                        T.C. Memo. 2001-136



                      UNITED STATES TAX COURT



            LARRY M. LEVY AND DIANE LEVY, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 11657-99.                       Filed June 8, 2001.


     Larry M. Levy and Diane Levy, pro sese.

     Kenneth C. Peterson, for respondent.


              MEMORANDUM FINDINGS OF FACT AND OPINION


     FOLEY, Judge:   By notice dated March 25, 1999, respondent

determined deficiencies in and penalties on petitioners’ Federal

income taxes as follows:

                                           Penalty
     Year            Deficiency          Sec. 6662(a)
     1991             $17,334              $3,467
     1992              27,024               5,405
     1994              48,671               9,734

Unless otherwise indicated, all section references are to the
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Internal Revenue Code for the years in issue, and all Rule

references are to the Tax Court Rules of Practice and Procedure.

After concessions, the issues remaining for determination are

whether petitioners are:    (1) Entitled to deduct, in 1991,

certain advances made to Jensen Talbert Fine Jewelers, Inc.

(JTFJ); (2) entitled to deduct, in 1991, payments made pursuant

to personal guaranties of JTFJ debt; and (3) liable for the

section 6662 accuracy-related penalty.

                           FINDINGS OF FACT

     When the petition was filed, Larry and Diane Levy resided in

Newport Beach and Torrance, California, respectively.

I.   Background

     JTFJ owned and operated the Jensen Talbert Fine Jewelry

Store (the store).    Robert Levy, Larry Levy’s father, was the

sole shareholder of JTFJ.

     Prior to 1985, Diane Levy worked as a salesperson in the

store.   In 1985, she began managing the store’s day-to-day

operations (i.e., she supervised employees, acted as lead

salesperson, and purchased inventory).    Diane Levy received wages

of $7,838, $10,125, $6,160, $11,480, and $13,720 in 1982 through

1986, respectively.

     Prior to 1985, Larry Levy began making advances to JTFJ.     By

May 2, 1985, Larry Levy had advanced $53,250 to JTFJ.    In 1985,

Larry Levy started working for JTFJ.    He worked for JTFJ an
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average of 20 hours per week (40 hours per week during the peak

retail periods) from 1985 through 1987 and more than 20 hours per

week from 1987 through 1989.   He provided financial, sales, and

management services to JTFJ.   From 1985 through 1989, JTFJ did

not compensate him for his services.    During 1990 through 1995 he

worked for, and received wages from, American Laser Corporation,

California JAMAR, Inc., and JAMAR Industries.   During 1991 and

1992, Larry Levy operated a consulting business, raising capital

for, but not advancing funds to, his client corporations.

II.   The Note and The Agreement

      On May 2, 1985, Robert Levy, as president of JTFJ, executed

a note (the note), which was secured by JTFJ’s assets but

subordinated to “all current or future financial obligations to

Republic Bank.”   The security interest in JTFJ’s assets was not

perfected.   Payment of principal and accrued interest was due on

or before May 1, 1988.

      On May 2, 1985, Larry Levy, Robert Levy, and JTFJ, executed

the Joint Venture Agreement (the agreement) to provide cash-flow

for JTFJ.    The agreement provided that Larry Levy make additional

advances to JTFJ, guarantee corporate debts, and deliver

professional services relating to JTFJ’s operations and

continuing capital needs.   In exchange, he would receive a 50-

percent interest in JTFJ’s profits, which was payable at his

discretion, after the advances were repaid.   Further, pursuant to
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the agreement, JTFJ reimbursed $15,442 of expenses Larry Levy

incurred on behalf of JTFJ.    The agreement characterized all of

Larry Levy’s advances as loans.    Petitioners’ advances were all

made directly to JTFJ.

       By May 1987, JTFJ was unable to pay its bills as they became

due.    Between May 1987 and April 1988, Larry Levy advanced an

additional $187,096.    On May 1, 1988, the note was not paid as

required by its terms.

III. Advances and Bankruptcy

       On May 5, 1988, JTFJ filed for protection under chapter 11

of the Bankruptcy Code.    The bankruptcy court’s file was

subsequently lost.    After the bankruptcy filing Larry Levy

continued to advance funds to JTFJ (i.e., an additional $92,076

between May 1988 and March 1990).    By March 31, 1990, Larry Levy

had advanced $599,077 to JTFJ (i.e., $48,250 prior to March 31,

1985, and $130,000, $141,655, $174,696, $80,754, and $23,722 in

JTFJ’s taxable years ending March 31, 1986 through March 31,

1990, respectively).    Of these advances, $125,000 of the $599,077

was memorialized by a written note.

       Pursuant to the agreement, Larry Levy guaranteed a number of

JTFJ’s debts.    From 1988 through 1993, petitioners paid $199,426

on the personal guaranties made to JTFJ’s creditors (i.e., $1,000

in 1988, $37,095 in 1989, $53,806 in 1990, $93,725 in 1992, and

$13,800 in 1993).
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     Larry Levy filed a claim as a creditor in JTFJ’s bankruptcy

proceeding.    During the bankruptcy, he agreed to subordinate his

claim to that of Betty Jo Byers.    Ms. Byers was a JTFJ creditor

and former bookkeeper who lent $42,500 to JTFJ.     Larry Levy

personally guaranteed the loan.    Ms. Byers received $26,008.86

from Larry Levy, pursuant to a judgment and subsequent

garnishment of his wages.

     In August 1989, the bankruptcy court ordered the sale of

JTFJ’s assets to Majestic Jewelers.      Majestic Jewelers agreed to

pay the bankruptcy trustee $200,000 for JTFJ’s assets (i.e.,

$50,000 at the time of purchase and the remainder in

installments).   Majestic Jewelers’ payments would go to JTFJ’s

secured creditors, first to Republic Bank and then to

petitioners.   On November 20, 1989, the chapter 11 case was

converted to a chapter 7 case.    In 1991, after making only a few

small payments, Majestic Jewelers defaulted on its obligations.

After Majestic Jewelers defaulted, petitioners were, pursuant to

Larry Levy’s personal guaranty, required to repay $103,622 to

Republic Bank.   Pursuant to the bankruptcy plan, petitioners

would have received the remaining payments.     Petitioners deducted

$445,104 as business bad debt on their 1991 tax return and

claimed a net operating loss carryover on their 1992 and 1994 tax

returns.
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                               OPINION

     Respondent determined that the advances and guaranty

payments were capital contributions to JTFJ, entitling

petitioners to a short term capital loss deduction in 1989, and a

short-term capital loss carryover deduction of $3,000 per year in

1991, 1992, and 1994.    Petitioners contend that they are entitled

to a section 166 business bad debt deduction of $445,104 in 1991.

In the alternative, petitioners contend that they are entitled to

deduct these payments as section 165 losses, or as section 162(a)

ordinary and necessary business expenses.

I.   The Joint Venture

     Petitioners contend that they are entitled to an ordinary

deduction because the advances to JTFJ and guaranty payments were

made pursuant to a joint venture.   Petitioners further contend

that the entity became worthless in 1991.

     A joint venture has been defined as a special combination of

two or more persons, where in some specific venture a profit is

jointly sought without any actual partnership or corporate

designation.   See Beck Chem. Equip. Corp. v. Commissioner, 27

T.C. 840, 848 (1957).    Whether an entity will be recognized as a

joint venture for tax purposes is determined by reference to the

same principles that govern recognition of a partnership.    See

Luna v. Commissioner, 42 T.C. 1067, 1077 (1964) (stating that the
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parties’ agreement and conduct shall be closely scrutinized).

The inquiry is

      whether, considering all the facts--the agreement, the
      conduct of the parties in execution of its provisions,
      their statements, the testimony of disinterested
      persons, the relationship of the parties, their
      respective abilities and capital contributions, the
      actual control of income and the purposes for which it
      is used, and any other facts throwing light on their
      true intent--the parties in good faith and acting with
      a business purpose intended to join together in the
      present conduct of the enterprise. * * * [Commissioner
      v. Culbertson, 337 U.S. 733, 742 (1949); fn. ref.
      omitted.]

      This was not a joint venture.    Larry Levy and Robert Levy

did not come together to make a profit.     The agreement merely

formalized the parties’ previous actions, where Larry Levy

advanced money to JTFJ in exchange for an interest in the

profits.   Moreover, the alleged joint venture did not transact

business, obtain a taxpayer identification number, file

partnership tax returns, maintain bank accounts, or receive

income or incur expenses.   Further, the parties to the agreement

did not report the pass-through of any income or loss.

Accordingly, we conclude that the advances were not made through

a joint venture, and petitioners are not entitled to deduct them

as a loss on the worthlessness of a partnership interest.

II.   Bad Debt Deduction

      In the alternative, petitioners contend that they are

entitled, pursuant to section 166, to a 1991 business bad debt

loss for their advances and payments on personal guaranties.
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Respondent contends that the advances and guaranty payments were

capital contributions to JTFJ.       Respondent further contends that,

even if they were loans, petitioners were not engaged in a trade

or business that would allow these payments to be characterized

as business bad debts.

     Section 166 allows a deduction for any debt that becomes

worthless during the taxable year and distinguishes between

business and nonbusiness bad debts.       A business bad debt is a

debt that is proximately related to the taxpayer’s trade or

business.     See Whipple v. Commissioner, 373 U.S. 193, 201 (1963);

sec. 1.166-5, Income Tax Regs.       Nonbusiness bad debts are treated

as short term capital losses and are subject to the section 1211

limitations on capital losses.       See sec. 166(d)(2).

     a.      The Guaranty Payments

     Petitioners were not in the trade or business of acting as a

guarantor.     Larry Levy’s consulting business did not guarantee

the debts of any corporation.     See sec. 1.166-9(a), Income Tax

Regs.     In addition, the guaranties were not made to protect

petitioners’ trade or business as employees of JTFJ, because

protection of their status as employees was not the dominant

motivation for making the guaranties.       See United States v.

Generes, 405 U.S. 93, 103 (1972) (stating that to qualify for the

business bad debt deduction the taxpayer’s trade or business must

be the dominant motivation for making the guaranties).       Larry
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Levy received no compensation for his services to JTFJ and Diane

Levy’s wages were very small in comparison to the amount of the

loans guaranteed.     See id. at 98-99 (considering the amount of

salary to be protected in relation to the amount advanced).

Petitioners’ guaranty payments (i.e., $1,000 in 1988, $37,095 in

1989, $53,806 in 1990, $93,725 in 1992, and $13,800 in 1993) were

made with a profit motive, the agreements were legally

enforceable against petitioners, and the guaranties were,

however, made before the obligations became worthless.    See sec.

1.166-9(d), Income Tax Regs.    The guaranty payments were

worthless when made.     Petitioners made only $93,725 of guaranty

payments during the years in issue, all during 1992. Accordingly,

petitioners are not entitled to deduct the guaranty payments in

1991.     Petitioners, however, are entitled to deduct $93,725 as a

1992 nonbusiness bad debt.

     b.      The Advances

     To determine whether a payment is a loan or a contribution

to capital, numerous factors are considered.    See Dixie Dairies

Corp. v. Commissioner, 74 T.C. 476, 493 (1980); see also Bauer v.

Commissioner, 748 F.2d 1365, 1368 (9th Cir. 1984) (stating that

11 factors are considered), revg. T.C. Memo. 1983-120.    No

individual factor is controlling, and the determination of

whether advances are loans or contributions to capital requires
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consideration of all of the circumstances.    See Dixie Dairies

Corp. v. Commissioner, supra at 493.

     All of the interest on petitioners’ advances was accrued,

not paid, and, with the exception of the note, there was no fixed

maturity date for repayment of the advances.    See A. R. Lantz Co.

v. United States, 424 F.2d 1330, 1333 (9th Cir. 1970) (concluding

that advances were an equity investment in similar

circumstances).   Further, petitioners agreed to subordinate their

interest to those of Republic Bank and Betty Jo Byers, whose debt

they had personally guaranteed, see O.H. Kruse Grain & Milling v.

Commissioner, 279 F.2d 123, 126 (9th Cir. 1960) (stating that

subordination to later incurred debt is an indication of equity

rather than debt), affg. T.C. Memo. 1959-110; made many advances

when JTFJ had no working capital, see Datamation Servs., Inc. v.

Commissioner, T.C. Memo. 1976-252 (stating that a transaction

appears to be a contribution to capital where advances are made

to provide working capital, and repayment depends solely on the

borrower’s success); and participated in JTFJ’s management, see

O.H. Kruse Grain & Milling v. Commissioner, supra at 126 (stating

that where the taxpayer participates in management, advances are

more likely capital contributions than debt).   Moreover,

petitioners made the advances in exchange for the future receipt

of a 50-percent interest in JTFJ’s profits.    See Aqualane Shores,

Inc. v. Commissioner, 269 F.2d 116, 119 (5th Cir. 1959) (stating
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that an equity investment is subject to the risks, but entitled

to share in the profits of the venture), affg. 30 T.C. 519

(1958).

     Accordingly, we conclude that $120,678 (i.e., the total 1991

deduction of $445,104 less the $199,426 in guaranty payments made

by petitioners and the $125,000 lent pursuant to the note) was a

contribution to capital and that petitioners are not entitled to

a section 166 deduction.   We further conclude that the $125,000

note was a bona fide loan.   The loan evidenced by the note was

legally enforceable.   It was made with a profit motive, before

the obligation became worthless, and not in the course of

petitioners’ trade or business.   The debt became worthless upon

Majestic Jewelers’ default in 1991.    Thus, the loss relating to

the loan is deductible in 1991 as a nonbusiness bad debt.

III. Loss Deduction

     Section 165(a) allows a deduction for certain losses

sustained during the taxable year that are not compensated by

insurance or otherwise.

     Petitioners’ capital interest in JTFJ became worthless in

1989, when JTFJ’s assets were transferred to Majestic Jewelers

for less than the amount of outstanding debt.   Although

petitioners were entitled to a capital loss deduction in that

year, and a carryover, pursuant to sections 1211 and 1212, to the
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years in issue, they are not entitled to the full deduction in

1991.     See sec. 165(f).

IV.   Expense Deduction

        Petitioners contend, in the alternative, that they are

entitled to a section 162(a) deduction relating to an ordinary

and necessary business expense.       Section 162(a) provides that a

taxpayer engaged in a trade or business may deduct all ordinary

and necessary expenses.      Petitioners have failed to establish

that JTFJ’s corporate expenses were the ordinary and necessary

expenses of their trade or business.        Petitioners, therefore, are

not entitled to deduct the advances and guaranty payments as

ordinary and necessary business expenses pursuant to section

162(a).

V.      Accuracy-Related Penalty

        Respondent determined that petitioners were negligent in

determining their 1991, 1992, and 1994 liabilities and are liable

for a section 6662 penalty.      The penalty applies to the portion

of petitioners’ underpayment that is attributable to negligence

or disregard of rules or regulations.       See sec. 6662(b)(1).

Petitioners, relying on the advice of an attorney and an

accountant, made a reasonable attempt to accurately report their

bad debt deduction.     See sec. 6664(c).    As a result, petitioners

are not liable for the accuracy-related penalty.
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     Contentions we have not addressed are moot, irrelevant, or

meritless.

     To reflect the foregoing,


                                        Decision will be entered

                                   under Rule 155.
