                        T.C. Memo. 2001-44



                      UNITED STATES TAX COURT


 JEFFREY M. GUERRERO AND GENEDINE R. GUERRERO, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent

        ALAN G. BONE AND KATHLEEN A. BONE, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 20218-98, 20219-98.      Filed February 23, 2001.



     James L. McDonald, Sr., for petitioners.

     Larry D. Anderson, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     GERBER, Judge:   In separate notices of deficiency,

respondent determined deficiencies in petitioners’ income taxes

and penalties as follows:
                                - 2 -

                                                   Penalty
     Docket No.     Year        Deficiency      Section 6662(a)
      20218-98      1992         $34,515           $6,903
      20219-98      1992          31,568            6,314

     These cases have been consolidated for purposes of trial,

briefing, and opinion.

     The issues for our consideration are:    (1) Whether

petitioners Jeffrey Guerrero (Mr. Guerrero) and Alan Bone (Mr.

Bone) had sufficient bases in 1992 to deduct $106,487 and

$98,064, respectively, as their shares of the operating loss from

a subchapter S corporation, Olympic Concrete Pumping, Inc.

(Olympic); (2) whether Olympic’s 1992 income was understated by

$56,598 as the result of an error in converting book income to

taxable income; and (3) whether petitioners are liable for the

penalties under section 6662(a)1 for negligence.

                           FINDINGS OF FACT

     We incorporate by this reference our findings of fact in

A.J. Concrete Pumping, Inc. v. Commissioner, T.C. Memo. 2001-42,

and Bone v. Commissioner, T.C. Memo. 2001-43.

     Petitioners Jeffrey and Genedine Guerrero resided at 4215

Osprey Pointe, Woodstock, Georgia, on the date they filed their

petition in this case.   Petitioners Alan and Kathleen Bone

resided at 617 North Lake Drive, Canton, Georgia.



     1
       Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the periods under
consideration.
                               - 3 -

     On March 15, 1990, Messrs. Guerrero and Bone formed Olympic,

a subchapter S corporation.   Olympic was formed to handle a

concrete project in Washington State.   Messrs. Bone and Guerrero

each contributed $500 in exchange for Olympic’s stock.

     A.J. Concrete Pumping, Inc. (A.J. Concrete), was a

corporation in the business of pumping concrete.   Mr. Bone owned

51 percent of its stock, and Mr. Guerrero owned 49 percent of its

stock.   Messrs. Bone and Guerrero arranged for Olympic to lease

concrete and pumping trucks and to borrow capital from A.J.

Concrete.   Olympic borrowed funds from A.J. Concrete during

Olympic’s existence.   Olympic discontinued operations in 1992.

     Olympic kept its books and records on an accrual basis and

converted to cash for tax purposes.    It reported, for Federal tax

purposes, on a calendar year basis.    Olympic reported a $64,491

loss in 1990, a $233,172 loss in 1991, and a $9,021 loss in 1992.

On Olympic’s Schedules L, Balance Sheet, attached to its 1990,

1991, and 1992 tax returns, Olympic did not list any loan

obligations to its shareholders.

     Mr. Bone claimed no loss from Olympic for 1990 because he

was not listed as a shareholder.   He claimed a $20,610 loss for

1991 and carried forward a $93,944 loss because of a basis

limitation.   In 1992, Mr. Bone claimed his 1991 Olympic carryover

loss of $93,644 plus his 49-percent share of Olympic’s 1992 loss

for a total of $98,064.
                                 - 4 -

      Mr. Guerrero reported a $64,491 loss for 1990.   He claimed a

$21,452 loss for 1991 and carried forward a $97,466 loss because

of a basis limitation.     For 1992, Mr. Guerrero claimed his 1991

Olympic carryover loss of $97,466 plus an additional 1992 loss

for a total of $106,487.

      Respondent determined that petitioners did not have

sufficient bases to claim the 1992 losses from Olympic.     That

adjustment resulted in determinations of income tax deficiencies

for petitioners.   Respondent also determined that petitioners

were liable for accuracy-related penalties under section 6662(a).

                                OPINION

I.   Shareholder’s Basis

      Under section 1366, an S corporation shareholder may deduct

his pro rata share of losses (deductions) of the S corporation.

The losses, however, are limited to the sum of the adjusted basis

of the shareholder’s stock in the corporation and the adjusted

basis of any indebtedness of the corporation to the shareholder.

See sec. 1366(d)(1)(A) and (B).

      In order to increase the basis in the indebtedness of an S

corporation, there must be an economic outlay on the part of the

shareholder.   See Estate of Leavitt v. Commissioner, 875 F.2d

420, 422 (4th Cir. 1989), affg. 90 T.C. 206 (1988); Brown v.

Commissioner, 706 F.2d 755, 756 (6th Cir. 1983), affg. T.C. Memo.

1981-608.   The economic outlay required under section
                                - 5 -

1366(d)(1)(B) must leave “‘the taxpayer poorer in a material

sense’” after the transaction than when the transaction began.

Perry v. Commissioner, 54 T.C. 1293, 1296 (1970) (quoting Horne

v. Commissioner, 5 T.C. 250, 254 (1945)), affd. per order 27 AFTR

2d 1464, 71-2 USTC par. 9502 (8th Cir. 1971).   Although a bona

fide loan from a shareholder to an S corporation will increase

the shareholder’s basis, the shareholder must make an actual

economic outlay and directly incur the indebtedness.   See

Underwood v. Commissioner, 63 T.C. 468, 476 (1975), affd. 535

F.2d 309 (5th Cir. 1976).

     Respondent contends that petitioners have insufficient bases

to claim 1992 losses because they failed to establish that they

made additional capital contributions or extended additional

loans in 1992.   Petitioners argue that they wrote checks and made

direct loans to Olympic.

     At trial, petitioners presented an unorganized collection of

checks and financial records.   They had previously presented

these same documents to respondent during the audit examination.

Even though the records were not in order and were difficult to

understand, neither petitioners nor their return preparer

attempted to explain the records in any detail.

     Moreover, Olympic’s corporate records do not reflect that

petitioners made any loans to Olympic during 1991 or 1992.

Olympic’s 1991 and 1992 Schedules L do not list any loans from
                                 - 6 -

its shareholders.   Thus, while petitioners have introduced copies

of checks they wrote to Olympic, they have failed to establish

that those checks were considered or intended to be capital

infusions or loans to Olympic.    The checks could represent

repayments of loans from Olympic to petitioners or payments for

expenditures that Olympic made on behalf of petitioners.    Without

adequate explanation of the evidence by petitioners or their

return preparer, petitioners have not shown that the payments

were capital in nature or that they constituted loans.

     Furthermore, even assuming that the checks were evidence of

direct loans from petitioners, there is no evidence that the

loans were outstanding on December 31, 1992, or that the amounts

had not already been used in claiming 1990 or 1991 flowthrough

losses.   Petitioners’ 1991 tax returns indicate that their bases

at the end of 1991 were zero.    Therefore, as a threshold matter,

petitioners would have had to show that they made additional

direct contributions or loans to Olympic in 1992, and petitioners

have simply failed to do that.

     Petitioners also argue that they pledged personal assets to

secure Olympic’s corporate debt.    Despite petitioners’ argument

to the contrary, their pledges of personal assets to secure

Olympic’s debt might indicate that they were guarantors.

However, even if petitioners were guarantors, Selfe v. United

States, 778 F.2d 769 (11th Cir. 1985), does not apply because
                                 - 7 -

there is no indication that the loans were originally made to the

shareholder, and the record does not indicate that the creditor

looked primarily to the shareholder for repayment of the loan.2

      Petitioners also argue that they received a $100,000

management fee from A.J. Concrete in 1992 which they did not

actually accept but instead constructively contributed to

Olympic.   Olympic’s 1992 return, however, does not support

petitioners’ argument.     There is no indication on Olympic’s

return that it received a capital infusion or loan from

petitioners of $100,000.     Moreover, A.J. Concrete’s tax returns

do not list any loans to Olympic after March 31, 1992.

Petitioners have simply failed to show that this was the case.

      Accordingly, respondent’s determination that petitioners had

insufficient bases in Olympic for 1992 is sustained.

II.   Understated Income

      Respondent determined that Olympic’s 1992 income was

understated by $56,598 as the result of an error in converting

book income to taxable income.     Petitioners did not present any

evidence on this issue and failed to address it in their post-




      2
       The Court of Appeals for the Eleventh Circuit has also
distinguished its holding in Selfe v. United States, 778 F.2d 769
(11th Cir. 1985). See, e.g., Sleiman v. Commissioner, 187 F.3d
1352 (11th Cir. 1999), affg. T.C. Memo. 1997-530; Spencer v.
Commissioner, 110 T.C. 62, 84-86 (1998), affd. 194 F.3d 1324
(11th Cir. 1999).
                                - 8 -

trial briefs.    Accordingly, respondent’s determination that

Olympic understated its income by $56,598 is sustained.

III.    Section 6662(a)

       Respondent determined accuracy-related penalties under

section 6662(a).    That section imposes a penalty in the amount of

20 percent of any portion of the underpayment attributable to

negligence or disregard of rules or regulations.    Negligence is

the lack of due care or the failure to do what a reasonable and

ordinarily prudent person would do under the circumstances.     See

Neely v. Commissioner, 85 T.C. 934, 947 (1985).     The negligence

penalty will apply if, among other things, the taxpayer fails to

maintain adequate books and records with regard to the items in

question.    See Crocker v. Commissioner, 92 T.C. 899, 917 (1989).

       Respondent determined that petitioners are liable for the

penalties on the understatements.    Petitioners failed to address

the accuracy-related penalties in their briefs and presented no

evidence at trial as to why the resulting understatements or

deficiencies were reasonable.    Petitioners did state that “many

records were either lost or destroyed and/or not available which

very likely would have substantiated further losses, not income,

from the failed Olympic Concrete Pumping Company” but did not

provide any explanation for the lost or destroyed records.

       Petitioners’ 1991 returns show their awareness that losses

claimed from S corporations are limited to basis.    In 1992,
                                 - 9 -

however, they claimed their carryover losses from 1991 even

though they had not made any capital contributions or loans in

1991 to increase their bases.    Petitioners provided no

explanation for their actions and accordingly have failed to show

that their actions were reasonable and not careless or made with

intentional disregard of rules or regulations.    Petitioners are

liable for the section 6662(a) penalties for the 1992 tax year.

     We have considered all other arguments of the parties, and,

to the extent not addressed herein, we find them to be either

moot, without merit, or irrelevant.

     To reflect the foregoing,

                                 Decisions will be entered for

                         respondent.
