                         T.C. Memo. 1998-183



                       UNITED STATES TAX COURT



        PATRICK F. AND ARLENE G. SHEEHY, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 22034-96.                Filed May 18, 1998.



     Ralph C. Larsen, for petitioners.

     Christine V. Olsen, for respondent.



                         MEMORANDUM OPINION


     RAUM, Judge:   The Commissioner determined deficiencies of

$31,643 and $1,605 in petitioners' 1992 and 1993 Federal income

taxes, respectively.   At issue is whether petitioners are

entitled to deduct an expenditure of $50,000 in connection with

their investment in Recyclable Containers Company.    This case was

submitted on the basis of a stipulation of facts.
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       Petitioners, Patrick and Arlene Sheehy, resided in

California when the petition in this case was filed.      References

to petitioner in the singular are to petitioner husband.

       In 1992, petitioner made $50,000 in capital contributions to

Recyclable Containers Company (RCC).1      His investment resulted in

his ownership of a 1-percent profit-share.

       According to an undated private placement memorandum, there

was $400,000 worth of limited partnership interests available in

RCC.       The private placement memorandum explains:

       Recyclable Containers Company * * * intends to offer
       privately to a limited number of sophisticated
       investors the opportunity to invest in [RCC], a
       California limited partnership organized to further
       research and development of the technology involved
       relating to the high volume manufacturing of a
       fabricated all-plastic, reusable and recyclable
       shipping and storage container and pallet * * * which
       has various proven produce and industrial applications;
       to build the production tooling and equipment to
       manufacture and sell the Product; and to license the
       technology to manufacture the Product on a world-wide
       basis.

       For taxable year 1992, petitioners deducted $50,000 as a

"Product Development" expense on a Schedule C, Profit or Loss

From Business, attached to their 1992 Federal income tax return.

On the Schedule C, petitioners listed "Recyclable Container

Company" as the business name, and characterized the business as


       1
        Petitioners contend     that the $50,000 is not a capital
contribution. However, RCC      characterized investments as either
"loan" or "capital", and we     use the capital contribution
designation for the sake of     convenience.
                               - 3 -


"Manufacturing Recyclable containers".    They also indicated that

petitioner materially participated in the operation of the

business.   Petitioners reported no income on the Schedule C, nor

did they deduct any expenses other than the $50,000 "Product

Development" expense.

     The Commissioner's notice of deficiency disallowed two

different research and development deductions, each for $50,000.

The first, taken in 1992 in connection with horse-breeding

activities, was conceded by respondent.   The second, taken in

1992 in connection with the investment in RCC, is still in

contention.   The remaining items contained in the notice of

deficiency have been conceded by the parties or are statutory

adjustments dependent upon the outcome of the RCC issue.

     Petitioners contend they are entitled to deduct the $50,000

they paid to RCC in 1992 under section 174(a).2   Section 174(a)

allows a taxpayer to "treat research or experimental expenditures

which are paid or incurred * * * in connection with his trade or

business as expenses which are not chargeable to capital account.

The expenditures so treated shall be allowed as a deduction."

Section 1.174-2(a)(2), Income Tax Regs., indicates that section

174 applies "not only to costs paid or incurred by the taxpayer


     2
        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.
                                - 4 -


for research or experimentation undertaken directly by him but

also to expenditures paid or incurred for research or

experimentation carried on in his behalf by another person or

organization".

     Deductions are a matter of legislative grace, and the

taxpayer has the burden of demonstrating that he is entitled to a

deduction.    New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440

(1934).   The burden of proof remains on the taxpayer even when

the case is submitted fully stipulated.    Borchers v.

Commissioner, 95 T.C. 82, 91 (1990), affd. 943 F.2d 22 (8th Cir.

1991).    Petitioners have adequately substantiated that they paid

$50,000 to RCC in 1992.   To be entitled to the deduction,

however, they must demonstrate that the amount was actually spent

for research or experimentation conducted by them or on their

behalf in connection with their trade or business.   See Grindle

v. Commissioner, T.C. Memo. 1993-297.

     Petitioners' evidence consists of two documents.    First, on

the Schedule C of their 1992 Federal income tax return, they list

RCC as petitioner's business.   They describe its function as

"Manufacturing Recyclable containers" and indicate that

petitioner "materially participated".   Plainly, petitioners'

Schedule C is self-serving, and hardly represents convincing

evidence on their behalf.
                               - 5 -


     Second, petitioners provide the first page of RCC's private

placement memorandum.   That document describes RCC as

     a California limited partnership organized to further
     research and development of the technology involved
     relating to the high volume manufacturing of a
     fabricated all-plastic, reusable and recyclable
     shipping and storage container and pallet * * * which
     has various proven produce and industrial applications;
     to build the production tooling and equipment to
     manufacture and sell the Product; and to license the
     technology to manufacture the Product on a world-wide
     basis.

     The Amended Certificate of Limited Partnership for RCC was

entered into on December 30, 1983.     Petitioner's checks to RCC

are dated June 12, 1992.   It is unclear when the private

placement memorandum was issued.   It is possible that during the

9 years between RCC's formation and petitioner's investment, RCC

started to manufacture and sell its product.     If that is the

case, petitioners would need to demonstrate that their $50,000

was spent on research or experimentation as opposed to

manufacturing.   This they have not done.    It is also possible

that RCC licensed the technology to another organization on an

exclusive basis.   In that event, RCC's research is not being

conducted in connection with a trade or business of its own or

petitioners' of developing recyclable plastic containers.     As a

result, petitioners, on whose behalf the research is being

conducted, have not met the requirements of section 174(a).

     The above situations are merely hypothetical.     The record

does not provide enough evidence for more than speculation.       It
                               - 6 -


might be, as petitioners argue, that RCC is involved in the

business of developing recyclable containers with the intention

of manufacturing them.   Then again, it might not.   It is up to

petitioners to prove that they engaged indirectly through RCC in

research or experimentation.   This they have not done.   It is

also up to petitioners to prove that their expenditure was paid

or spent in connection with their own trade or business.    The

controlling inquiry in determining whether an expenditure under

section 174 was made "in connection with" a taxpayer's trade or

business is whether the taxpayer is "'actively involved in the *

* * [research project] as a trade or business.'"     LDL Research &

Dev. II, Ltd. v. Commissioner, 124 F.3d 1338, 1342 (10th Cir.

1997) (quoting Nickeson v. Commissioner, 962 F.2d 973, 978 (10th

Cir. 1992), affg. Brock v. Commissioner, T.C. Memo. 1989-641),

affg. T.C. Memo. 1995-172.   As stated by the Court of Appeals for

the Ninth Circuit:

     The language of * * * [section 1.174-2(a)(2), Income
     Tax Regs.] makes clear that a taxpayer may enjoy the
     section 174 deduction for research conducted by another
     entity. Read in isolation, the regulation might
     suggest that the * * * [taxpayer] is entitled to the
     deduction even though it engaged the research firm to
     conduct its research. The regulation, however, does
     not eliminate the trade or business requirement of
     section 174. If a * * * [taxpayer] engages another
     firm to conduct its research, it must satisfy the trade
     or business requirement in some other way, such as by
     manufacturing or marketing the resulting technology.
     * * *
                               - 7 -


Kantor v. Commissioner, 998 F.2d 1514, 1521 (9th Cir. 1993),

affg. in part and revg. in part T.C. Memo. 1990-380.

     Petitioners rely on Cleveland v. Commissioner, 297 F.2d 169

(4th Cir. 1961), affg. in part, revg. in part and remanding 34

T.C. 517 (1960), and Green v. Commissioner, 83 T.C. 667 (1984),

to support their contention that petitioner was an active

participant in RCC.

     In Cleveland, Mr. Cleveland, an attorney, formed an informal

partnership with Hans Kerla, an inventor and chemist.   Kerla was

working on the development and commercialization of an inorganic

binding material.   Cleveland provided the funding, and Kerla

performed the experiments.   Id. at 170.   Cleveland also used his

business contacts to market Kerla's invention.    Id. at 171.   The

Court of Appeals concluded that Cleveland and Kerla were involved

in a joint venture:

     Each of the parties was to participate in the
     enterprise, Kerla giving his time and effort and
     Cleveland providing the necessary funds, and they were
     to share equally in the avails thereof. * * *
     Cleveland was thereafter engaging with Kerla in the
     trade or business of promoting the commercial
     development of the invention in which Cleveland was the
     owner of a participating one-half interest.

Id. at 173-174.

     According to petitioners, petitioner was as active a

participant in RCC as Mr. Cleveland was in his joint venture.

However, they have not shown that petitioner's contribution to

RCC was comparable to Mr. Cleveland's efforts on behalf of his
                                 - 8 -


partnership.    Their characterizations about petitioner's

participation in RCC are not supported by the record.    According

to the exhibits, petitioner's only contribution to the running of

RCC was checks totaling $50,000.    Moreover, petitioners

misconstrue Mr. Cleveland's contribution to his partnership,

characterizing it as "cash invested and attending to some

paperwork."    Cleveland has been interpreted to mean that an

active role is necessary to qualify as being in a trade or

business:

     Furthermore, the court in Cleveland did not hold that
     the act of financing research in itself constitutes the
     trade or business of promoting an invention. The
     combined activities of both participants in the joint
     venture formed the basis for the court's finding of a
     trade or business. * * *

Green v. Commissioner, supra at 691.     Petitioners have not shown

that petitioner did any more than provide financing.

     Neither does Green v. Commissioner, supra, support

petitioners' entitlement to a deduction.    The taxpayers in Green

were limited partners in a partnership called LaSala.    LaSala was

organized to acquire, improve, and develop four inventions.     Id.

at 668-669.    On the day LaSala acquired the inventions, it

entered into an agreement with NPDC, a patent development

company.    Under the agreement, NPDC was to research and develop

the inventions.    Id. at 671.   LaSala had no authority to direct

NPDC's efforts.    Id. at 672.   This Court held that LaSala
                                 - 9 -


functioned only as an investor, id. at 687, and denied the

taxpayers the deduction under section 174(a):

            LaSala's "royalty" interest in the development and
       commercialization of the four inventions was analogous
       to that of an investor in securities. After the
       transactions of December 24, 1979, LaSala had no
       ownership interest in the inventions and no control
       over their actual development, production, or
       marketing. * * *

Id. at 689.

       The factual situation in Green is similar to that of

petitioners'.    In both, a limited partnership rather than the

taxpayers themselves was in charge of conducting the research and

development.    The Court in Green analyzed the agreements between

LaSala and NPDC to determine whether LaSala was actually

controlling the research and development.    That analysis is

impossible here, because petitioners have not submitted any

substantive information on RCC and how it plans to develop the

recyclable plastic containers.    Lacking such evidence here, we

cannot find that petitioner or RCC was actively involved in a

trade or business involving the development or manufacture of

recyclable plastic containers.    Nor can we find that petitioner

or RCC had a realistic prospect of entering into a trade or

business with regard to the products that were to be developed by

RCC.    See Snow v. Commissioner, 416 U.S. 500, 503-504 (1974);

Kantor v. Commissioner, supra at 1518.    Based on the record, we

cannot say that petitioner was any more than an investor in RCC.
                               - 10 -


     Petitioners have not shown that the $50,000 paid to RCC in

1992 was spent on research or experimentation activities.      Nor

have they shown a connection between any research or

experimentation activities and a trade or business conducted by

petitioner.    Accordingly, we hold that petitioners are not

entitled to deduct their $50,000 payment to RCC in 1992 under

section 174.   Additionally, because the activities of petitioner

did not constitute a trade or business, petitioners are not

entitled to deduct the expenditure as an ordinary and necessary

business expense under section 162(a).

                                     Decision will be entered

                                under Rule 155.
