                         T.C. Memo. 2000-380



                     UNITED STATES TAX COURT



                FRANKLIN W. BRIGGS, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent

      JIMMY D. MORRIS AND SANDRA B. MORRIS, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 5412-98, 5413-98.        Filed December 18, 2000.



     Graydon W. Florence, Jr., for petitioners.

     Mark S. Mesler and Pamela L. Mable, for respondent.



                         MEMORANDUM OPINION


     THORNTON, Judge:    These cases were consolidated for trial,

briefing, and opinion.   Respondent determined the following

deficiencies, additions to tax, and penalties with respect to

petitioners’ Federal income taxes:
                                           - 2 -
                                     Franklin W. Briggs

                                        Penalties and Additions To Tax
                           Sec.           Sec.           Sec.         Sec.      Sec.
Year       Deficiency   6651(a)(1)   6653(b)(1)(A) 6653(b)(1)(B) 6653(b)(1)     6661
1986        $69,077       $2,927        $37,536           **           --     $17,269
1987         10,875       (2,109)*       20,540          ***        $18,000     4,828
1988         20,490         --             --             --           --       5,123

   * The record does not conclusively establish the source of what is apparently
a penalty refund.
  ** 50 percent of the interest due on $50,048.
 *** 50 percent of the interest due on $7,935.


                            Jimmy D. Morris and Sandra B. Morris

                                        Penalties and Additions to Tax
                           Sec.           Sec.           Sec.         Sec.      Sec.
Year   Deficiency       6651(a)(1)   6653(b)(1)(A) 6653(b)(1)(B) 6653(b)(1)     6661
1986    $77,278          $6,928         $37,175           **           --     $19,320
1987     (1,048)*         4,489          26,613          ***           --      13,173
1988      2,606            --              --             --         $1,955      --

   * The negative adjustment resulted from a net operating loss carryback from
1990.
  ** 50 percent of the interest due on $43,838.
 *** 50 percent of the interest due on $8,207.


       Unless otherwise indicated, 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.

       After concessions,1 the issues for decision are:

       1.     The amount of ordinary income petitioners realized with

respect to certain gas rebate checks earned by their wholly

owned S corporation but received by petitioners individually;


       1
       The parties have stipulated various adjustments to
petitioners’ reported income. In addition, on brief petitioners
concede that for taxable year 1988 petitioners Franklin Briggs
(Briggs) and Jimmy Morris (Mr. Morris) each have additional
income of $36,000 from the proceeds of the sale of Association
Cable TV, Inc.’s (ACT’s) assets and of $40,200 from proceeds from
a covenant not to compete.
                              - 3 -

     2.   whether petitioners’ bases in their wholly owned S

corporation include loans made directly to the S corporation by

an unrelated lender;

     3.   whether gains that petitioners realized from certain

1986 land sales represent capital gains or ordinary income;

     4.   whether petitioners are entitled to net operating loss

carryback deductions for 1987 arising from liabilities that

their wholly owned S corporation incurred to a bank with respect

to the bank’s payments to a third party pursuant to a letter of

credit between the bank and the S corporation;

     5.   whether petitioners are liable for additions to tax

pursuant to section 6651(a)(1) for failure to file timely income

tax returns for taxable years 1986 and 1987;

     6.   whether petitioners are liable for additions to tax for

fraud pursuant to section 6653(b) for taxable years 1986, 1987,

and 1988;

     7.   whether Jimmy and Sandra Morris (the Morrises) are

liable for additions to tax pursuant to section 6661 for taxable

years 1986 and 1987; and

     8.   whether Franklin Briggs (Briggs) is liable for

additions to tax pursuant to section 6661 for taxable years

1986, 1987, and 1988.

     For purposes of order and clarity, after a brief

description of general background, each of the issues submitted
                                - 4 -

for our consideration is set forth below with separate

background and discussion.

                        General Background

     The parties have stipulated some of the facts.    When the

petitions were filed, Briggs resided in Alford, Florida, and the

Morrises were married and resided in Panama City, Florida.

     In 1982, Briggs and the Morrises started a multi-million-

dollar real estate construction business known as the Towers

Group.   The Towers Group ultimately comprised nine corporations,

with activities ranging from real estate management to town

house construction and sales.    Two of the Towers Group

corporations were:   (1) Towers Construction Co. of Panama City,

Inc. (Towers Construction), which was in the construction

business and eventually constructed town house units in a Panama

City Beach, Florida, project known as the Gulf Highlands Beach

Resort (Gulf Highlands); and (2) Towers Development Co. of

Panama City, Inc. (Towers Development), which was in the

development business and eventually developed the Gulf Highlands

project.

     For the years in issue, Sandra Morris (Mrs. Morris) and

Briggs each owned 50 percent of the stock of Towers Construction

and Towers Development.2   Briggs was president of Towers

Construction and Towers Development for the years in issue.


     2
       Mr. Morris was not a shareholder of any of the
corporations in the Towers Group, having placed all his interests
in his wife’s name to avoid his creditors.
                              - 5 -

     For Federal income tax purposes, Towers Construction

elected on June 1, 1983, to be treated as an S corporation as

defined by section 1361(a)(1).   Towers Development made its S

corporation election on January 1, 1984.

                 Issue 1.   Gas Rebate Payments

Background

     In 1985, West Florida Natural Gas, Inc., of Panama City,

Florida (West Florida Gas), began participating in an energy

conservation program, authorized by the State of Florida, to

encourage the use of natural gas instead of electricity.    Under

the program, contractors who installed gas heating and cooling

units were eligible to receive rebates from gas companies.

     Beginning in 1985, Towers Construction participated in the

West Florida Gas rebate program.   Towers Construction, as the

contractor on the Gulf Highlands project, was entitled to

receive the gas rebate checks from West Florida Gas.   In 1985,

Towers Construction received from West Florida Gas six rebate

checks totaling $112,000, and in January 1986, it received two

more rebate checks totaling $22,620.   Beginning in May 1986, and

continuing through November 1988, with respect to gas rebates
                              - 6 -

earned by Towers Construction, West Florida Gas issued rebate

checks listing the payee as either Briggs or Jimmy Morris (Mr.

Morris).3

     Each rebate check that was issued after 1985, with one

exception, was either cashed by one of the petitioners or

deposited in one of their personal banking accounts.4   Attached

as the appendix is a schedule detailing the West Florida Gas

rebate payments received by Briggs and the Morrises.    The total

rebate payments were as follows:

               Year         Briggs      The Morrises
               1986       $50,677.50     $38,497.50
               1987        14,355.00      21,315.00
               1988        43,500.00      38,280.00
                 Total    108,532.50      98,092.50

     On their Federal income tax returns, as originally filed,

neither petitioners nor Towers Construction reported as income

the West Florida Gas rebate checks that had been issued in the

individual name of either Briggs or Mr. Morris.   On October 20,

1994, Briggs and Mr. Morris were each convicted by the U.S.



     3
       William Webb (Webb), an employee of West Florida Natural
Gas, Inc. (West Florida Gas), handled the part of the rebate
program in which Towers Construction Co. of Panama City, Inc.
(Towers Construction), was participating. Webb, now deceased,
was Mr. Morris’ first cousin. In 1987 and 1988, Webb embezzled
between $20,000 and $100,000 from West Florida Gas. In July
1989, Webb pled guilty to grand theft.
     4
       The one exception relates to a $20,445 check issued by
West Florida Gas to Towers Construction on Jan. 30, 1986, which
was deposited into Towers Construction’s bank account and then
split equally between Briggs and Sandra Morris (Mrs. Morris).
                                - 7 -

District Court for the Northern District of Florida, pursuant to

section 7207 for willfully filing false Federal income tax

returns for taxable years 1986, 1987, and 1988.

        Before the conclusion of the criminal proceedings against

Briggs and Mr. Morris, Towers Construction filed amended income

tax returns for at least 1986 and 1987 reporting at least some

previously unreported gas rebate income.5    The amended returns

included Schedules K-1, Shareholder’s Share of Income, Credits,

Deductions, Etc., reflecting that Briggs and Mrs. Morris were

allocated equal shares of all the gas rebate income.

Petitioners filed amended individual income tax returns to

reflect the amounts of income reported on the amended Schedules

K-1.6




        5
       On July 6, 1992, Towers Construction filed untimely
amended tax returns for 1986 and 1987. The record contains no
amended return filed by Towers Construction for 1988. The
notices of deficiency, however, make reference to amended
Schedules K-1, Shareholder’s Share of Income, Credits,
Deductions, Etc., from Towers Construction for 1988, reflecting
corrected shares of gas rebate payments, from which we infer that
Towers Construction filed an amended return for 1988 reporting
previously unreported gas rebate income.
        6
       On July 6, 1992, petitioners filed amended tax returns for
1986 and 1987. Briggs also filed an untimely 1988 return on July
6, 1992. The record contains no amended return for the Morrises
for 1988. The notices of deficiency, however, appear to be
predicated on petitioners’ having reported on amended returns the
amounts of gas rebate income reflected on the amended Schedules
K-1 from Towers Construction, from which we infer that the
Morrises filed an amended return for 1988 reporting gas rebate
income as reflected on the corrected Schedules K-1.
                              - 8 -

     In the notices of deficiency, respondent determined that

petitioners had ordinary income from the gas rebate payments in

the amounts that they actually received rather than in the

amounts reported on the corrected Schedules K-1.

Discussion

     Petitioners do not dispute that they received ordinary

income from the West Florida Gas rebates, but they disagree with

respondent’s determination as to the manner in which the income

should be allocated between Briggs and the Morrises.   On brief,

petitioners state that the issue is “whether the gas rebates

should go through Towers Construction and pass through to the

petitioners equally or be divided according to whom the checks

were made out.”   Petitioners contend that the gas rebates were

earned by Towers Construction and should pass through to

Briggs and Mrs. Morris equally, each being a 50-percent

shareholder.7

     Respondent replies first, in essence, that if petitioners

wanted the gas rebate payments allocated in this manner, they

should have done so when they first filed their returns, and

second, that respondent’s allocation “accurately reflects how

petitioners in fact treated the payments.”




     7
       Petitioners’ position has the effect of producing equal
and opposite adjustments to the Morrises’ and Briggs’
redetermined taxable incomes.
                               - 9 -

     Neither party has offered any meaningful legal analysis.

The only citation of any legal authority by either party appears

in respondent’s opening brief, which cites without elaboration

section 61 for the proposition that petitioners had unreported

income from the gas rebate payments.    As discussed below, we

sustain respondent’s determination, but on different grounds.

     The parties have stipulated in at least 37 separate

numbered stipulations that the gas rebates were “earned by

Towers Construction”.   Two of the checks in question were made

payable to Towers Construction.    We conclude that the gas rebate

payments were gross income to Towers Construction and should

pass through to the shareholders--Briggs and Mrs. Morris–-pro

rata; i.e., equally.    See sec. 1366(a), (c).

     Our analysis does not end there, however, for the tax

treatment of S corporation shareholders takes into consideration

not only their pro rata shares of the corporation’s items of

gross income (the pass-through amounts), but also distributions

they receive from the S corporation.   An S corporation’s

distributions to its shareholders may give rise to gross income

to the shareholders in excess of the pass-through amounts,

depending upon a variety of considerations.      See sec. 1368.

     Here, the payments of Towers Construction’s gas rebates to

Briggs and the Morrises represent, in substance, distributions of
                              - 10 -

Towers Construction’s earnings to Briggs and Mrs. Morris.8

Thus, we must consider the tax treatment of these distributions.

     If an S corporation has no accumulated earnings and profits,

then a distribution is generally excluded from the shareholder’s

gross income to the extent of his or her adjusted basis in the S

corporation stock, and distributions in excess of the adjusted

basis are treated as gains from the sale or exchange of property.

See sec. 1368(b).   Although the record is inconclusive on this

point, it appears most likely that Towers Construction had no

accumulated earnings and profits for the years in issue.9    The

record is devoid of evidence, however, of Briggs’ and Mrs.

Morris’ adjusted bases in their Towers Construction stock.

Generally, a shareholder’s adjusted basis in S corporation stock


     8
       For this purpose, we treat distributions to Mr. Morris,
who was in effect a beneficial owner or coowner of the stock
nominally held by Mrs. Morris, as being with respect to that
stock.
     9
       An S corporation may have accumulated earnings and profits
from a variety of sources, including: (1) As a carryover from
years in which it was a C corporation before it became an S
corporation, see Cameron v. Commissioner, 105 T.C. 380, 384
(1995), affd. sub nom. Broadway v. Commissioner, 111 F.3d 593
(8th Cir. 1997); (2) as S corporation earnings for taxable years
prior to 1983, see H. Conf. Rept. 104-737, at 227 (1996), 1996-3
C.B. 741, 967; and (3) as the result of certain reorganizations
and the like involving the application of subch. C to an S
corporation, as described in sec. 1371(c)(2), see Toberman v.
Commissioner, T.C. Memo. 2000-221. Towers Construction elected S
corporation status in June 1983. It appears that Towers
Construction was never a C corporation. From the sketchy
information contained in the record, it seems most likely that
Towers Construction was never involved in reorganizations and the
like within the meaning of sec. 1371(c)(2).
                               - 11 -

is increased for his or her share of the pass-through amounts.

See sec. 1367(a)(1).10   Consequently, we assume that Briggs’ and

Mrs. Morris’ adjusted bases in their stock included their pro

rata shares of Towers Construction’s gas rebate earnings.    To

that extent, the distributions of the gas rebate payments would

give rise to no additional gross income apart from the pass-

through amounts.   Because petitioners have not shown and the

record does not otherwise establish any additional amounts of

adjusted basis in their Towers Construction stock, distributions

in excess of the pass-through amounts represent additional gross

income to Briggs and Mrs. Morris, which generally would be

treated as gains from the sale or exchange of property.11    See

sec. 1368(b)(2).

     Without further refinement, this analysis would result in

Briggs and the Morrises having, for each taxable year in issue,

combined redetermined gross income from the gas rebate payments


     10
       An amount that is required to be included in the S
corporation’s gross income on the shareholder’s tax return is
taken into account under these basis-adjustment rules only to the
extent “included in the shareholder’s gross income on his return,
increased or decreased by any adjustment of such amount in a
redetermination of the shareholder’s tax liability.” Sec.
1367(b)(1). Since we herein redetermine petitioners’ gross
incomes to include shares of Tower Construction’s gas rebate
income, their adjusted bases would be increased accordingly.
     11
       For taxable years 1986 and 1988, this potential problem
affects only Briggs, to the extent he received more than half of
the rebates. For taxable year 1987, this potential problem
affects only Mrs. Morris, to the extent the Morrises received
more than half of the rebates.
                               - 12 -

exceeding the aggregate amount of gas rebate payments made to

them each year.   Although the rules governing the tax treatment

of S corporation shareholders do not foreclose this result,

respondent has not sought this result either in the statutory

notice or at trial.   In an attempt to reconcile respondent’s

position in the statutory notices and at trial with the operation

of the relevant statutory provisions (which respondent has not

cited or alluded to), we construe respondent’s position as

reflecting a misfounded concession that, for each taxable year in

issue, Briggs’ and Mrs. Morris’ pass-through incomes from Towers

Construction did not exceed the amount of payments they each

actually received.    Giving effect to this deemed concession cures

the problem of attributing to petitioners aggregate amounts of

gross income exceeding the aggregate amount of the gas rebate

payments, but opens the issue of the character of the gains

represented by distributions in excess of the pass-through

amounts (as deemed conceded by respondent).12   As previously

discussed, under section 1368(b)(2), these excess distributions


     12
        For example, for taxable year 1986, the total gas rebate
payments were $89,175 ($50,677.50 to Briggs and $38,497.50 to the
Morrises), and each of them would have pass-through income of
$44,587.50 (one half of $89,175), without regard to respondent’s
deemed concession, which would limit the Morrisses’ pass-through
income to $38,497.50. The question then arises as to the
character of the $6,090 of rebate payments that Briggs received
in excess of his pass-through amount ($50,677.50 less
$44,587.50). Similar considerations apply for each of the
taxable years in issue, with the character of the income in
excess of the pass-through amounts becoming an issue for the
Morrises for taxable year 1987 and for Briggs again for taxable
year 1988.
                                - 13 -

generally would be treated as capital gains from the sale or

exchange of property.    Petitioners, however, have not disputed

respondent’s characterization of the gas rebate payments as

ordinary income to petitioners.    Striving for even-handed

treatment of geese and ganders, we deem petitioners to have

conceded this issue.

     In sum, after a long roundabout to apply the statutory

analysis that the parties have neglected to favor us with, we

sustain respondent’s determination on this issue.

              Issue 2.    Basis in Towers Development

Background

     Acquisitions of Land for Development

     On May 30, 1985, as part of its plan to develop the Gulf

Highlands project, Towers Development purchased 60 acres of land

(the phase I land) from Mariners Cove of Panama City Beach, Inc.

(Mariners Cove).13   This property, located in Bay County, Florida,

was to become phase I of Gulf Highlands.    On the same day, Briggs

and a business partner, John Lee Daniell (Daniell), purchased

from Mariners Cove approximately 40 acres of land (the 40 acres)

adjacent to the phase I land.    Eventually, part of the 40 acres

was to become phase II of Gulf Highlands.    To finance acquisition

of the 40 acres, Briggs and Daniell made a $50,000 cash



     13
       The record does not reveal the purchase price of the
phase I land or the manner in which Towers Development financed
the purchase.
                              - 14 -

downpayment and gave Mariners Cove promissory notes and

indentures totaling $1,550,000, with Mariners Cove retaining a

security interest in the 40 acres.

     Loans From AMI

     In May 1985, Associated Mortgage Investors (AMI), a

Massachusetts real estate trust, sent Towers Development a

commitment letter evidencing AMI’s intent to provide a $2.7

million construction line of credit and a $1.5 million

acquisition and development loan.    The commitment letter states

that the loan will be disbursed in accordance with the terms of a

line of credit construction loan agreement.14

     On May 31, 1985, Towers Development executed various

documents, including a real estate note and a mortgage and

security agreement, evidencing the $2.7 million construction line

of credit from AMI (the line of credit).    The real estate note

states that Towers Development agrees to pay to AMI, with

interest, the principal sum of $2.7 million “or as much thereof

as may be disbursed from time to time.”    The mortgage and

security agreement gives AMI a first priority security interest

in the phase I land and any improvements “now or hereafter”

located on the land.   The mortgage and security agreement states

that in the event of default by Towers Development, AMI may take



     14
       The record does not contain the line of credit
construction loan agreement or otherwise establish its terms.
                              - 15 -

possession of the collateral and receive the “rents, incomes,

issues, and profits of the Collateral”, to be applied to the

amount of the “secured indebtedness”, defined in the agreement by

reference to the “indebtedness evidenced by the [real estate]

Note in accordance with the terms thereof”.

     On May 31, 1985, Briggs and Daniell executed a personal

guaranty with respect to the line of credit, agreeing that “if

the Debt is not paid by * * * [Towers Development] when due,

* * * [Briggs and Daniell] will immediately do so.”   AMI also

intended to require Mr. Morris’ personal guaranty, but because of

his past credit problems, his name was struck from all documents.

     Also on May 31, 1985, Briggs and Daniell executed a mortgage

and security agreement in favor of AMI, evidencing the $1.5

million acquisition and development loan for the 40 acres.    The

loans from AMI to Towers Development and to Briggs and Daniell

were cross-collateralized.   That is, default under either

mortgage would be deemed to constitute a default under the other

mortgage, so that AMI could exercise its security interest with

respect to the property collateralizing either mortgage.     In the

event of default on the Towers Development loan, however, AMI was

subordinated to Mariners Cove’s security interest in the 40

acres.

     To secure its mortgage interest with respect to its loans to

Towers Development and to Briggs and Daniell, AMI filed two
                              - 16 -

separate Uniform Commercial Code Financing Statements in Bay

County, Florida, listing Towers Development as the debtor on the

loan made directly to Towers Development, and listing Briggs and

Daniell as the debtors on the other loan.

     On October 15, 1985, AMI provided Towers Development a $1

million increase to the existing $2.7 million line of credit.

Again, Briggs and Daniell executed a guaranty in favor of AMI for

the loan.

     As additional collateral for the $1 million loan increment

from AMI, Imperial Pines Development Corp. (Imperial Pines)--a

Florida corporation owned equally by Briggs and Mrs. Morris–-

conveyed to AMI a mortgage deed with respect to an office

building it owned in Bay County, Florida.   The agreement provided

that AMI would release its security interest in the Imperial

Pines property when Towers Development repaid the $1 million loan

increment.   At some unspecified date, AMI released its security

interest in the Imperial Pines property.

     On April 29, 1986, Briggs and Daniell sold to Towers

Development part of the 40 acres adjacent to the phase I land.

On the same date, AMI sent a commitment letter to Towers

Development, evidencing an intention to provide a $3.9 million

loan to Towers Development for the construction of 158 town house

units.   The commitment letter stated that the loan would be

guaranteed by Briggs and Daniell, and required as additional
                               - 17 -

collateral that Towers Development pledge a certificate of

deposit in the amount of $208,000, the pledge to remain in effect

until the sale of 70 town house units.     At some unspecified date,

Briggs assigned to AMI a certificate of deposit in the amount of

$138,666.66 issued by First American Bank and Trust.15

     Towers Development’s Use and Repayment of AMI Loan Proceeds

     On all its financing agreements with Towers Development, AMI

specified that Towers Development was to use the loan proceeds

for purposes that included purchasing land and funding the

development and construction of phases I and II of the Gulf

Highlands project.    With respect to the loans to Towers

Development, AMI paid the loan proceeds directly to Towers

Development.    On its corporate books, Towers Development reported

the loans as being from AMI and not from shareholders.

     Towers Development made all loan repayments, including

principal and interest, not only on its own loans, but also on

AMI’s loans to Briggs and Daniell.      Towers Development made

payments to AMI as it sold town house units at Gulf Highlands.

Neither petitioners nor Daniell made any payments on the AMI

loans.    AMI never required Briggs or Daniell to honor his

personal guaranty or to surrender assets used as collateral for

the loans to Towers Development.


     15
       The record does not explain the apparent discrepancy
between the amount of the certificate of deposit as required in
the commitment letter and the amount actually assigned by Briggs.
                                - 18 -

     New Construction Loan

     At some point, AMI stopped funding the construction loan.

Thereafter, Towers Development completed the Gulf Highlands

project with funds provided by various sources, including Towers

Construction, Imperial Pines, and other companies, as well as by

a new construction loan.     The new construction loan, in the

amount of $1,947,000, was made on June 30, 1987, by First Federal

Savings & Loan Association of Panama City, Florida (First

Federal), to Briggs, Daniell, Towers Development, and Towers

Construction.   Under the terms of the construction loan

agreement, First Federal was to provide periodic advances based

on the percentage of completion of the construction project, as

determined by First Federal.     The borrowers agreed to receive the

advances and to hold them “as a trust fund for the purpose of

paying the costs of construction of the Improvements * * * and

for no other purpose.”   Towers Development made all of the loan

payments, including principal and interest, to First Federal.

Briggs, the Morrises, Daniell, and Towers Construction made no

loan repayments to First Federal.

     Not taking into account any adjustment relating to AMI’s

loans to Towers Development, petitioners’ bases in their Towers

Development stock for the years in issue were as follows:
                               - 19 -

                             1986      1987      1988
             Briggs          $581    $87,106   $210,142
             The Morrises     581      1,106    199,490

     For each of the taxable years 1986, 1987, and 1988,

petitioners each claimed, and respondent disallowed, pass-through

losses from Towers Development in excess of the basis amounts

stated above.

Discussion

     The question, as framed by the parties, is whether, for

purposes of determining the pro rata shares of Towers Development

losses that petitioners may take into account under section

1366(d), petitioners had bases in their Towers Development stock

attributable to the construction loans that AMI made directly to

Towers Development.    Relying on Selfe v. United States, 778 F.2d

769, 772 (11th Cir. 1985), petitioners argue that because they

were personally liable with respect to these construction loans,

guaranteed them, and pledged certain assets to AMI, their bases

in their Towers Development stock should include allocable shares

of these construction loans.   Disputing petitioners’ factual

premises and distinguishing Selfe on its facts, respondent argues

that because petitioners made no economic outlays with regard to

these construction loans, they are entitled to no increased bases

therefrom.

     An S corporation shareholder generally must take into

account a pro rata share of the corporation’s income, losses, and
                                   - 20 -

deductions.        See sec. 1366(a).   The aggregate amount of

deductions and losses that the taxpayer may take into account

generally is limited, however, to the sum of:         (1) The adjusted

basis of the shareholder’s stock in the S corporation, and (2)

the shareholder’s adjusted basis in any indebtedness owed by the

corporation to the shareholder.         See sec. 1366(d)(1).16

     Petitioners have failed to establish what balance, if any,

was outstanding with respect to the line of credit, or

enhancements thereof, between AMI and Towers Development as of

each taxable year in question.         AMI was to make loan

disbursements to Towers Development in accordance with a line of

credit construction loan agreement, but petitioners have put into

evidence neither the line of credit construction loan agreement

nor other evidence that would credibly establish the amounts and

dates of disbursements made by AMI under the line of credit.

     AMI extended the line of credit to Towers Development in May

1985.        One of petitioners’ witnesses, James Guerino (Guerino), a


        16
       For the years in issue, the regulations provide that
adjustments to the basis of a shareholder’s stock and to the
basis of indebtedness of an S corporation to a shareholder “must
be determined in a reasonable manner, taking into account the
statute and the legislative history.” Sec. 1.1367-3, Income Tax
Regs. For the years in issue, return positions are deemed
reasonable if consistent with the regulatory rule, expressly
applicable to taxable years of corporations beginning on or after
Jan. 1, 1994, that adjustments to the basis of a shareholder’s
stock and to the basis of indebtedness are generally determined
as of the close of the corporation’s taxable year and are
generally effective as of that date. See secs. 1.1367-1(d)(1),
1.1367-2(d)(1), and 1.1367-3, Income Tax Regs.
                              - 21 -

former employee of AMI, testified:     “I think the initial

disbursement on the $2.7 million loan was right at $1 million.”

There is no evidence what disbursements remained outstanding as

of December 31, 1986, or at any other particular time.     Guerino

testified that “all monies to be paid on that loan would be

received as [Gulf Highlands town house] units were sold.”      The

record does not indicate when town house units were sold or for

what amounts.   Nor does the record indicate that any outstanding

balance was due on the AMI construction loan when AMI stopped

funding the line of credit at some unspecified date, presumably

before June 30, 1987, when Towers Development secured a new

construction line of credit with First Federal.17    Consequently,

not only does the record fail to establish the outstanding

balance of the line of credit during 1986, 1987, or 1988; the

record does not even establish that the AMI line of credit

remained in force after June 30, 1987.

     The burden of proof is on petitioners.    See Rule 142(a).

We cannot assume that the many gaps in the evidence support

inferences favorable to petitioners; to the contrary, the usual

inference is that the missing evidence would be adverse.      See




     17
       The record indicates that AMI’s security interest in the
Imperial Pines property–-which served as collateral for the Oct.
16, 1985, $1 million extension on the original $2.7 million line
of credit–-was released at some unspecified date, from which we
infer that the $1 million loan extension was in fact repaid.
                               - 22 -

Pollack v. Commissioner, 47 T.C. 92, 108 (1966), affd. 392 F.2d

409 (5th Cir. 1968).

     Even if we were to assume, for sake of argument, that there

existed some amount of outstanding indebtedness on the line of

credit between AMI and Towers Development as of any taxable year

in question, petitioners have not established that their Towers

Development stock bases should be increased as a result of any

such indebtedness.   AMI made the loans directly to Towers

Development, which made all repayments, including principal and

interest.   Towers Development made every payment to AMI out of

funds received from the sale of town houses.   Petitioners made no

economic outlays with regard to the loans in question.18

     This Court and various Courts of Appeals have held generally

that a shareholder’s guaranty of a corporate loan cannot increase

the shareholder’s stock basis absent an economic outlay by the

shareholder.   See Estate of Leavitt v. Commissioner, 90 T.C. 206

(1988), affd. 875 F.2d 420 (4th Cir. 1989), and cases cited

therein.    The Court of Appeals for the Eleventh Circuit has held


     18
       Petitioners argue that Briggs and Daniell were primary
makers on the June 30, 1987, construction line of credit from
First Federal and suggest that the loan proceeds were used to pay
off the AMI construction line of credit to Towers Development.
The record clearly indicates, however, that the First Federal
loan disbursements were to be made only as construction
progressed on Gulf Highlands, and that these disbursements were
to be used solely to pay construction costs. Furthermore, as
previously discussed, the record does not establish that there
was any outstanding balance on the AMI construction line of
credit when the First Federal loan was obtained.
                                - 23 -

that, in some circumstances, a shareholder guaranty may be

treated as an equity investment where the facts demonstrate that

“in substance, the shareholder has borrowed funds and

subsequently advanced them to her corporation.”     Selfe v. United

States, 778 F.2d at 773.    Under this approach, a key factor is

whether “the lender looks to the shareholder as the primary

obligor.”   Id. at 774.    The Court of Appeals for the Eleventh

Circuit has indicated, however, that it is only “unusual sets of

facts that would lead us to conclude that the substance of * * *

[a lender’s] loans * * * [would] not equal their form.”     Sleiman

v. Commissioner, 187 F.3d 1352, 1359 (11th Cir. 1999), affg. T.C.

Memo. 1997-530.

     Because appeal of our decision would generally lie in the

Court of Appeals for the Eleventh Circuit, we must decide whether

Selfe would compel a holding for petitioners on this issue.19

     The facts do not indicate that petitioners borrowed the

funds in issue from AMI and subsequently advanced them to Towers

Development.   To the contrary, AMI made the loans directly to

Towers Development, identifying Towers Development as the debtor

in its Uniform Commercial Code Financing Statements relating to

the loans in question.    AMI designated how Towers Development



     19
       We are constrained to follow, if it is directly on point,
a holding of the Court of Appeals for the Eleventh Circuit, to
which our decision is appealable. See Golsen v. Commissioner, 54
T.C. 742 (1970), affd. 445 F.2d 985 (10th Cir. 1971).
                              - 24 -

could use the funds.   Towers Development reported the loans in

its corporate books as loans from AMI to Towers Development.

     AMI looked primarily to Towers Development for repayment of

the loans in question.   Towers Development put up valuable

collateral, in the form of a security interest in the Gulf

Highlands project.   As far as the record reveals, it was this

collateral that AMI primarily relied upon in extending the line

of credit to Towers Development.     Although Briggs also pledged

significant collateral, including the $138,666.66 certificate of

deposit and his interest in the 40 acres that cross-

collateralized AMI’s loans to Towers Development and to Briggs

and Daniell, the record does not establish that Towers

Development would have primarily relied upon this collateral as

security for the line of credit.20    Guerino testified that AMI did

not require more collateral from individuals in part because of

the sufficiency of the collateral that Towers Development had put

up in the form of the Gulf Highlands property:     “if they build on

there and were to rent units, * * * any of the collateral that




     20
       James Guerino (Guerino) testified that “We took, I
believe, some life insurance policies –- paid-up life insurance
policies on the principals.” Such collateral is not described in
any of the loan documents in the record, however, and Guerino’s
own testimony is too indefinite on this point to convince us that
petitioners provided any such collateral, or if they did, what
the value of such policies might have been.
                              - 25 -

came from those units in the form of rent, * * * et cetera, we

were entitled to.”

     Although Guerino testified that AMI “would not have loaned

to * * * [Towers Development] on the strength of that company’s

assets”, we are not persuaded that AMI looked primarily to

petitioners as the primary obligors.   “It is not surprising that

a lender of a loan to a small, closely held corporation

* * * would seek the personal guaranty of the corporation’s

shareholders” or require them to pledge collateral.   Spencer v.

Commissioner, 110 T.C. 62, 86 (1998), affd. without published

opinion 194 F.3d 1324 (11th Cir. 1999).   As Guerino’s testimony

also makes clear, AMI looked to the operating assets of Towers

Development, particularly the cash-flow from the Gulf Highlands

project, for repayment of cash disbursements under the line of

credit.   In light of these circumstances, it seems most likely

that the cross-collateralization of AMI’s loan to Towers

Development and to Briggs and Daniell was meant to enhance AMI’s

security interest in the loan to Briggs and Daniell, rather than

the other way around.   This conclusion is bolstered by the fact

that AMI was subordinated to Mariners Cove in its security

interest in the 40 acres that was the primary security for the

loan to Briggs and Daniell.

     Unlike Selfe v. United States, supra at 769, this is not a

case where the lender made loans to the corporation as renewals
                               - 26 -

of loans originally made to the individual shareholder in his or

her individual capacity.   See Spencer v. Commissioner, supra at

84-85.    Indeed, the Morrises did not even personally guarantee

the loans in question.21   Although Briggs, together with Daniell,

personally guaranteed the loans, he made no economic outlay that

entitled him to add to his basis in his Towers Development stock.

Moreover, petitioners have not treated the loans in question as

personal loans by them to Towers Development.     They have not

reported Towers Development’s interest payments as constructive

dividends, nor have they claimed any interest deductions with

respect to the loans.   See id. at 86.

     In sum, unlike Selfe v. Commissioner, 778 F.2d at 769, the

instant case does not present one of the “unusual sets of facts”

that would lead us to believe that the substance of the

transactions in question was unfaithful to their form.      Sleiman

v. Commissioner, 187 F.3d at 1359.      On the basis of all the

evidence in the record, we conclude and hold that AMI looked to

Towers Development as the primary obligor on the loans in




     21
       In fact, AMI mandated that Mr. Morris’ name be removed
from the loan documents because he had a poor credit history.
Imperial Pines Development Corp., which Mrs. Morris owned with
Briggs, pledged property to AMI to secure additional financing
for Towers Development. At some unspecified date, however, this
security was released when Towers Development repaid the loan.
There is no evidence that AMI looked to Mrs. Morris individually
for repayment.
                                - 27 -

question, and the loans that AMI made to Towers Development did

not increase petitioners’ stock bases in Towers Development.

     We sustain respondent’s determination on this issue.

    Issue 3.     Treatment of Sale of Land Held in Joint Venture

Background

     In 1983, Briggs, Mr. Morris, and Daniell agreed orally to

form a joint venture to develop and sell real estate in Panama

City Beach, Florida (the joint venture).    Mr. Morris was to

direct construction, Briggs was to handle negotiations, and

Daniell was to handle sales.    None of them put any money into the

joint venture.    They agreed to share net profits equally, one-

third each.    Because of previous credit problems, Mr. Morris

could not hold property in his individual name.    Consequently,

Briggs conducted all transactions in his name both for himself

and for Mr. Morris.

     As part of their joint venture, Briggs, Mr. Morris, and

Daniell worked together on at least three different projects–-the

CharBett Motel, a property known as Holiday Point, and Gulf

Highlands.

     As previously discussed, in May 1985, Towers Development

bought the 60 acres of phase I land, and Briggs and Daniell

purchased the adjacent 40 acres in their individual names.

Ownership of the 40 acres was split two-thirds to Briggs and one-

third to Daniell, with Briggs and Mr. Morris agreeing pursuant to
                              - 28 -

a gentlemen’s agreement to split Briggs’ share 50-50 between

them.

     On July 20, 1985, Briggs, Mr. Morris, and Daniell executed a

“letter agreement” which states that its purpose was to “reaffirm

the agreement” between the three of them regarding these

purchases of real estate.   With regard to the phase I land, the

letter states the three of them were to share equally in net

profits from the construction and development of Gulf Highlands

by Towers Development.   With regard to the adjacent 40 acres, the

letter states:   “Any further development * * * is also to be

equally shared among * * * [Briggs, Mr. Morris, and Daniell].

All three will share in residual rights, re: telephone, cable

television, and development of commercial properties.”

     On April 25, 1986, after various business disagreements,

Briggs, Mr. Morris, and Daniell, with the assistance of outside

counsel, executed a written joint venture agreement.   The written

agreement states that they each have a one-third interest in the

joint venture.   The written agreement describes the purpose and

character of the joint venture as follows:

     The purpose and character of the business of the
     Venture shall be to engage (i) in real estate
     activities, (ii) in any related activity associated
     with any specific project developed by the Venture
     * * *. Such real estate activities shall include without
     limitation the acquisition, design, construction, ownership,
     development, marketing, leasing and sale of commercial
     property, townhouses, beach resort property, including
     without limitation those beach resort developments known as
                              - 29 -

     Gulf Highlands Project and all activities necessary and
     proper to accomplish the foregoing activities.

     The written agreement further describes the management and

control of the joint venture’s activities as follows:

     All decisions of the Venture relating to the commencement,
     design, development, management, financing, pledging,
     mortgaging, disposition or marketing of any project or
     business activity of the Venture * * * shall be made only
     with the unanimous consent of * * * [Briggs, Mr. Morris, and
     Daniell].

     On April 24, 1986, one day before the execution of the

written joint venture agreement, Briggs and Daniell sold a small

portion of the 40 acres to Sunshine-Jr. Stores, Inc., an

unrelated third party.   On April 29, 1986, Briggs and Daniell

sold the much larger, remaining portion of the 40 acres to Towers

Development, which thereafter developed it as phase II of Gulf

Highlands.

     Later in 1986, Daniell had a further dispute with Briggs and

Mr. Morris.   In a letter to Briggs and Mr. Morris dated September

5, 1986, Daniell recited various grievances regarding the

handling of several of the joint venture’s real estate

activities.   The letter notes that “In the fall of 1983 at the

Boar’s Head Restaurant, the three of us verbally agreed to begin

a Joint Venture on Panama City Beach where all of us would

participate equally in all profits generated from all real estate

activities on the beach.”
                              - 30 -

     On July 16, 1988, Daniell ended his business relationship

with Briggs and Mr. Morris by selling them his undivided interest

in the joint venture.

     On their 1986 individual Federal income tax returns, Briggs

and the Morrises each reported the sales of their one-third

interests in the 40 acres as long-term capital gains.22

Respondent determined that the gain was ordinary income.

Discussion

     Petitioners argue that the 40 acres was a capital asset

because it was “purchased for investment purposes in their

individual names, and not in the joint venture’s name.”    They

argue that the 40 acres was not held or offered for sale in

petitioners’ trade or business.   Respondent argues that the 40

acres was held by the joint venture as part of its trade or

business of acquiring and developing real estate, and

consequently was not a capital asset.

     Section 1221 defines “capital asset” generally as any

property held by a taxpayer, with certain exceptions, including

property held by the taxpayer primarily for sale to customers in

the ordinary course of his trade or business, and real property

used in the taxpayer’s trade or business.   See sec. 1221(1) and



     22
       On their respective Schedules D, Capital Gains and
Losses, Briggs and the Morrises each reported a single sale of a
one-third interest in land, with a sale price of $363,333 and
basis of $209,980.
                               - 31 -

(2).   Section 1231 mandates capital gain treatment for certain

gains and losses recognized on the sale of property used by the

taxpayer in a trade or business, even if the property was not

otherwise a capital asset, but provides that property used in the

trade or business excludes, among other things, property held by

the taxpayer primarily for sale to customers in the ordinary

course of his trade or business.   See sec. 1231(b)(1)(B); see

also S & H, Inc. v. Commissioner, 78 T.C. 234, 241 (1982).

       Resolution of this issue, then, depends on whether

petitioners, through their joint venture, held the 40 acres

primarily for sale to customers in the ordinary course of

business.    If they did, the land was not a capital asset.   The

question is a factual one.    The burden of proof is on

petitioners.    See Rule 142(a).

       In 1983, Briggs, Mr. Morris, and Daniell entered into a

joint venture to participate equally in profits generated from

real estate activities.    As reflected in the July 20, 1985,

“letter agreement”, the joint venture specifically included

development of phase I of Gulf Highlands as well as future

development of the adjacent 40 acres as phase II of Gulf

Highlands.    As reflected in the April 25, 1986, written joint

venture agreement, the joint venture’s real estate activities

were intended to include all aspects of acquiring, developing,
                               - 32 -

and selling commercial property, including the Gulf Highlands

resort.

     Petitioners argue that the 40 acres was acquired as a

passive investment and that the development activities of Towers

Development should not be attributed to them.    The record is

clear, however, that from the outset, Briggs, Mr. Morris, and

Daniell had a preconceived plan to develop both the phase I land

acquired by Towers Development and the adjacent 40 acres, and to

split net profits therefrom equally as part of their joint

venture.    Briggs testified that the acquisition by Towers

Development of the 100 acres making up phase I and the

acquisition by Briggs and Daniell of the adjacent 40 acres were

structured as separate transactions for tax reasons.23   About 13




     23
          On direct examination, Briggs testified as follows:

     Q. When you bought this property, did you consult your
     accountants about the transaction?

     A. They recommended that we structured [sic] it that way.
     They said-–and I’m paraphrasing this and I may not be
     exactly right. It was a long time ago. They said, Well, if
     you buy it over here–-one piece over here-–you’ve got one
     entity–-and this other one here is a different entity, when
     you get-–if this different entity causes some action that
     causes the value of the land to go up, you know, and you
     buy–-the other entity goes and buys it for the real value of
     the land, as it went up, but the second one didn’t work,
     well, then you’d be stuck with the land.

          But anyway, that would be qualified for what they said
     was long-term capital gain, and you’d pay less taxes.
                              - 33 -

months after they acquired the 40 acres, Briggs and Daniell sold

it for substantially more than they paid for it.   Most of the 40

acres was sold to Towers Development, which then proceeded to

build and sell town house units.

     Pursuant to the joint venture agreement as memorialized in

the April 25, 1986, written agreement, Briggs, Mr. Morris, and

Daniell controlled all decisions relating to any business

activity of the joint venture, including the Gulf Highlands

project.   On the basis of all the evidence, we conclude that

Towers Development acted as the joint venture’s agent in carrying

on the joint venture’s trade or business of acquiring,

developing, and selling real estate.   This conclusion is

bolstered by the fluid nature of the formal ownership

arrangements, whereby Towers Development was nominally owned by

Briggs and Mrs. Morris, the 60 acres was nominally owned by

Towers Development, and the 40 acres was nominally owned by

Briggs and Daniell, even though the joint venture agreement

clearly contemplated that Briggs, Mr. Morris, and Daniell were to

own equal profits interests in all activities relating to these

properties.

     We are convinced that the joint venture intended from the

outset to develop or sell the 40 acres in the ordinary course of

its trade or business, pursuant to the terms of the joint venture

agreement as memorialized in the July 20, 1985, letter agreement
                                  - 34 -

and in the April 25, 1986, written agreement.24     We conclude that

the acquisition of the 40 acres in the names of Briggs and

Daniell, on the same date that Towers Development acquired the

phase I land from the same seller, and the disposition of the 40

acres about a year later were part of a preconceived, tax-

motivated plan by the joint venture to avoid ordinary income

treatment of gains realized from appreciation of the 40 acres as

phase I of Gulf Highlands progressed.      See Boyer v. Commissioner,

58 T.C. 316, 324 (1972); cf. Ackerman v. United States, 335 F.2d

521 (5th Cir. 1964).

     A joint venture conducting a business operation is taxable

as a partnership unless it is a trust, estate, or association.

See sec. 301.7701-3(a), Proced. & Admin. Regs.     Here, the joint

venture was not a trust or estate and had not elected to be taxed

as an association; therefore, it is taxed as a partnership.     See

id.; see also sec. 761(a) (the term “partnership” includes a




     24
          On direct examination, Mr. Morris testified as follows:

     Q.     What was your intent with respect to this property–-
            this 40 acres that you acquired with Mr. Briggs and Mr.
            Daniell? What were you going to do with the property?

     A.     We was [sic] going to develop it out into townhouses
            and commercial property.

     Q.     Were you planning to develop it in your own name or as
            a joint venture?

     A.     As a joint venture.
                               - 35 -

joint venture through which any business or venture is carried

on, and which is not a corporation, trust, or estate).   The

nature of an item of income, gain, loss, deduction, or credit is

determined in the hands of the partnership before distribution to

the partner.   See sec. 702(b); Podell v. Commissioner, 55 T.C.

429, 432-433 (1970).   Here, the trade or business of the joint

venture included the acquisition, development, and sale to

customers of real estate.   Consequently, the 40 acres did not

constitute a capital asset, and the income realized by the joint

venture on the sale of the 40 acres was ordinary income.    See

Podell v. Commissioner, supra at 433.

     We sustain respondent’s determination on this issue.

   Issue 4.    Deductibility of Liability Under Letter of Credit

Background

     On August 16, 1988, Towers Construction entered into a

contract (the construction contract) with Key West Polo Club

Apartments, Ltd. (Key West Polo), to build apartments in Key

West, Florida.   Because of poor credit, Towers Construction was

unable to secure bonding.   On August 22, 1988, Columbus Bank &

Trust Co. of Columbus, Georgia (CB&T), established with Towers

Construction a $460,000 irrevocable letter of credit (the letter

of credit), which states that it was given in lieu of Towers
                               - 36 -

Construction’s furnishing a performance bond to Key West Polo

with regard to the construction contract.25

     On June 19, 1989, Key West Polo sent Towers Construction a

notice of default on the construction contract, alleging that Key

West Polo had disbursed $3,473,900.48 directly to Towers

Construction, relying upon Towers Construction’s representations

that “you have paid all bills for material and supplies as well

as all subcontractors and labor out of funds requested by you and

paid by us.”   The notice of default states that Key West Polo had

been advised by various suppliers and subcontractors that “there

are considerable balances past due that were to have been paid

with funds you received from us”.

     On July 26, 1989, Key West Polo notified CB&T that Towers

Construction had breached the construction contract and requested

CB&T to pay Key West Polo $460,000 against the letter of credit.

Towers Construction attempted unsuccessfully to enjoin CB&T from

making payment to Key West Polo.    Although Towers Construction

continued to dispute its liability to Key West Polo, CB&T paid

$460,000 to Key West Polo.26   Towers Construction stopped work on

the construction contract and filed a claim of lien against Key



     25
       In consideration for the letter of credit, Columbus Bank
& Trust Co. (CB&T) was to receive a share of profits from the
construction project.
     26
       The record does not reveal the exact date of the payment
by CB&T to Key West Polo.
                              - 37 -

West Polo.   Litigation ensued between Towers Construction and Key

West Polo over the validity of the claim of lien as well as other

matters relating to the construction contract.   The litigation

was not concluded until 1992.27

     On its 1990 Form 1120S, Income Tax Return for an S

Corporation, Towers Construction deducted $460,000 relating to

the letter of credit payment as part of cost of goods sold,

giving rise to a reported 1990 net operating loss for Towers

Construction.   Briggs and the Morrises filed amended 1987

individual income tax returns, each claiming net operating loss

carryback deductions arising from the pass-through of the claimed

1990 Towers Construction net operating loss.

Discussion

     Petitioners argue that in 1990 Towers Construction incurred

a loss of $460,000 as a result of CB&T’s payment to Key West Polo

against the letter of credit and that this amount is deductible

pursuant to section 162 as a cost of goods sold because Towers

Construction used the money to pay bills for materials, supplies,

subcontractors, and labor.

     Respondent argues that Towers Construction is not entitled

to deduct (and thus petitioners are not entitled to carry back



     27
       The record indicates that Towers Construction ultimately
lost its lien but does not otherwise establish how this
litigation may have affected any effort by Towers Construction to
recover the $460,000 paid out by CB&T on the letter of credit.
                                - 38 -

any resulting net operating loss attributable to) any losses

associated with the $460,000 letter of credit payment because:

(1) Petitioners failed to substantiate the deduction; and (2) the

claimed loss arose from a contingent liability that was not

determined until 1992, when the litigation between Towers

Construction and Key West Polo was concluded.

     Cost of goods sold is not a deduction within the meaning of

section 162(a) but instead is subtracted from gross receipts in

determining a taxpayer’s gross income.   See Max Sobel Wholesale

Liquors v. Commissioner, 69 T.C. 477 (1977), affd. 630 F.2d 670

(9th Cir. 1980); sec. 1.162-1(a), Income Tax Regs.   Taxpayers

must show their entitlement to amounts claimed as cost of goods

sold, see Rule 142(a), and must keep sufficient records to

substantiate the cost of goods sold, see sec. 6001; Newman v.

Commissioner, T.C. Memo. 2000-345.

     Petitioners have failed to document Towers Construction’s

gross sales or to substantiate any expenses or costs relating to

any gross sales.   Accordingly, petitioners have failed to

establish that Towers Construction is entitled to claim cost of

goods sold or, if it is, what the proper amount of cost of goods

sold might be.

     Petitioners have also failed to establish that the amount in

dispute is allowable as an ordinary and necessary business

expense under section 162(a).    Pursuant to the letter of credit,
                                - 39 -

CB&T paid Key West Polo $460,000 to discharge Key West Polo’s

claim against Towers Construction relating to prior advances.

CB&T became subrogated to the rights of Key West Polo and had a

right of reimbursement from Towers Construction.28    Thus, CB&T

stood in the shoes of Key West Polo, and Towers Construction’s

liability to repay CB&T was akin to its liability to repay Key

West Polo its advances.     Clearly, liability to repay an advance,

particularly one never taken into gross income in the first

instance, does not give rise to a deductible expense under

section 162 or otherwise.29    See Crawford v. Commissioner, 11

B.T.A. 1299, 1302 (1928).

     In light of our disposition of this issue, we need not reach

respondent’s alternative argument that Towers Construction’s


     28
       Applicable Florida law recognizes two types of
subrogation–-conventional subrogation, which arises from
contractual rights between parties, and equitable or legal
subrogation, which arises from legal consequences of the acts and
relationships of the parties. See Dade County Sch. Bd. v. Radio
Station WQBA, 731 So. 2d 638, 646 (Fla. 1999). Although the
distinction is not significant for present purposes, it appears
most likely that conventional subrogation arose from the
contractual rights between CB&T and Towers Construction regarding
the letter of credit.
     29
       The record does not suggest that Towers Construction or
petitioners ever included the $460,000 advance in gross income.
Petitioners have not raised, and we do not reach, any issue as to
whether Towers Construction’s liability to CB&T should be
deductible as an amount previously taken into gross income by
Towers Construction under a claim of right when it received the
advances from Key West Polo. Cf. sec. 1341(a)(1) (in computing
tax where the taxpayer repays amounts held under claim of right,
the remedial mechanism of sec. 1341 applies only if the item was
included in gross income for prior years).
                               - 40 -

liability to CB&T is a nondeductible contingent liability under

section 461(f).30

     We sustain respondent’s determination on this issue.

            Issue 5.   Additions to Tax for Late Filing

     Briggs untimely filed his 1986, 1987, and 1988 individual

Federal income tax returns on April 28, 1988, February 7, 1990,

and February 7, 1990, respectively.     The Morrises untimely filed

their 1986, 1987, and 1988 individual Federal income tax returns

on May 19, 1988, February 13, 1990, and February 13, 1990,

respectively.   Respondent determined that petitioners are liable

for additions to tax pursuant to section 6651(a)(1) for the late

filing of their 1986 and 1987 Federal income tax returns.31

     Section 6651(a)(1) imposes an addition to tax if a required

return is not filed on or before its due date, unless it is shown




     30
       Respondent has not raised, and we do not reach, any issue
as to whether the deductions in issue are subject to the
limitations of sec. 461(h), which provides that certain
deductions cannot accrue until there has been “economic
performance” with respect to the item. We note, however, that
the record does not conclusively establish that Towers
Construction ever reimbursed CB&T for its $460,000 payment to Key
West Polo against the letter of credit, or if it did, exactly
when. Mr. Morris testified that Towers Development (rather than
Towers Construction) repaid the $460,000 out of proceeds of one
of its developments.

     31
       Although the parties have stipulated that petitioners
filed their 1988 individual Federal income tax returns late,
respondent has not asserted sec. 6651(a)(1) additions to tax with
regard to the 1988 returns.
                                  - 41 -

that the failure to file is due to reasonable cause and not

willful neglect.

     Petitioners concede that their 1986 and 1987 Federal income

tax returns were filed late.      On brief, petitioners argue that

they are not liable for the section 6651(a)(1) addition to tax

because they reasonably relied on their accountants, who charged

much and performed poorly.       Although acknowledging that “The tax

law does not recognize that the delegation of this responsibility

constitutes reasonable cause for not filing”, petitioners argue

that the law should be otherwise.

     We decline petitioners’ invitation to revisit legal

principles that by their own admission are well established.      As

stated by the Supreme Court in United States v. Boyle, 469 U.S.

241, 249-252 (1985):

          Congress has placed the burden of prompt filing on the
     * * * [taxpayer], not on some agent or employee of the
     * * * [taxpayer]. The duty is fixed and clear; Congress
     intended to place upon the taxpayer an obligation to
     ascertain the statutory deadline and then to meet that
     deadline, except in a very narrow range of situations.

              *     *        *      *      *    *     *

          It requires no special training or effort to ascertain
     a deadline and make sure that it is met. The failure to
     make a timely filing of a tax return is not excused by the
     taxpayer’s reliance on an agent, and such reliance is not
     “reasonable cause” for a late filing under sec. 6651(a)(1).

     We sustain respondent’s determination on this issue.
                                - 42 -

                Issue 6.   Additions to Tax for Fraud

Background

     As discussed supra, on their tax returns as originally filed

for each year in issue, petitioners omitted from gross income the

West Florida Gas rebate checks that had been issued in the

individual names of either Briggs or Mr. Morris.    Briggs and Mr.

Morris were each convicted by the U.S. District Court for the

Northern District of Florida, pursuant to section 7207, for

willfully filing false Federal income tax returns for taxable

years 1986, 1987, and 1988.

     In 1985, Briggs, Mr. Morris, Daniell, and Michael Gay

incorporated Association Cable TV, Inc. (ACT), to provide cable

television services to a beach resort.    The four were equal

shareholders.   In 1988, they sold ACT’s assets to Jones

Spacelink, Ltd.   In connection with the sale, each of the four

shareholders received $199,490 in gross proceeds.       Of this

amount, $82,600 represented proceeds from the sale of a covenant

not to compete.   Petitioners’ 1988 Federal income tax returns

each omitted $40,200 of this $82,600 amount from gross income and

also omitted $36,000 of other sale proceeds, erroneously

characterizing them as “loan repayments”.    On brief, petitioners

agree to respondent’s adjustments increasing each of their

taxable year 1988 gross incomes by these amounts, conceding that

their return positions were “unexplained and * * * erroneous”.
                               - 43 -

     Respondent determined that petitioners are liable for

additions to tax for fraud under section 6653(b)(1) for all years

in issue.    Respondent asserts that for all years in issue,

petitioners’ omitted West Florida Gas rebate income gave rise to

underpayments attributable to fraud.    In addition, for taxable

year 1988, respondent asserts that petitioners’ omission from

gross income of ACT assets sales proceeds gave rise to additional

amounts of underpayment attributable to fraud.

Discussion

     For 1986 and 1987, if any part of any underpayment of a tax

required to be shown on a return is due to fraud, there is an

addition to tax equal to 75 percent of the portion of the

underpayment attributable to fraud, along with 50 percent of the

interest due on the portion of the underpayment attributable to

fraud.   See sec. 6653(b)(1)(A) and (B).   For 1988, if any part of

any underpayment of a tax required to be shown on a return is due

to fraud, there is an addition to tax of 75 percent of the

portion of the underpayment that is attributable to fraud.     See

sec. 6653(b)(1).

     Respondent must prove fraud by clear and convincing

evidence.    See sec. 7454(a); Rule 142(b).   Fraud is the

intentional wrongdoing of a taxpayer to evade tax believed to be

owing.   See Petzoldt v. Commissioner, 92 T.C. 661, 698 (1989).      A

finding of fraud requires a showing that the taxpayer intended to
                               - 44 -

evade tax known or believed to be owing by conduct intended to

conceal, mislead, or otherwise prevent the collection of taxes.

See Korecky v. Commissioner, 781 F.2d 1566, 1568 (11th Cir.

1986), affg. T.C. Memo. 1985-63.

     Fraud is never presumed but must be proved by clear and

convincing evidence.   See Petzoldt v. Commissioner, supra at 699.

Because direct proof of a taxpayer’s intent is rarely available,

however, fraudulent intent may be established by various kinds of

circumstantial evidence, or “badges of fraud”, including

consistent, material understatements of income; the filing of

false statements or documents; failure to maintain complete and

accurate records; the concealing of assets or covering up sources

of income; failure to cooperate fully with the Internal Revenue

Service; implausible or inconsistent explanations of behavior;

illegal activity; and attempted concealment thereof.   See Spies

v. United States, 317 U.S. 492, 499 (1943); Bradford v.

Commissioner, 796 F.2d 303, 307 (9th Cir. 1986), affg. T.C. Memo.

1984-601; Korecky v. Commissioner, supra at 1568; Stephenson v.

Commissioner, 79 T.C. 995, 1005-1006 (1982), affd. 748 F.2d 331

(6th Cir. 1984).

     The Gas Rebate Payments

     Petitioners’ consistent and substantial omission of the gas

rebate payments from gross income over 3 years is persuasive
                               - 45 -

evidence of fraud with regard to these items.    See Korecky v.

Commissioner, supra at 1568.

     When petitioners met with their accountants to review their

tax returns for the years in issue, they did not mention the gas

rebate income even though they were asked whether any items of

income had been omitted.32

     Petitioners cashed the rebate checks, deposited them into

their personal bank accounts, or, in one instance, deposited the

check in Towers Construction’s bank account before dividing the

proceeds between Briggs and Mrs. Morris.    Petitioners’

explanations of their behavior in this regard were implausible

and inconsistent.

     Petitioners kept inadequate records.    By Briggs’ own

admission, petitioners were “sorry bookkeepers”.    Daniell’s

accountant testified that the records were “appalling”.    The

funds of petitioners’ various business entities, and possibly

their personal funds as well, were commingled in something called

an “intercompany” bank account that apparently was in the name of

Briggs.33   Petitioners disregarded corporate formalities in their


      32
       Briggs testified implausibly that he informed his
accountants of the gas rebate payments “indirectly” by giving
them a copy of a newspaper article concerning the rebate program.
“I gave them a copy of it. And I laughed and joked and said,
Here you go. Look at this.”
      33
       Briggs testified on direct examination that “I didn’t
have a personal account. My account was commingled with the
                                                   (continued...)
                                - 46 -

joint venture business operations and used what they referred to

as a “funnel method” of accounting, whereby they commingled and

directed funds to various entities, making it difficult for even

their accountants to associate transactions with specific

entities.

      It is also significant that Briggs and Mr. Morris were

convicted pursuant to section 7207 for filing false Federal

income tax returns for the years in issue.34      These convictions

establish that Briggs and Mr. Morris willfully filed false

documents and provide circumstantial evidence of their intention

to evade taxes with regard to the gas rebate payments.      See

Wright v. Commissioner, 84 T.C. 636 (1985); Pariseau v.

Commissioner, T.C. Memo. 1985-124.       Although Mrs. Morris was not

convicted, she cashed a number of the rebate checks, as indicated

in the appendix, which we view as evidence that she committed

fraud along with her husband.




     33
      (...continued)
company account in there.” On cross-examination, Briggs admitted
that he also had a personal account.
      34
       Respondent does not contend, and we do not conclude, that
these convictions under sec. 7207 collaterally estop petitioners
from asserting a defense to the fraud penalty. Cf. Sansone v.
United States, 380 U.S. 343, 352 (1965) (“Section 7207 requires
the willful filing of a document known to be false or fraudulent
in any material manner. * * * Section 7207 does not require,
however, that the act be done as an attempt to evade or defeat
taxes.”).
                              - 47 -

     Respondent has met his burden of proving by clear and

convincing evidence that petitioners acted with the intention to

evade taxes in omitting the gas rebate income for each of the

years 1986, 1987, and 1988.

     Proceeds From Sale of ACT’s Assets

     Respondent also contends that petitioners acted with

fraudulent intention in underreporting the proceeds they each

received from the sale of ACT assets in 1988.

     Petitioners identified the ACT transaction on their 1988 tax

returns and included in gross income well over half of the

$199,490 proceeds they each received from ACT’s sale of assets.

They omitted a portion of the proceeds from the sale of the

covenant not to compete and mischaracterized part of the proceeds

as repayment of a loan.   Respondent has not clearly and

convincingly shown that, in reporting over half of the proceeds

from this transaction, petitioners acted fraudulently with regard

to the remainder.

     Respondent asserts that petitioners attempted to disguise

the true nature of the “loan repayments”.    In support of this

contention, respondent relies largely on evidence that ACT’s

accountants advised Daniell’s accountant that, consistent with

ACT’s treatment of the proceeds on its corporate books, Daniell

should report part of the proceeds as stockholder loans on his

individual Federal income tax return.     Respondent has not clearly
                              - 48 -

established how this evidence pertains to petitioners.

Apparently, respondent would have us infer that the advice itself

was in some manner fraudulent and that petitioners played a role

in it.   The record does not clearly support any such inference.

The advice that ACT’s accountants provided Daniell is consistent

with spreadsheets in evidence, apparently prepared by ACT’s

accountants, which allocated the ACT proceeds partly to loan

repayments and partly to other sources, consistent with the

manner in which petitioners reported them on their individual tax

returns.   Without more, it is impossible to know whether ACT’s

accountants were negligent in doing their work and in giving

advice to Daniell’s accountant (and presumably to petitioners).

There is no evidence to indicate fraud on the part of ACT’s

accountants.

     In Association Cable TV, Inc. v. Commissioner, T.C. Memo.

1995-596, we held that ACT acted with fraudulent intent in

representing falsely to the Internal Revenue Service that it had

adopted a formal plan of liquidation under section 337, attaching

false minutes to its return and treating the sale of its assets

as nontaxable on its Federal corporate income tax return.

Whatever inferences we might draw from ACT’s fraudulent

intentions in this regard, we conclude that respondent has failed

to meet his burden of proving by clear and convincing evidence

that petitioners acted with fraudulent intent in underreporting
                               - 49 -

the proceeds from the sale of ACT’s assets on their individual

Federal income tax returns.

     Summary

     For taxable years 1986, 1987, and 1988, petitioners are

liable for the section 6653(b)(1) addition to tax solely as

results from their fraudulent underreporting of the gas rebate

payments.

Issues 7 and 8.    Additions to Tax for Substantial Understatement

     Respondent determined that the Morrises are liable for

additions to tax pursuant to section 6661 for taxable years 1986

and 1987, and that Briggs is liable for section 6661 additions to

tax for taxable years 1986, 1987, and 1988.

     Section 6661 imposes a 25-percent addition to tax on any

underpayment attributable to a substantial understatement of

income tax.    A substantial understatement of tax is one that

exceeds the greater of 10 percent of the tax required to be shown

on the return or $5,000.    See sec. 6661(b)(1)(A).   For this

purpose, the amount of the understatement is to be reduced by the

portion attributable to any item for which there was substantial

authority or any item that was adequately disclosed.     See sec.

6661(b)(2)(B).    In addition, the Commissioner may waive all or

part of a section 6661 addition to tax upon a showing by the

taxpayer that there was reasonable cause for the understatement

and that the taxpayer acted in good faith.    See sec. 6661(c).
                               - 50 -

     Petitioners’ understatements of income tax each exceed the

greater of 10 percent of the tax required to be shown on the

returns or $5,000.   Consequently, there are substantial

understatements within the meaning of section 6661.

     On brief, petitioners contend only that they reasonably and

in good faith relied on the advice of their accountants in

preparing their tax returns.   Ostensibly, petitioners seek

thereby to invoke the Commissioner’s authority to waive the

addition to tax pursuant to section 6661(c).   The Commissioner’s

denial of waiver under section 6661(c) is reviewable for abuse of

discretion.   See Martin Ice Cream Co. v. Commissioner, 110 T.C.

189, 234 (1998).   The record does not show that petitioners ever

requested respondent to waive the penalty.   Accordingly, absent

such a request by petitioners, we cannot find that respondent

abused his discretion.   See id. at 234-235, and cases cited

therein.35

     Even if we were to assume arguendo that petitioners did

request waivers pursuant to section 6661(c), petitioners have not

established that respondent would have abused his discretion in

refusing the requests.   Petitioners have not proved that they

provided their accountants with complete information for

preparing their returns.   The evidence shows that the books and

      35
       Under sec. 6664(c) of current law, effective for returns
with a due date after Dec. 31, 1989, no penalty may be imposed
for understatements if the taxpayer shows that it had reasonable
cause and acted in good faith. See Omnibus Budget Reconciliation
Act of 1989, Pub. L. 101-239, sec. 7721(a), 103 Stat. 2398.
                              - 51 -

records were inadequate, partly because of petitioners’ practice

of commingling funds and disregarding corporate formalities.    We

have determined that petitioners acted with fraudulent intent as

regards the omitted gas rebate income.

     Although petitioners have not expressly argued that they had

substantial authority or made adequate disclosure within the

meaning of section 6661(b)(2)(B), on brief they argue that they

relied on Selfe v. United States, 778 F.2d at 769.   Any such

reliance was misplaced.   As previously discussed, the Morrises

did not even personally guarantee the loans in question.

Moreover, petitioners have failed to establish the outstanding

balance, if any, of loans between AMI and Towers Development for

any year in issue.   Accordingly, we conclude that Selfe and its

progeny are “so dissimilar that they must be discarded as

providing no substantial authority for the tax returns filed in

this case.”   Osteen v. Commissioner, 62 F.3d 356, 360 (11th Cir.

1995), revg. on this point T.C. Memo. 1993-519.   Moreover,

petitioners have not shown substantial authority or adequate

disclosure for other positions taken on their returns.   Opinions

rendered by tax professionals are not substantial authority.    See

sec. 1.6661-3(b)(2), Income Tax Regs.

     We sustain respondent’s determination on this issue.
                              - 52 -

     We have considered all other arguments advanced by the

parties.   Arguments not addressed herein we conclude are without

merit or unnecessary to reach.

     To reflect the foregoing,


                                         Decisions will be entered

                                    under Rule 155.
                                - 53 -

                               Appendix

           West Florida Gas Rebate Payments to Petitioners

                                                             The
  Date        Payee          Disposition1      Briggs      Morrises

01/14/86   Towers Const.    Cashed by FWB     $2,175.00       --
01/30/86   Towers Const.    070505 (Towers    10,222.50   $10,222.50
                                          2
                            Construction)
05/27/86   Jimmy   Morris   402028 (SBM)         --         5,220.00
05/27/86   Frank   Briggs   Bay B&T (FWB)      5,220.00        --
06/05/86   Frank   Briggs   Bay B&T (FWB)     10,875.00        --
06/05/86   Jimmy   Morris   402028 (SBM)         --        10,875.00
07/03/86   Frank   Briggs   Springfield (FWB) 2,610.00         --
08/07/86   Jimmy   Morris   Springfield (SBM)    --         9,570.00
08/07/86   Frank   Briggs   402737 (FWB)       8,265.00        --
08/07/86   Jimmy   Morris   Springfield (SBM)    --         2,610.00
08/07/86   Frank   Briggs   402737 (FWB)       8,700.00        --
11/11/86   Frank   Briggs   Cashed by FWB      2,610.00        --
07/21/87   Jimmy   Morris   402028 (SBM)         --         2,610.00
08/20/87   Jimmy   Morris   Cashed by JDM        --         7,395.00
09/08/87   Frank   Briggs   Cashed by FWB      7,395.00        --
09/24/87   Jimmy   Morris   Cashed by JDM        --         4,350.00
11/03/87   Frank   Briggs   390607 (FWB)       5,220.00        --
11/05/87   Jimmy   Morris   Cashed by JDM        --         5,220.00
12/15/87   Frank   Briggs   Cashed by FWB      1,740.00        --
12/15/87   Jimmy   Morris   2210851 (SBM)        --         1,740.00
02/02/88   Frank   Briggs   402737 (FWB)       3,045.00        --
02/04/88   Jimmy   Morris   402028 (SBM)         --         3,480.00
03/01/88   Frank   Briggs   Cashed by FWB      2,175.00        --
03/17/88   Frank   Briggs   402737 (FWB)       2,610.00        --
03/17/88   Jimmy   Morris   402028 (SBM)         --         2,610.00
03/31/88   Frank   Briggs   Cashed by FWB      3,045.00        --
03/31/88   Jimmy   Morris   1118951 (SBM)        --         2,610.00
04/19/88   Frank   Briggs   390607 (FWB)       1,305.00        --
04/19/88   Jimmy   Morris   390607 (FWB)         --         1,740.00
06/14/88   Frank   Briggs   Cashed by FWB      1,305.00        --
06/14/88   Jimmy   Morris   1118951 (SBM)        --         1,305.00
08/02/88   Frank   Briggs   Cashed by FWB        870.00        --
08/02/88   Frank   Briggs   Cashed by FWB      2,610.00        --
08/02/88   Jimmy   Morris   Cashed by JDM        --         4,350.00
09/06/88   Frank   Briggs   402737 (FWB)       8,265.00        --
09/06/88   Jimmy   Morris   1118951 (SBM)        --         6,525.00
10/27/88   Jimmy   Morris   1118951 (SBM)        --        11,745.00
10/27/88   Frank   Briggs   402737 (FWB)      10,875.00        --
11/22/88   Frank   Briggs   390607 (FWB)       7,395.00        --
11/29/88   Jimmy   Morris   Cashed by JDM        –-         3,915.00
                                            $108,532.50   $98,092.50

                                                          $206,625.00
                             - 54 -
    1
       Disposition. These entries reflect the accounts into
which the rebate checks were deposited or the person who cashed
them. FWB refers to petitioner Franklin W. Briggs; JDM refers to
petitioner Jimmy Morris; and SBM refers to petitioner Sandra
Morris.
    2
       Disposition of Check No. 17539. This rebate check was
made payable to Towers Construction and then split equally
between Briggs and Sandra Morris.
