                         T.C. Memo. 1997-386



                       UNITED STATES TAX COURT




         ROBERT R. PLANTE AND MARY B. PLANTE, Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



       Docket No. 24341-95.                   Filed August 25, 1997.



       Thomas A. Lawler, for petitioners.

       Albert B. Kerkhove, for respondent.


                         MEMORANDUM OPINION


       CARLUZZO, Special Trial Judge:   This case was heard pursuant

to the provisions of section 7443A(b)(3) and Rules 180, 181, and

182.    Unless otherwise indicated, section references are to the

Internal Revenue Code in effect during the relevant year.      Rule

references are to the Tax Court Rules of Practice and Procedure.
                                - 2 -


     In a notice of deficiency issued to petitioners on

September 27, 1995, respondent determined a deficiency in their

1992 Federal income tax in the amount of $8,849.    The issue for

decision is whether petitioners are entitled to a net operating

loss carryover deduction for the year 1992.    The resolution of

this issue depends upon whether petitioners suffered a net

operating loss for the year 1991, which in turn depends upon

whether petitioners are entitled to a business bad debt deduction

for that year, claim for which was made for the first time in the

petition.

Background

     Petitioners filed a joint Federal income tax return for the

year 1992.    At the time that the petition was filed they resided

in Cumming, Georgia.    References to petitioner are to Robert R.

Plante.

     After his graduation from Harvard University in 1962,

petitioner worked for various companies in the packaging

industry, including Boise Cascade, Continental Can, and Maryland

Cup Corp.    At the time petitioner was employed by Maryland Cup

Corp. petitioners lived in the Baltimore, Maryland, area.    When

Maryland Cup Corp. announced plans to relocate to Green Bay,

Wisconsin, petitioner rather than transfer, resigned from the

company with the intent to invest in and manage a marina

business.
                                - 3 -


     On March 31, 1987, petitioner acquired an operating marina

business located on the Middle River in Essex, Maryland, a suburb

of Baltimore.   The purchase date and conflicting evidence as to

the form of the sale are the only details of this transaction

that have been placed in the record.1   At the time of the

purchase, or shortly thereafter, petitioner incorporated Boating

Center of Baltimore, Inc. (BCBI or the corporation).   Petitioner

paid $25,000 for 5,000 shares of common stock of BCBI, which

represented all of the corporation's issued and outstanding

stock.   On April 3, 1987, petitioner transferred all of the

assets of the marina to BCBI.   From the date of its incorporation

through December 20, 1991, petitioner was president and sole

shareholder of BCBI.   Petitioner entered into an agreement to

sell his interest in BCBI, as discussed in more detail later in

this opinion, on December 20, 1991.

     On March 31 and October 15, 1987, petitioner advanced

$275,000 and $45,000, respectively, to BCBI.   Each transaction is

evidenced by a promissory note (the notes) and a resolution

adopted by BCBI's board of directors authorizing the corporation

to accept the terms and conditions set forth in the relevant

promissory note.   The notes were signed by petitioner as

     1
      The parties stipulated that petitioner "purchased the
assets of an existing marina". Petitioner's direct testimony
suggests that he purchased the stock of the corporation that
owned and operated the marina. We proceed as though the
stipulation accurately describes the transaction.
                                - 4 -


president of BCBI, and the corporate resolutions were signed by

petitioner as the sole member of BCBI's board of directors.     The

funds advanced by petitioner on both occasions were used for

BCBI's current operating expenses.

     Except for the amounts and due dates, the terms and

conditions of the notes are identical.      Each refers to petitioner

as the lender and BCBI as the borrower.      The advances are

characterized as loans from petitioner to BCBI with principal and

interest (prime rate plus 2 percent computed quarterly) due in

1 year from the date of the note.    Each note was renewable at the

option of petitioner (as the lender).      If BCBI defaulted on any

term of the notes, became insolvent, filed a bankruptcy petition,

or had a receiver appointed, the notes would become immediately

due and payable in full.    Neither note was fully paid as of its

due date.   The notes were not renewed, and the repayment periods

were not extended.

     Petitioners reported interest income from BCBI on their

joint Federal income tax returns as follows:

                     Year                Amount

                     1987                  -0-
                     1988                  -0-
                     1989               $39,102
                     1990                35,236
                     1991                20,599


Although less than clear from the record, it appears that from

time to time prior to December 20, 1991, petitioner, or
                               - 5 -


petitioners, advanced other funds considered by them to

constitute loans, to BCBI.   Some of the interest referred to in

the above table may relate to these other unspecified

transactions, and the balance presumably relates to the notes.

Aside from the two notes previously described, petitioners

presented no documents evidencing additional loans made by either

of them to BCBI.

     Uncertified financial statements prepared by BCBI's

certified public accountants reflect, among other things, long-

term liabilities to petitioner as follows (year references are to

fiscal years ended October 31):

                Year           Liability

                1987           $320,000
                1988            396,750
                1989            392,409
                1990            419,069
                1991            491,243

No explanation of, or accounting for, the changes in the amount

of the liability from year to year has been provided.   We cannot

tell whether the above amounts include principal and interest.

Comparing the amount of liability for each year to the face

amounts of the notes makes it obvious that, after October 31,

1987, the liabilities are not attributable exclusively to the

notes.   A statement included in BCBI's financial statement for

its fiscal year ended October 31, 1988, indicates that the

liability with respect to that year relates to "unsecured notes
                                   - 6 -


payable to stockholder * * * due in 1997 bearing interest at 10%

per annum, payable monthly."     But for this reference, the record

does not contain any evidence of notes fitting that description

or loans from petitioners to BCBI under such terms.

     As indicated, having resigned his position with Maryland Cup

Corp., petitioner intended to participate actively in the marina

business.    Consistent with this intent, petitioners were employed

by BCBI from 1987 through 1991 and received the following

compensation:

            Year      Petitioner           Mary B. Plante

            1987       $39,000               $3,900
            1988        33,000                5,100
            1989          -0-                 1,800
            1990         1,500                  -0-
            1991        38,000                  -0-


     Although petitioner intended to make a career out of the

marina business, his intentions were frustrated by the operating

losses suffered by BCBI.   In order to minimize his loss with

respect to his investment in BCBI, petitioner decided to sell his

interest in the corporation.

     BCBI was listed for sale for $2.25 million through a broker,

who in August or September 1991 identified Douglas and Kay Hansen

as prospective purchasers.   After preliminary negotiations,

petitioner indicated that he would be willing to accept

$1,050,000 from the Hansens for his interest in BCBI.
                                - 7 -


     On December 20, 1991, petitioner and his attorney met with

the Hansens and their attorney.    After extended discussions,

petitioner entered into a stock purchase agreement (the

agreement) wherein he agreed to sell his interest in BCBI to the

Hansens for $1,050,000 ($300,000 in cash, payable at various

dates, and a note from the Hansens and BCBI in the amount of

$750,000).    The purchase price was allocated as follows:

$575,000 for all issued and outstanding stock of BCBI; $100,000

for petitioner's covenant not to compete; $75,000 for consulting

services to be provided by petitioner as described in the

agreement; and $300,000 for the assumption of a lease and

assignment of petitioner's option to purchase certain land near

the marina.

     During the meeting that took place on December 20, 1991,

Mr. Hansen learned about petitioner's outstanding advances to

BCBI, which at the time amounted to $475,000.    Apparently, Mr.

Hansen was unaware that BCBI's books reflected a liability to

petitioner, and he insisted that any debt owed to petitioner be

eliminated.    Petitioner and the Hansens reached an understanding

as to how the outstanding advances were to be treated, as

reflected in the following paragraphs in the agreement:

          The shareholder, as the sole Shareholder and as
     President of the Corporation, hereby makes the following
     representations and warranties which shall survive the
     Closing Date;
                               - 8 -


               Shareholder has transferred Four Hundred Seventy-
          Five Thousand ($475,000.00) Dollars of notes and
          accrued interest of the Corporation due Shareholder as
          of 11/1/91 to the equity account of the Corporation and
          has made this an irrevocable capital contribution to
          the Corporation. The notes, accrued interest and
          capital lease due Shareholder as of the Closing have
          been tendered to Buyer in exchange for Buyer notes.


Petitioner wrote "PAID IN FULL" and the date of "12-20-91" on

each note.

     Petitioners' 1991 Federal income tax return (the 1991

return) was prepared by Russell Marshall, a certified public

accountant.   Mr. Marshall advised petitioner that the transaction

in which petitioner transferred his interest in BCBI to the

Hansens resulted in a long-term capital loss, only a portion of

which was currently deductible.   On the Schedule D attached to

their 1991 return, petitioners reported a basis of $1,743,492 in

the BCBI stock and reported a long-term capital loss of $693,492

from its sale.2   Petitioners deducted $3,000 of this loss and

treated the remaining portion as a long-term capital loss

carryover to 1992.

     On March 26, 1993, petitioners filed an amended 1991 return.

On the amended return, petitioners treated the BCBI stock as

small business stock defined by section 1244 and claimed an

     2
      In preparing petitioners' original and amended 1991 Federal
income tax returns, the allocation schedule in the agreement was
obviously ignored, and petitioners reported the transaction as
though the entire purchase price was attributable to the sale of
BCBI stock. See infra note 3.
                               - 9 -


ordinary loss of $693,492 from the sale of such stock.   Also on

amended returns, a net operating loss in the amount of $655,191

was carried back to 1988, and then forward into 1989 and 1990, in

the amounts of $601,814 and $591,629, respectively.

     On their 1992 Federal income tax return, petitioners claimed

a net operating loss carryover deduction in the amount of

$587,581, the source of which is not readily identifiable on the

return, but apparently relates to the sale of petitioner's BCBI

stock.   Petitioners' amended returns for the years 1988 through

1991, all of which claimed refunds, and their 1992 return were

prepared by Thomas A. Lawler, Esq., who is also their counsel of

record in this case.

     In the notice of deficiency, respondent determined that

petitioner suffered a loss of $693,492 ($1,743,793 basis, minus

$1,050,000 realized) on the sale of his BCBI stock and further

determined, pursuant to section 1244, that petitioners were

limited to an ordinary loss deduction of $100,000 in 1991 from

the transaction.3   Respondent treated the balance of the loss

     3
       It would appear that respondent was unaware of or
disregarded the allocation schedule in the agreement, potentially
allowing petitioners (at least with respect to the amounts
attributed to the covenant not to compete and consulting
services) to offset ordinary income by long-term capital loss in
excess of the amounts otherwise allowable under sec. 1211(b). We
cannot tell at this point whether treating the sale of
petitioner's option in the real estate as though it were
inherently part of the sale of his BCBI stock worked to
petitioners' advantage or disadvantage for Federal income tax
                                                   (continued...)
                              - 10 -


($593,492) as a long-term capital loss, allowed a $3,000 capital

loss deduction in 1991, and treated $590,492 as a long-term

capital loss carryover from 1991 to 1992.   Consistent with this

treatment of the transaction in 1991, respondent determined that

petitioners had a net operating loss of $61,698 for that year.

After carrying the net operating loss back to 1988 and forward to

1989 and 1990, respondent determined that the loss had been

extinguished prior to 1992.   As a result of the foregoing,

respondent disallowed the net operating loss carryover deduction

of $587,581 claimed by petitioners in 1992, which disallowance

results in the issue here in dispute.   Other adjustments made in

the notice of deficiency are computational in nature and will be

resolved automatically with the resolution of the disputed issue.

Discussion

     Although not specifically addressed by either party, there

appears to be agreement between them on the following points.

First, the BCBI stock in the hands of petitioner constituted a

capital asset as defined by section 1221.   Except as provided by

section 1244, because of the period that petitioner held the


     3
      (...continued)
purposes. In this regard it should also be noted that the
parties stipulated that in the agreement petitioner "agreed to
sell all of the issued and outstanding shares of stock of * * *
[BCBI] for $1,050,000" which does not accurately describe the
transaction, but is consistent with the positions taken on
petitioners' original and amended 1991 returns and in the notice
of deficiency.
                               - 11 -


stock any loss that resulted from its sale or disposition would

be treated as a long-term capital loss.   Secs. 1222 and 1223.

Secondly, the parties agree that petitioner suffered a loss on

the sale of his BCBI stock (the resolution of the issue here

under consideration could have an effect on the amount of the

loss; otherwise there is no dispute between the parties on the

point).   Lastly, the parties apparently agree that petitioner's

BCBI stock constituted small business stock within the meaning of

section 1244(c), subject to the provisions of section 1244(a) and

(b), which under the circumstances of this case would allow

petitioners to treat $100,000 of the loss sustained on the sale

of the stock as an ordinary loss.   In this regard we note that

petitioners' treatment of the transaction on their 1991 amended

return (treating the entire loss as ordinary) is patently

incorrect and inconsistent with section 1244, which as indicated

allows for only a limited amount of the loss to be treated as

ordinary.   Sec. 1244(b)(2).   From the allegations in the petition

and the arguments in petitioners' brief, we assume that

petitioners have recognized their error on this point, and now

support their claim for a 1992 net operating loss carryover

deduction upon the theory that they were entitled to a previously

unclaimed bad debt deduction in 1991.

     In general, section 166 allows a taxpayer a deduction for

any debt that becomes worthless within the taxable year.    Sec.
                              - 12 -


166(a).   To justify a deduction under section 166, petitioners

must establish that a bona fide debt existed.   Sec. 1.166-1(c),

Income Tax Regs.   A bona fide debt arises from a debtor-creditor

relationship based upon a valid and enforceable obligation to pay

a fixed or determinable sum of money.   A shareholder's

contribution to the capital of a corporation is not considered a

debt for purposes of section 166.   Sec. 1.166-1(c), Income Tax

Regs; see United States v. Uneco, Inc. (In re Uneco, Inc.), 532

F.2d 1204, 1207 (8th Cir. 1976); Kean v. Commissioner, 91 T.C.

575, 594 (1988).

     Characterization of an advance by a shareholder to a

corporation as either a loan (debt) or contribution to capital

(equity) is a question of fact that can be resolved only by

reviewing the circumstances surrounding the transaction.    Dixie

Dairies Corp. v. Commissioner, 74 T.C. 476, 493 (1980).

     In reviewing the surrounding circumstances of such

transactions, the following factors should be considered:   (1)

The name given to the certificate evidencing the indebtedness;

(2) the presence or absence of a fixed maturity date; (3) the

source of payments; (4) the right to enforce payment of principal

and interest; (5) participation in management flowing as a result

of the advance; (6) the status of the contribution in relation to

regular corporate creditors; (7) the intent of the parties; (8)

"thin" or adequate capitalization; (9) identity of interest
                              - 13 -


between creditor and stockholder; (10) the source of interest

payments; (11) the ability of the corporation to obtain loans

from outside lending institutions; (12) the extent to which the

advance was used to acquire capital assets; and (13) the failure

of the debtor to repay on the due date or to seek a postponement.

Estate of Mixon v. United States, 464 F.2d 394 (5th Cir. 1972);

see also Lane v. United States (In re Lane), 742 F.2d 1311 (11th

Cir. 1984); Stinnett's Pontiac Serv., Inc. v. Commissioner, 730

F.2d 634 (11th Cir. 1984), affg. T.C. Memo. 1982-314.

     A shareholder/taxpayer seeking to treat an advance to a

corporation as a loan bears the burden of proof on the point,

Rule 142(a); Dixie Dairies Corp. v. Commissioner, supra, as do

petitioners in this case.   Transactions between a shareholder and

a closely held corporation require special scrutiny.    Gilboy v.

Commissioner, T.C. Memo. 1978-114.

      Taking into account the above factors, we first consider

whether the $475,000, or any portion thereof, constituted a loan,

or loans, for Federal income tax purposes.   Petitioners contend

that as of December 20, 1991, the entire $475,000 represented a

worthless bona fide debt, within the meaning of section

166(a)(1), owed to petitioner from BCBI.   They further argue that

no part of the debt constitutes a nonbusiness debt within the

meaning of section 166(d), and therefore they are entitled to a

business bad debt deduction in the amount of $475,000 for the
                               - 14 -


year 1991 that ultimately results in a net operating loss

carryover deduction for the year 1992; respondent disagrees on

virtually every point.    Neither party makes a distinction between

the portion of the $475,000 in unpaid advances represented by

notes and the remaining portion.4

     But for the advances evidenced by the notes, there is

little, if any, evidence in the record regarding the details of

any other transaction(s) that account for the $155,000 difference

between the face value of the notes and the stipulated amount of

the unpaid advances.   As we have often stated, deductions are a

matter of legislative grace.    A taxpayer who claims a deduction

must identify the specific statute that allows for the deduction

and demonstrate that all of the requirements of the statute have

been satisfied.    Rule 142(a); INDOPCO, Inc. v. Commissioner, 503

U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S.

435, 440 (1934).    Having provided the Court with virtually no

information regarding $155,000 of the amount here in dispute,

petitioners have failed to establish that the requirements of

section 166 have been satisfied with respect to that amount.      On


     4
      The parties stipulated that as of Nov. 1, 1991, "the
petitioner had unpaid advances to the corporation totaling
$475,000". The preamble to the stipulation states that
respondent "does not stipulate and agree by the use of the terms
'note,' 'loan,' or 'advance' in this stipulation or annexed
exhibits that amounts paid to or on behalf of * * * [BCBI] by
petitioner * * * constituted loans for federal income tax
purposes."
                               - 15 -


the basis of the record before us, we have no choice but to deny

their claim to the deduction, at least to the extent of $155,000,

and turn our attention to the portion of the deduction

represented by the notes.

     Narrowing our focus on the treatment of the notes in

connection with disposition of petitioner's BCBI stock leads us

to conclude that the balance of petitioners' claim for a bad debt

deduction (the amount represented by the notes) must also be

rejected.

     Assuming, without finding, that the advances evidenced by

the notes represent bona fide loans from petitioner to BCBI, it

is clear that the underlying "debt" was satisfied, "paid",

canceled, or forgiven in connection with petitioner's sale of his

stock to the Hansens.   The agreement clearly makes the

disposition of the notes part of the sale transaction and

characterizes their disposition as a contribution to BCBI's

capital.    Petitioners have presented us with nothing that

suggests otherwise.   Petitioners' argument that the amount

evidenced by the notes should now result in a section 166 bad

debt deduction is inconsistent with the nature of the underlying

transaction.   Respondent's arguments regarding the application of

Commissioner v. Danielson, 378 F.2d 771 (3d Cir. 1967), revg. 44

T.C. 549 (1965), notwithstanding, petitioners have presented no

evidence that attempts to recharacterize the nature of the
                                - 16 -


agreement between petitioner and the Hansens.    The fact is that

petitioner canceled, or otherwise considered satisfied, any debt

owed to him by the corporation as part of his agreement with the

Hansens.    It was characterized as contribution of capital in the

agreement, and there is no basis in fact for considering it

otherwise for Federal income tax purposes.

     Furthermore, a shareholder's cancellation or forgiveness of

any debt owed to the shareholder from the shareholder's closely

held corporation is generally considered a contribution to the

corporation's capital, which is what occurred in this matter.

Lidgerwood Manufacturing Co. v. Commissioner, 229 F.2d 241 (2d

Cir. 1956), affg. 22 T.C. 1152 (1954); Bratton v. Commissioner,

217 F.2d 486 (6th Cir. 1954); Frantz v. Commissioner, 83 T.C. 162

(1984), affd. 784 F.2d 119 (2d Cir. 1986); sec. 1.61-12(a),

Income Tax Regs.    But cf. Giblin v. Commissioner, 227 F.2d 692

(5th Cir. 1955), revg. T.C. Memo. 1954-186.    A creditor's

voluntary forgiveness of a debt ordinarily does not provide

sufficient grounds for claiming a bad debt deduction.    See W.D.

Haden Co. v. Commissioner, 165 F.2d 588 (5th Cir. 1948); Thompson

v. Commissioner, 6 T.C. 285 (1946), affd. 161 F.2d 185 (5th Cir.

1947).     Accordingly, petitioners are not entitled to a bad debt

deduction for 1991 to the extent of the amount of debt evidenced

by the notes, or, as previously indicated, for the unexplained

balance of the $475,000.
                             - 17 -


     Because petitioners are not entitled to a bad debt deduction

for the year 1991, it follows, and we hold, that petitioners are

not entitled to the net operating loss carryover deduction here

in dispute.

     To reflect the foregoing,

                                        Decision will be

                                   entered for respondent.
