                         T.C. Memo. 1998-10



                       UNITED STATES TAX COURT



         LARRY A. AND KATHLEEN T. MONICO, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 23496-95.              Filed January 12, 1998.



          Ps claim certain payments received in 1990, 1991,
     and 1992 are a return of capital. Held: Ps have
     failed to so prove.



     Rodger G. Mohagen and Daniel J. Frisk, for petitioners.

     Gail K. Gibson, for respondent.


                         MEMORANDUM OPINION


     HALPERN, Judge:    By notice of deficiency dated September 21,

1995, respondent determined the following deficiencies in

petitioners' Federal income taxes:
                               - 2 -

          Tax Year                     Deficiency
            1990                        $35,219
            1991                         60,129
            1992                         66,435

After concessions, the only issue is whether payments received by

petitioners in 1990, 1991, and 1992 should have been reported as

income in those years.

     Unless otherwise noted, 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.

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

The stipulation of facts, with accompanying exhibits, is

incorporated by this reference.   We need find few facts in

addition to those stipulated and, accordingly, will not

separately set forth those findings.     We include our additional

findings of fact in the discussion that follows.    Petitioners

bear the burden of proof on all questions of fact.    Rule 142(a).

                            Background

     At the time the petition was filed, petitioners resided in

Park Rapids, Minnesota.   Petitioners filed joint returns for the

taxable (calendar) years in question and used the cash method of

accounting.

     From about November 1, 1980, until sometime in the late

1980's, petitioner Larry A. Monico (Larry Monico) was an equal

partner with R.D. Offut Co. (Offut Co.), a Minnesota corporation,
                              - 3 -

in a Minnesota general partnership, M & O Farms.    M & O Farms was

in the business of growing potatoes.    M & O Farms' annual

accounting period was a fiscal year ending on October 31, and it

used the cash method of accounting.    Ronald Offut owned Offut Co.

and was part owner of a business called Chef-Reddy Foods (Chef-

Reddy), a food processing business that made frozen french fries.

     During its 1983 fiscal year, M & O Farms sold potatoes

valued at $1,172,790 to Chef-Reddy.    The potatoes were sold on

credit, and M & O Farms treated the amount due as an account

receivable (the account receivable).    M & O Farms never received

payment for the potatoes; M & O Farms distributed the account

receivable to its partners.

     Petitioners reported nothing with respect to the account

receivable on either their 1983 or 1984 income tax return.

Petitioners have failed to prove that they have ever reported

anything with respect to the account receivable.

     By agreement executed February 14, 1989 (the purchase

agreement), Larry Monico and Offut Co. agreed that Offut Co.

would purchase Larry Monico's interest in M & O Farms.    Under the

heading "Other Matters", the purchase agreement recites:

     It is hereby agreed that Offutt [Chef-Reddy] owes
     Monico Five Hundred Eighty-six Thousand Dollars
     ($586,000), which debt is unrelated to the purchase of
     the Partnership interest described herein. A note will
     be signed by Offutt in favor of Monico for that sum at
     closing which will provide for the payment of interest
     at the rate of ten percent (10%) per annum commencing
     as of July 1, 1987, with the term of said note to be
     five (5) years from the date of closing with interest
                              - 4 -

     only being payable on July 1, 1988, and each July 1
     thereafter until July 1, 1993, when the entire
     principal balance together with accrued interest shall
     be due and payable.

Notwithstanding that it was executed on February 14, 1989, the

purchase agreement recites that it was made and entered into as

of November 1, 1987.

     In 1990, 1991, and 1992, petitioners received payments from

Chef-Reddy (the Chef-Reddy payments) in the amounts of $283,874,

$165,956, and $64,719, respectively, which payments petitioners

did not report on their income tax returns for those years.

     Respondent determined deficiencies in petitioners' Federal

income taxes for 1990, 1991, and 1992 on the grounds, in part,

that the Chef-Reddy payments were items of gross income

improperly omitted from gross income by petitioners.

     Petitioners contend that the Chef-Reddy payments are not

items of gross income because they represent a return of capital;

i.e., the Chef-Reddy payments represent amounts that, previously,

                             income. 1
should have been taken into Discussion

1
     Rule 151(e) deals with the form and content of briefs, and
provides as follows:

          (e) Form and Content: All briefs shall contain
     the following in the order indicated:
          (1) On the first page, a table of contents with
     page references, followed by a list of all citations
     arranged alphabetically as to cited cases and stating
     the pages in the brief at which cited. Citations shall
     be in italics when printed and underscored when
     typewritten.
          (2) A statement of the nature of the controversy,
                                                   (continued...)
                                - 5 -

I.   Arguments of the Parties

      A.   Petitioners' Receipt of a Note

      Petitioners' argument that returns of capital are not gross

income is well supported.    Doyle v. Mitchell Bros. Co., 247 U.S.

179, 185 (1918).    Unfortunately for petitioners, they have failed


1
 (...continued)
     the tax involved, and the issues to be decided.
          (3) Proposed findings of fact (in the opening
     brief or briefs), based on the evidence, in the form of
     numbered statements, each of which shall be complete
     and shall consist of a concise statement of essential
     fact and not a recital of testimony nor a discussion or
     argument relating to the evidence or the law. In each
     such numbered statement, there shall be inserted
     references to the pages of the transcript or the
     exhibits or other sources relied upon to support the
     statement. In an answering or reply brief, the party
     shall set forth any objections, together with the
     reasons therefor, to any proposed findings of any other
     party, showing the numbers of the statements to which
     the objections are directed; in addition, the party may
     set forth alternative proposed findings of fact.
          (4) A concise statement of the points on which
     the party relies.
          (5) The argument, which sets forth and discusses
     the points of law involved and any disputed questions
     of fact.
          (6) The signature of counsel or the party
     submitting the brief. As to signature, see Rule
     23(a)(3).

     Petitioners have failed to follow the requirements of
Rule 151(e) by failing in their opening brief to individually set
forth and number each statement of a proposed finding of fact and
by failing, in many instances, to insert references to
appropriate sources for the statements they make. In their reply
brief, petitioners have failed to set forth any objections to the
proposed findings of fact set forth in respondent's opening
brief. The record in this case is not large and we have reviewed
it completely; nevertheless, by their failure to follow our
Rules, petitioners have assumed the risk that we have not
considered the record in a light of their own illumination.
                                - 6 -

to prove that the Chef-Reddy payments constitute a return of

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

The parties have locked horns on whether, sometime prior to

receipt of the Chef-Reddy payments, Larry Monico received a

payment in liquidation of his interest in the account receivable.

Petitioners describe the nature of the controversy as follows:

     Petitioners exchanged a short term account receivable
     for a long term promissory note in a preceding year.
     Petitioners assert the receipt of the promissory note
     was a cash equivalent right, requiring the Petitioners
     to recognize taxable gain in the year of exchange
     [which they failed to recognize]. Petitioners claim
     basis in the promissory note equal to the gain that
     should have been recognized in the year of the
     exchange.

Respondent describes the principal question presented as:

"Whether the account receivable * * * distributed to petitioner

Larry Monico by M & O Farms was converted to a note receivable at

a specific point in time between 1983 and 1989."

     There is some confusion in petitioners' argument as to when

income should have been recognized by them with respect to the

account receivable.   Petitioners conclude their opening brief

with the following argument:   "When the Petitioners exchanged

their rights to collect the account receivable for a

long term promissory note [pursuant to the Other Matters section

of the purchase agreement], they should have recognized income in

that year (1987)."    In their reply brief, petitioners propose a

finding of fact that Larry Monico accepted a promissory note from

Chef-Reddy in 1983 "rather than collecting full payment on the
                                - 7 -

account receivable."   Also in that brief, they propose an

"ultimate" finding of fact:   "Petitioners should have recognized

gain in the year of exchange.   Evidence concludes the exchange

was definite by 1989."

     We need not resolve the confusion in petitioners’ briefs

because, whenever it is that petitioners allege Larry Monico

received a note (or notes), they have failed to prove that Larry

Monico received any note, and we so find.     Petitioners produced

no note, and Alan Knoll, the chief financial officer of Offut Co.

and an employee of Offut Co. since 1974, could recall no note.

Petitioners failed to produce Ronald Offut, who would have

knowledge of any note, and we infer from that unexplained failure

that his testimony would have been adverse to petitioners.     McKay

v. Commissioner, 886 F.2d 1237, 1238 (9th Cir. 1989), affg. 89

T.C. 1063 (1987); Wichita Terminal Elevator Co. v. Commissioner,

6 T.C. 1158, 1165 (1946), affd. 162 F.2d 513 (10th Cir. 1947).

     B.   Cash Method of Accounting

     Despite petitioners' failure to prove that Larry Monico

received any note, we must still address petitioners' argument

based on the cash equivalence doctrine.    See Cowden v.

Commissioner, 289 F.2d 20, 24 (5th Cir. 1961) ("negotiability is

not the test of taxability in an equivalent of cash case"), revg.

and remanding 32 T.C. 853 (1959).     Section 1.446-1(a)(3), Income

Tax Regs., makes clear:   “Items of gross income * * * which are

elements in the computation of taxable income need not be in the
                                - 8 -

form of cash.    It is sufficient that such items can be valued in

terms of money.”    Nevertheless, generally, a cash-method taxpayer

only takes into account an item of gross income when actually or

constructively received.    Sec. 1.446-1(c)(1)(i), Income Tax Regs.

A promise to pay is includable in gross income when received by a

cash-method taxpayer if it is the equivalent of cash.    Cowden v.

Commissioner, supra at 24.    Not all promises received by a cash-

method taxpayer, however, are the equivalent of cash.    E.g.,

Richardson v. Commissioner, 76 T.C. 512, 531-532 (1981) (notes

received for noncompetition fees), affd. 693 F.2d 1189 (5th Cir.

1982).    The characteristics of a promise to pay that is the

equivalent of cash were described by the Court of Appeals for the

Fifth Circuit in Cowden:

     We are convinced that if a promise to pay of a solvent
     obligor is unconditional and assignable, not subject to
     set-offs, and is of a kind that is frequently
     transferred to lenders or investors at a discount not
     substantially greater than the generally prevailing
     premium for the use of money, such promise is the
     equivalent of cash and taxable in like manner as cash
     would have been taxable had it been received by the
     taxpayer rather than the obligation. * * * [Cowden v.
     Commissioner, supra at 24.]

Accord Estate of Silverman v. Commissioner, 98 T.C. 54, 61

(1992).

     Petitioners have failed to prove that the obligation of

either Chef-Reddy or Offut Co. to make the Chef-Reddy payments is

a cash equivalent.    Among other failures, petitioners have failed

to prove that either Chef-Reddy's or Offut Co.'s obligation to
                                  - 9 -

make the Chef-Reddy payments is the kind of promise to pay that

is frequently transferred to lenders or investors at a discount

not substantially greater than the generally prevailing premium

for the use of money.      We therefore find that the obligation to

make the Chef-Reddy payments is not the equivalent of cash.

      C. Cottage Sav. Association v. Commissioner

      Petitioners attempt to buttress their argument by citing

Cottage Sav. Association v. Commissioner, 499 U.S. 554 (1991)

(exchange of property gives rise to a realization event under

section 1001 so long as the exchanged properties are “materially

different”; i.e., so long as they embody a legally distinct

entitlement).      Petitioners argue that, when Larry Monico

“exchanged the account receivable for the promissory note, the

Petitioners realized and should have recognized income.”

Petitioners have failed to prove that there was any such

exchange.   Moreover, they have failed to prove any material

change in the obligation.      Cottage Savings Association is

inapplicable.

II.   Conclusion

      Petitioners have failed to prove that the Chef-Reddy

payments constitute a return of capital.      That being the

exclusive basis on which they assigned error to respondent’s

determination of a deficiency with respect to the Chef-Reddy
                                - 10 -

payments, respondent’s determination of a deficiency in tax with

respect thereto is sustained.


                                          Decision will be entered

                                     under Rule 155.
