                        T.C. Memo. 1999-30



                      UNITED STATES TAX COURT



            JOHN C. AND KAROL BOWDEN, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 11152-95.                Filed February 1, 1999.



     David P. Leeper, for petitioners.

     Gerald L. Brantley, for respondent.



                        MEMORANDUM OPINION


     DEAN, Special Trial Judge: This case was assigned to Special

Trial Judge John F. Dean for the purpose of disposing of

petitioners':   (1) Motion for an Award of Reasonable Litigation

Costs; and (2) Motion to Determine Prevailing Party Pursuant to
                               - 2 -


Rules 230 through 233.1   Respondent filed responses to both

motions.   Neither party requested a hearing.   Rule 232(a).

     Accordingly, we rule on petitioners' motions on the basis of

the parties' submissions and the record in this case.    The

underlying issues raised in the petition were settled, and the

Court entered a stipulated decision.

     Upon petitioners' subsequent filing of the motions, the

decision was vacated and set aside.    The order decreed that the

stipulated decision document was to be filed as a Settlement

Stipulation.

     Respondent determined deficiencies in petitioners' Federal

income taxes for the taxable years 1991, 1992, and 1993 in the

amounts of $102,781, $6,262, and $1,323, respectively.    John C.

and Karol Bowden resided in El Paso, Texas, at the time their

petition was filed.

                            Background

     John Bowden, Inc. (the corporation), was incorporated by

John Bowden (petitioner) in June 1991 to perform services in the

insurance industry.   Prior to its incorporation, petitioner

operated his business as a sole proprietorship, working under

contract as a district manager for a group of insurance



     1
      All Rule references are to the Tax Court Rules of Practice
and Procedure. All section references, unless otherwise noted,
are to the Internal Revenue Code.
                               - 3 -


companies2 in the El Paso, Texas, area.   Pursuant to the

contract, petitioner recruited and trained insurance agents to

sell insurance exclusively for the insurance companies with which

he had contracted.   After incorporation of his business,

petitioner continued to perform substantially the same services

for the insurance companies that he performed prior to

incorporation, but now he worked as an employee of the

corporation.3

     Petitioner served as the sole director of the corporation,

and his wife, Karol Bowden, served as secretary.4   The corporate

minutes reflect that B. Kent Straughan was appointed as corporate

accountant and was instructed to handle the tax preparation and

accounting requirements associated with the incorporation.   E. P.

"Bud" Kirk was appointed as corporate attorney.

     In a transaction to which section 351 is applicable,

petitioner transferred property to the corporation in 1991

consisting of $10,000 cash, an airplane with a zero basis, a Ford



     2
      The insurance companies are Farmers Insurance Exchange,
Truck Insurance Exchange, Fire Insurance Exchange, Mid-Century
Insurance Co., Farmers' Texas County Mutual Insurance Co., and
Farmers New World Life Insurance Co.
     3
      Because petitioner no longer operated the business as a
sole proprietorship, the insurance companies renewed their
service contract with petitioner's corporation, with petitioner
personally performing the services.
     4
      The corporate minutes reflect that Karol Bowden served as
temporary secretary for purposes of the corporate meetings.
                               - 4 -


van with a stated basis of $21,139, a computer system with a

stated basis of $97, office furniture and equipment with a stated

basis of $241, and insurance premium renewals with a stated basis

of $245,000.

     In return, the corporation issued petitioner 1,000 shares of

stock.   The corporation also assumed a $220,468 liability,

evidenced by a note, that petitioner had incurred to acquire his

ex-wife's community property interest in the sole proprietorship.

Assumption of the debt by the corporation did not relieve

petitioner of his primary liability on the note.

     Upon incorporation, an account payable of $60,009 was

created on the books of the corporation to pay cash to petitioner

or pay other personal expenses on his behalf in the amounts of

$15,768, $21,540, and $23,951, for the years 1991, 1992, and

1993, respectively.5

     Respondent issued a notice of deficiency to petitioners for

taxable years 1991, 1992, and 1993, determining that they must

recognize net capital gain on incorporation of the business in

the amount of $280,477.   The explanation of adjustments in the

notice of deficiency states that in taxable year 1991,

petitioners received boot in the amounts of $60,009 in cash from

     5
      Although the parties stipulated the yearly amounts paid to
petitioner, the Court notes that the sum of these three payments
exceeds the $60,009 account payable recorded on the books of the
corporation. It is unclear to what source the additional funds
paid to petitioner were attributable.
                              - 5 -


the note payable and $220,468 for the note assumed by the

corporation for petitioner's liability to his ex-wife.

     Respondent also denied $13,885 in business expenses for 1991

and determined petitioners received constructive dividend income

in the amounts of $28,197 for 1991 and $13,651 for 1992.    In

addition, their taxable income was increased in the amounts of

$32,976 and $1,547 for 1991 and 1992, respectively, pursuant to

the passive activity loss limitation provisions of section 469.

For taxable years 1992 and 1993, respondent characterized

petitioners' reported self-employment income as wage income and

disallowed deductions of $10,000 and $9,500, respectively, for

their contribution to a Simplified Employee Pension/Keogh Plan.

     Petitioners filed a petition with the Court, alleging error

in each determination contained in the notice of deficiency.

Respondent filed an answer denying each allegation contained in

the petition.

     Respondent subsequently filed an amendment to answer

asserting that the insurance premium renewals transferred to the

corporation had a basis of zero, not $245,000 as stated by

petitioners in their 1991 tax return.   The amendment to answer

also asserted that there was a deficiency attributable to gain

resulting from the difference between the $220,468 liability

assumed by the corporation and the adjusted basis of all the
                                - 6 -


property transferred, including the insurance renewal contract

rights with a zero basis.

     The net capital gain to be recognized by petitioners under

these circumstances would be $249,000, consisting of the $60,009

account payable and $188,991 in excess debt assumed over the

total basis of property transferred.

     Disputing respondent's contentions, petitioners filed two

motions to shift the burden of proof to respondent on the grounds

that (1) respondent's amended answer contained a new matter for

which respondent should have the burden of proof pursuant to Rule

142(a), and (2) respondent erroneously determined the boot

received in the section 351 transaction.   Petitioners also filed

a motion to strike the notice of deficiency, alleging that the

notice of deficiency was arbitrary and erroneous.   Petitioners'

motions were denied by order.

     This case was eventually settled, and deficiencies were

stipulated in the amounts of $88,292, $4,044, and $1,323 for

taxable years 1991, 1992, and 1993, respectively.   Petitioners

then filed a motion for an award of reasonable litigation costs

and a motion to determine prevailing party.

                            Discussion

     Taxpayers may be awarded an amount for reasonable litigation

costs if they meet the requirements of section 7430.   In order to

qualify for such an award, a party must:   (1) Qualify as a
                                - 7 -


prevailing party; (2) have exhausted available administrative

remedies; (3) not have unreasonably protracted the court

proceeding; and (4) show that the costs claimed are reasonable

litigation costs incurred in connection with the court

proceeding.   Sec. 7430(c)(4), (b)(1), (b)(4), (a)(2).   The

taxpayers have the burden of establishing that all the foregoing

criteria have been satisfied.    See Rule 232(e); Maggie Management

Co. v. Commissioner, 108 T.C. 430 (1997).

     Both petitioners and respondent agree that all the

administrative remedies available within the Internal Revenue

Service have been exhausted.    There is some dispute, however, as

to the other requirements of section 7430.

     Prevailing Party

     To be a "prevailing party", a taxpayer must establish: (1)

The taxpayer substantially prevailed with respect to either the

amount in controversy or the most significant issue or set of

issues presented; (2) the position of the United States was not

substantially justified; and (3) the taxpayer met the net worth

requirements of 28 U.S.C. section 2412(d)(2)(B) (1994) at the

time the petition was filed.    Sec. 7430(c)(4).

     Respondent concedes that petitioners meet the net worth

requirements.   Therefore, we need examine only the question of

whether petitioners substantially prevailed with respect to the

amount in controversy or the most significant issue or issues
                               - 8 -


presented in their case, and whether the Government's litigation

position was substantially justified.   See Swanson v.

Commissioner, 106 T.C. 76, 86 (1996).

Substantially Prevail Requirement

     In petitioners' motion to determine the prevailing party,

petitioners argue that because respondent ultimately agreed to a

reduced deficiency and settled the case on a different legal

theory from that on which the notice of deficiency was issued,

petitioners are the prevailing party with respect to the most

substantial issue in their case.    Respondent, on the other hand,

denies that the case was settled on a new legal theory and

further alleges that the settlement did not substantially reduce

the deficiency.   Rather, respondent contends that the settlement

reduced the ultimate deficiency amount only by about $10,000 and

respondent prevailed on 88 percent of the adjustment.

     To determine whether the taxpayer has substantially

prevailed within the meaning of section 7430(c)(4)(A), we look to

the final outcome of the case, whether by judgment or settlement.

Cassuto v. Commissioner, 936 F.2d 736, 741 (2d Cir. 1991), affg.

in part and revg. in part 93 T.C. 256 (1989).   Section

7430(c)(4)(A)(i) is phrased in terms of issues, not claims.    See

Huckaby v. United States, 804 F.2d 297, 299 (5th Cir. 1986).

     In this case, the issues presented were:   (1) Whether

petitioners must recognize net capital gain on the incorporation
                               - 9 -


of their insurance business; (2) whether the self-employment

income reported on petitioners' Schedule C should be reclassified

as wage income; (3) whether petitioners are entitled to deduct

certain expenses on the Schedule C; (4) whether petitioners

received constructive dividends; (5) whether petitioners are

entitled to deduct rental losses; and (6) whether petitioners are

allowed a deduction for contributions to petitioner's retirement

plan.

     The record does not reflect, and the parties did not provide

the Court with the details surrounding, the settlement of these

issues.   If petitioners prevail on the most significant issue,

however, they have satisfied the requirement of section

7430(c)(4)(A).   See Huckaby v. United States, supra.

     Based on documents contained in the record, the most

significant issue in this case was whether petitioners must

recognize gain upon the transfer of assets and liabilities to the

corporation.   Upon settlement of this case, petitioners conceded

that they must indeed recognize such gain.

     Petitioners argue, nevertheless, that because they

recognized gain under section 357(c) instead of section 357(b),

they are the prevailing party on this issue.   We disagree.   Given

the facts and circumstances of this case, we find it irrelevant

whether gain was recognized under section 357(c) or 357(b).

Simply stated, petitioners must recognize gain due to the
                              - 10 -


transfer of assets and liabilities in a section 351 transaction

and therefore did not substantially prevail on the most

significant issue in the case.

     We are puzzled by petitioners' unyielding attention to the

section 357(b) and (c) distinction.     Petitioners filed a motion

to shift the burden of proof to respondent on the basis that the

Government's amendment to answer asserted gain under section

357(c) and contained a new matter and because the calculation of

gain to be recognized by petitioners was incorrect.     This motion

was denied by order of this Court, determining that the section

357(c) gain was not a new issue in the case, and the burden of

proof did not shift to respondent.     In light of this Court's

order, we shall not rule in favor of petitioners on a theory that

the section 357(c) issue was not encompassed by the notice of

deficiency.   Our earlier ruling concluded that the section 357(c)

issue was indeed contemplated by the notice of deficiency, and we

decline to revisit the issue on petitioners' motion.

     With respect to the amount in controversy, the parties

settled on tax deficiency amounts of $88,292, $4,044, and $1,323

for taxable years 1991, 1992, and 1993, respectively.     These

settlement figures amount to 86 percent, 65 percent, and 100

percent of the total amounts determined in the notice of

deficiency.   Therefore, petitioners have not shown that they are

the prevailing party with respect to either the amount in
                              - 11 -


controversy or with respect to the most significant issue

presented.   See Bragg v. Commissioner, 102 T.C. 715 (1994).

     Because petitioners are not the prevailing party, we need

not decide whether petitioners' litigation costs are reasonable,

or whether petitioners unreasonably protracted the court

proceedings.   Accordingly, we hold for respondent and

petitioners' motions for litigation costs and to determine

prevailing party will be denied.

     To reflect the foregoing,

                                      An appropriate Order and

                                 Decision will be entered
