                        T.C. Memo. 1997-122



                      UNITED STATES TAX COURT



         STEPHEN P. AND JUTTA A. MARANTO, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 19822-95.             Filed March 10, 1997.



     Stephen P. and Jutta Maranto, pro sese.

     James J. Posedel, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     RUWE, Judge:   Respondent determined a deficiency of $10,810

in petitioners' 1991 Federal income tax.   Respondent further

determined an addition to tax pursuant to section 66541 in the

     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable year in
issue, and all Rule references are to the Tax Court Rules of
                                                   (continued...)
                               - 2 -


amount of $769 and an accuracy-related penalty pursuant to

section 6662(a) in the amount of $2,162.

     After concessions by respondent, the issues remaining for

decision are:   (1) Whether the period of limitations for the

assessment of a deficiency had expired at the time of the

issuance of the notice of deficiency; (2) whether petitioners had

unreported Schedule C income in the amount of $15,000; (3)

whether petitioners are entitled to exclude from income $300 that

they received from the Herkeios Group as reimbursement for

educational expenses; (4) whether petitioners are entitled to

exclude $1,688.92 that they received from the Herkeios Group as

reimbursement for health care expenses; and (5) whether

petitioners are liable for an accuracy-related penalty pursuant

to section 6662(a).


                          FINDINGS OF FACT


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

Petitioners resided in San Diego, California, when they filed

their petition in this case.   For all relevant periods,

petitioners were cash basis taxpayers.

     On February 12, 1991, petitioners transferred J.S. Khalsa

Co., their high-rise window-washing business, into a trust called


     1
      (...continued)
Practice and Procedure.
                                  - 3 -


the Herkeios Group.2    Petitioners paid $2,950 to Freedom

Enterprises for a trust package which they used to convey the

business, and they received no consideration from the Herkeios

Group in the exchange.

     The Herkeios Group continued to operate the window-washing

business under the name of J.S. Khalsa.         Mr. Maranto served as

the general manager, and he performed accounting and bookkeeping

services, handled bidding work, and washed windows.           Following

the transfer to the trust, the gross receipts from the business

were deposited into an account at International Savings Bank in

San Diego, California.     Mr. Maranto was a signatory to this

account.

     Beginning in March 1991, petitioners executed five unsecured

"Universal Notes" in favor of the Herkeios Group.           These notes

were in the following amounts and bore the following interest

rates:


                                                Interest     Payment
  Date     Amount         Promisee                Rate         Date

 3/31/91   $4,000      Herkeios Group           5 percent    3/31/92
 5/10/91    1,100      Herkeios Group           5 percent    5/10/92
 5/28/91    3,400      The Herkeios Group -     0 percent    5/28/91
                         Alex Yung, Trustee
 6/19/91   1,000       Herkeios Group dba       5 percent    12/31/91
                         J.S. Khalsa Co.
 7/29/91   2,500       J.S. Khalsa Co.          5 percent    7/19/92
                         (The Herkeios Group)




     2
      Mr. Maranto started J.S. Khalsa Co. in 1985 and operated it
as a proprietorship before the transfer to the Herkeios Group.
                                - 4 -


Petitioners did not fill out either a credit or loan application

prior to receipt of the funds reflected in the Universal Notes.

     On August 19, 1991, petitioners and Alex Yung, as trustee of

the Herkeios Group, entered into a Credit Agreement, which

extended petitioners a $25,000 unsecured line-of-credit at 5-

percent interest.   Petitioners did not complete a loan or credit

application for purposes of the Credit Agreement.   Petitioners

received $3,100 of funds in 1991 pursuant to this agreement.

     Mr. Maranto wrote several checks to himself on the account

of J.S. Khalsa during 1991, including checks advancing funds to

petitioners pursuant to the Universal Notes.   Petitioners

deposited the funds received pursuant to the Universal Notes and

Credit Agreement, which totaled $15,100, into their checking and

savings accounts at Grossmont Bank in San Diego, California.

     On Schedule C (Profit or Loss From Business) of their 1991

Federal income tax return, petitioners included as part of gross

receipts $2,450, which represented Mr. Maranto's compensation for

1991 from the Herkeios Group.   Apart from the $2,450, petitioners

also reported a net profit from the business of $1,756.23.   On

their 1990 return, petitioners had reported a net profit from

J.S. Khalsa of $43,920.

     The Herkeios Group did not provide Mr. Maranto with a Form

W-2 for 1991.   Mr. Maranto had no other employment during this

time.
                              - 5 -


     Mrs. Maranto was employed as a Deputy Clerk for the County

of San Diego during this time, and her gross salary for 1991 was

$19,708.05.


Petitioners' Educational and Health Care Expenses


     In May 1991, petitioners paid $300 to National Note, Inc.,

for the Behle Real Estate Education Correspondence Course, a

home-study course on investments in real estate trust deeds.

Petitioners received $300 from the Herkeios Group as

reimbursement for educational materials, which was deposited into

their joint checking account at Grossmont Bank.

     On September 25, 1991, petitioners received $1,688.92 from

the Herkeios Group as reimbursements for health expenses, which

was deposited into their joint checking account at Grossmont

Bank.


Proceedings in the U.S. District Court for the Southern District
of California


     On August 24, 1994, respondent issued a third-party

recordkeeper3 summons to International Savings Bank with respect

to petitioners' 1991 Federal income tax return.   On September 13,

1994, petitioners filed a petition with the U.S. District Court

     3
      Sec. 7609(a)(3)(A) defines a "third-party recordkeeper" to
include "any mutual savings bank, cooperative bank, domestic
building and loan association, or other savings institution
chartered and supervised as a savings and loan".
                                - 6 -


for the Southern District of California to quash the summons.   On

September 22, 1994, respondent withdrew the summons, and the

District Court entered an order denying the petition to quash on

October 25, 1994.

     On November 30, 1994, respondent issued another third-party

recordkeeper summons to International Savings Bank requesting

information concerning petitioners' 1991 taxable year.

Petitioners filed a motion to quash the summons on December 20,

1994.   The District Court entered its order denying the petition

to quash and enforcing the summons on March 13, 1995.

     On June 29, 1995, respondent issued a notice of deficiency.


                               OPINION


     The first issue we must decide is whether the period of

limitations for assessment of a deficiency had expired when

respondent issued the notice of deficiency in this case.   Section

6501(a) sets forth the general rule that respondent shall assess

an income tax within 3 years from the date the taxpayer's return

is filed.    Section 7609(e)(1) suspends the period of limitations

when a taxpayer initiates a proceeding to quash a third-party

recordkeeper summons issued with respect to that taxpayer's

liability.   In such a case, the period of limitations "shall be

suspended for the period during which a proceeding, and appeals
                                 - 7 -


therein, with respect to the enforcement of such summons is

pending."    Sec. 7609(e)(1).4

     Petitioners timely filed their 1991 Federal income tax

return.    The period of limitations for assessment of any

deficiency in petitioners' 1991 Federal income taxes normally

would have expired on April 17, 1995, since April 15, 1995, was a

Saturday.    See sec. 7503.   Respondent issued the notice of

deficiency on June 29, 1995, 73 days later.

     However, on August 24 and November 30, 1994, respondent

issued summonses to International Savings Bank requesting

information with respect to petitioners' 1991 taxable year.

Petitioners filed motions to quash both summonses in the U.S.

District Court for the Southern District of California.      With

respect to the second summons, petitioners filed their motion to

quash on December 20, 1994, and the District Court entered its

order denying the petition and enforcing the summons on March 13,

1995.5    The period from the date of petitioners' filing of their


     4
      Sec. 301.7609-5(b), Proced. & Admin. Regs., provides that
the period of suspension "begins on the date the petition to
quash the summons is filed in district court. This period
continues until all appeals are disposed of, or until the
expiration of the period in which an appeal may be taken or a
request for a rehearing may be made." This regulation has been
upheld as a reasonable interpretation of sec. 7609(e). Hefti v.
Commissioner, 97 T.C. 180, 196 (1991), affd. 983 F.2d 868 (8th
Cir. 1993).
     5
      See Fed. R. Civ. P. 58 ("A judgment is effective only when
so set forth and when entered as provided in Rule 79(a).").
                                - 8 -


motion to quash to the date of entry of the court's order was 83

days.    Thus, even without taking into account the period during

which the petition to quash the original summons was pending, or

the period for an appeal, we find that the notice of deficiency

was issued to petitioners within the period of limitations.     See

sec. 7609(e)(1).

     The second issue for decision is whether petitioners had

$15,000 of unreported Schedule C income for 1991.    Petitioners

contend that the funds in question were loans from the Herkeios

Group.    Borrowed funds are excluded from a taxpayer's gross

income, "because the taxpayer's obligation to repay the funds

offsets any increase in the taxpayer's assets".     United States v.

Centennial Sav. Bank FSB, 499 U.S. 573, 582 (1991).    The

hallmarks of a loan are:    (1) Consensual recognition between the

borrower and the lender of the existence of the loan (i.e., the

obligation to repay); and (2) a bona fide intent on the part of

the borrower to repay the funds advanced.    Collins v.

Commissioner, 3 F.3d 625, 631 (2d Cir. 1993), affg. T.C. Memo.

1992-478.    Whether a debtor-creditor relationship exists is a

question of fact.    Beaver v. Commissioner, 55 T.C. 85, 91 (1970);

Fisher v. Commissioner, 54 T.C. 905, 909 (1970).    Petitioners

bear the burden of proof.    Rule 142(a); Welch v. Helvering, 290

U.S. 111, 115 (1933).
                                - 9 -


     Petitioners have presented copies of the five Universal

Notes in question, as well as a copy of the Credit Agreement with

the Herkeios Group.    However, these allegedly objective economic

indicia of debt are little more than additional declarations of

intent without any accompanying objective economic indicia of

debt.   Alterman Foods, Inc. v. United States, 505 F.2d 873, 879

(5th Cir. 1974); Dixie Dairies Corp. v. Commissioner, 74 T.C.

476, 495 (1980).

     Petitioners contend that they have since repaid the alleged

loans, but they have failed to offer any documentary evidence of

repayment.    R. Richard Evans, the current trustee of the Herkeios

Group, testified at trial that he had become aware that the

advances were repaid.    However, Mr. Evans was not the trustee

when the advances were made in 1991, and he did not provide any

loan repayment documents to substantiate that the funds were, in

fact, repaid.

     In addition, Mr. Maranto's own testimony regarding both the

Herkeios Group and the purported loans was unpersuasive.    For

instance, in response to respondent's question as to whether he

was the grantor or settlor of the Herkeios Group trust, Mr.

Maranto testified:    "I can't say with certainty, but I don't

believe so.   What I'm certain of is that it [the Herkeios Group]

doesn't belong to me.    I could be fired at any time."   When asked

by respondent whether the Herkeios Group had existed before the
                               - 10 -


transfer of the window-washing business, Mr. Maranto stated:        "I

can only assume so.    You know, that's not information I'm privy

to."

       Mr. Maranto testified that he did not fill out either a

credit or loan application before receiving funds pursuant to the

Universal Notes or the Credit Agreement.      The Universal Notes

were unsecured.    Four of the notes had a 5-percent interest rate,

while one bore no interest at all.      The terms of the Credit

Agreement provided petitioners with an unsecured line-of-credit

for $25,000 at 5-percent interest.      When asked by respondent how

he was able to obtain such favorable terms, Mr. Maranto testified

that he simply "negotiat[ed] with the [Herkeios Group's]

information officer who trusted me".

       Mr. Maranto further testified that he and Mrs. Maranto did

not receive any consideration for the transfer of their window-

washing business to the Herkeios Group.      Rather, petitioners paid

$2,950 to Freedom Enterprises for a trust package used to

transfer the business to the trust.      Moreover, Mr. Maranto served

as general manager of the trust in 1991 but reported compensation

of only $2,450.    On their Schedule C for 1991, petitioners

reported a net profit from the business of only $4,206.23, and

this amount included Mr. Maranto's compensation from the trust.

On their Schedule C for 1990, petitioners reported a net profit

of $43,920.
                                - 11 -


     Petitioners have not established that the so-called "loans"

were bona fide loans as opposed to income.     Rather, the evidence

indicates that petitioners attempted to use the trust to funnel

the income earned from their window-washing business to

themselves under the guise of loans.     We conclude that the funds

in issue constitute unreported income.     Accordingly, we sustain

respondent's determination of additional income in the amount of

$15,000.6

     The third issue for decision is whether petitioners are

entitled to exclude from income $300 that they received from the

Herkeios Group in 1991 as reimbursement for educational expenses.

Petitioners purchased a home-study course on investments in real

estate trust deeds, and they now argue that the $300

reimbursement received from the Herkeios Group is excludable from

income.     We disagree.

     Section 127(a)(1) provides that "Gross income of an employee

does not include amounts paid or expenses incurred by the

employer for educational assistance to the employee if the

assistance is furnished pursuant to a program which is described

in subsection (b)."     Subsection (b)(1), in turn, defines an

"educational assistance program" as a "separate written plan of

     6
      The record indicates that respondent understated her
computation of income. Par. 8 of the stipulation of facts
incorrectly states that the Herkeios Group made an advance of
$1,000 to petitioners in May 1991. The relevant exhibit lists
the amount of the advance at $1,100.
                               - 12 -


an employer for the exclusive benefit of his employees to provide

such employees with educational assistance."   Both Mr. Maranto

and Mr. Evans testified that Mr. Maranto was not an "employee" of

the Herkeios Group.   Mr. Evans testified that Mr. Maranto had a

contractual relationship with the trust to provide certain

services.   In addition, petitioners presented no evidence of any

written plan setting forth the Herkeios Group's educational

assistance program as required in section 127(b)(1).   We,

therefore, sustain respondent's determination.

     The next issue for decision is whether petitioners are

entitled to exclude from income $1,688.92 that they received from

the Herkeios Group in 1991 as reimbursement for health care

expenses. Petitioners contend that this amount is excludable from

income.   We disagree.

     Section 105(b) provides in certain cases for the exclusion

from gross income of amounts paid by an employer to an employee

as reimbursement for medical expenses incurred by the employee,

his spouse, or dependents.    However, we have already found that

Mr. Maranto was not an employee of the Herkeios Group.   Moreover,

section 6039D(a) requires employers who maintain a "specified

fringe benefit plan", to file a return each year listing certain

relevant information.    A plan maintained pursuant to section 105

is a "specified fringe benefit plan".   Sec. 6039D(d)(1).

Petitioners produced no evidence that the Herkeios Group filed
                                - 13 -


the necessary return.    Thus, we sustain respondent's

determination.

     Finally, respondent determined that petitioners are liable

for an accuracy-related penalty under section 6662.         Section

6662(a) imposes a penalty in an amount equal to 20 percent of the

underpayment of tax attributable to one or more of the items set

forth in section 6662(b).    Respondent asserts that the entire

underpayment in issue was due to petitioners' negligence or

disregard of rules or regulations.       Sec. 6662(b)(1).    Petitioners

bear the burden of proving that respondent's determination is

erroneous.   Rule 142(a); Bixby v. Commissioner, 58 T.C. 757, 791

(1972).

     "Negligence" includes a failure to make a reasonable attempt

to comply with the provisions of the internal revenue laws.           Sec.

6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.       A position with

respect to an item is attributable to negligence if it lacks a

reasonable basis.    Sec. 1.6662-3(b)(1), Income Tax Regs.

"Disregard" includes any careless, reckless, or intentional

disregard of rules or regulations.       Sec. 6662(c); sec. 1.6662-

3(b)(2), Income Tax Regs.    Petitioners have offered no evidence

in this case to demonstrate that the underpayment in question was

not attributable to their negligence or disregard of rules or

regulations.     Accordingly, we sustain respondent's determination.
                             - 14 -


     We have considered all of petitioners' arguments, and, to

the extent not discussed herein, find them to be irrelevant or

without merit.


                                      Decision will be entered

                                 under Rule 155.
