                        T.C. Memo. 1995-521




                      UNITED STATES TAX COURT



      HARRY D. BLEDSOE AND ANNIE L. BLEDSOE, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 4572-93.                Filed October 31, 1995.



     Ted M. Riseling and Jeff K. Rhodes, for petitioners.

     Elizabeth Downs, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     GERBER, Judge:   Respondent determined deficiencies in

petitioners' Federal income taxes, additions to tax, and a

penalty as follows:
                                  - 2 -


Year       Deficiency             Additions to Tax          Penalty
                             Sec.            Sec.    Sec.
                        6653(a)(1)(A) 6653(a)(1)(B)  6661
                                             1
1987        $91,789         $4,589                  $22,947

                            Sec.             Sec.        Sec.
                         6651(a)(1)       6653(a)(1)     6661
1988         40,848              8        $2,050        10,212

                                                                 Sec.
                                                                 6662
1989              9                                               $2
       1
           50 percent of the interest due on $91,789.

       All section references are to the Internal Revenue Code in

effect for the years in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure, unless otherwise

indicated.

       After concessions, the issues remaining for our

consideration are:      (1) Whether petitioners are entitled to a bad

debt deduction in the amount of $55,000; (2) whether petitioners

are entitled to Schedule E deductions for legal fees for 1987 and

1988 in the amounts of $88,199 and $37,419, respectively; (3)

whether petitioners are entitled to section 1244 stock loss

deductions for 1988 and 1989 in the amounts of $92,500 and

$96,503, respectively; (4) whether petitioners received dividend

distributions from their S corporation in 1987, 1988, and 1989 in

the amounts of $106,212, $66,423, and $48,632, respectively; (5)

whether petitioners are liable for additions to tax for 1987 and
                               - 3 -


1988 and an accuracy-related penalty for 1989 for negligence or

intentional disregard of rules or regulations; (6) whether

petitioners are liable for an addition to tax for the late filing

of their 1988 tax return; and (7) whether petitioners are liable

for additions to tax for 1987 and 1988 and an accuracy-related

penalty for 1989 for substantially understating their income tax

liability.

     Petitioners also claim that they had an overpayment of tax

for 1989 due to an error made in the notice of deficiency,

because, as the parties now agree, petitioners' basis in

Resthaven should not be reduced by the amount of dividend

distributions.1

                         FINDINGS OF FACT2

     Petitioners, who during the years in issue were husband and

wife, filed joint Federal income tax returns for the years 1987,

1988, and 1989.   Petitioners resided in Wichita, Kansas, at all

times relevant to this case.

     Harry D. Bledsoe (petitioner), a high school graduate, began

his career in the cemetery business in 1950.   He started as a


     1
       This Court has jurisdiction to determine the amount of a
potential overpayment to which this petition relates. Sec.
6512(b)(1).
     2
       The stipulation of facts and the exhibits are incorporated
by this reference.
                                - 4 -


salesman and became a sales or division manager, where he learned

to hire and train salesmen to sell cemetery plots in advance of

need.   Eventually, petitioner became a sales manager for four

small cemeteries, where he was responsible for all of their sales

in advance of need.    Desiring to build his own cemetery

operation, petitioner saved his earnings and

organized/incorporated Resthaven Gardens of Memory, Inc.

(Resthaven), in 1958.    During the years at issue, petitioner was

the sole shareholder, president, and chairman of the board of

Resthaven.   In 1958, Resthaven entered into certain land option

contracts with petitioner and his then wife, Mary Louise Bledsoe

(Ms. Bledsoe).   Together, they held an undivided three-fourths

interest in land adjoining the Resthaven cemetery.    Wichita

Developers, Inc., an affiliated corporation, held the remaining

one-fourth interest.    The land option contracts granted

petitioner and Ms. Bledsoe an interest in the gross sales of

Resthaven.

     In 1979, petitioner filed for divorce from Ms. Bledsoe.     The

two owned considerable property during their marriage.      In 1981,

petitioner was granted a divorce, and property division was the

principal issue in the divorce proceedings.    The divorce decree

granted Ms. Bledsoe the right to receive payments from Resthaven

on the land option contracts which had previously been payable to
                                - 5 -


both petitioner and Ms. Bledsoe, and she was granted the entire

three-fourths interest in the adjacent land.   She was thus

required to assume liability for a note and mortgage on that land

which was payable to Resthaven.

     In 1983, after Ms. Bledsoe did not make certain payments,

Resthaven sued her to recover the $14,250 due on the note and to

foreclose the mortgage.   She counterclaimed, alleging that

Resthaven had not paid her certain amounts to which she was

entitled under the land option contracts, and that she was not

provided with her annual accounting to which she was entitled.

In its 1983 petition with the District Court of Sedgwick County,

Kansas, Resthaven based its claim on the 1981 divorce decree and

alleged that Ms. Bledsoe had failed to comply with the divorce

decree.    Resthaven's proceeding was ultimately consolidated with

the divorce proceeding; both cases were resolved in 1989.     The

State appellate proceedings, to which the legal fees relate,

concerned the property division between petitioner and Ms.

Bledsoe.   For instance, the court was to determine the value of

certain property awarded to Ms. Bledsoe and her rights under the

divorce decree.

     During 1987 and 1988, Resthaven paid the consolidated

litigation legal costs in the amounts of $88,199 and $37,419,

respectively.   The legal costs included payments for the divorce
                                - 6 -


case settlement of $66,721 and the Resthaven note case settlement

of $14,695.26.   The remaining amounts were paid to the attorneys.

     In 1986, petitioner, as president and chairman of the board,

caused Resthaven to lend $110,000 to Albert Kamas (Kamas), a

personal friend.   The loan was to help Kamas finance the

construction of a gasohol plant.   Petitioner, on occasion, asked

Kamas to make payments on the loan.     In 1987, Kamas informed

petitioner that he could not repay/make payments on the loan

because the project had lost its government backing.     Kamas

received a discharge in bankruptcy in approximately 1992.

     On May 7, 1987, Diamond Inn Enterprises, Inc. (Diamond), was

incorporated.    On or about June 1, 1987, Diamond authorized the

issuance of 10,000 shares of section 1244 stock, and it received

a total of $10,000 from its three incorporators.     Seventy-five

percent of Diamond's stock was issued to petitioner.     Initially,

petitioner paid $7,500 to Diamond and, for 1988, deducted a

section 1244 loss in the amount of $100,000.     In order to support

the claimed loss, petitioner relied on each shareholder's

postincorporation payments in amounts proportionate to his

Diamond stock ownership percentage.     From its incorporation

through its failure in 1988, Diamond recorded loans from

shareholders in the total amount of $252,004.     Petitioner's

accountant subsequently determined that the $252,004 should not
                                 - 7 -


have been reflected on Diamond's books as loans from

shareholders.    The postincorporation amounts contributed by

Diamond shareholders were capital contributions which were not in

payment of section 1244 stock.

     On February 28, 1987, Resthaven's parent corporation,

Developer and Management, Inc. (Developer), ceased operation and

merged with Resthaven.    On March 1, 1987, Resthaven became an S

corporation.    During 1987, when S corporation treatment was

elected for Resthaven, the deferred gross profits of the prior C

corporation were picked up and included in Resthaven's income

over the next 4 years.    This occurred because Resthaven changed

from the installment to the cash method of tax accounting.

Resthaven included these "built-in gains" in income:    $262,875,

$197,156, and $139,831 in 1987, 1988, and 1989, respectively.

     Respondent determined that Resthaven paid some of

petitioners' personal expenses and that the amount of those

expenditures should be treated as dividend income to petitioners.

During the administrative proceeding, petitioner's accountant

discovered that Resthaven had unrecorded liabilities for 4,000

burial vaults.    He conducted a sampling of invoices and

determined that $150 was the average cost of a burial vault and

that $50 was the cost of putting the vault into the ground.

Petitioner's accountant, accordingly, determined that Resthaven
                               - 8 -


had $800,000 of unrecorded liabilities which should have been

offset against the S corporation's earnings and profits.

Respondent did not reduce the earnings and profits by any portion

of the unrecorded liabilities in the notice of deficiency

determination.

     Petitioners filed their 1988 joint Federal income tax return

after October 31, 1989, and they had not requested an extension

of time in which to file their return.   Petitioners conceded the

following adjustments:   Resthaven's travel and entertainment

expenses of $14,937, $14,828, and $47,928 for 1987, 1988, and

1989, respectively; a $15,400 reduction in Resthaven's cost of

goods sold; Resthaven's equipment lease expense of $1,183,

$8,882, and $8,076 for 1987, 1988, and 1989, respectively;

Resthaven's vehicle insurance expense of $412, $933, and $1,805

for 1987, 1988, and 1989, respectively; disallowed medical

expense for 1987; and an adjustment to miscellaneous itemized

deductions for 1987.


                              OPINION

Bad Debt

     Resthaven lent petitioner's friend, Mr. Kamas, $110,000 in

December 1986.   Petitioner caused his corporation to lend Kamas

$110,000 so that Kamas could participate in the building of a
                                - 9 -


gasohol plant.   Respondent agrees that this loan would be

deductible to the extent that it became worthless in 1987.      We

must decide whether any part of Resthaven's loan to Kamas became

worthless in 1987.    Sec. 166(a).    Petitioners bear the burden of

proving that Resthaven's loan to Kamas became worthless in 1987.

Rule 142(a).

     Respondent argues that there were no identifiable events in

1987 that would support a finding that $55,000 of the $110,000

debt was worthless.    Respondent contends that the only event

which would have evidenced the loan's worthlessness was Kamas'

bankruptcy discharge in 1992 and that the events relied on by

petitioners are speculative.    We disagree.

     In 1987, the gasohol plant project did not proceed because

it lost its government backing.      Petitioner asked Kamas to pay

the loan back, and Kamas could not pay the principal or the

interest.   During 1987, petitioner also discovered that Kamas had

substantial financial obligations to a bank.      Because the bank

could not collect its debt from Kamas, petitioner believed that

Resthaven would not collect its debt.      By late 1987, the loan to

Kamas was approximately 1 year old and no payments had been made.

After discussions with his accountant, petitioner expected that

Resthaven would collect only half of the $110,000 debt.
                               - 10 -


     A bad debt is deductible only in the year that it becomes

worthless.    Denver & R.G. W. R.R. v. Commissioner, 32 T.C. 43

(1959), affd. 279 F.2d 368 (10th Cir. 1960).    Petitioner has

shown that, in 1987, Kamas' debt to Resthaven became partially

worthless.    We hold that petitioner's judgment and conclusion

about worthlessness were reasonable and are supported by the

record.   Respondent argues that, if the loan became worthless, it

happened in 1992; i.e., when Kamas' bankruptcy discharge

occurred.    We believe, however, that Kamas' 1992 bankruptcy

discharge was simply the result of his 1987 financial troubles,

and resulted in the worthlessness of the remainder of the loan.

     Petitioners are entitled to a $55,000 bad debt deduction for

1987.

Legal Expenses

     Petitioners claimed professional fees of $134,985 for 1987

and $80,885 for 1988.    Respondent disallowed $88,199 and $37,419

for 1987 and 1988, respectively, determining that petitioners had

not established that these amounts were ordinary and necessary

legal expenses of the cemetery business.    Respondent contends

that these payments were made in connection with petitioner's

divorce proceedings.    Petitioners bear the burden of showing that

these expenses were ordinary and necessary business expenses of

Resthaven.    Rule 142(a).
                               - 11 -


     Petitioner's litigation began in 1979 when he sought a

divorce from his former wife, Ms. Bledsoe.   This litigation

required the division of extensive property that had been

acquired during their marriage.   After the divorce was granted in

1981, Ms. Bledsoe appealed the decision, claiming that the court

abused its discretion regarding the property division.   The

divorce decree was affirmed.

     In 1983, Resthaven sued Ms. Bledsoe for $14,250 plus

interest for the balance due on the note that she had assumed.

Resthaven's claim was based in large part on the divorce decree.

Ms. Bledsoe counterclaimed and argued that petitioner and

Resthaven had failed to fulfill their obligations to her under

the divorce decree.   In 1985, Ms. Bledsoe confessed judgment on

the note and mortgage, and in 1989, this litigation ended.

     Section 162 provides taxpayers with deductions for all

"ordinary and necessary expenses paid or incurred during the

taxable year in carrying on any trade or business".   Section 212

allows deductions for all

     ordinary and necessary expenses paid or incurred during
     the taxable year--

          (1) for the production or collection of income;

          (2) for the management, conservation, or maintenance of
        property held for the production of income * * *
                                - 12 -


  We must decide whether any of the claimed legal expenses which

petitioners deducted were attributable to Resthaven's cemetery

business and, therefore, deductible under either section 162 or

212.

       In United States v. Gilmore, 372 U.S. 39, 49 (1963), the

Supreme Court held that the proper time for characterizing an

expense as either "business" or "personal" is when the expense is

incurred.    The U.S. Court of Appeals for the Tenth Circuit, based

on the Supreme Court's holding, formulated the "origin of the

claim" test.    That test must be separately applied to the divided

parts:    the divorce action and the action in which the

corporation was a party.     Dolese v. United States, 605 F.2d 1146,

1151 (10th Cir. 1979).     Hence, we must decide the origin of the

expenditures as they apply to petitioners and to Resthaven.

Wallace v. Commissioner, 56 T.C. 624, 632 (1971).

       This Court has held that, when appropriate, litigation

expenses should be allocated between personal and business costs.

Michaels v. Commissioner, 12 T.C. 17 (1949).     "Such an allocation

between deductible and non-deductible expenses is not unusual, *

* * although 'a rough approximation is all that can be

expected.'"    Burch v. United States, 698 F.2d 575, 579-580 (2d

Cir. 1983) (quoting Ditmars v. Commissioner, 302 F.2d 481, 488

(2d Cir. 1962), revg. and remanding T.C. Memo. 1961-105).
                              - 13 -


     The evidence regarding the legal expenses consists of two

joint exhibits and the testimony of petitioners' witnesses.    One

exhibit is the petition for enforcement of Resthaven's rights

under the divorce decree between petitioner and Ms. Bledsoe.    The

other exhibit is the memorandum opinion from an appeal by

petitioner and Resthaven which, the court notes, represents the

"aftermath of the divorce granted to the parties in 1981."    At

the trial here, petitioner's witness Edwin Carpenter, an attorney

who was personally involved with the divorce litigation,

explained that the litigation was consolidated in order to

address the rights and obligations of both Ms. Bledsoe and

Resthaven.

     It is evident that Resthaven had an interest in protecting

and conserving its corporate assets, which were at risk in the

consolidated litigation.   Resthaven was a party to a portion of

these proceedings, and it had financial interests in protecting

its assets independent of petitioner.   Specifically, it claimed

rights to the proceeds of the note on which Ms. Bledsoe was

liable.   If Ms. Bledsoe had prevailed in her counterclaim,

Resthaven and its cemetery might have suffered substantial

economic hardship.   Although the proceedings were "an aftermath

of the divorce", as the court which entertained petitioner's and

Resthaven's appeal noted, Resthaven had a financial stake in a
                               - 14 -


part of the proceedings.    Accordingly, we find that the part of

these proceedings in which Resthaven had an interest originated

with respect to Resthaven.

     After examining the evidence and analyzing the breakdown of

the legal fees, we hold that, in 1987 and 1988, 35 percent of the

amount disallowed by respondent was, in fact, incurred to

maintain the property held by Resthaven and is deductible.3     See

sec. 212; Burch v. United States, supra.

Section 1244 Stock

     Ordinary loss treatment is available to those individuals

with "section 1244 stock" in a corporation with total equity of

$1 million or less.   The section 1244 stock must have been

originally issued to them for money or property by a domestic

small business corporation.    Sec. 1244(a), (c).    Section 1244

stock loss deductions cannot exceed $50,000 (or $100,000 if a

joint return was filed) per annum.      Sec. 1244(b).

     For 1988 and 1989, petitioners claimed section 1244 losses

on their Diamond stock.    Petitioners assert that they were

entitled to an ordinary loss deduction of $196,503, the amount of

their claimed basis in Diamond.    Due to the section 1244



     3
       We note that $600.75 of the fees paid to Carpenter, Hein,
Carpenter was paid in 1989, but has not been placed in issue for
1989.
                              - 15 -


limitation, petitioners deducted $100,000 in 1988 and the $96,503

remainder as an ordinary loss carryover for 1989.4   Respondent

determined that petitioners' ordinary section 1244 loss deduction

was limited to $7,500, which respondent contends was the amount

that petitioners paid for the stock when it was issued.

     If a shareholder owns section 1244 stock and makes

additional capital contributions and receives no additional

shares of stock, then the basis in the stock increases.    However,

such an increase in basis "shall be treated as allocable to stock

which is not section 1244 stock."   Sec. 1244(d)(1)(B).   Any

additional contributions to capital for which one receives no

additional stock are not eligible for section 1244 ordinary loss

treatment.   Id.

     The parties here agree that the stock at issue is "section

1244 stock" as defined in section 1244(c).   We must decide

whether petitioner's payments subsequent to the initial $7,500

were for the issuance of additional section 1244 stock or were

capital contributions to be treated as "allocable to stock which

is not section 1244 stock."   Id.




     4
       At trial, petitioners acknowledged that, should they
prevail on this issue, their sec. 1244 ordinary loss deduction
should have been limited to $100,000 in 1988 with the balance as
a capital loss carryover. See secs. 1212, 1244(b).
                               - 16 -


     Diamond was incorporated on May 7, 1987.     On June 1, 1988,

Diamond held its first shareholders' meeting.      The minutes of

this meeting specified that, on June 1, 1987, Diamond was

authorized to issue 10,000 shares of section 1244 common stock.

The section 1244 plan stated that the maximum amount of

consideration that could be received by Diamond for the issuance

of this stock would be $1 million.      Accordingly, even though

$1 million was authorized, only $10,000 was paid for the 10,000

shares issued.    In that regard, the minutes of Diamond's first

meeting on June 1, 1988, reflect that petitioner, as one of the

incorporators, contributed $7,500 of the initial $10,000.       Of the

10,000 shares of stock that Diamond had issued on June 1, 1987,

petitioner received 75 percent or 7,500 shares.      Although

additional amounts over $10,000 were later paid to the

corporation, those payments were not designated as payment for

the 10,000 shares issued on June 1, 1988.

     Petitioner relies heavily on Miller v. Commissioner, T.C.

Memo. 1991-126.    In that case, the taxpayer formed a corporation

with another individual for the purpose of constructing a water

amusement park.    The articles of incorporation provided for the

issuance of 100,000 shares of common stock at $1 par value per

share.   The taxpayer and another individual were the directors,

and each paid one-half of the fees for incorporation or $210.       A
                                - 17 -


stock certificate was issued which represented that the taxpayer

owned 30,250 shares of stock.    The taxpayer and the other

shareholders paid debts of the corporation.    Subsequently, a new

stockholder was brought in and paid $43,000 in exchange for

20,000 shares.

     In Miller v. Commissioner, supra, this Court cited Morgan v.

Commissioner, 46 T.C. 878, 890 (1966), where it was reasoned that

"when stock is paid for, it is normally considered issued in

fact, irrespective of the manual issuance of the certificate."

The taxpayer in Miller v. Commissioner, supra, believed that, by

paying one-half of the corporate expenses, such payments would be

applied towards the purchase of his stock.    The taxpayer's only

monetary contribution at the time of incorporation was a $210

incorporation fee.   Because 100,000 shares of stock were

authorized, as a 50-percent owner, the taxpayer in Miller would

have received 50,000 shares.    This, along with the fact that the

new shareholder paid $43,000 for her 20,000 shares, evidenced the

fact that the $210 initial payment was not consideration for the

stock.

     While Morgan v. Commissioner, supra, does not require the

issuance of a certificate to evidence the fact that stock was

issued, in the instant case, the minutes of Diamond's meeting

clearly state that 10,000 shares were authorized and were issued
                              - 18 -


on June 1, 1988:   7,500 shares to petitioner for $7,500 and 2,500

shares to the other shareholders for $2,500.

     Petitioner recalled virtually no details regarding the

issuance of the Diamond stock.   When asked about the stock, he

did state that his $7,500 payment was made "to start the

financial corporation."   Moreover, he remembered that he "was to

own 75 percent of the corporation", yet he could not remember

when and if he received shares of stock.    Finally, petitioner did

state that the other shareholders and he would calculate what

additional funds Diamond needed, and they would contribute based

on their original ownership percentage.    There is no evidence

that petitioner or the other shareholders sought to issue

additional stock, that these payments were part of the original

issue of stock, or that the shareholders intended to somehow

change their ownership percentage.

     The premise of petitioners' position is that there was an

understanding that the 10,000 authorized shares were being issued

for an amount in excess of $10,000 or $1 per share.    While, as a

practical matter, such a premise would appear logical and

reasonable (i.e., the business needed more than $10,000 capital

and possibly petitioner intended all payments to be in exchange

for section 1244 stock), the record here does not support

petitioners' premise.   Accordingly, we find that petitioner's
                              - 19 -


additional contributions to Diamond made after the issuance of

its 10,000 shares constituted contributions to capital which,

while increasing the basis of the stock, are treated as

"allocable to stock which is not section 1244 stock."   Sec.

1244(d)(1)(B).

Dividend Income

     In March 1987, Resthaven merged with its parent and

converted from a C corporation to an S corporation.   The S

corporation included deferred gross profit of the former C

corporation in its income over the next 4 years, 1987 through

1990, because Resthaven changed from the installment method to

the cash method of accounting.   See sec. 481; sec. 1.1374-4(h),

Income Tax Regs.   The gross profit of the former C corporation

constituted earnings and profits to Resthaven.   Respondent

determined that Resthaven had made expenditures for the personal

benefit of petitioner and members of his family, and, therefore,

petitioners realized dividend income in 1987, 1988, and 1989 in

the amounts of $106,212, $66,423, and $48,623, respectively.

     Section 1368(c)(2) provides that distributions from an S

corporation with accumulated earnings and profits are dividends

to the extent that such distributions exceed the corporation's

accumulated adjustments account (AAA) and do not exceed earnings
                              - 20 -


and profits.5   Respondent contends that Resthaven paid certain

personal expenses of petitioner during the years at issue and

that these payments were dividends to petitioner.   Petitioners do

not dispute that Resthaven paid these expenses.   See, e.g., Old

Colony Trust Co. v. Commissioner, 279 U.S. 716, 729-731 (1929).

They claim, however, that Resthaven's earnings and profits should

be reduced by certain unbooked liabilities of the C corporation

and that the expense payments were not dividends.   Petitioners

claim that 4,000 previously sold burial vaults which should have

been recorded on Resthaven's books in 1984 were not.   The

unrecorded liabilities would have reduced the income reported for

sales in advance of need.   Petitioners have the burden of proving

that these liabilities existed and that they should have been

recorded.   Rule 142(a).

     The unrecorded liabilities were discovered in connection

with a proposal to purchase Resthaven.   In correspondence, the

undisclosed liabilities were expressed as the reason the proposal

did not come to fruition.   The failure to record the liability


     5
       If an S corporation has earnings and profits,
distributions generally (to the extent of the shareholder's
basis) can be made tax free to the extent of the corporation's
accumulated adjustments account (AAA) to the extent of the
shareholder's basis. Sec. 1.1368-2(a), Income Tax Regs.,
promulgated in 1993, provides that an AAA is relevant for all tax
years beginning on or after Jan. 1, 1983, for which the
corporation is an S corporation.
                               - 21 -


for the vaults was discovered after the returns in question were

filed, and it was raised during the administrative audit.    The

accountant conducted a random sampling of the universe of

invoices and was able to arrive at an average cost of $150 per

vault.   He also was able to determine that the average cost to

install the vaults should have been $50 each.    Through this

methodology, it was established that the corporation had an

$800,000 (4,000 x $200) unrecorded liability.

     Petitioners have carried their burden of showing the

existence of Resthaven's unrecorded burial vault liability of

$800,000.    Consequently, petitioners did not receive dividend

income in the amounts determined by respondent during the years

in issue.

Negligence

     Respondent determined that petitioners are liable for

additions to tax and a penalty for negligence or intentional

disregard of rules or regulations during the years at issue,

under their respective sections in 1987, 1988, and 1989.

Petitioners have the burden of showing that they were not

negligent with respect to their tax returns at issue.    Rule

142(a); Bixby v. Commissioner, 58 T.C. 757, 791-792 (1972).

     Negligence is a "lack of due care or failure to do what a

reasonable and ordinarily prudent person would do under the
                              - 22 -


circumstances."   Marcello v. Commissioner, 380 F.2d 499, 506 (5th

Cir. 1967), affg. in part and remanding in part 43 T.C. 168

(1964) and T.C. Memo. 1964-299.

     Regarding the section 1244 loss and loss carryover

petitioners claimed for 1988 and 1989, respectively, the evidence

produced was insufficient for us to conclude that they had paid

more than $7,500 for their section 1244 stock.    Petitioners'

argument that the subsequent payments were in exchange for

section 1244 stock may be a plausible one but is an untested

concept.   Petitioners had met the other requirements of section

1244 but failed solely because the subsequent payments could not

be factually linked to the 7,500 shares of section 1244 stock

issued in 1987.   Consequently, we find that petitioners were not

negligent with respect to their section 1244 loss deduction.

     Respondent disallowed legal fees in 1987 and 1988, asserting

that these were personal expenses of petitioners rather than

business expenses of Resthaven.   We have found that 35 percent of

the disallowed expenses were, in fact, incurred by Resthaven in

the ordinary course of its cemetery business.    However, our

determination required that we make a reasonable estimate, as

petitioners' records were quite difficult to analyze in this

case.   With respect to the disallowed portion of legal fees which

we sustain and regarding the other disallowed items conceded by
                                - 23 -


petitioners, petitioners failed to produce adequate records from

which to sustain their deductions.       Therefore, to the extent that

the amount petitioners claimed for legal fee deductions was

excessive and to the extent petitioners conceded some items, we

find that they were negligent.

Late Filing

     Respondent determined that petitioners are liable for an

addition to tax for filing their 1988 return past its due date.

The addition to tax applies unless it is shown that the failure

to timely file is due to reasonable cause and not due to willful

neglect.    Sec. 6651(a)(1).   Because petitioners have not shown

that they had reasonable cause or that their failure to timely

file was not due to willful neglect, we find that they are liable

for the addition to tax for failing to timely file their 1988 tax

return.

Substantial Understatement

     Respondent determined that petitioners are liable for

additions to tax for substantially understating their income tax.

Income tax is substantially understated if, in any year, the

amount of the understatement exceeds the greater of 10 percent of

the tax required to be shown on the return or $5,000.      Secs. 6661

and 6662.
                              - 24 -


     Any such understatements are reduced by that portion for

which there is "substantial authority" or where the transaction

has been "adequately disclosed".   For 1987 and 1988, there were

several items determined by respondent, some of which were

sustained by this Court.   Petitioners have not shown that,

factually or legally, there was substantial authority for the

items composing the understatements.   Furthermore, petitioners

did not adequately disclose their legal fee deductions through

Resthaven.   Regarding the section 1244 stock sale, however, we do

find adequate disclosure in petitioners' 1988 tax return.

Through an attached statement, petitioners fully disclosed the

identity of the corporation, their proposed section 1244 basis,

and the date that the corporation closed.    Therefore, for

purposes of the section 6661 addition to tax, petitioners'

understatement is reduced by that portion which relates to

petitioners' section 1244 stock deduction.

     For 1989, respondent seeks the accuracy-related penalty

under section 6662.   As we have already discussed the issue of

petitioners' negligence with respect to their 1989 year, we shall

address only the substantial understatement aspect of section

6662.   Respondent determined that petitioners' deficiency was $9.

The amount of income tax required to be shown on their return was

over $70,000.   For 1989, petitioners' understatement of $9
                                - 25 -


neither exceeded 10 percent of the amount required to be shown,

nor was over $5,000.   Hence, the understatement was not

substantial as defined by section 6662.

Petitioners' Claim for Refund

     The parties agree that the notice of deficiency contains an

error in the calculation of petitioners' basis in Resthaven.

They have further agreed that petitioners' basis in Resthaven

should not be reduced by the amount of dividend distributions.

The parties are to reflect their agreement in the Rule 155

computation.

     To reflect the foregoing,


                                      Decision will be entered

                                 under Rule 155.
