                         T.C. Memo. 1996-200



                       UNITED STATES TAX COURT



      FRANK A. WALTER AND JOANN R. WALTER, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 11519-94.                      Filed April 24, 1996.


     Frank A. Walter, pro se.

     Gerald W. Douglas, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     CHIECHI, Judge:    Respondent determined a deficiency in

petitioners' Federal income tax for 1991 in the amount of

$10,902.

     The sole issue for decision is whether petitioners are

entitled for 1991 to a nonbusiness bad debt deduction under
                               - 2 -


section 166(d)(1)(B)1 for punitive damages that were awarded to,

but not collected by, petitioner Frank A. Walter during that

year?2   We hold that they are not.

                         FINDINGS OF FACT

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

     Petitioners resided in Yachats, Oregon, at the time the

petition was filed.   Petitioners used the cash method of account-

ing for Federal income tax purposes and filed a joint Federal

income tax return for 1991 (1991 return).

     On February 27, 1991, petitioner Frank A. Walter3 instituted

a civil lawsuit in the Superior Court of California for the

county of Sacramento against an individual named Jeffrey Erkel

(Mr. Erkel) alleging fraud in connection with the handling of a

real estate project in which petitioners had invested $10,000.

     On June 19, 1991, a default judgment was entered against Mr.

1
   All section references are to the Internal Revenue Code in
effect for the year at issue. All Rule references are to the Tax
Court Rules of Practice and Procedure.
2
   In the notice of deficiency, respondent disallowed the $50,000
with respect to the punitive damages at issue that petitioners
claimed in their 1991 Federal income tax return as a loss that
reduced their gross income. As a result of the foregoing adjust-
ment, respondent determined that petitioners' Social Security
income for that year was understated. Petitioners do not dispute
that if respondent's determination disallowing their claimed
$50,000 loss were to be sustained, respondent's determination
relating to their Social Security income for 1991 would be
correct.
3
   References to petitioner in the singular are to petitioner
Frank A. Walter.
                                 - 3 -


Erkel and in favor of petitioner.    Under the terms of that

default judgment, petitioner was to recover from Mr. Erkel

general damages (general damages) in the amount of $20,200 and

punitive damages (punitive damages) in the amount of $50,000.

     Petitioner did not at any time recover from Mr. Erkel any

portion of the general damages award, nor did he recover any

portion of the punitive damages award.

     In their 1991 return, petitioners reduced their gross income

in the amount of $50,000 by claiming a loss attributable to the

punitive damages that were awarded to, but not collected by,

petitioner during that year.    Petitioners did not include in

their gross income for 1991 any portion of the $20,200 general

damages award or any portion of the $50,000 punitive damages

award.

     In the notice of deficiency, respondent disallowed the

$50,000 loss that was claimed by petitioners in their 1991 return

on the following grounds:   (1) Petitioners did not include any

portion of the $50,000 punitive damages award in their gross

income for Federal income tax purposes, and (2) petitioners

failed to establish that that award became worthless during 1991.

                                OPINION

     Petitioners bear the burden of proving that respondent's

determinations are erroneous.    Rule 142(a); Welch v. Helvering,

290 U.S. 111, 115 (1933).   Deductions are strictly a matter of
                               - 4 -


legislative grace, and petitioners bear the burden of proving

that they are entitled to any deduction claimed.   New Colonial

Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).

     As we understand petitioners' position, they contend that

(1) the $50,000 punitive damages award constituted a nonbusiness

debt owed to petitioner by Mr. Erkel, (2) that debt became

worthless during 1991, and (3) they are therefore entitled to a

$50,000 nonbusiness bad debt deduction for 1991.   Respondent does

not dispute that the $50,000 punitive damages award constituted a

debt owed to petitioner by Mr. Erkel within the meaning of

section 166.   However, respondent contends that petitioners are

not entitled under section 166 to a deduction for 1991 with

respect to that debt because (1) they failed to establish that

the punitive damages award became a worthless debt during 1991

within the meaning of that section, (2) they did not include any

portion of the punitive damages award in their gross income for

Federal income tax purposes, and (3) they failed to establish

that they had any basis in the punitive damages award.4


4
   Respondent notes on brief that it is not clear to her whether
petitioners are also taking the position that they are entitled
to a $50,000 deduction for 1991 under the general loss provisions
of sec. 165(a) for the punitive damages award at issue. Conse-
quently, respondent also contends on brief that if petitioners
were advancing any such position, it would be unsupported and
must be rejected. While we do not agree with respondent that
petitioners also are relying on sec. 165(a) in this case, we do
agree with respondent that any such position would be without
merit.
                               - 5 -


     Section 166(a) generally allows a deduction for any debt

that becomes wholly or partially worthless within the taxable

year.   Section 166(d)(1)(A) provides that section 166(a) shall

not apply to any nonbusiness debt of a noncorporate taxpayer.

Section 166(d)(1)(B) provides that, where a nonbusiness debt of a

noncorporate taxpayer becomes worthless within a taxable year,

the loss resulting from the worthlessness of such debt shall be

considered a loss from the sale or exchange during the taxable

year of a capital asset held for not more than one year.   For

purposes of section 166, the basis for determining the amount of

the deduction for any bad debt is the adjusted basis of the debt

as prescribed by section 1011 for purposes of determining the

loss from the sale or other disposition of property.   See sec.

166(b); sec. 1.166-1(d)(1), Income Tax Regs.

     In deciding whether petitioners are entitled for 1991 to a

nonbusiness bad debt deduction under section 166(d)(1)(B) for the

$50,000 punitive damages that were awarded to, but not collected

by, petitioner during that year, we need not, and do not, decide

whether that award constituted a valid debt owed to petitioner by

Mr. Erkel within the meaning of section 166(d)(1)(B) or whether

that award became a worthless debt during 1991 within the meaning

of that section.   That is because, assuming arguendo, as peti-

tioners and respondent maintain, that the $50,000 punitive

damages award were in fact a debt and further assuming arguendo,
                               - 6 -


as petitioners contend, that that award became worthless during

1991, petitioners nonetheless would not be entitled for 1991 to a

nonbusiness bad debt deduction with respect to that award.

     A taxpayer is not entitled to a deduction for a worthless

debt under section 166 in connection with an income item unless

it has been included in the taxpayer's gross income for Federal

income tax purposes either for the year for which the deduction

is claimed or for a prior year.   Seymour v. Commissioner, 14 T.C.

1111, 1117 (1950); see Gertz v. Commissioner, 64 T.C. 598, 600

(1975); O'Meara v. Commissioner, 8 T.C. 622, 633 (1947); sec.

1.166-1(e), Income Tax Regs.

     As petitioners concede on brief, the $50,000 punitive

damages award at issue is an item of gross income.5    See Commis-

sioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955); sec.

1.61-14(a), Income Tax Regs.   Petitioner did not at any time

recover from Mr. Erkel any portion of that award.     Petitioners,

who use the cash method of accounting, were not required to, and

did not, include in their gross income for 1991 any portion of

the $50,000 punitive damages award.    See sec. 451(a); sec. 1.451-

5
   Petitioners argue on brief that since punitive damages that
are collected by a taxpayer are included in the taxpayer's gross
income for Federal income tax purposes under Commissioner v.
Glenshaw Glass Co., 348 U.S. 426, 431 (1955), punitive damages
that are awarded to, but not collected by, the taxpayer give rise
to a bad debt deduction under sec. 166. Petitioners' reliance on
the Glenshaw Glass Co. case is misplaced. That case does not in
any way indicate that uncollected punitive damages give rise to a
bad debt deduction under sec. 166.
                                  - 7 -


1(a), Income Tax Regs.   Nor does the record indicate that peti-

tioners included that award in their gross income for any other

year.6   Therefore, petitioners are not entitled for 1991 to a

nonbusiness bad debt deduction under section 166(d)(1)(B) with

respect to the punitive damages that were awarded to, but not

collected by, petitioner during that year.        Accordingly, respon-

dent's determinations are sustained.7

      To reflect the foregoing,


                                          Decision will be entered

                                  for respondent.




6
   Consequently, petitioners did not have any basis in the
punitive damages at issue. "[T]he process of establishing a
basis for an income item consists, in effect, of reporting it in
the taxpayer's gross income for tax purposes." O'Meara v.
Commissioner, 8 T.C. 622, 633 (1947).
7
    See supra note 2.
