                        T.C. Memo. 2007-105



                      UNITED STATES TAX COURT



 IN TOUCH PROPERTIES, LLC, DAVID ENGLAND, TAX MATTERS PARTNER,
                         Petitioner v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent.



     Docket No. 9809-05.              Filed April 30, 2007.



     Eugene P. de Verges, for petitioner.

     Gary L. Bloom, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION



     MARVEL, Judge:   Respondent issued a Notice of Final

Partnership Administrative Adjustment (FPAA) for 2000 pursuant to
                                -2-

section 62231 to the Tax Matters Partner (TMP) of In Touch

Properties, LLC (In Touch), a limited liability company

classified as a partnership for Federal income tax purposes.2      In

the FPAA, respondent disallowed deductions claimed by In Touch

for professional fees, marketing expenses, consulting fees, and

amortized startup expenditures; determined that the members’ at-

risk amount under section 465 must be reduced by $176,818;

determined that the total capital contributed to In Touch as of

December 31, 2000, was $50,000; and determined that a

computational adjustment to net earnings (loss) from self-

employment must be made.   A petition for a readjustment of

partnership items was filed on behalf of In Touch.    Because the

petition did not identify a TMP or reflect that it was filed by

the TMP, we ordered In Touch to identify its TMP.    On June 13,

2005, we received and filed a Notice of Identification of Tax

Matters Partner, which identified David England as the TMP.     We


     1
       Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable year in
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
     2
       Although In Touch had fewer than 10 members during 2000,
it did not meet the definition of a small partnership under sec.
6231(a)(1)(B) because one of its members was a passthrough
entity. See sec. 6231(a)(1)(B)(i); sec. 301.6231(a)(1)-1(a)(2),
Proced. & Admin. Regs. Consequently, In Touch is an entity
subject to the partnership audit and litigation procedures of
secs. 6221-6231.
                               -3-

shall refer to Mr. England in his capacity as In Touch’s TMP as

petitioner.

     The parties tried and briefed the following issues:

     (1) Whether consulting fees, marketing expenses,

professional fees, and startup expenditures claimed by In Touch

on its 2000 return were properly accrued in 2000 and/or

adequately substantiated;

     (2) whether promissory notes contributed to In Touch by

its members are properly included in calculating the members’

bases in In Touch; and

     (3) whether promissory notes contributed to In Touch by its

members are properly included in calculating each member’s at-

risk amount under section 465(a).

     For reasons explained, infra, we decide only issue (1) in

this opinion.

                         FINDINGS OF FACT

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

The stipulations of the parties are incorporated herein by this

reference.

Background

     In Touch is an Oklahoma limited liability company (LLC) that

was organized and formed by Lloyd Gilbert, Mark Hanna, and David
                                 -4-

England on January 6, 2000.3    In Touch’s stated business

objective is to create, protect, and develop the value of

licensing agreements associated with the “ALPHA Critters”.    The

ALPHA Critters are cartoon characters of each letter of the

alphabet designed to provide parents and educators a unique and

entertaining alternative to the traditional methods of teaching

children how to read.   In Touch commenced the active conduct of

its business on June 1, 2000.    At all relevant times, In Touch

used the accrual method of accounting for Federal income tax

purposes.

     In Touch timely filed its 2000 Form 1065, U.S. Return of

Partnership Income, in October 2001, pursuant to two extensions

of time to file.   On its return, In Touch claimed deductions

totaling $277,560, including $160,000 for consulting fees,

$22,990 for marketing expenses, $59,615 for professional fees,

and a $15,711 amortization deduction.4    In Touch’s 2000 Form 1065




     3
       Its principal place of business was in Tulsa, Okla., when
the petition in this case was filed.
     4
       In Touch elected, under sec. 195(b), to amortize startup
expenditures totaling $134,664 for a period of 60 months
beginning in June 2000. The startup expenditures that In Touch
claimed on its 2000 partnership return consisted of marketing
expenses of $17,423, rent of $15,000, printing costs of $111,
bank charges of $20, meals and entertainment of $277, and
consulting fees of $101,833.
                                 -5-

showed a net loss of $276,560,5 which was allocated to its

members as follows:

                Partner                     Share of loss

           Lloyd Gilbert                       $30,000
           David England                       121,560
           Mark Hanna                            -0-
           Jim Coates                           25,000
           Abraham Joseph                       50,000
           Reebud Resources                     50,000
             Total                             276,560

Disputed Adjustments

     On July 24, 2002, respondent commenced an examination of In

Touch’s 2000 partnership return by mailing both an appointment

letter and an Information Document Request (IDR) to petitioner.

On September 9, 2002, respondent issued a second IDR to

petitioner.    Among other things, the IDRs requested documentation

to substantiate the consulting fees, marketing expenses,

professional fees, and startup expenditures claimed on In Touch’s

2000 return.

     With respect to the consulting fees, respondent requested

invoices and other documentation substantiating payment dates and

detailing the services provided to In Touch.   In response, In

Touch produced Letters of Understanding (Letters) dated November

10, 2000, with respect to Beverly Stool, Jeff Giddings, and Gene


     5
       In Touch reported total income of $1,000 and total
deductions of $277,560 on its 2000 partnership return.
                                 -6-

Longcrier (the consultants).    The Letters were not signed by the

consultants.6    The Letters purported to summarize the terms of a

consulting/employment arrangement with In Touch, including the

amount of compensation and benefits to be paid to the

consultants.    Each Letter contained the following statement:

“Payments will be deferred until adequate funding can be

obtained.”7    In Touch provided no other documents to respondent

to substantiate the consulting fees claimed as ordinary and

necessary business expenses and/or as startup expenditures.

     With respect to marketing expenses, respondent requested

receipts and invoices, the business purpose of these expenses,

and proof of payment.    The only documentation produced by

In Touch in response to this request was a typed list of expenses

without any accompanying receipts or invoices.

     With respect to professional fees, respondent requested

detailed invoices for professional services rendered, the dates

of service, and canceled checks or receipts to prove payment.       In

Touch submitted typed summaries of the professional fees that

failed to list the date and type of services provided.


     6
       The record contains no evidence that the Letters were ever
delivered to the consultants.
     7
       As of the trial date, In Touch had not paid the consulting
fees it accrued as deductible expenses and/or startup
expenditures.
                                -7-

     On March 7, 2005, respondent sent petitioner an FPAA

determining adjustments to the above expenses.   In the FPAA,

respondent determined that In Touch had overstated its deductions

for consulting fees, marketing expenses, professional fees, and

amortization.8   Respondent also determined that the at-risk

amounts of In Touch’s members must be reduced and that the

capital contributed by In Touch’s members as of December 31,

2000, was $50,000.

Tax Court Litigation

     On May 27, 2005, petitioner filed his petition for

readjustment of partnership items.    A trial was held in Oklahoma

City, Oklahoma, on March 9, 2006.

     Petitioner, who was a member of In Touch during 2000, was

the only witness who testified at trial on In Touch’s behalf.

Petitioner, over respondent’s objection, attempted to introduce

copies of seven promissory notes, each dated December 31, 2000.9

The promissory notes were as follows:




     8
       Respondent allowed In Touch’s startup costs of $11,408,
consisting of meals and entertainment of $277, bank charges of
$20, printing costs of $111, and rent of $11,000. Respondent
recomputed In Touch’s allowable amortization expense deduction
for 2000 ($11,408 x 7/60 = $1,331).
     9
       Petitioner also introduced a promissory note (Exh. 17-P)
that he had executed in favor of In Touch. Respondent did not
object to this exhibit.
                                  -8-

  Exhibit No.         Obligor              Obligee            Amount

      12-P         In Touch             Beverly Stool      $80,000
      13-P         In Touch             Jeff Giddings       60,000
      14-P         In Touch             Gene Longcrier      48,000
      15-P         In Touch             Curzon, Cumbey      33,615
      16-P         In Touch             Eugene de Verges    15,000
      18-P         Lloyd Gilbert        In Touch            30,000
      19-P         James Coates         In Touch            25,000

     Although we initially deferred ruling on the admissibility

of the promissory notes, respondent’s counsel withdrew his

objection to Exhibits 12-P, 13-P, and 14-P after he introduced

the original promissory notes as Exhibits 22-R, 21-R, and 20-R,

respectively.   In his posttrial brief, respondent conceded that,

under Federal Rule of Evidence 901(a), petitioner properly

authenticated the remaining promissory notes containing the

signatures of James Coates and Lloyd Gilbert.    Consequently, we

admit Exhibits 15-P, 16-P, 18-P, and 19-P.

     Petitioner introduced three of the promissory notes,

Exhibits 12-P, 13-P, and 14-P, to substantiate the consulting

fees deducted and amortized as startup costs on In Touch’s 2000

return and in support of his contention that the fees in question

were properly accrued in 2000.    However, petitioner never

delivered the promissory notes to the consultants and did not

introduce any evidence to describe the dates, nature, and amounts

of the services allegedly provided by the three consultants who

were the obligees of the notes.
                                 -9-

     Petitioner introduced two promissory notes, Exhibits 15-P

and 16-P, to substantiate the professional fees deducted on In

Touch’s 2000 return and in support of his contention that the

fees in question were properly accrued and deducted in 2000.

However, petitioner did not introduce any evidence to describe

the dates, nature, and amount of the services allegedly provided

by the obligees of the promissory notes.

     Petitioner introduced three promissory notes, Exhibits 17-P,

18-P, and 19-P, to substantiate alleged additional capital

contributions and at-risk amounts by three of In Touch’s members:

petitioner, Lloyd Gilbert, and James Coates.    The total principal

amount of the three notes coincides precisely with the three

members’ distributive shares of the net loss claimed by In Touch

on its 2000 return.    Petitioner testified that he executed his

note on December 31, 2000, as a guaranty of In Touch’s

obligations to the consultants and professionals to whom In Touch

allegedly owed payment as of December 31, 2000.    However,

petitioner did not introduce any evidence regarding the purpose

of the Gilbert and Coates promissory notes.

                               OPINION

I.   Burden of Proof

     The Commissioner’s determinations are generally presumed to

be correct, and the taxpayer must prove by a preponderance of
                               -10-

evidence that those determinations are erroneous.    Rule

142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933).

However, a taxpayer can shift the burden of proof to the

Commissioner under section 7491(a) if the taxpayer satisfies the

requirements of section 7491(a)(2).10

      Because the record does not support a finding that In Touch

or its TMP maintained required records and substantiated the

items claimed on its 2000 return, we conclude that petitioner did

not satisfy the requirements of section 7491(a).    Therefore, the

burden of proof remains with petitioner on all issues.

II.   Accrual of Consulting Fees

      Section 461(a) states that a deduction must be taken in the

proper taxable year under the taxpayer’s method of accounting.

Accrual method taxpayers generally become entitled to a deduction

when all the events have occurred to establish the fact of the

liability and the amount of such liability can be determined with

reasonable accuracy.   Sec. 461(h)(4); sec. 1.461-1(a)(2), Income

Tax Regs.   To be properly accruable under the “all events test”,



      10
       Under sec. 7491(a)(2), a taxpayer must prove: (1) The
taxpayer has complied with the Code’s substantiation
requirements; (2) the taxpayer has maintained all required
records; and (3) the taxpayer has cooperated with reasonable
requests by the Commissioner for witnesses, information,
documents, meetings, and interviews.
                               -11-

(1) a liability must be binding and enforceable, (2) the

liability must not be contingent on a future event, (3) the

liability must be certain as to amount, and (4) the debtor must

have a reasonable belief that the liability will be paid.        United

Control Corp. v. Commissioner, 38 T.C. 957, 967 (1962).     In

addition, section 461(h)(1) provides that in determining whether

an amount has been incurred with respect to any item during a

taxable year, “the all events test shall not be treated as met

any earlier than when economic performance with respect to such

item occurs.”   See also Restore, Inc. v. Commissioner, T.C. Memo.

1997-571 n.5, affd. without published opinion 174 F.3d 203 (11th

Cir. 1999).

     Respondent argues that the consulting fees deducted by In

Touch as business expenses and/or included as startup

expenditures in calculating its amortization deduction were not

properly accruable because a contingency existed as to their

payment.   In Putoma Corp. v. Commissioner, 66 T.C. 652, 659-663

(1976), affd. 601 F.2d 734 (5th Cir. 1979), a corporation’s

obligation to pay compensation to its shareholder-employees was

not properly accruable because payment of the salaries depended

upon the future profits of the company.   The obligation to pay

salaries was not fixed since payment was contingent on the

availability of funds.   Id. at 663.
                               -12-

     Petitioner acknowledges that the Letters defer payment until

adequate funding can be obtained.     Petitioner argues, however,

that the Letters represent only outlines of employment contracts

that In Touch might execute in the future and do not represent a

complete statement of the rights and obligations between the

consultants and In Touch.   Moreover, petitioner contends that the

Letters do not refer to any consulting work performed before the

finalization of an employment agreement and that no contingency

or deferral exists as to liabilities due for past services.

Petitioner argues that the consultants invoiced In Touch for the

services they rendered, and In Touch responded by issuing

promissory notes as payment.   These notes, petitioner believes,

clearly reflect that the amounts claimed are fixed and

immediately payable.

     Petitioner’s arguments are not supported by the record.    In

Touch did not have the necessary funds to pay the consultants.

According to the only consultant who testified at trial, a

representative of In Touch told him that he would be paid once In

Touch was financially capable of doing so.    In reliance on this

statement, the consultant did not send any invoices to In Touch

for the service he rendered.   The consultant also testified that

he did not receive the executed original of In Touch’s promissory
                               -13-

note, which allegedly was executed to guarantee payment of the

consultant’s fees.

     The record supports an inference that none of the promissory

notes allegedly executed on behalf of In Touch in favor of the

consultants was ever delivered to the consultants.   Petitioner

produced the original promissory notes in response to a subpoena

duces tecum issued by respondent before trial.   It is reasonable

to conclude from the fact that petitioner had the original

promissory notes in his possession that the original promissory

notes allegedly executed for the benefit of the consultants were

never delivered to the consultants.   Under Oklahoma State law,

delivery is an essential element to complete the legal transfer

of a negotiable instrument such as a promissory note.   Harber v.

Lincoln, 51 P.2d 967, 969 (Okla. 1935).11   Because petitioner

failed to prove that In Touch delivered the promissory notes to

their intended recipients, petitioner has failed to prove that




     11
       Both execution and delivery are prerequisites to the
validity of a note. Luker v. Kells, 411 P.2d 511, 515 (Okla.
1966). Under Oklahoma law, the issuance of an instrument is
defined as “the first delivery of an instrument by the maker or
drawer, whether to a holder or nonholder, for the purpose of
giving rights on the instrument to any person.” Okla. Stat. Ann.
tit. 12A, sec. 3-105(a) (West 1998). Delivery is deemed to occur
upon a “voluntary transfer of possession.” Okla. Stat. Ann. tit.
12A, sec. 1-201(14) (West 2004).
                                -14-

the promissory notes were valid negotiable instruments under

State law.

       Finally, petitioner failed to produce credible evidence to

prove the nature and extent of the consulting services provided

to In Touch during 2000 or to prove that the economic performance

requirement of section 461(h)(1) was satisfied with respect to

the consulting fees claimed by In Touch on its 2000 return.

Consequently, we hold that petitioner failed to demonstrate that

respondent’s disallowance of In Touch’s claimed consulting fees

was erroneous, and we sustain respondent’s determination.

III.    Substantiation of Expenses

       Deductions are a matter of legislative grace, and the

taxpayer must clearly demonstrate entitlement to any deductions

claimed.    INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992).

A taxpayer is obligated to keep records sufficient to allow the

Commissioner to establish the correct amount of the taxpayer’s

deductions.    Sec. 6001; sec. 1.6001-1(a), Income Tax Regs.    A

taxpayer must produce those records upon request for inspection

by authorized internal revenue officers or employees.    Sec.

7602(a); sec. 1.6001-1(e), Income Tax Regs.    If upon examination

the Commissioner disallows a business expense deduction, the

taxpayer bears the burden of introducing evidence to substantiate

the claimed deduction.    Rule 142(a); see also Wilson v.
                                 -15-

Commissioner, T.C. Memo. 2001-301; Joseph v. Commissioner, T.C.

Memo. 1997-447.    If the taxpayer claims a deduction but cannot

fully substantiate it, we may estimate the allowable amount if

there is sufficient evidence in the record to provide a basis for

the estimate.     Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d

Cir. 1930); see also Vanicek v. Commissioner, 85 T.C. 731, 742-

743 (1985).

     Petitioner failed to substantiate the business expenses and

startup expenditures disallowed by respondent.    At trial,

petitioner introduced only a brief summary of expenses and two

promissory notes purportedly issued as payment for professional

services.   None of those documents established the dates,

description, or business purpose of the expenses.    The evidence

offered was completely inadequate to substantiate petitioner’s

claimed expenses as required by section 6001 and related

regulations.

     The complete absence of credible evidence in the record also

precludes us from estimating petitioner’s expenses under Cohan.

Petitioner did not offer testimony or documents to describe the

nature and amount of the startup expenditures and business

expenses that In Touch allegedly incurred during 2000, nor did

petitioner offer the Court any credible explanation for In
                                 -16-

Touch’s failure to produce invoices, receipts, checks, or other

business records during the audit or at trial.

        We sustain respondent’s determinations disallowing

petitioner’s deductions for professional fees, marketing

expenses, and amortization.

IV.     Other Issues

      Petitioner raised, and the parties briefed, two additional

issues:     (1) Whether In Touch’s members had sufficient bases to

deduct their distributive share of In Touch’s 2000 net loss and

(2) whether property in the form of promissory notes contributed

to In Touch was “at risk” under section 465(a).     Neither party

disputed that these issues involved partnership items that we

could properly decide in this partnership-level proceeding.

      We decline to decide the remaining issues identified in this

opinion for several reasons.     The first is that respondent

determined in the FPAA that the bases of In Touch’s members and

their at-risk amounts as of December 31, 2000, were limited to

$50,000, the amount of capital contributed as of December 31,

2000.     Because we have sustained respondent’s determination

disallowing the vast majority of In Touch’s deductions for 2000,

it no longer appears to be necessary for us to decide whether the

members had sufficient bases or at-risk amounts to claim their

distributive shares of In Touch’s adjusted net loss.
                                -17-

     We also question whether determinations regarding the

members’ bases and at-risk amounts satisfy the definition of

partnership item.   If they are not partnership items, we may not

decide issues involving them in a partnership-level proceeding.

Section 6221 provides that, except as otherwise provided in

subchapter C dealing with the tax treatment of partnership items,

the tax treatment of any partnership item must be determined at

the partnership level.    Section 6226(a) authorizes a tax matters

partner to file a petition for readjustment of partnership items

within 90 days after the date on which an FPAA is mailed to the

tax matters partner.    A partnership-level proceeding filed

pursuant to section 6226(a) permits a court to consider and

resolve partnership items and the proper allocation of such items

among the partners.    Sec. 301.6226(f)-1T, Temporary Proced. &

Admin. Regs., 52 Fed. Reg. 6788 (Mar. 5, 1987).

     Section 6231(a)(3) defines a “partnership item” as:

     any item required to be taken into account for the
     partnership’s taxable year under any provision of
     subtitle A to the extent regulations prescribed by the
     Secretary provide that, for purposes of this subtitle,
     such item is more appropriately determined at the
     partnership level than at the partner level.

In section 301.6231(a)(3)-1, Proced. & Admin. Regs., the

Commissioner has provided guidance that amplifies the definition

of partnership item contained in section 6231(a)(3).    However,
                               -18-

section 301.6231(a)(3)-1, Proced. & Admin. Regs., does not

clearly answer the question of whether determinations regarding

contributions to a partnership’s capital and the effect of those

contributions on the partner’s basis and at-risk amounts are

partnership items.   See the discussion of section 301.6231(a)(3)-

1, Proced. & Admin. Regs., in Hambrose Leasing 1984-5 Ltd. Pship.

v. Commissioner, 99 T.C. 298, 306-312 (1992).

     In Hambrose Leasing, we interpreted section 301.6231(a)(3)-

1, Proced. & Admin. Regs., in the context of determining whether

individual partners were at risk under section 465(b)(4).    After

carefully considering the provisions of section 301.6231(a)(3)-1,

Proced. & Admin. Regs., and the arguments of the parties therein,

we stated the following:

          We conclude, based on the circumstances of this
     case, that the determination of amounts at risk with
     respect to partnership liabilities personally assumed
     by individual partners is not a partnership item, but
     is an affected item, which can be dealt with only in a
     proceeding involving the partners and not in this
     partnership level proceeding. Sec. 6226(f); N.C.F.
     Energy Partners v. Commissioner, 89 T.C. 741, 743
     (1987). We base this conclusion on the definition of
     “partnership item” in section 6231 (“required to be
     taken into account for the partnership’s taxable
     year”), our interpretation of the pertinent
     regulations, in light of the statute (an approach which
     makes it unnecessary for us to rule on petitioners’
     contention that the regulations are invalid), and the
     application of the statute and regulations in the
     decided cases. In short, the application of section
     465 as such is not an issue appropriate for a
     determination in a partnership level proceeding. See
                                 -19-

     Dial USA, Inc. v. Commissioner, 95 T.C. at 5 n.5.       [Id.
     at 312; fn. ref. omitted.]

     We have also considered a similar issue with respect to

contributions of property to a passthrough entity and the effect

of the contributions on the basis of individual members.      In Dial

USA, Inc. v. Commissioner, 95 T.C. 1 (1990), we considered

whether a member’s basis in an S corporation is a “subchapter S

item” within the meaning of former section 6245.12      We

acknowledged that the partnership audit and litigation provisions

contained in sections 6221-6231 “were, in effect, grafted onto

the subchapter S audit and litigation provisions” by former

section 6244, id. at 3, and we held that a member’s basis in the

passthrough entity was not an item “required” to be taken into

account by the entity for the entity’s taxable year, id. at 5-6.

     We conclude that it is not necessary or appropriate to

decide the basis and at-risk issues.

     To reflect the foregoing,


                                        An appropriate decision will

                                 be entered.




     12
      The subch. S audit and litigation provisions were repealed
by the Small Business Job Protection Act of 1996, Pub. L. 104-
188, sec. 1307(c)(1), 110 Stat. 1781, applicable to tax years
beginning after Dec. 31, 1996.
