                        T.C. Memo. 1997-468



                      UNITED STATES TAX COURT



                  MELVIN R. SWEATMAN, Petitioner v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 16680-94.                  Filed October 14, 1997.



     Linda S. Paine and George W. Connelly, Jr., for petitioner.

     Shelia Dansby Harvey, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     GALE, Judge:   Respondent determined the following deficiency

in petitioner's Federal income tax and the following accuracy-

related penalty:

                                         Accuracy-Related Penalty
     Year               Deficiency              Sec. 6662(a)
     1990                $43,122                    $8,624
                               - 2 -

Unless otherwise noted, all section references are to the

Internal Revenue Code in effect for the year in issue, and all

Rule references are to the Tax Court Rules of Practice and

Procedure.

     We must decide the following issues:

     (1) Whether the transfer of Las Colinas Ranch from Paz Gas

Corporation to petitioner, the controlling shareholder, was a

sale or a dividend.   We hold that the transfer was a dividend.

     (2) Whether petitioner is liable for the accuracy-related

penalty as determined by respondent.   We hold that petitioner is

so liable.

                         FINDINGS OF FACT

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

incorporate by this reference the stipulation of facts,

supplemental stipulation of facts, and attached exhibits.    At the

time of filing the petition, petitioner resided in Cuero, Texas.

Background

     Petitioner's formal education consisted of secondary school

through approximately ninth grade and 2½ years of college.   After

college, he took a job with Houston Natural Gas, and about 16

years later became president of Houston Pipeline Company.

Following this, in 1989 or 1990, he took a position as president

and chief operating officer of Tejas Gas Corporation.   Petitioner

formed Paz Gas Corporation (Paz) in 1988, and he was the sole

shareholder.
                                - 3 -

The Ranch

       Petitioner and a friend, William Anderson (Anderson),

planned to acquire Las Colinas Ranch (the Ranch), in Westhoff,

Texas, in order to operate a parimutuel horse-betting business.

Anderson owned a corporation called Shoreline Resources, Inc.,

which acquired the Ranch.    When Shoreline Resources acquired it,

the Ranch consisted of 133 acres of land and an old, run-down

frame house.    Anderson paid to build the exterior shell of a

ranch house on the land, but did not pay to complete the

interior.    Petitioner paid to complete the interior of the ranch

house, paid for some repairs to the frame house, and paid for

other improvements on the property.     Shoreline Resources merged

with Paz in December 1988, and Paz was the corporation that

survived the merger, with petitioner as president and 78-percent

shareholder and Anderson as 22-percent shareholder.    As a result

of the merger, Paz became the owner of the Ranch, with book

values of $115,007 for the land and $39,000 for the ranch house.

Petitioner moved to the ranch house after he left Tejas Gas

Corporation in 1989 or 1990, and it was petitioner's primary

residence from July 1990 to April 1991.

The Transfer of the Ranch

       Petitioner and Paz employed the accounting firm of Davidson,

Eagleson & Co (Davidson, Eagleson).     John Eagleson (Eagleson), a

partner with Davidson, Eagleson, was an officer and director of

Paz.    Davidson, Eagleson prepared tax returns for both petitioner
                               - 4 -

and Paz; in addition, Davidson, Eagleson also kept the books and

functioned as in-house accountant for Paz.

     In 1990, petitioner began contemplating sale of the Ranch.

Before doing so, because he believed that he had title to some of

the improvements and Paz had title to the remainder of the Ranch,

he wanted to get title in one name to facilitate sale.

Therefore, he decided to cause Paz to transfer the Ranch to him.

Petitioner discussed the idea of transferring the Ranch with

Audrey Kuntz (Kuntz), an accountant employed by Davidson,

Eagleson at that time.   In April 1990, Kuntz wrote an agenda for

an upcoming meeting with petitioner, in which she noted a

question as to when petitioner was going to "purchase" the Ranch

from Paz.   She met with petitioner in June 1990, and in her notes

of the meeting, she stated that petitioner planned to sell the

Ranch in about a year, that petitioner would "buy" the Ranch from

Paz, and that Davidson, Eagleson would draw up a 2-year demand

note for petitioner's "purchase" of the Ranch.

     Another accountant at Davidson, Eagleson, Stephen Guerra

(Guerra), was responsible for reviewing petitioner's and Paz's

tax returns.   Petitioner also met with Guerra in June 1990, and

they talked about the idea of petitioner purchasing the Ranch

from Paz, discussing sales price and financing.    Petitioner

believed the fair market value of the Ranch was less than book

value, but Guerra suggested that he buy the Ranch at book value

to avoid a bargain sale characterization.    With respect to a
                               - 5 -

promissory note, Guerra advised petitioner that it should be in

writing and should reflect a market rate of interest.

     The transfer of the Ranch from Paz to petitioner was

accomplished by warranty deed on July 2, 1990.    Petitioner did

not execute a promissory note at the time of the transfer.

After the Transfer

     In the period of July through September 1991, Michelle

Youngs (Youngs), also of Davidson, Eagleson, began preparing

Paz's books for 1990 and Paz's 1990 tax return.    She came upon

the notes that Kuntz had written in 1990 with respect to the

transfer of the ranch.   This was the first she learned of the

transfer.   She asked Eagleson whether she needed to book the

transfer and whether it in fact had taken place.    He confirmed

that the transfer had occurred, so Youngs made accounting

adjustment entries to reflect the sale of the Ranch to

petitioner.   Youngs recorded the transfer on Paz's books as a

note receivable from shareholder in the amount of $154,007, the

book value of the Ranch prior to the transfer.    In addition,

Youngs prepared Paz's 1990 tax return, on which Paz reported the

$154,007 amount as a loan to shareholder and the transfer as a

sale of a capital asset.

     At the time of the transfer of the Ranch, petitioner was

married to Linda Glass Sweatman.   In June 1991, as part of their

divorce agreement, Linda Glass Sweatman conveyed her interest in

the Ranch to petitioner.
                                - 6 -

     In August 1991, petitioner sold the Ranch for $200,000,

taking a promissory note for $150,000 and the remainder in cash.1

In October 1992, petitioner assigned this promissory note to a

bank for $167,342.82 cash.

The Note

     In May 1992, Youngs was preparing petitioner's 1991 tax

return.    When attempting to calculate petitioner's gain or loss

on the sale of the Ranch, she realized there was no note with

respect to the transfer of the Ranch.   She raised this point with

Eagleson, who said he would prepare a note.    In May 1992,

Eagleson prepared a promissory note (the Note) with respect to

the transfer, and in June 1992, petitioner executed it.

     The date appearing in the top right corner of the Note

executed in June of 1992 was July 2, 1990, which was the date of

the transfer of the Ranch.   The Note listed the Ranch as

security, stating that "payment of this note is secured by that

tract of land [i.e., the Ranch] * * * more fully described in the

Deed executed on this date, July 2, 1990."    There was no date

next to petitioner's signature at the end of the Note.    The Note

called for annual payments beginning July 2, 1992.

The Audit

     Guerra next became significantly involved with the details

of the transfer of the Ranch in July 1993, when an audit of Paz


     1
       Settlement expenses were $13,873.70 and taxes were
$1,568.32, so petitioner received net cash of $34,557.98.
                               - 7 -

was taking place.   Prior to July 1993, in response to a document

request dated February 8, 1993, Guerra sent Revenue Agent Allen

Sohrt (Agent Sohrt) a copy of the Note, which was unsigned.     On

July 16, 1993, Guerra met with Agent Sohrt, at which time Agent

Sohrt requested a signed copy of the Note as well as copies of

any checks showing payments on the Note.   Guerra looked for the

documents requested at the July 16 meeting and did not find any

copies of checks, so he notified Eagleson.   On July 22, 1993,

petitioner made his first payment on the Note, equal to two

principal payments of $15,400 each and interest accrued to date

of $36,961.68.   On August 2, 1993, Guerra sent Agent Sohrt a

signed copy of the Note and stated in a cover letter that

petitioner had missed the first payment due on the Note (the July

2, 1992, payment), in part because of the failure of the

accountants at Davidson, Eagleson to notify him the payment was

due.   At the time he sent this letter, Guerra had not been made

aware that the Note had been signed in 1992, and the letter made

no mention of when the Note had been signed.   On October 8, 1993,

Agent Sohrt wrote Guerra asking petitioner to provide a signed

statement as to when the Note had been signed.   Later that month

Guerra drafted a letter for Eagleson's signature stating that the

Note had been signed on or shortly after May 26, 1992, even

though it was effective July 2, 1990.   This letter advised that

the accountants were partly responsible for the failure to

prepare the Note at the time of the transfer of the Ranch.
                                - 8 -

Earnings

     Paz reported retained earnings of $376,792 at the beginning

of the year in issue and $566,944 at the end of the year in

issue.

                               OPINION

     Respondent determined that the transfer of the Ranch was a

dividend from Paz and therefore income to petitioner.2

Petitioner contends, however, that the transfer was pursuant to

his purchase of the Ranch from Paz, in which the purchase price

was advanced to petitioner by Paz in exchange for a promissory

note.    It is respondent's position that petitioner did not intend

to pay for the Ranch, and consequently that dividend treatment is

appropriate.   Petitioner's contention requires us to decide

whether a bona fide indebtedness was created between Paz and

petitioner, its controlling shareholder, when the transfer

occurred.    The question of whether an advance by a corporation to

its shareholder is a dividend or a loan is a recurrent one, the

central issue therein being whether the parties to the alleged

loan intended to create a bona fide indebtedness.   See, e.g.,

Alterman Foods, Inc. v. United States, 505 F.2d 873 (5th Cir.

1974), and cases cited therein; Electric & Neon, Inc. v.




     2
       In the notice of deficiency, respondent determined that
the value of the dividend to petitioner was $154,007, the book
value of Ranch at the time of the transfer.
                                - 9 -

Commissioner, 56 T.C. 1324, 1338-1339 (1971), affd. without

published opinion 496 F.2d 876 (5th Cir. 1974).

       A determination of whether there was an intent to create

bona fide indebtedness depends on all the facts and

circumstances; not every factor gets equal weight, and no one

factor is controlling.    Alterman Foods, Inc. v. United States,

supra at 876 n.6.    Arrangements between a corporation and a

controlling shareholder are subject to close scrutiny. Electric &

Neon, Inc. v. Commissioner, supra at 1339.

       Based on the evidence in this case, we conclude that there

was no intention to create bona fide indebtedness or to repay the

advanced amounts when petitioner received the Ranch from Paz, and

consequently the transfer constituted a dividend.     We base this

conclusion on the numerous instances in which petitioner

disregarded the purported debt and his obligations thereunder.

       First, no promissory note evidencing petitioner's

indebtedness to Paz was drafted or executed at the time of the

transfer of the Ranch to petitioner.    This "error" was not

corrected until approximately 2 years later when an accountant at

Davidson, Eagleson who was attempting to compute petitioner's

gain    or loss on the later sale of the Ranch discovered that

there was no note.    As a result, Paz was unsecured during this

period.    The absence of a written promissory note was not

corrected when petitioner sold the Ranch to third parties, even

though petitioner contends that the Ranch was security for the
                                - 10 -

indebtedness to Paz.   When the Note was executed in June of 1992,

the Ranch had already been sold.    Yet the Note continued to

recite the Ranch as security.    Thus Paz remained effectively

unsecured.   Petitioner argues that the failure to execute a note

was due to the oversight of his accountants, but we note that

petitioner observed other formalities with respect to title to

the Ranch, such as obtaining his wife's community interest in the

Ranch prior to their divorce.    We believe that the failure to

draft or execute a note evidencing petitioner's indebtedness to

Paz for nearly 2 years, and the failure to provide security when

purporting to do so, reveal that both borrower and lender treated

the obligation casually at best.    We believe that greater care

would have been exercised in these matters if the purported debt

had been intended as a genuine obligation.

     Second, and of most significance, petitioner failed to make

any payments with respect to the indebtedness, even though they

were past due under the terms of the subsequently drafted Note,

until a revenue agent auditing Paz made specific inquiries

regarding the transaction.   The Note required annual payments,

commencing 2 years after the July 2, 1990, transfer of the Ranch

to petitioner, namely July 2, 1992.      Nonetheless, despite the

fact that the Note had been executed by petitioner in June 1992

after its absence had been discovered, petitioner failed to make

the first payment due 1 month later on July 2, 1992.      Petitioner

also failed to make the second payment, due July 2, 1993.
                              - 11 -

Indeed, no payments were made on the Note until July 22, 1993,

after a revenue agent auditing Paz met with one of petitioner's

accountants and requested a signed copy of the Note and evidence

of repayment.   Petitioner contends that his failure to make

payments when due resulted from oversight, specifically, his

failure to recall when payments were due and the failure of his

accountants to remind him.   We do not find this contention

credible.   Even accepting the view that petitioner was a busy

executive who relied on his accountants, we do not believe that

he could fail to recall at some point, over a period exceeding 3

years, his obligation to repay $150,000 on which interest was

accruing, particularly in light of the fact that, during such

period, he liquidated the asset that was the purported security

for the obligation.   Petitioner received substantial cash upon

the sale of the Ranch to third parties in August 1991, and while

this was concededly before the agreed due date of his first

repayment, payment on the Note was past due when petitioner

converted the third-party purchasers' promissory note to cash in

October 1992.   We believe that if petitioner had intended to

create bona fide indebtedness to Paz, he would have made some

payment on the Note prior to a request by a revenue agent for

evidence of repayment.

     Finally, the circumstances surrounding the ex post facto

execution of the Note cast doubt upon the bona fides of the

obligation and upon the credibility of petitioner and his
                                - 12 -

principal accountant, Eagleson.     Petitioner concedes in testimony

that the Note was not executed until June of 1992.     However, the

Note on its face is misleading as to the execution date in two

key respects.     First, although there is no date next to

petitioner's signature, the date July 2, 1990 (the date of the

transfer of the Ranch to petitioner), appears at the top of the

Note.     Second, the text of the Note states that payment is

secured by the tract of land "more fully described in the Deed

executed on this date, July 2, 1990" (emphasis added);       this

implies that the Note was executed on the same date as the deed.

The only other date that appears on the Note is the due date of

the first payment under the Note, July 2, 1992.     It is true that

Eagleson disclosed the actual date the Note was executed after

probing by Agent Sohrt, but the fact remains that the Note was

misleading on its face.     In addition, at the time the Note was

executed, petitioner no longer owned the property recited as

security in the Note, which creates another misleading element.

The discrepancies surrounding the date of execution and the

Note's security cast doubt upon the bona fides of the

indebtedness that the Note purported to memorialize.

        Based on the foregoing factors, we conclude that there was

no bona fide indebtedness between petitioner and Paz.

Accordingly, we uphold respondent's determination that the

transfer of the Ranch to petitioner was a dividend to him.
                                - 13 -

Accuracy-Related Penalty

     In the notice of deficiency, respondent determined that

petitioner was liable for the accuracy-related penalty under

section 6662(a) on the ground that the entire deficiency was

attributable to (1) negligence or disregard of rules or

regulations and (2) substantial understatement of income tax.

See sec. 6662(b)(1) and (2).     "[T]he term 'negligence' includes

any failure to make a reasonable attempt to comply with the

provisions of * * * [the Internal Revenue Code], and the term

'disregard' includes any careless, reckless, or intentional

disregard."    Sec. 6662(c).   A substantial understatement is an

understatement of tax that exceeds the greater of 10 percent of

the tax required to be shown on the return or $5,000.      Sec.

6662(d).    Petitioner will be relieved of the accuracy-related

penalty under either theory if there was reasonable cause and

petitioner acted in good faith.     Sec. 6664(c).   Petitioner has

the burden of proof to show reasonable cause and good faith.

Rule 142(a).    Petitioner argues that even if we uphold

respondent's deficiency determination, he is not liable for the

accuracy-related penalty because he reasonably relied on his

accountants.    See Chamberlain v. Commissioner, 66 F.3d 729, 732-

733 (5th Cir. 1995), affg. in part and revg. in part T.C. Memo.

1994-228.    For the reasons underlying our conclusion that

petitioner did not intend to create bona fide indebtedness,

discussed above, we also conclude that petitioner's reliance on
                              - 14 -

his accountants was not reasonable.    Therefore, petitioner has

not shown reasonable cause for his failure to include the receipt

of the Ranch in income.   Accordingly, petitioner is liable for

the accuracy-related penalty pursuant to section 6662(a) as

determined by respondent.

     To reflect the foregoing,

                                        Decision will be entered

                                 for respondent.
