                          T.C. Memo. 2000-166



                        UNITED STATES TAX COURT



         JOHN C. ARCHER AND NANCY M. ARCHER, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



       Docket No. 11587-98.                       Filed May 22, 2000.



       Robert E. Reetz, Jr., Kenneth D. Owens, and Carleton A.

Davis, for petitioners.

       Rosemary Schell, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


       COLVIN, Judge:   Respondent determined a deficiency in

petitioners’ income tax of $23,188 for 1994 and a penalty of

$4,637.60 under section 6662(a) for substantial understatement of

tax.

       After concessions, the issues for decision are:
                                - 2 -

     1.   Whether petitioners may deduct $37,739 for 1994 which

petitioners contend they paid to settle a threatened lawsuit.1

We hold that they may not.

     2.   Whether petitioners are liable under section 6662(a)

for a penalty of $4,637.60 for 1994 for substantial

understatement of income tax.   We hold that they are.

     Section references are to the Internal Revenue Code in

effect for 1994.   Rule references are to the Tax Court Rules of

Practice and Procedure.   References to petitioner are to John C.

Archer.

                          FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

A.   Petitioners

     Petitioner lived in Liberty, Texas, and petitioner Nancy M.

Archer lived in Austin, Texas, when they filed their petition.

Petitioners were cash basis, calendar year taxpayers.    Petitioner

is a lawyer who specializes in collecting delinquent taxes for

Texas counties and districts.

B.   Petitioner’s Law Firm

     Parmer, Archer, Young & Steen, P.C. (PAYS), a professional

service corporation, was incorporated before 1994 under the Texas

Professional Corporation Act.   PAYS provided legal services to


     1
        Petitioners concede that they may not deduct $37,606 of
the $75,345 that they deducted for settlement of a threatened
lawsuit.
                                - 3 -

Texas counties, school districts, cities, and water districts

relating to collection of delinquent taxes.

     PAYS was an S corporation.    Petitioner held 100 shares in

PAYS, which was a 10-percent ownership interest.    Petitioner’s

adjusted basis in his 100 shares was $92,039.

     In 1994, petitioner became dissatisfied with PAYS’

management and decided to open his own law office and represent

certain PAYS clients.    The officers of PAYS learned about

petitioner’s plan, discharged him from the firm, and threatened

to sue him for tortious interference with PAYS’ contracts with

its clients.

C.   The Settlement Agreement

     On December 23, 1994, petitioner and PAYS negotiated and

settled their dispute.    Their agreement had five pages.

Petitioner and the remaining PAYS members initialed each page,

and signed the agreement on page 5.     The first two pages of the

agreement (part 1) were entitled “AGREEMENT TO PURCHASE/SELL

SHARES”.   The heading “ASSIGNMENT AND NON-COMPETITION” appears at

the top center of the third, fourth, and fifth pages of the

agreement (part 2).   Centered beneath that title is “PAGE TWO” on

the fourth page and “PAGE THREE” on the fifth page.    In part 2,

petitioner and PAYS resolved the threatened lawsuit related to

petitioner’s plan to take the Liberty County account with him.
                                    - 4 -

     The following chart lists the provisions in parts 1 and 2 of

the agreement which benefit PAYS or petitioner:

Provisions Which Benefit PAYS       Provisions Which Benefit Petitioner

Contained in part 1:                Contained in part 1:

1. PAYS gets petitioner’s 100       1. PAYS forgives petitioner’s $12,500
shares. (No value stated.)          debt to PAYS.

2. Petitioner will pay the          2. PAYS assumes petitioner’s $37,000 debt
$25,000 deductible for any          to Henry Steen, Jr. and Gates Steen.
payment made for a claim against
him under PAYS’ professional        3. PAYS will try to obtain a release of
lawyer’s liability policy. (No      petitioner’s guarantee of the PAYS note to
value stated.)                      Chester Young, or will indemnify
                                    petitioner against claims arising from
Contained in part 2:                that guarantee. (No value stated.)

1. Petitioner will not compete      4. PAYS will give petitioner three
with PAYS for tax collection        computers. (Stipulated value of $2,000.)
contracts, other than the two
assigned to him, for a period of    5. PAYS will indemnify against judgments
2 years (petitioner’s covenant      arising out of a pending lawsuit unless
not to compete). (No value          petitioner made the statement which is the
stated.)                            subject of the lawsuit. (No value
                                    stated.)
2. Petitioner will make no claim
for any part of legal fees earned   6. PAYS gives petitioner an interest in
for services provided to Liberty    the settlement of a certain lawsuit.
County before January 1, 1995       (Stipulated value of $2,800.)
(petitioner’s covenant not to
sue). (No value stated.)            7. PAYS releases petitioner from
                                    liability as a guarantor of the firm's
3. Petitioner will indemnify        $100,000 line of credit. (No value
PAYS and its shareholders and       stated.)
directors from any claims
resulting from his departure and    Contained in parts 1 and 2:
the contract assignments. (No
value stated.)                      1. PAYS assigns its collection contracts
                                    with Liberty County and Trinity County to
4. Petitioner will return all       petitioner. (No value stated.)
PAYS property not specifically
given to him under the agreement.   2. PAYS will not sue petitioner or
(No value stated.)                  Liberty County for cancelling or assigning
                                    the Liberty County contract (PAYS'
                                    covenant not to sue). (No value stated.)



     No specific items were given by one party to the agreement

for any specific items given by the other party.
                                - 5 -

D.   Petitioners’ Income Tax Return

     Frank Melvin (Melvin), a certified public accountant

(C.P.A.) licensed in Texas, prepared petitioners’ 1994 income tax

return.   Petitioners deducted $75,345 on their 1994 Schedule C,

Profit or Loss From Business (Sole Proprietorship), for

litigation settlement (i.e., PAYS’ covenant not to sue).    On

Schedule D, Capital Gains and Losses, they reported that they

sold PAYS stock for $75,345, that their basis in that stock was

$75,345, and that their net long-term capital gain or loss was

zero.

                               OPINION

A.   Whether Petitioners Paid $37,739 to Settle a Threatened
     Lawsuit for 1994

     1.    Contentions of the Parties

     Petitioners contend that a taxpayer may deduct as a business

expense settlement payments made to avoid litigation related to

the taxpayer’s business.   See Anchor Coupling Co. v. United

States, 427 F.2d 429, 433 (7th Cir. 1970).   Petitioners contend

that petitioners paid at least $37,739 to PAYS to settle PAYS’

threatened lawsuit against petitioner (i.e., for PAYS’ covenant

not to sue).   Respondent contends that petitioners have not shown

how much they paid to settle the threatened lawsuit.

     As cash basis, calendar year taxpayers, petitioners may

deduct an expense in the year in which the expense was paid in

cash or its equivalent.    See Helvering v. Price, 309 U.S. 409,
                                - 6 -

413 (1940).   Petitioners did not pay any cash to settle the

threatened lawsuit.   Thus, petitioners must prove how much they

paid in 1994 in the equivalent of cash to settle the threatened

lawsuit.   See Rule 142(a).

     2.    Whether Petitioners Paid $37,739 in 1994 To Settle the
           Threatened Lawsuit

     Petitioners contend that the amount that petitioner paid to

settle the threatened lawsuit can be derived from the values

stated in the agreement and stipulated values for some of the

provisions of the agreement.2   We disagree.   PAYS benefitted from

six provisions in the agreement.    There is no stated or

stipulated value for any of those provisions.    Petitioner

benefited from nine provisions in the agreement, five of which

have a stated or stipulated value and four of which do not.

Petitioners calculate the value of PAYS’ covenant not to sue

(item 5 under consideration received by petitioner in the chart

below) as follows:

Consideration given by petitioner                   Amount
1. PAYS stock                                       $92,039

Consideration received by petitioner
1. Forgiveness of debt to PAYS                       12,500
2. Release of debts to Henry Steen, Jr.,             37,000
   and Gates Steen


     2
        Respondent contends that the settlement consists of two
separate agreements. We disagree. PAYS and petitioner prepared
and executed the settlement at the same time. They signed the
settlement only at the end of page 5. We doubt that they would
have agreed to either part without agreeing to both parts. We
conclude that the settlement is one agreement.
                                  - 7 -

3. Three computers                                      2,000
4. 30 percent of the proceeds from                      2,800
   Archer v. Houseman
5. PAYS’ covenant not to sue                           37,739
   (litigation settlement)
     Total                                             92,039

        For petitioners’ calculation to be valid, petitioner’s stock

in PAYS must have a value of at least $92,039, and the following

provisions in the agreement must have no value or values that

benefit the two parties to the agreement equally:      (1)

Petitioner’s agreement to pay the $25,000 deductible for

professional liability claims payments, (2) petitioner’s covenant

not to compete, (3) petitioner’s covenant not to sue, (4)

petitioner’s agreement to indemnify PAYS for claims due to his

departure, (5) petitioner’s agreement to return PAYS’ property

not specifically given to him, (6) PAYS’ agreement to obtain

release or indemnify petitioner with respect to the note to

Chester Young, (7) PAYS’ agreement to indemnify petitioner

against judgments in a pending lawsuit, (8) PAYS’ assignment of

its collection contracts with Liberty and Trinity Counties to

petitioner, and (9) PAYS’ release of petitioner from liability

for the $100,000 line of credit.      Petitioners did not establish

that these items have no value or have offsetting values.       Thus,

it is impossible to calculate the value of PAYS’ covenant not to

sue.3


        3
            Petitioners contend that petitioner’s stock was worth
                                                       (continued...)
                               - 8 -

     Petitioners contend that the fact that PAYS and its

shareholders did not hesitate to file suits against each other

when a shareholder left the firm shows that PAYS’ covenant not to

sue had value.   We recognize that PAYS’ covenant not to sue may

well have had value.   However, petitioners have not given us a

satisfactory basis to estimate its value.

     We conclude that petitioners have failed to show that they

may deduct $37,739, or any other amount, as a litigation

expense.4

B.   Whether Petitioners Are Liable for the Accuracy-Related
     Penalty for Substantial Understatement Under Section 6662

     Petitioners contend that they are not liable for the

accuracy-related penalty under section 6662 because they properly

relied on their accountant and because the transaction was

complex.

     A taxpayer may be liable for an accuracy-related penalty on

a substantial understatement of tax.   See sec. 6662.   The

understatement is reduced to the extent that it (1) is based on

substantial authority, (2) is adequately disclosed on the return


     3
      (...continued)
$200,000 to $250,000 or that it was worth at least $92,039, the
amount of their adjusted basis. Regardless of the value of
petitioner’s PAYS stock, it would not establish the value of
PAYS’ covenant not to sue for the reasons given in the
accompanying text.
     4
        Because of this conclusion, we need not decide, as
petitioners contend, whether 1994 is the proper year to deduct
the litigation expense.
                               - 9 -

or in a statement attached to the return and there is a

reasonable basis for the tax treatment of that item, or (3) is

due to reasonable cause and petitioners acted in good faith.    See

secs. 6662(d)(2)(B)(i) and (ii), 6664(c)(1); sec. 1.6664-4(c),

Income Tax Regs.   Petitioners do not contend that they have

substantial authority for their positions or that they adequately

disclosed their positions on their returns.   They contend only

that they had reasonable cause and acted in good faith.

     Petitioners concede that they may not deduct as a bad debt

loss $37,606 of the $75,345 they claimed as a litigation expense

for 1994.   We have concluded that they may not deduct any amount

as a litigation expense for 1994.

     Petitioners contend that they had reasonable cause and acted

in good faith because they relied on their accountant and the

transaction was complex.   Petitioners point out that they are not

required to question whether their accountant is competent,

citing Streber v. Commissioner, 138 F.3d 216, 220 (5th Cir.

1998), revg. T.C. Memo. 1995-601, and Reser v. Commissioner, 112

F.3d 1258 (5th Cir. 1997), affg. in part and revg. in part

(including on this issue) T.C. Memo. 1995-572.

     To establish good faith reliance on the advice of a

competent adviser, a taxpayer must show:   (1) That he or she

provided the return preparer with complete and accurate

information, (2) that an incorrect return resulted from the
                                 - 10 -

preparer’s mistakes, and (3) that the taxpayer was relying in

good faith on the advice of a competent return preparer.        See

Westbrook v. Commissioner, 68 F.3d. 868, 881 (5th Cir. 1995),

affg. T.C. Memo. 1993-634; Cramer v. Commissioner, 101 T.C. 225,

251 (1993), affd. 64 F.3d 1406 (9th Cir. 1995).         Petitioner

testified in general terms that he described the substance of the

sale of the shares to Melvin, but petitioners have not shown that

they provided Melvin with complete and accurate information or

that the incorrect return resulted from Melvin’s mistakes.

Melvin did not testify.

     The taxpayers in Streber v. Commissioner, supra, were about

20 and 25 years old and lacked business experience when they each

received an inheritance of more than $1 million.        They hired a

lawyer to advise them of their potential tax liability.        They

followed the advice of the lawyer.        Petitioner is not like the

taxpayers in Streber because he is a lawyer, and he negotiated

the agreement at issue.

     The taxpayer in Reser v. Commissioner, supra, was not

personally involved with the transaction which caused the

deficiency.   See id. at 1268.    In contrast, petitioner personally

negotiated the terms of the agreement in the instant case.           The

tax issue in Reser was a complex basis computation for which the

taxpayer had no special knowledge.        See id.   In contrast, the

issue of how much the parties allocated to PAYS’ covenant not to
                              - 11 -

sue is a question of fact.   In Reser, two C.P.A.’s from a

national accounting firm (one of whom testified at trial) agreed

that the taxpayers were entitled to the deduction they claimed.

See id. at 1271.   In contrast, petitioners’ C.P.A. did not

testify in this case.

     We conclude that petitioners are liable for the section 6662

penalty.   To reflect concessions and the foregoing,


                                         Decision will be entered

                                    under Rule 155.
