs.

DuPont.   After petitioner’s winning bid on the Mahogany Lane

property and subsequent receipt of the sheriff’s deed, Bank of

America accelerated the indebtedness, demanding payment in full.

In August 2001 petitioner formed Land Purchase of Jasper County,

L.L.C. (Jasper LLC), a single-member LLC funded with money

derived from a mortgage secured by petitioner’s residence and

cash.   On February 20, 2002, petitioner used Jasper LLC to

acquire the accelerated promissory note from Bank of America for

the unpaid principal balance of the note plus accrued interest

totaling $268,468.   Petitioner believed that without a separate

entity to hold the collateral, State law would cause the legal
                                -5-

title in the mortgage to merge into the equitable title he held

through the sheriff’s deed, essentially relieving Mr. DuPont of

liability under the promissory note.

     Intent on collecting from the DuPonts’ other assets, Jasper

LLC made a demand for payment and brought a collection action

against the DuPonts for breach of the note shortly after

acquiring it on February 20, 2002.    Despite the loss of the

Mahogany Lane property the DuPonts continued to own 10 guest

homes for the mentally impaired and were also receiving payments

from a second deed of trust on a commercial building they had

sold.

     On March 21, 2002, shortly after Jasper LLC purchased the

note from Bank of America, the Duponts formed a section 501(c)(3)

corporation, Joplin River of Life Ministries, Inc. (JROL).

Sometime thereafter, the DuPonts transferred five of the guest

homes to JROL and leased to JROL the remaining five guest homes

for $12,000 per month.3   During this time the DuPonts also

received an early discounted lump-sum payoff of a second deed of

trust from the buyer of the commercial building.

     On November 24, 2003, a final judgment was entered in favor

of Jasper LLC against the DuPonts, requiring them to pay

$369,793, including attorney’s fees of $28,531 and expenses.



     3
      Mr. DuPont was one of the two incorporators, and the
DuPonts were two of the initial six directors.
                                -6-

However, petitioners believed that the DuPonts’ transfer of the

guest homes to JROL and the lump-sum payoff of the commercial

building loan they had negotiated, in combination with Mr.

DuPont’s imprisonment for Medicare fraud with a projected release

date of September 28, 2004, reduced the value of the DuPonts’

remaining collectible assets.   Thus, petitioners claimed a bad

debt deduction for 2003 of $269,622 shortly after receiving the

favorable judgment.

Farming Activities

     The Mahogany Lane property consisted of 100 acres of higher

ground, containing pastures, woodlands, and the DuPonts’

residence; and 100 river-bottom acres planted in soybeans by

Charles Honey (Mr. Honey) pursuant to an oral agreement with Mr.

DuPont.   Under the agreement Mr. Honey was to deduct the cost of

chemicals and fertilizer from the total sale proceeds of the

soybeans and pay Mr. DuPont one-third of the net proceeds of the

sale.

     During the years at issue petitioner resided 150 miles from

the property and had never met Mr. Honey in person.   On July 26,

2001, petitioner contacted Mr. Honey by phone, and they orally

agreed to continue the same arrangement with respect to a soybean

crop in 2002 under the same terms that Mr. Honey had had with Mr.

DuPont.   Mr. Honey paid expenses with respect to the 2001 and

2002 soybean crops on the property, including the cost of seeds,
                                -7-

and provided the equipment and labor with some assistance from

his grandson.   Mr. Honey made all of the decisions with respect

to the crop, including what crop to plant, when to plant, what

equipment to use, when to spray for weeds, when to harvest, and

when and where to sell the soybeans.   After harvesting the

soybean crops in 2001 and 2002 Mr. Honey marked petitioner’s name

on the scale tickets to identify the origin of the crops, sold

the crops, and paid petitioner $775 and $1,162 for 2001 and 2002,

respectively.   The payments consisted of one-third of the net

proceeds after deducting the cost of chemicals to kill weeds and

grass.

     Petitioner’s farm-related activities for 2002 consisted of

having Mr. Haskell, his tenant who rented the pastureland and

barn, mow the nearby pastures and tend the fences.   Petitioner

also consulted with soil and horticultural experts, who advised

him to change from soybeans to Bermuda grass on the river-bottom

acres.   Unbeknownst to petitioner, while harvesting the October

2002 soybean crop Mr. Honey had planted wheat on the property

under the assumption that the oral agreement he had with

petitioner carried over into 2003.    A dispute arose between Mr.

Honey and petitioner with respect to whether Mr. Honey had

authority to plant the wheat, which led to a January 2003 letter

from petitioner demanding Mr. Honey stay off the property.

Petitioner subsequently chained the gate to the property and
                                -8-

filed a suit against Mr. Honey that was pending at the time of

trial of the instant case.   The wheat crop was never harvested.

     In January 2003, after learning of the wheat Mr. Honey

planted in October 2002, petitioner entered into a contract with

Joe McCoy (Mr. McCoy) to plant Bermuda grass on the river-bottom

property in 2003, but the planting did not occur.   In April 2003

petitioner also contacted Dennis Elbrader (Mr. Elbrader) about

planting Bermuda grass on the river-bottom property in 2003.    Mr.

Elbrader determined that because of the property’s wet condition,

the weeds, and the weather, it was unlikely that he could plant

Bermuda grass in 2003.   Petitioner did not tend to Mr. Honey’s

wheat crops, plant any crops on the Mahogany Lane property in

2003, or report any income on Schedule F, Profit or Loss From

Farming, for the year.   Petitioner eventually had the wheat

plowed under in the spring of 2004, shortly before the first

planting of Bermuda grass in June 2004.

     Petitioner purchased two tractors in 2002 and another

tractor and hay equipment on December 19, 2003.   Petitioner also

purchased an additional 50 acres from a neighbor for Bermuda

grass cultivation in December 2003.

Loan Acquisition and Collection Activities

     In December 2003, after receiving the $369,793 judgment on

the note acquired from Bank of America, Jasper LLC and petitioner

began negotiations with the DuPonts.   In a letter dated December
                                -9-

19, 2003, petitioner’s attorney contacted the attorney for the

DuPonts to determine their interest in setting up a payment

schedule.   In similar correspondence on January 5, 2004,

petitioner’s attorney confirmed petitioner’s interest in

collecting via payments and requested a payment schedule.      The

DuPonts’ attorney responded on January 14, 2004, stating that Mr.

DuPont suffered some heart trouble in January 2004.    No more than

2 weeks of recovery were anticipated.    In the light of the

circumstances, petitioner’s attorney advised him that further

collection efforts would be futile.

     Nevertheless, during 2004 petitioner and Jasper LLC began

efforts to collect on the judgment against the DuPonts.     Jasper

LLC issued three garnishment summonses to reach amounts owed by

JROL, the lessee of five of the guest homes, to the DuPonts.      The

summonses resulted in payments of $868 to Jasper LLC.    At the

time of the garnishments, petitioner did not know that the

DuPonts had retained ownership of any guest homes.    In August

2004 Jasper LLC’s garnishment summons upon U.S. Bank resulted in

a payment of $66.

     The DuPonts owned a personal residence purchased after

losing the Mahogany Lane property.    On July 28, 2004, petitioner

authorized his attorney to initiate a levy on the personal

residence of the DuPonts despite the existence of a first

mortgage, a tax lien, and a restitution lien of $120,100 in favor
                                 -10-

of the Federal Government arising out of Mr. DuPont’s conviction

for Medicare fraud.4   On September 27, 2004, the DuPonts filed a

chapter 11 bankruptcy petition 1 day before the scheduled

sheriff’s sale of their residence.      Jasper LLC filed a motion for

relief from the automatic stay or, in the alternative, adequate

protection on January 7, 2005.    The Bankruptcy Court granted

petitioner’s motion on January 26, 2005, and the DuPonts

subsequently filed a motion to dismiss their bankruptcy case on

February 1, 2005, that was granted on February 25, 2005.

     During the DuPonts’ bankruptcy proceeding, petitioners

learned that the DuPonts were still the owners of five of the

guest homes operated by JROL and that JROL had failed to report

lease payments owed to the DuPonts in the earlier garnishment

actions.   Once JROL’s intentional misrepresentation came to

light, Missouri State law permitted Jasper LLC to obtain a

judgment against JROL on March 11, 2005, for the amounts JROL

paid to the DuPonts; i.e., $108,000, plus attorney’s fees of

$7,467.

     On April 4, 2005, petitioner’s attorney sent a letter to Mr.

DuPont with an attached agreement to pay judgment and suspend

collection and release of garnishment (agreement).     The agreement

covered both the final judgment obtained by Jasper LLC against



     4
      These liens also covered the five guest homes the DuPonts
retained.
                                -11-

the DuPonts on November 24, 2003, on the promissory note acquired

from Bank of America, and the judgment obtained by Jasper LLC

against JROL in March 2005.   The parties entered into the

agreement, and the DuPonts made all scheduled payments in 2005

totaling $81,392 (i.e., $44,928 of attorney’s fees accrued after

December 31, 2003, and $36,464 of interest accrued on the

judgment), which petitioners reported in Schedule C, Profit or

Loss From Business, of their 2005 Form 1040.    The DuPonts made

payments for the first 11 months of 2006 totaling $44,568

(composed entirely of interest on the outstanding judgments), as

reflected in Schedule C of petitioners’ 2006 Form 1040.     Jasper

LLC recovered $126,894 on the final judgment it obtained against

the DuPonts, consisting of $934 received from garnishments in

2004, $81,392 in payments received in 2005 representing

attorney’s fees and interest, and $44,568 in interest received in

2006.   The payments made in 2004, 2005, and 2006 did not

represent recovery of the $369,793 principal amount but simply

attorney’s fees incurred by Jasper LLC and interest on the 2003

judgment.   These payments continued until November 28, 2006, when

a fire at JROL caused the death of 10 people.   Mr. DuPont was

again indicted for fraud, and the payments to petitioners ceased.

Accuracy-Related Penalties

     Ms. Vianello prepared petitioners’ 2002 and 2003 income tax

returns.    Before claiming the farm losses reported on Schedule F,
                               -12-

Ms. Vianello used Internal Revenue Service (IRS) Publication 225,

Farmer’s Tax Guide, as the basis for conducting an interview with

petitioner to conclude that he materially participated in the

farm trade or business.   In preparing Schedule C, Ms. Vianello

interviewed petitioner and determined that Jasper LLC was engaged

in the trade or business of acquiring and collecting the DuPonts’

debts.

                              OPINION

I.   Trade or Business of Farming

     Respondent determined that petitioner was not in the trade

or business of farming in 2002 and 2003 and thus could not claim

his depreciation and expenses as Schedule F deductions.

Petitioner argues he was in the trade or business of farming

since he purchased a farm and shared in its production with Mr.

Honey.   Petitioner further cites his involvement in major

management decisions and his risk of loss in the activity as

factors indicative of a trade or business.

     Deductions are strictly a matter of legislative grace, and

taxpayers must satisfy the specific requirements for any

deduction claimed.   See INDOPCO, Inc. v. Commissioner, 503 U.S.

79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435,

440 (1934).   Taxpayers bear the burden of substantiating the

amount and purpose of any claimed deduction.   See Hradesky v.
                               -13-

Commissioner, 65 T.C. 87 (1975), affd. 540 F.2d 821 (5th Cir.

1976).

     Under section 162(a) a taxpayer may deduct all ordinary and

necessary expenses paid or incurred during the taxable year in

carrying on any trade or business.    Although the term “trade or

business” is not precisely defined in section 162 or the

regulations promulgated thereunder, it is well established that

in order for an activity to be considered a taxpayer’s trade or

business for purposes relevant here, the activity must be

conducted “with continuity and regularity” and “the taxpayer’s

primary purpose for engaging in the activity must be for income

or profit.”   Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987);

Wittstruck v. Commissioner, 645 F.2d 618, 619 (8th Cir. 1981),

affg. T.C. Memo. 1980-62.   In addition, the taxpayer’s business

operations must have actually commenced.    Goodwin v.

Commissioner, 75 T.C. 424, 433 (1980), affd. without published

opinion 691 F.2d 490 (3d Cir. 1982).

     A.   Trade or Business of Farming in 2002

     Petitioner argues that he was in the trade or business of

farming because he claims he was involved in major farm

management decisions; provided and maintained fences, road

access, and security; and discussed row crop alternatives,

cockleburs, and Bermuda grass planting with Mr. Honey.     In

further support of his involvement in 2002, petitioner argues
                               -14-

that he purchased a farm and continued the agreement with Mr.

Honey, whereby each shared in the farm’s proceeds, with

petitioner treating it as income from the production of crops.

As proof of the arrangement petitioner cites Smith v. McNew, 381

S.W.2d 369 (Mo. Ct. App. 1964), which distinguishes a tenant’s

interest from that of a cropper, and offers a letter from the

U.S. Department of Agriculture (USDA) that states Mr. Honey and

petitioner’s revocable trust were producers and were actively

engaged in farming.

     Despite petitioner’s claimed involvement, Mr. Honey paid all

expenses with respect to the 2002 soybean crop, including the

costs of seeds and pesticides, and provided the equipment and

labor.   Mr. Honey also made all decisions with respect to the

crop, including what crop to plant, when to plant it, what

equipment to use, when to spray for weeds, when to harvest, and

when and where to sell the soybeans.   Moreover, the USDA

determination that Mr. Honey and petitioner’s revocable trust

were actively engaged in farming and were coproducers for USDA

purposes has no bearing on whether petitioner was engaged in such

a trade or business for purposes of section 162(a), nor does it

permit petitioner to impute Mr. Honey’s farming activities to

himself for such purposes.   It is clear to us that different

criteria are taken into account by the USDA in making such

determinations.   See A.B.C.D. Lands, Inc. v. Commissioner, 41
                               -15-

T.C. 840, 849 (1964); Hasbrouck v. Commissioner, T.C. Memo. 1998-

249, affd. without published opinion 189 F.3d 473 (9th Cir.

1999).5

     As further evidence of the existence of a trade or business,

petitioners claim they had a risk of loss with regard to the

crops since an unsuccessful harvest would decrease the income

from the property and leave petitioners responsible for

reimbursing Mr. Honey for his one-third share of the cost of the

chemicals.   However, it does not seem clear from the facts that

petitioners were responsible for any costs of chemicals and

fertilizer in the event of an unprofitable harvest as opposed to

Mr. Honey’s bearing the risk of his decisions’ failing to produce

a crop.   Petitioner did not provide equipment or labor and was

not involved in the planting, spraying, harvesting, or selling of



     5
      Petitioner cites Mizell v. Commissioner, T.C. Memo. 1995-
571, and Estate of Sherrod v. Commissioner, 82 T.C. 523 (1984),
revd. on another issue 774 F.2d 1057 (11th Cir. 1985), inviting
us to look beyond the agreement between petitioner and Mr. Honey
to find that petitioner materially participated and was engaged
in the trade or business of farming. We decline petitioner’s
invitation and note that the issue of material participation, as
it arose in those cases, is a factor that we consider in the
context of net earnings from self-employment under sec. 1402(a)
and/or special use valuation under sec. 2032A. Sec. 1402(a)
requires a lessor or owner to include rental income in net
earnings from self-employment if it is received from a farm in
which he materially participates. Furthermore, the regulations
under sec. 1402(a) make it clear that petitioner’s efforts do not
constitute production or the management of the production as
required to meet the material participation standard. See sec.
1.1402(a)-4(b), Income Tax Regs.
                                -16-

the crop.    Petitioner’s services in connection with production of

the crop in 2002 seemingly consisted of asking Mr. Haskell to mow

the grassy areas of petitioner’s adjacent pastures and tend the

fences.   Such services are not integrally related to the income-

producing activity of growing soybeans during the years at issue

inasmuch as Mr. Honey testified that he has never met Mr. Haskell

or petitioner.    Furthermore, petitioner resided 150 miles from

the property and was primarily engaged in the business of

forensic consulting, billing substantial hours during the years

at issue.    Thus, we hold that petitioners were not engaged in the

trade or business of farming in 2002.

     B.     Trade or Business of Farming in 2003

     During the 2002 harvest Mr. Honey planted wheat and was

informed in January 2003 that he was not permitted to enter the

property.    During 2003 petitioner did not tend to Mr. Honey’s

wheat crop or plant any crops of his own. Nor did he report any

income on Schedule F for the year.     Mr. Elbrader testified that

petitioners intended but were unable to plant in 2003 because the

property was covered by unharvested wheat and was also too wet

and muddy.    In December 2003 petitioner purchased 50 additional

acres from a neighbor.    On December 19, 2003, petitioner

purchased a tractor, a loader, a mower, and a baler for use with

Bermuda grass, despite the fact that it would not have been

possible to plant Bermuda grass on the property until spring 2004
                                -17-

at the earliest.    On the basis of the absence of farm-related

activities during 2003, we find that petitioner’s purchases of

the tractor and attachments were not ordinary and necessary

expenses incurred in connection with the trade or business of

farming in 2003.6

     Petitioner’s farm-related activities in 2002 and 2003 were

not sufficient to constitute a trade or business.    During 2003

petitioner did not plant, cultivate, or tend a crop of any kind,

and his farm-related activities were not continuous or regular.

Moreover, petitioner has not established that a trade or business

with respect to soybeans, Bermuda grass, or any other crop

commenced during the years at issue.    Finally, petitioner has

failed to show how the claimed Schedule C expenses would

constitute ordinary and necessary expenses of a farm trade or

business or that such expenses were not preproduction expenses

incurred in anticipation of a trade or business in farming.

Section 195, in effect for the years at issue, provides that no

deduction shall be allowed for startup expenditures, except that

a taxpayer may elect to treat such expenditures as deferred

expenses deductible over a period of not less than 60 months,

beginning with the month in which the active trade or business



     6
      Petitioner argues that 1 year of no sales of crops such as
occurred in 2003 should not remove him from the trade or business
of farming. However, petitioner was not regularly and actively
involved in farming activity until at least 2004.
                               -18-

begins.   Petitioners failed to make such an election for the

years at issue but later filed a “Protective Election to Amortize

Start-Up Expenses”, citing section 195(b), with their 2004

Federal income tax return.   For the above reasons, the Schedule F

depreciation and expenses petitioners claimed in 2002 and 2003

may not be deducted and must be capitalized.

II.   The Trade or Business of Loan Acquisition in 2002 and 2003

      Respondent determined that neither petitioner nor the solely

owned Jasper LLC was in the trade or business of loan acquisition

and thus could not claim Schedule C loss deductions for the years

2002 and 2003 of $18,723 and $302,007, respectively.7    Petitioners

assert that the Vianello & Leonard suit for nonpayment and the

subsequent judgment, the purchase of the Dean judgment, the suit

against the DuPonts for unlawful detainer, and the purchase of

the note from Bank of America constitute a trade or business of

engaging in profitable litigation against the DuPonts.

      These four actions do not constitute the type of activity

that rises to the level of a trade or business.   In Green v.

Commissioner, T.C. Memo. 2005-250, affd. 507 F.3d 857 (5th Cir.

2007), cited by petitioners, we rejected the taxpayer’s argument

that his repeated attempts to collect a judgment against the

State of Texas constituted a trade or business, stating:



      7
      Jasper LLC was a disregarded entity and did not make an
election to be treated as a corporation under the regulations.
                               -19-

          Though petitioner continuously and regularly
     engaged in the activity of attempting to recover his
     judgment between 1991 and 1995, we cannot conclude that
     petitioner was in a trade or business in the customary
     use of those terms. Petitioner did not perform
     services for others, he had no customers, and he was
     not in the business of trading securities or gambling
     on a regular and continuous basis. See id.
     [Commissioner v. Groetzinger] at 33-34. Petitioner’s
     asserted purpose was to secure the compensation to
     which he was entitled. Although a trade or business
     requires continuous and regular activity, continuity
     and regularity, do not, standing alone, constitute a
     trade or business. * * *

     Despite their claim, neither petitioners nor the LLC

performed services for others, had customers, or were in the

business of trading notes or loans.   Furthermore, there is no

evidence that petitioners ever considered the Vianello & Leonard

judgment or the suit for unlawful detainer to be part of a trade

or business.   Of the remaining actions, petitioners used Jasper

LLC to purchase the note from Bank of America to prevent merger

of title instead of purchasing the note themselves.    That action

establishes petitioners’ interest, not in establishing a trade or

business of acquiring loans, but in preserving the opportunity to

collect against other property owned by the DuPonts.   Thus,

petitioner’s four actions against the DuPonts do not establish

the continuous and regular activity needed to prove the existence

of a trade or business but highlight his attempts to “secure the

compensation to which he was entitled.” See id.

     Under such circumstances we find that petitioners have

failed to prove petitioner’s or Jasper LLC’s involvement in the
                                  -20-

trade or business of acquiring loans, the ongoing business of

collecting debts, or of farming during the years at issue.

Therefore, we disallow the disputed Schedule C deductions for the

years at issue.

III. Treatment of the Bad Debt Deduction

     Most of the $302,007 Schedule C loss petitioners claimed in

2003 consists of a claimed bad debt of $269,622 arising from the

worthlessness of the promissory note against the DuPonts Jasper

LLC acquired on February 20, 2002.       The issue we must address is

whether that debt became worthless in 2003.

     An individual taxpayer may deduct as a short-term capital

loss a nonbusiness debt that becomes wholly worthless during the

taxable year.     Sec. 166(d).   However, the taxpayer has the burden

of proving that he or she is entitled to any claimed deductions.

INDOPCO, Inc. v. Commissioner, 503 U.S. at 84.       Thus, petitioners

have the burden of proving that the $269,622 note became wholly
                                -21-

worthless in 2003.8   See Rule 142(a); Crown v. Commissioner, 77

T.C. 582, 598 (1981).

     There is no standard test or formula for determining

worthlessness, and the determination depends upon the particular

facts and circumstances of the case.     Lucas v. Am. Code Co., 280

U.S. 445, 449 (1930); Crown v. Commissioner, supra at 598.    A

taxpayer usually must show identifiable events to prove

worthlessness in the year claimed.     Crown v. Commissioner, supra;

Dallmeyer v. Commissioner, 14 T.C. 1282, 1291-1292 (1950).     The

taxpayer must demonstrate that the debt had value at the

beginning of the year in which the taxpayer claimed worthlessness

and that the debt became worthless in that year.     Am. Offshore,

Inc. v. Commissioner, 97 T.C. 579, 593 (1991); Dustin v.

Commissioner, 53 T.C. 491, 501 (1969), affd. 467 F.2d 47 (9th

Cir. 1972).



     8
      Petitioners argue that the burden of proof with respect to
the issue of worthlessness of the note should shift to respondent
pursuant to Rule 142(a)(1) on the grounds that it constitutes a
new matter. We disagree. In SDI Netherlands B.V. v.
Commissioner, 107 T.C. 161, 168 (1996) (quoting Zarin v.
Commissioner, 92 T.C. 1084 (1989), revd. on other grounds 916
F.2d 110 (3d Cir. 1990)), we stated that: “‘A new position taken
by respondent is not necessarily a “new matter” if it merely
clarifies or develops respondent’s original determination without
requiring the presentation of different evidence, being
inconsistent with respondent’s original determination, or
increasing the amount of the deficiency.’” Here, respondent has
not increased the deficiency, the issue of worthlessness is not
inconsistent with respondent’s original determination, the issue
does not require new evidence, and it develops respondent’s
original determination.
                                -22-

     Debts become wholly worthless when the taxpayer has no

reasonable expectation of repayment.     Crown v. Commissioner,

supra.    The worthlessness of the debt must be determined as of

the time the deduction is claimed.     Estate of Scofield v.

Commissioner, 266 F.2d 154, 163 (6th Cir. 1959), affg. in part

and revg. in part 25 T.C. 774 (1956).    However, subsequent events

may be considered to test the soundness of the decision.       Am.

Offshore, Inc. v. Commissioner, supra at 597.

     A.     Absence of an Identifiable Event Causing Worthlessness

     Petitioners contend the judgment became worthless during

2003 and subsequent collection attempts in 2004 were made to

confirm its worthlessness.    In characterizing the judgment as

worthless, petitioners point to the fact that the DuPonts

transferred their business assets to JROL and liquidated a second

mortgage on a commercial building, which were the targets of

petitioners’ collection action.    Petitioners note that Mr. DuPont

was incarcerated and, as part of his sentence, the Federal

Government obtained a restitution lien and Mr. DuPont was barred

from participating in any business associated with insured

healthcare benefits.    Petitioners further claim that Mr. DuPont

suffered a severe heart attack, that the IRS filed an NFTL

against the DuPonts’ property, and the DuPonts’ residence was

subject to a first mortgage.
                               -23-

     Despite their characterization of the facts, petitioners

failed to point to an identifiable event that demonstrated the

debt was worthless at the end of 2003.    Contrary to petitioners’

allegations, the DuPonts did not transfer all of their business

assets to JROL, and the substantial rental income the DuPonts

received from the five retained guest homes could continue

despite Mr. DuPont’s imprisonment.    Mr. DuPont’s imprisonment

does not establish that the debt was worthless, and petitioners

were aware of his indictment in January 2001 before they

purchased the Mahogany Lane property or acquired the note against

the DuPonts.   See Tower Loan of Miss., Inc. v. Commissioner, T.C.

Memo. 1996-152.   Nonetheless, petitioners made numerous attempts

to collect the judgment during Mr. DuPont’s imprisonment.

Furthermore, despite petitioner’s allegation that Mr. DuPont

suffered a severe heart attack, the record indicates that the

heart problem did not arise until January 2004 and that no more

than 2 weeks of recovery were anticipated.

     B.   Attempts at Settlement

     Respondent argues that the debt owed to petitioners was not

worthless at the end of 2003 and cites the parties’ postjudgment

settlement attempts as evidence of its perceived value.     The

judgment was not obtained until November 24, 2003, and in

December 2003 negotiations began between Jasper LLC and the

DuPonts to enter into a payment schedule to satisfy the judgment.
                                 -24-

The negotiations were ongoing as of December 31, 2003, and

continued into 2004 as evidenced by correspondence between the

attorneys for petitioners and the DuPonts.       We find that these

ongoing negotiations detail petitioners’ intention to continue

collection efforts into 2004 and beyond and highlight the absence

of an identifiable event showing worthlessness of the debt at the

end of 2003.

     C.      Payments Received on the Judgment

     Petitioners received $126,894 in payments from the DuPonts

on the judgment in the 3 years after 2003.       Petitioners argue

that the $934 collected through garnishments in 2004 was paltry

and inconsequential while the $81,392 received in 2005 and the

$44,568 in 2006 pursuant to the April 2005 agreement with the

DuPonts were related not to the 2003 judgment but the JROL

judgment from 2005.     The fact that a claimed bad debt is paid in

a subsequent year does not necessarily bar a deduction in a prior

year.     However, the fact that substantial payments were made in

2004 through 2006 further suggests that the debt held by Jasper

LLC against the DuPonts had value as of the end of 2003.       See

Buchanan v. United States, 87 F.3d 197 (7th Cir. 1996).

Moreover, the 2005 agreement between petitioners and the DuPonts

to pay the judgment and suspend collection clearly indicates that

the 2005 and 2006 payments were made in satisfaction of the
                               -25-

judgment against the DuPonts entered on November 23, 2004, and

the one against JROL entered on March 11, 2005.

     D.   Petitioners’ Subsequent Collection Efforts

     Respondent further emphasizes petitioners’ substantial

collection efforts in 2004 through 2006 to demonstrate the value

of the judgments to petitioners and Jasper LLC.   Beginning in

2002 Jasper LLC pursued the suit against the DuPonts on the note

for more than a year, incurring $28,531 in attorney’s fees and

expenses before being awarded a judgment on November 24, 2003.

Jasper LLC subsequently incurred legal fees and expenses of

$44,928 over the next few years, primarily in connection with the

attempted collection of the judgment.   On July 28, 2004,

petitioner authorized his attorney to initiate the costly process

of levying on the personal residence of the DuPonts to collect on

the judgment.   We are not persuaded that petitioners, through

Jasper LLC, incurred such substantial attorney’s fees and

expenses to obtain and collect on the judgment against the

DuPonts without any reasonable expectation of repayment.

     After carefully considering all the facts and circumstances,

we find that petitioners have failed to prove that the $269,622

nonbusiness debt became wholly worthless in 2003.   See sec.

166(d).   Petitioners failed to demonstrate an identifiable event

causing the debt to become worthless in 2003, their settlement

negotiations carried over beyond 2003, they ultimately recovered
                                   -26-

a significant amount on the judgment in the subsequent 3 years,

and they incurred extensive costs in attempting to collect.

Thus, we sustain respondent’s determination on this issue.9

IV.     Section 6662(a) Penalty

        Section 6662(a) and (b)(2) imposes a 20-percent accuracy-

related penalty on the portion of any underpayment that is

attributable to a substantial understatement of income tax.          An

understatement is substantial if it exceeds the greater of 10

percent of the tax required to be shown on the return or $5,000.

Sec. 6662(d)(1)(A).       The Commissioner bears the burden of

production with respect to penalties.       Sec. 7491(c); Higbee v.

Commissioner, 116 T.C. 438, 446-447 (2001).       Once the burden of

production is met, the taxpayer must come forward with evidence

sufficient to show that the penalty does not apply.       Higbee v.

Commissioner, supra at 447.

      According to our determinations above, the tax required to

be shown on petitioners’ return was $18,391 and $226,357 for 2002

and 2003, respectively.       Ten percent of the amount of tax

required to be shown in 2002 and 2003 is $1,839 and $22,635,

respectively.       Consequently, petitioners’ understatements are

substantial only if they exceeded $5,000 for 2002 and $22,635 for

2003.       Petitioners’ understatements for 2002 and 2003 were $9,013


        9
      Because of our holding herein, we do not address the
question of whether the debt involved was a business or
nonbusiness bad debt.
                                -27-

and $157,486, respectively.    Thus, respondent has satisfied his

burden of production by showing that petitioners’ understatements

of tax were substantial in both of the years at issue.

     Respondent determined petitioners are liable for accuracy-

related penalties under section 6662(a) of $1,803 and $31,497 for

2002 and 2003, respectively.   For purposes of determining the

accuracy-related penalty, the amount of the understatement is

reduced by the portion of the understatement that was

attributable to the tax treatment of an item where:    (1) The

taxpayer had substantial authority for his position; or (2) the

taxpayer adequately disclosed his or her position and has a

reasonable basis for such position.    Sec. 6662(d)(2)(B).

Petitioners argue that they had substantial authority for

claiming the deductions and that they made adequate disclosures

and had a reasonable basis for their position.    Respondent

disagrees.

     A.   Substantial Authority and Adequate Disclosure

     There is substantial authority for a specific tax treatment

only if the weight of the authorities supporting the treatment is

substantial in relation to the weight of those supporting

contrary treatment.   See sec. 1.6662-4(d)(3)(i), Income Tax Regs.

Moreover, the substantial authority standard is an objective one,

and the taxpayer’s belief that there is substantial authority for

the tax treatment of an item is not relevant.    Id.   Petitioners
                                 -28-

have not met this objective standard.     As we found above, the

cases petitioners cited are distinguishable and do not stand for

the proposition that the expenses petitioners incurred before

engaging in the trade or business of farming are deductible or

that Jasper LLC’s purchase of a single loan qualifies as a trade

or business for tax purposes.

     Petitioners argue that they adequately disclosed the

relevant information in a footnote to Schedule C and had a

reasonable basis for their position.     Adequate disclosure

generally requires the inclusion of Form 8275, Disclosure

Statement, with the return.     See sec. 1.6662-4(f), Income Tax

Regs.     Petitioners did not include that form.   Moreover,

reasonable basis “is a relatively high standard of tax reporting,

that is, significantly higher than not frivolous or not patently

improper.     The reasonable basis standard is not satisfied by a

return position that is merely arguable or that is merely a

colorable claim”.     Sec. 1.6662-3(b)(3), Income Tax Regs.    Thus,

we find petitioners did not have a reasonable basis for their tax

treatment.

     B.      Reasonable Cause and Good Faith

     The accuracy-related penalty is not imposed with respect to

any portion of the underpayment if the taxpayer can establish he

acted with reasonable cause and in good faith.      Sec. 6664(c)(1).

The determination of whether a taxpayer acted with reasonable
                                 -29-

cause and in good faith is made on a case-by-case basis, taking

into account all pertinent facts and circumstances, including the

extent of the taxpayer’s efforts to assess his or her proper tax

liability and the taxpayer’s education, knowledge, and

experience.    Sec. 1.6664-4(b)(1), Income Tax Regs.    The extent of

the taxpayer’s efforts to assess the proper tax liability is

generally the most important factor.     Id.

     Both petitioners were certified public accountants in 2002

and 2003.     The returns for the years at issue were prepared by

Ms. Vianello, who has been a CPA since 1980, who started her own

practice 25 years ago, and who is a tax specialist.       Despite this

background and her admitted lack of experience in farm matters,

there is no evidence that she did any research with respect to

the deductibility of the claimed Schedule F losses other than

consulting an IRS publication and related forms.       There is no

evidence that she did any research with respect to the claimed

Schedule C losses.     Rather, she merely interviewed petitioner to

assess the proper tax liability.     Petitioners have extensive

knowledge and experience in tax law but did not make a

significant effort to determine their eligibility for the claimed

losses under Schedule C or F or properly evaluate the facts

regarding the worthlessness of the DuPonts’ debt in 2003.       Under

the circumstances, petitioners have not shown they acted with

reasonable cause and good faith.
                                 -30-

     For the above reasons, we find petitioners are liable for

accuracy-related penalties under section 6662(a) of $1,803 and

$31,497 for 2002 and 2003, respectively.

     In reaching our holdings, we have considered all arguments

made, and, to the extent not mentioned, we conclude that they are

moot, irrelevant, or without merit.

     To reflect the foregoing,


                                          Decision will be entered for

                                        respondent.
