                       T.C. Memo. 1995-583



                      UNITED STATES TAX COURT



         HAROLD T. AND CHRISTINE B. COUCH, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 22110-93.             Filed December 6, 1995.



     Joseph D. Anroman, for petitioners.

     Carmino J. Santaniello, for respondent.



                        MEMORANDUM OPINION

     RAUM, Judge:   The Commissioner determined a $10,962

deficiency in petitioners' 1990 income tax plus a section

6662(a)1 penalty in the amount of $2,192.    The issues for


     1
       Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue. All
Rule references are to the Tax Court Rules of Practice and
Procedure.
                                   - 2 -

decision are:       (1) Whether a deduction claimed by petitioners as

a business bad debt became worthless in 1990, and (2) whether the

debt involved qualifies as a "business" bad debt under section

166.2       The case was submitted on the basis of a stipulation and

two supplemental stipulations of fact.

        Petitioners Harold and Christine Couch (Dr. and Mrs. Couch)

resided in Simsbury, Connecticut, at the time they filed their

petition in this case.       From 1969 until August 1984, Dr. Couch, a

Ph.D. research scientist, was employed by United Technologies

Corporation (UTC).       In 1978, Dr. Couch began supervising efforts

to reduce the Titanium Diboride coating process ("coating

process") to commercial practice.       Titanium Diboride (TiD2) is an

extremely hard metal which can be electroplated on a number of

surfaces.       An employee of Hamilton Standard, a Division of UTC,

had invented the coating process in 1970.       Sometime in 1971, that

employee transferred to the United Technologies Research Center

to reduce the process to commercial practice.       UTC terminated its

efforts to reduce the coating process to commercial practice in

1982.

        When Dr. Couch left UTC's employ in August 1984, he believed

that substantial commercial and military applications for the

coating process existed and that the process could be reduced to

        2
       The Commissioner has conceded in a supplemental
stipulation that petitioners are not liable for the penalty.
Also, concessions by the parties have removed other issues from
this case. See infra note 5.
                                 - 3 -

commercial applications utilizing advanced electron microprobing

techniques as an analytical tool.    In August 1984, petitioners

incorporated HTC Industries, Inc. (HTC) in Connecticut, and, as

HTC's board of directors, adopted a resolution for the issuance

of "Section 1244 Stock", as defined in the Internal Revenue

Code.3   All stock issued by HTC qualifies as section 1244 stock.

     Dr. and Mrs. Couch were HTC's president and secretary/

treasurer, respectively.     In October 1984, they acquired for cash

60 percent and 40 percent, respectively, of HTC's issued and

outstanding common stock.4    At the same time they also loaned HTC

$49,500 from their personal savings to use as start-up capital.

The loan was evidenced by a promissory note bearing interest at

12 percent per annum.

     On August 30, 1984, HTC had submitted a proposal to the

Department of the Army regarding a possible contract involving

Titanium Diboride research.    During a pre-award qualification

audit in September 1984, the Defense Contracting Administrative

Services Management Agency informed HTC that it would have to

obtain a $20,000 line of credit as a condition of any contract

     3
       Pursuant to sec. 1244, "a loss on section 1244 stock"
which would otherwise be treated as a loss from the sale or
exchange of a capital asset is treated as an ordinary loss,
subject to various conditions apparently not applicable here,
except that in the case of a husband and wife filing a joint
return the amount allowable may not exceed $100,000.
     4
       HTC's address shown on 4 of its 5 returns in evidence,
from its first through its final return, appears to be the same
as petitioners' home address.
                               - 4 -

award.   After the audit, petitioners approached a number of local

lending institutions for the purpose of obtaining a line of

credit on behalf of HTC.   However, on each occasion, they were

informed that such financing of a small, start-up company was not

possible.

     In October 1984, petitioners obtained a personal line of

credit from Society for Savings secured by a second mortgage on

their residence.   They personally guaranteed the $20,000 credit

line to HTC contingent upon the contract being awarded to HTC.

In March 1985, the Army awarded a Cost Plus Fixed Fee Contract

("the Contract") to HTC.   HTC began work under the Contract on

April 1, 1985.   On April 12, 1988, the Army terminated the

Contract.

     Between August 1984 and September 1989, petitioners made

loans to HTC in the total amount of $187,143.86.   During this

period and through March 31, 1990, HTC made principal payments on

its indebtedness to petitioners in the total amount of

$97,757.36.   As of March 31, 1990, petitioners computed interest

outstanding on the unpaid loans to HTC in the amount of

$62,480.31.

     HTC sought the balance of the unpaid loans and interest from

the contracting officer of the Army.   The contracting officer

offered a settlement proposal for $6,107.47, the difference

between the contract amount ($248,962) and the amount HTC had

previously been paid.   However, he denied their claim for
                                 - 5 -

equitable adjustment of the contract price.   On June 19, 1990,

HTC was dissolved by the State of Connecticut.   The Couchs were

given standing to pursue an appeal before the Armed Services

Board of Contract Appeals on behalf of HTC.   They timely filed an

appeal that was denied by the Board in an opinion dated October

30, 1992.   However, the Board ordered that the parties were to

negotiate an equitable distribution of the property owned by HTC.

     The Couchs caused HTC to appeal the Board's decision to the

United States Court of Appeals for the Federal Circuit.

Extensive briefs were filed on the appellant's behalf, dated July

30, 1993, and September 30, 1993.    A divided panel of the Court

of Appeals affirmed the Board's decision on March 7, 1994.

Thereafter the appellant filed with the Court of Appeals a

"Combined Petition for Rehearing and Suggestion for Rehearing in

Banc", which was denied.   The Couchs on behalf of HTC then sought

review by the Supreme Court, but their petition for certiorari

was denied on October 3, 1994.    Finally, in accord with the order

of the Armed Services Board of Contract Appeals, petitioners'

counsel by letter of January 15, 1995, took steps to begin

negotiations with the Army on the "quantum as to the two

outstanding issues on which the Board of Contract Appeals ruled

for HTC."   The record does not disclose whether such negotiations

have in fact been commenced, or whether, if commenced, they have

been concluded, or, if concluded, the results thereof.
                                - 6 -

     On Schedule C, Profit or Loss From Business, of their 1990

return, petitioners claimed a business bad debt deduction in the

amount of $100,000.   This $100,000 represents a portion of the

unpaid loans made to HTC.   The Commissioner's determination of

deficiency in the amount of $10,962 is based primarily upon the

disallowance of this $100,000 bad debt deduction claimed by

petitioners.5

     At the calendar call of this case the parties orally

stipulated that the debts of HTC amounted to $133,000 at the end

of 1990, and that none of that amount had ever been repaid to

petitioners.    However, that oral stipulation fails to specify how

much of the $133,000 consists of unpaid interest.6

     Section 166(a) allows "as a deduction any debt which becomes

worthless within the taxable year."     Section 1.166-1(c), Income

Tax Regs., requires that the debt be a bona fide one.    The


     5
       The Commissioner also disallowed other deductions claimed
on Schedules A and C. Petitioners have conceded these other
deductions in their opening brief. The Commissioner concedes
that petitioners are entitled to a charitable contribution
deduction in the amount of $733, which had previously been
disallowed.
     6
       Since it does not appear that petitioners were other than
cash basis taxpayers, any unpaid accrued interest would not have
been included in their gross income. Therefore, no deduction
would in any event be allowable for a loss based upon unpaid or
unrealized income, in accordance with the long established
principle that no deduction for a loss is allowable in respect of
an item of unrealized income. Hort v. Commissioner, 313 U.S. 28,
32-33 (1941); Hutcheson v. Commissioner, 17 T.C. 14, 19 (1951);
Lewicki v. Commissioner, T.C. Memo. 1974-86 (unrealized
interest).
                                 - 7 -

Government concedes that the advances made in this case

constitute bona fide loans.     Section 1.166-2(a), Income Tax

Regs., provides that, in determining the worthlessness of the

debt, "the district director will consider all pertinent

evidence, including the value of the collateral, if any, securing

the debt and the financial condition of the debtor."

     As recognized by the Supreme Court in United States v. S.S.

White Dental Manufacturing Co., 274 U.S. 398, 400-401 (1927),

quoting from and relying upon Article 141 of Treasury Regulations

45, the loss "must usually be evidenced by [a] closed and

completed" transaction.   The Court also quoted with approval

Article 151 of those regulations to the effect that a sufficient

showing of worthlessness has been made "[w]here all the

surrounding and attendant circumstances indicate that a debt is

worthless and uncollectible and that legal action to enforce

payment would in all probability not result in the satisfaction

of execution on a judgment."7    Id. at 401.

     The worthlessness of a debt is a factual question confined

to the particulars of each case.     Boehm v. Commissioner, 326 U.S.

287, 292-293 (1945); Dustin v. Commissioner, 53 T.C. 491, 501

(1969), affd. 467 F.2d 47 (9th Cir. 1972).     Although


     7
       Regulations currently in effect and applicable during the
taxable year are substantially identical in all significant
respects to the regulations quoted above in United States v. S.S.
White Dental Manufacturing Co., 274 U.S. 398 (1927). Sec. 1.166-
2(b), Income Tax Regs.
                                - 8 -

worthlessness must be determined objectively, not subjectively,

and although the taxpayer must exercise business judgment in

determining in the first instance whether to take a deduction, he

is not required to be an "incorrigible optimist".     S.S. White

Dental Manufacturing Co., 274 U.S. at 403.    The worthlessness of

the debt must be determined as of the time the deduction is

taken.   Estate of Scofield v. Commissioner, 266 F.2d 154, 163

(6th Cir. 1959), affg. in part, revg. in part 25 T.C. 774 (1956).

However, subsequent events may be considered to test the

soundness of the decision.    American Offshore, Inc. v.

Commissioner, 97 T.C. 579, 597 (1991).

     The taxpayer must demonstrate that the debt had value at the

beginning of the year in which the taxpayer claimed

worthlessness, and that the debt became worthless in that year.

American Offshore, Inc. v. Commissioner, supra at 593; Dustin v.

Commissioner, supra at 501.   A taxpayer may deduct a bad debt

only in the year it in fact becomes worthless.     American

Offshore, Inc., supra at 594.   The opinion in that case sets

forth an extensive list of factors that have been considered in

determining worthlessness.    Id.   Factors that are relevant in

this case include the value of any collateral securing the debt,

the financial condition of the debtor, the bankruptcy or

receivership of the debtor, and lack of assets.     Id. at 594-595.

The taxpayer has the burden of proving the year of worthlessness.

Rule 142(a); Crown v. Commissioner, 77 T.C. 582, 598 (1981).
                                 - 9 -

      In the present case, petitioners contend that the debt

became worthless during 1990.    They rely first on the fact that

HTC was dissolved by the State of Connecticut on June 19, 1990.

They equate HTC's dissolution to bankruptcy.     They argue that

section 1.166-2(c)(2), Income Tax Regs., provides that the year

of settlement in bankruptcy cases is the proper year to consider

the debt worthless, that the dissolution of their corporation is

equivalent to bankruptcy, and that a deduction should therefore

be allowed here in the same manner.

      Petitioners misread section 1.166-2(c)(2), Income Tax Regs.

That section provides:

      In bankruptcy cases a debt may become worthless before
      settlement in some instances; and in others, only when
      a settlement in bankruptcy has been reached. In either
      case, the mere fact that bankruptcy proceedings
      instituted against the debtor are terminated in a later
      year, thereby confirming the conclusion that the debt
      is worthless, shall not authorize the shifting of the
      deduction under section 166 to such later year.
      [Emphasis added.]

Id.   Petitioners ignore the word "may" in the regulation.    They

also ignore section 1.166-2(c)(1), Income Tax Regs.     That section

states that "[b]ankruptcy is generally an indication of

worthlessness".   Id.    (Emphasis added).   It has been held that

bankruptcy "is not enough by itself to establish worthlessness."

Cox v. Commissioner, 68 F.3d 128, 131 (5th Cir. 1995), affg. T.C.

Memo. 1994-189.

      Petitioners next point out that the corporation had no

property with which to secure the debts.     Because the corporation
                              - 10 -

had been dissolved, they argue, "a judgment against the same

would be a legal and factual impossibility."   Petitioners' own

actions regarding HTC belie this claim.   In September 1990, after

HTC had been dissolved, petitioners filed for personal

bankruptcy.   HTC Indus., ASBCA No. 40562, 93-1 B.C.A. (CCH) par.

25,560 affd. on reconsideration, 93-2 B.C.A. (CCH) par. 25,701

(1992).   In their petition for bankruptcy, they listed as

"personal property" the litigation "Couch v. Army, ASBCA No.

40562" with a market value of $2,000,000.   Id.    The Bankruptcy

Court order was not issued until March 19, 1991.     In July 1991,

the Couchs amended their Bankruptcy Petition to read:    "Couch v.

Army ASBCA #40562.   Fair market value is unknown.   Property

claimed exempt under 11 U.S.C. 522(d)(1) and (5)."     Id.    The

Couchs' actions indicate that through July 1991 they believed the

claim held by HTC and pursued by them on HTC's behalf had

substantial value.   Their actions contradict their claim of

worthlessness for 1990.

     Subsequent events support the actions of petitioners.      See

American Offshore, Inc. v. Commissioner, supra at 597.       In its

decision, the Board of Contract Appeals observed that the

property of HTC had not been distributed.   Although the Board did

not give the property specific value, and even noted that the

property may have had no value, the Board ordered the parties to

negotiate an equitable distribution of what remained.    The

Board's order indicates its belief that, as late as 1992, the
                               - 11 -

property of HTC still had some value.    This belief, in turn, is

evidence that the dissolution of HTC in 1990 was not a "closed

and completed" transaction indicating the worthlessness of the

loans HTC held.

     Petitioners also contend that their unsuccessful attempts to

recover the debts through litigation are evidence of the

worthlessness of the debts.    HTC submitted a formal claim under

the Contract Disputes Act of 1978 for an equitable adjustment in

the Contract price in November 1989.    The Army denied the claim

in March 1990.    That same month, HTC appealed the Army's denial

of its claim to the Armed Services Board of Contract Appeals.

The Board rendered a decision in 1992 against petitioners.

Petitioners then caused that decision to be appealed to the

United States Court of Appeals for the Federal Circuit, and

pursued that appeal vigorously and aggressively as evidenced by

the extensive briefs filed in that litigation.    And after a

divided panel of the Court of Appeals affirmed the Board's

decision in an unpublished opinion, HTC Indus., Inc. v. Aspin,

Secretary of Defense, 22 F.3d 1103 (Fed. Cir. 1994), petitioners

caused HTC to file a petition for rehearing including a

suggestion for a rehearing en banc.     The petition for rehearing

was denied, and the suggestion for rehearing en banc was

apparently not favorably acted upon.    Finally, the Couchs caused

HTC to seek further review in the Supreme Court, which denied the
                              - 12 -

petition for certiorari.   HTC Industries, Inc. v. Perry,

Secretary of Defense, 513 U.S. __ (1994).

     It is well established that normally if a taxpayer is

willing to pursue the claim in court, "there is as a matter of

fact sufficient chance of at least part recovery to justify that

taxpayer in deferring the claim of a loss deduction * * * until

the litigation in question is concluded."   Estate of Scofield v.

Commissioner, 266 F.2d 154, 159 (6th Cir. 1959), affg. in part,

revg. in part 25 T.C. 774 (1956); see Dawn v. Commissioner, 675

F.2d 1077, 1078 (9th Cir. 1982), affg. T.C. Memo. 1979-479; Gale

v. Commissioner, 41 T.C. 269, 276 (1963).

     In our judgment petitioners would not have pursued the claim

against the Army as vigorously and aggressively as they did

unless they believed they could recover something.   That they

have not had any success does not objectively negate the value of

their claim to them.   In fact, their pursuit of the claim through

the Board of Appeals, the Federal Circuit, and even the Supreme

Court indicates their belief, at least as late as 1994, that they

held a valuable asset.

     We find that the debt in question did not in fact become

worthless in 1990.   In the circumstances, we need not consider

whether the loss was a business or nonbusiness bad debt.

     Due to concessions by the parties,

                                    Decision will be entered

                               under Rule 155.
