                       T.C. Memo. 2003-204



                     UNITED STATES TAX COURT



      DALE H. AND EDITH LITTLEFIELD SUNDBY, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 13000-01.              Filed July 11, 2003.


     Dale H. and Edith Littlefield Sundby, pro sese.

     Michael S. Hensley, Kevin M. Brown, James A. Nelson, and

 Jeffrey A. Schlei, for respondent.



                       MEMORANDUM OPINION


     WELLS, Chief Judge:    Respondent determined a deficiency in

petitioners’ 1997 Federal income tax of $77,372.   The issue to be

decided is whether petitioners are entitled to a bad debt

deduction of $350,000 which they claimed on Schedule C of their
                               - 2 -

1997 Federal income tax return.1   All section references are to

the Internal Revenue Code, as amended, and all Rule references

are to the Tax Court Rules of Practice and Procedure.

                            Background

     The parties submitted the instant case fully stipulated

without trial pursuant to Rule 122.    The parties’ stipulations of

fact and the accompanying exhibits are hereby incorporated by

this reference and are found as facts in the instant case.

Petitioners resided in San Diego, California, when their petition

was filed.

     On April 6, 1993, Access Anytime Anywhere, Inc. (Access),

was incorporated in the State of California.   Petitioners were

the sole shareholders of Access.   On May 12, 1993, Access was

renamed Navis Communications (Navis).    Petitioners were the sole

shareholders of Navis.   Navis was assigned a Federal Employer

Identification Number.   On June 1, 2001, Navis’s corporate status

was suspended by the California Franchise Tax Board.

     On November 9, 1994, Search2000 was incorporated in the

State of California.   Petitioner Dale H. Sundby (Mr. Sundby) was

the president of Search2000.   On September 19, 1995, Search2000

was renamed PowerAgent, Inc.   Mr. Sundby was the president of

PowerAgent, Inc.   The California Franchise Tax Board suspended

PowerAgent, Inc.’s corporate status on January 2, 2001.   Navis


     1
      Petitioners failed to file a brief addressing this issue.
                               - 3 -

and Search2000 were corporations during 1995.   Navis held itself

out as a corporation.   Navis was engaged in limited business

activity during 1994, as reflected in a bill from a law firm,2 a

long-distance phone bill, and several shipping receipts.     Navis

remained a California corporation until its corporate status was

suspended.

     On July 21, 1995, Search2000 held a board of directors

meeting, and the minutes of that meeting state in part:

     WHEREAS, the Corporation desires to accept the offer of
     Navis Communications, a California Sole
     Proprietorship,[3] to sell all of its ownership rights
     to business plans and intellectual property defined as
     WorkWorld and PowerAgent.

     RESOLVED, that the Corporation purchase all rights to
     business plans and intellectual property defined as
     WorkWorld and PowerAgent for a consideration of
     $300,000.00.

     On July 21, 1995, Search2000 created the following

instrument in connection with the alleged purchase by Search2000

of business plans and intellectual property, defined as WorkWorld

and PowerAgent, which were owned by Navis:


     2
      The bill indicated that the law firm, Higgs, Fletcher &
Mack, of San Diego, California, performed services related to the
incorporation of Navis Communication.
     3
      We note that petitioners stipulated that Access was
incorporated under the laws of the State of California and that
it later changed its name to Navis. Petitioners stipulated that
Navis was a corporation in 1995. We shall treat Navis as a
corporation. Petitioners have not provided this Court with
evidence that Navis elected to be treated as a subchapter S
corporation under sec. 1362(a).
                         - 4 -

                    PROMISSORY NOTE

                                                 July 21, 1995
$300,000.00

FOR VALUE RECEIVED, Search2000, Inc., a California
Corporation (the “Maker”), promises to pay Navis
Communication (the “Holder”), at the offices of the
Holder of this Note or at such other place as the
Holder of this Note may designate, the principal sum of
$300,000.00, together with interest on the unpaid
principal balance of this Note from time to time
outstanding at the rate of 8% per year until paid in
full. The principal sum of this Note and all accrued
interest thereon shall be payable on demand. Interest
on this Note shall be computed on the basis of a year
of 365 days for the actual number of days elapsed. All
payments by the Maker under this Note shall be in
immediately available funds.

In no event shall any interest charged, collected or
reserved under this Note exceed the maximum rate then
permitted by applicable law and if any such payment is
paid by the Maker, then such sum shall be credited by
the Holder as a payment of principal.

All payments by the Maker under this Note shall be made
without set-off or counterclaim and be free and clear
and without any deduction or withholding for any taxes
or fees of any nature whatsoever, unless the obligation
to make such deduction or withholding is imposed by
law. The Maker shall pay and save the Holder harmless
from all liabilities with respect to or resulting from
any delay or omission to make any such deduction or
withholding required by law.

Whenever any amount is paid   under this Note, all or
part of the amount paid may   be applied to principal,
premium or interest in such   order and manner as shall
be determined by the Holder   in its discretion.

In the event of any actual or deemed entry or any order
for relief with respect to the Maker under the Federal
Bankruptcy Code, this Note, all interest thereon and
all other amounts payable hereunder shall automatically
become and be due and payable, without presentation,
demand, protest, or any notice of any kind, all of
which are hereby expressly waived by the Maker.
                                  - 5 -

     The Maker agrees to pay on demand all costs of
     collection, including reasonable attorneys’ fees,
     incurred by the Holder in enforcing the obligations of
     the Maker under this Note.

     No delay or omission on the part of the Holder in
     exercising any right under this Note shall operate as a
     waiver of such right or of any other right of such
     Holder, nor shall any delay, omission or waiver on any
     one occasion be deemed a bar to or waiver of the same
     or any other right on any future occasion.

     None of the terms or provisions of this Note may be
     excluded, modified or amended except by a written
     instrument duly executed on behalf of the Holder
     expressly referring to this Note and setting forth the
     provision so excluded, modified or amended.

     All rights and obligations hereunder shall be governed
     by the laws of the Sate of California.
     Search2000, Inc.

     By:   [signed] Dale Sundby

     Name:    Dale Sundby

     Title:    Chairman and CEO

     Neither petitioners nor Navis reported on any Federal income

tax return the sale of a business plan or intellectual property

rights.    Neither petitioners nor Navis reported on any Federal

income tax return the sale of PowerAgent or WorkWorld.    Moreover,

Navis did not file a Federal income tax return for 1995.

Additionally, there is no evidence suggesting that WorkWorld had

any value.    Moreover, there is no evidence to suggest that the

promissory note was ever sold, transferred, or otherwise conveyed

to petitioners by Navis.

     Neither petitioners nor Navis reported on any Federal income
                                    - 6 -

tax return interest income arising from the sale of a business

plan or intellectual property.       Neither petitioners nor Navis

reported on any Federal income tax return interest income arising

from the sale of PowerAgent or WorkWorld.

     Petitioners claimed a bad debt deduction on Schedule C of

their 1997 Federal income tax return.         On Schedule C, Mr. Sundby

indicated that his principal business was that of a lender,

reporting income on the cash basis.         Mr. Sundby also indicated

that he did not “materially participate” in the operation of this

business.

                              Discussion

     Petitioners bear the burden of proving that they are

entitled to their claimed bad debt deduction.         Rule 142(a);4

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

themselves of a bad debt deduction pursuant to section 166,5


     4
      Sec. 7491 does not apply in the instant case to shift the
burden of proof to respondent because petitioners neither alleged
that sec. 7491 was applicable nor established that they fully
complied with the requirements of sec. 7491(a)(2).
     5
      Sec. 166. BAD DEBTS.

            (a)   General Rule.--

                 (1) Wholly worthless debts.-–There shall be
            allowed as a deduction any debt which becomes worthless
            within the taxable year.

                 (2) Partially worthless debts.-–When satisfied
            that a debt is recoverable only in part, the Secretary
            may allow such debt, in an amount not in excess of the
                                                     (continued...)
                               - 7 -

petitioners must prove (1) a bona fide debt existed between them

and Search2000, and (2) the debt became worthless in 1997, the

year in which they claimed the deduction. See also Dixie Dairies

v. Commissioner, 74 T.C. 476, 493-494 (1980); Kim v.

Commissioner, T.C. Memo. 1995-598; Hotel Continental, Inc. v.


     5
      (...continued)
          part charged off within the taxable year, as a
          deduction.

          (b) Amount of Deduction.-–For purposes of subsection
     (a), the basis for determining the amount of the deduction
     for any bad debt shall be the adjusted basis provided in
     section 1011 for determining the loss from the sale or other
     disposition of property.

          (d)   Nonbusiness Debts.--

               (1) General rule.-–In the case of a taxpayer
          other than a corporation–-

                     (A) subsection (a) shall not apply to any
                nonbusiness debt; and

                      (B) where any nonbusiness debt becomes
                worthless within the taxable year, the loss
                resulting therefrom shall be considered a loss
                from the sale or exchange, during the taxable
                year, of a capital asset held for not more than 1
                year.

               (2) Nonbusiness debt defined.-–For purposes of
          paragraph (1), the term “nonbusiness debt” means a debt
          other than–

                     (A) a debt created or acquired (as the case
                may be) in connection with a trade or business of
                the taxpayer; or

                     (B) a debt the loss from the worthlessness
                of which is incurred in the taxpayer’s trade or
                business.
                                - 8 -

Commissioner, T.C. Memo. 1995-364, affd. without published

opinion 113 F.3d 1241 (9th Cir. 1997).

     A bona fide debt is a debt which “arises from a debtor-

creditor relationship based upon a valid and enforceable

obligation to pay a fixed or determinable sum of money.”    Sec.

1.166-1(c), Income Tax Regs.; see Dixie Dairies Corp. v.

Commissioner, supra at 494.   The existence of a bona fide debtor-

creditor relationship may be determined by examination of all

relevant facts.    Fisher v. Commissioner, 54 T.C. 905, 909 (1970).

     In deciding whether a bona fide debt existed, we may

consider a number of factors, including:    (1) Whether evidence of

indebtedness exists, such as a note; (2) whether any collateral

or security is requested; (3) whether a demand for repayment has

been made; (4) whether the parties’ records reflect the

transaction as a loan; (5) whether any repayments have been made;

and (6) whether any interest was charged.    See Kim v.

Commissioner, supra; see also Dixie Dairies Corp. v.

Commissioner, supra; Baker Commodities, Inc. v. Commissioner, 48

T.C. 374 (1967), affd. 415 F.2d 519 (9th Cir. 1969); Bragg v.

Commissioner, T.C. Memo. 1993-479.      However, “Formal indicia of

debt are not in themselves sufficient to establish a bona fide

indebtedness”.    Hotel Continental, Inc. v. Commissioner, supra.

     The alleged debt transaction requires close scrutiny to

determine whether the parties were engaged in an arm’s-length
                               - 9 -

transaction because petitioners controlled both corporations.6

See Baldwin v. Commissioner, T.C. Memo. 1993-433; see also Ludwig

Baumann & Co. v. Commissioner, T.C. Memo. 1961-271, affd. 312

F.2d 557 (2d Cir. 1963).

     In the instant case, petitioners have failed to prove their

entitlement to the bad debt deduction claimed on their return.

Petitioners have failed to prove that Search2000 and Navis were

engaged in an arm’s-length transaction or that Navis and

Search2000 ever entered into a valid debtor-creditor

relationship.   See Rule 142(a).   While the record contains a

promissory note and the minutes of the July 21, 1995, Search2000

board of directors meeting authorizing Search2000 to purchase the

alleged WorkWorld and PowerAgent business plans and intellectual

property from Navis, the record contains no evidence (other than

the promissory note) that the alleged transaction actually took

place.   Moreover, there is no evidence that the note was

acquired, transferred, or otherwise conveyed by Navis to

petitioners, who are claiming the bad debt deduction on Schedule

C of their personal return.


     6
      Mr. Sundby was the president of both Search2000 and Navis
in 1995. The minutes of the July 21, 1995, Search2000 board of
directors meeting indicate that petitioners and Mr. J. Tim Konold
were on the Search2000 board of directors. Moreover, the
promissory note indicates that Mr. Sundby was the chairman and
CEO (chief executive officer) of Search2000. The California
Franchise Tax Board’s records list Mr. Sundby as the only officer
or director of both Search2000 (later PowerAgent, Inc.) and
Navis.
                              - 10 -

     Neither Navis nor petitioners reported the sale of the

alleged business plan and intellectual property on its or their

1995 Federal income tax return.   There is no indication that

Navis even filed a Federal income tax return for 1995.

Petitioners have not shown that the alleged business plan and

intellectual property, PowerAgent and WorkWorld, had any value.

Petitioners have not presented this Court with any evidence that

the alleged business plan and intellectual property even existed.

   The promissory note, a demand note, lacks a date of maturity

and does not require regular interest and principal payments to

be made.   There is no evidence that Search2000 made any interest

or principal payments on the promissory note.   Moreover, there is

no evidence that either Navis or petitioners demanded payment

from Search2000.   There is no evidence that either Navis or

petitioners required Search2000 to provide collateral for the

promissory note.   Petitioners have failed to show that, when the

promissory note was created, there was a genuine intention to

create a bona fide debt.7


     7
      Petitioners alleged on their 1997 Federal income tax return
that Mr. Sundby was a lender. Petitioners must prove that Mr.
Sundby was in a trade or business and that the alleged debt was
connected to that trade or business in order to take their
claimed deduction. Sec. 166(d); see Commissioner v. Groetzinger,
480 U.S. 23, 35 (1987) (“the taxpayer must be involved in the
activity with continuity and regularity and * * * the taxpayer’s
primary purpose for engaging in the activity must be for income
or profit.”). Moreover, on Schedule C of their 1997 Federal
income tax return, petitioners indicated that Mr. Sundby did not
                                                   (continued...)
                                - 11 -

     Assuming arguendo that petitioners were able to prove that a

bona fide debt was created with respect to the July 21, 1995,

transaction, petitioners still would not be entitled to the bad

debt deduction.    Petitioners have failed to show that they are

entitled to deductions that on their face would be allowable to

Navis, if at all.    The promissory note was made between

Search2000 and Navis.    Because Navis was incorporated under the

laws of the State of California and there are other indicia of

its separate status, we shall treat it as a separate entity.     See

Moline Properties, Inc. v. Commissioner, 319 U.S. 436, 438-439

(1943).

     Since the promissory note was made payable to Navis, it is

Navis that would be entitled to the bad debt deduction, if any

were to be allowed, and petitioners have not shown that the note

was transferred to them personally.      Moreover, petitioners have

not shown that any S corporation election was in effect for Navis

for the year in issue.

         On the basis of the foregoing, we hold that petitioners may


     7
      (...continued)
materially participate in the business of lending. Petitioners
have not provided this Court with any evidence which supports
their contention that Mr. Sundby was in the trade or business of
being a lender during 1995, 1996, or 1997. Petitioners have
failed to show that Mr. Sundby continually or regularly engaged
in lending for income or profit. Even though Mr. Sundby was
president of both Search2000 and Navis, full-time service to a
corporation does not necessarily amount to engaging in a trade or
business (other than the trade or business of being an employee).
See Whipple v. Commissioner, 373 U.S. 193, 203 (1963).
                             - 12 -

not claim a deduction for a bad debt, pursuant to section 166(a).

We have considered all of the contentions and arguments of the

parties that are not discussed herein,8 and we find them to be

without merit, irrelevant, or moot.

     To reflect the foregoing,


                                      Decision will be entered

                                 for respondent.




     8
      Having held that petitioners have failed to show that a
bona fide debt exists, we need not decide whether the claimed
debt became worthless in 1997.
