                        T.C. Memo. 1997-316


                      UNITED STATES TAX COURT



          FRANK PETAR CONTRACTING, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 21936-94.              Filed July 9, 1997.



     Frank Petar (an officer), for petitioner.

     Carmino J. Santaniello, Jr., for respondent.


             MEMORANDUM FINDINGS OF FACT AND OPINION

     BEGHE, Judge:   Respondent determined a deficiency in

petitioner’s Federal income tax for the fiscal year ended May 31,

1990 (FYE 5/31/90) in the amount of $38,164.     The sole issue for

decision is whether petitioner is entitled to deduct for the

taxable year in issue an accrued bonus awarded to its president
                                - 2 -


and sole shareholder.1   Resolution of this issue turns on the

factual question of whether petitioner issued a promissory note

in payment of the bonus during the taxable year.    Unless

otherwise indicated, section references are to the Internal

Revenue Code in effect for the taxable year in issue; all Rule

references are to the Tax Court Rules of Practice and Procedure.

                           FINDINGS OF FACT

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

The stipulations of fact and attached exhibits are incorporated

by this reference.   Petitioner is a construction company

incorporated in 1987 under the laws of the State of New York.     At

the time the petition was filed, petitioner maintained its

principal place of business in Ballston Spa, New York.    Frank

Petar (Mr. Petar) has been petitioner’s sole shareholder,

president, and one of two members of the board of directors since

the company’s incorporation.    His wife, Franka Petar

(Mrs. Petar), is the other member of the board of directors and

the corporate secretary.    Thomas Cunniff (Mr. Cunniff) has at all

times served as petitioner’s accountant and tax return preparer.

For all relevant years, petitioner computed its income for book


     1
       The $38,164 deficiency for FYE 5/31/90 is entirely
attributable to the disallowance of the bonus deduction.
Respondent has allowed the deduction for the following taxable
year, as a result of which the deficiency is partly offset by an
overpayment for that year and, by reason of the carryback of a
net operating loss, by overpayments in 2 earlier years.
                                - 3 -


and tax purposes on the basis of a fiscal year ending May 31

using the accrual method of accounting.

     Sometime in the middle of May 1990, Messrs. Cunniff and

Petar met for the purpose of reviewing petitioner’s results for

the taxable year.    At this meeting it was decided that petitioner

would award Mr. Petar a bonus of $100,000 in consideration of his

extraordinary efforts and the company’s favorable performance for

the year.    The bonus was accrued on petitioner’s books for FYE

5/31/90.    For cash-flow reasons Mr. Petar wanted to postpone

actual payment until some time in the next fiscal year.     Mr.

Cunniff advised him that in order for petitioner to claim a

deduction for the accrued bonus for FYE 5/31/90, payment would

have to be made by August 15, 2-1/2 months following the close of

the taxable year.    In accordance with its accountant’s advice,

petitioner issued Mr. Petar a check for $100,000 on August 14,

1990.   In prior years bonuses had always either been paid in cash

by the end of the fiscal year or accrued and paid in cash within

2-1/2 months of the fiscal yearend.     In no prior year in which

actual payment of a bonus was deferred had petitioner issued a

note evidencing the accrued liability.

     On its Federal income tax return (Form 1120) for FYE

5/31/90, petitioner claimed a deduction for compensation of

officers in the total amount of $169,800, which included the

$100,000 bonus awarded to Mr. Petar.     Mr. Petar reported the
                                 - 4 -


bonus on his individual income tax return (Form 1040) for the

1990 calendar year.

     In March 1993 Revenue Agent Mockus began an examination of

petitioner’s tax return for FYE 5/31/90.      Mr. Cunniff represented

petitioner in three meetings with the revenue agent in March,

April, and August 1993.   The treatment of the bonus was among the

issues discussed at the initial meeting.      Mr. Mockus informed

Mr. Cunniff that under section 267(a)(2), as amended, petitioner

would have been entitled to deduct the bonus for FYE 5/31/90 only

if it paid the bonus before the close of that year.      Mr. Cunniff

admitted that both he and Mr. Petar had mistakenly believed that

under the circumstances the law still permitted compensation to

be deducted for the year accrued so long as payment was made

within 2-1/2 months after the close of the year.      Following the

initial meeting Mr. Mockus mailed to Mr. Cunniff photocopies of

the relevant provisions of the statute and regulations together

with the explanatory comments and annotations published in the

Standard Federal Tax Reports (CCH).      These materials addressed

the issue of whether a promissory note qualified as payment for

purposes of section 267(a)(2).

     At the second meeting Mr. Cunniff and Mr. Mockus discussed

further the revenue agent’s proposed disallowance of the bonus

deduction, but did not reach agreement.      Mr. Cunniff agreed to

all other proposed adjustments.    A third meeting, which Mr. Petar
                                   - 5 -


also attended, was held for the purpose of ensuring review of all

relevant documents and consideration of all relevant facts in a

final effort to settle the bonus issue.         For reasons that are not

evident from the record, petitioner’s representatives continued

to dispute the proposed disallowance of the bonus deduction for

FYE 5/31/90.   In November 1993 the case was closed to Appeals.

At no time during the 8- to 9-month examination did petitioner’s

representatives inform the Internal Revenue Service that

petitioner had issued Mr. Petar a note evidencing the bonus award

during FYE 5/31/90.    No corporate documents examined by the

Internal Revenue Service revealed the existence of such a note.

Although the revenue agent specifically requested petitioner’s

corporate minute book, it was never shown to him.

     In the petition, filed on November 23, 1994, petitioner set

forth its objection to respondent’s determination as follows:

     We disagree with the salary bonus of $100,000.00
     accrued on our books [for] FYE 5-31-90 being
     disallowed.

                      *   *   *     *      *   *   *

     because we took all necessary steps to make the
     deduction proper as follows:
     1- Took Promissory Note between Frank Petar Contracting
     Inc. & Frank Petar on 5-23-1990.
     2- Reflected income on Frank Petar Form 1040 for 1990.
     3- Performed services by Frank Petar for this
     remuneration during FYE 5-23-90.

                                  OPINION

     Section 267(a)(2) limits the deductibility of a business

expense payable to a related person if the amount is not
                                - 6 -


currently includable in gross income under the payee’s method of

accounting.    Prior to its amendment as part of the Deficit

Reduction Act of 1984, Pub. L. 98-369, sec. 174(a)(1), 98 Stat.

704, the section operated to deny an accrual basis taxpayer a

current deduction for accrued business expenses payable to a

related cash basis taxpayer unless payment was made within 2-1/2

months after the close of the taxable year.    Under the law in

effect for the taxable year in issue, deduction of the accrued

expenses is not allowable until paid to the related cash basis

taxpayer.   See Tate & Lyle, Inc. v. Commissioner, 103 T.C. 656,

659-661 (1994), revd. and remanded on other grounds 87 F.3d 99

(3d Cir. 1996); H. Rept. 98-861, at 1032-1033 (1984), 1984-3 C.B.

(Vol. 2) 1, 286-287.    A corporation and an individual who owns

more than 50 percent of its stock are related parties within the

meaning of section 267(a)(2).    Sec. 267(b)(2).   An expense is

considered paid for purposes of this section to the extent of the

fair market value of any negotiable note received in payment of

the expense.    Musselman Hub-Brake Co. v. Commissioner, 139 F.2d

65 (6th Cir. 1943); Hartland Associates v. Commissioner, 54 T.C.

1580, 1587-1588 (1970); cf. Don E. Williams Co. v. Commissioner,

429 U.S. 569, 579-583 (1977); sec. 1.267(a)-1(b)(3), Income Tax

Regs.

     The parties agree that section 267(a)(2) governs the

deductibility of the bonus awarded to Mr. Petar during FYE

5/31/90.    In support of the claimed deduction petitioner produced
                                 - 7 -


a reproduction of a handwritten document entitled “Promissory

Note” and dated May 23, 1990, acknowledging petitioner’s

obligation, on or before August 15, 1990, to pay Mr. Petar

$100,000 for services performed during the fiscal year (the

Note).   Petitioner presented the testimony of Mrs. Petar and her

daughter Sonya to establish the authenticity of the Note.    These

witnesses testified that they drafted the Note in accordance with

Mr. Cunniff’s instructions while Mr. Petar was temporarily living

at a construction site out of town, and that Mrs. Petar delivered

the Note to Mr. Petar for execution on petitioner’s behalf about

2 or 3 days later.   Sonya had no clear recollection of when the

events she described occurred.    According to Mrs. Petar, they

occurred at some time during the last week of May 1990,

consistent with the date shown on the Note.    There were

inconsistences in Mrs. Petar’s account that appeared to be

attributable to language comprehension problems.

     Both Mrs. Petar and Mr. Cunniff testified that it was

Mr. Petar who originally identified the need for the Note.    When

Mr. Petar was asked to explain the circumstances requiring the

issuance of the Note, his initial response was that he would

prefer to let his accountant explain.    After the Court encouraged

him to testify on the subject, he testified that, at the time the

bonus was awarded to him, the company needed to conserve its cash

balances pending collection of unpaid accounts from third

parties.
                                - 8 -


     Although petitioner’s cash-flow concerns may explain why the

bonus was not paid in cash during FYE 5/31/90, they do not

explain why petitioner allegedly took the unprecedented step of

issuing a note to Mr. Petar evidencing the deferred payment

obligation.   In the following colloquy with the Court and Mr.

Cunniff, who was seated in the courtroom during Mr. Petar’s

testimony, Mr. Petar was given another opportunity to address

this crucial issue:

     The Court: Okay. Is there anything else that I ought
     to be aware of that you want to tell me?

     Mr. Cunniff: Why the note was made out in the first
     place, Frank.

     The Witness: We made the note out for different other
     reasons, you know. We needed some performance bonds
     for the -- you know, for the bank and things like that.

     Mr. Cunniff: The reason it ended up being made out was
     because we showed on your personal return, your
     personal financial statement, $100,000 owed to you and
     they wanted to know why that was so you could go
     through the bonding company, so that’s why -- that is
     actually the reason why we made the note up. We didn’t
     make it up for this thing at all. It happened to come
     out all right.

     The Court:   Anything else?

     Mr. Cunniff:    Go ahead, tell him that.

     The Witness:    I think that is all, Your Honor, I have.


     In his own testimony, Mr. Cunniff elaborated on the account

he had tried to elicit from Mr. Petar by means of his prompting

from the audience.    According to Mr. Cunniff, the Note was not

issued before the close of FYE 5/31/90 for the purpose of
                                - 9 -


supporting a tax deduction for that year.       Both he and Mr. Petar

had believed that payment by check within 2-1/2 months, as

planned, would be sufficient for that purpose.      In Mr. Cunniff’s

view, it was just a fortunate coincidence that petitioner issued

the Note in time to qualify for a deduction for FYE 5/31/90.

     The Witness: * * * The note came about because back
     in, I don’t know when, it was -- I think it was tax
     season still * * * Mr. Petar needed some bonding, okay,
     performance bonds, because he has his own personal land
     over there that he was going to put a project in on.
     What happened is that we met sometime early in May when
     we did this. At the time Frank told me he needed a
     financial statement, his personal financial statement,
     because of the bonding company. I think it was Aetna
     or whatever. Okay.

          So I made him up a personal statement. On the
     statement I showed a receivable on his asset statement
     of $100,000. Frank and I talked, and when this
     occurred, Frank had called me and said after I gave him
     this statement that we should show something in the way
     of substantiating this because -- I guess -- I have
     never gone through bonding myself but I guess they ask
     you everything on your thing, they want to know, you
     know, where this came from and everything.

                    *   *   *    *      *   *   *

     * * * we drafted up this note just for something to
     send with this financial statement to show that there
     was a $100,000 asset that was actually due and payable
     to Frank very shortly.

                    *   *   *    *      *   *   *

     The Court: Now why would Mr. Petar get personal
     bonding if he was doing business as the corporation?

     The Witness: Because this is -- this is personal
     property that he owned. This wasn’t land in the
     corporation.
                             - 10 -


The Court: So was he -- in order -- I take it that it
was the corporation that was being bonded and he was
guaranteeing the bond?

The Witness: I guess. Isn’t that -- well, I can’t
talk to him, I guess, but I believe, you know, it is
the old story when you got such a closely-held
corporation, it is all one entity, almost.

The Court: Let me ask you, do you have any -- do you
have the financial statement that you have just
mentioned? That is, is it part of Mr. Petar’s records?

The Witness:   No.

The Court:   What happened to it?         It just would be --

The Witness: I might have it somewhere. I think the
reason we don’t have this is because we really -- as I
say, this note in the beginning is not something that
we were really aware of.

The Court:   When you say you weren’t aware of it?

The Witness: Aware of why -- we weren’t aware of the
reason, that this note would become so important. This
note just happened because of certain things that
happened, okay?

The Court:   So you are saying that --

The Witness:    Our timing was good, I am
                saying.

                *    *   *     *      *    *   *

The Court: But we -- you don’t actually have the
documentation that would support and describe the
circumstances surrounding that other situation?

The Witness:   No, Your Honor.

The Court:   That is, correspondence with the bonding
company?

The Witness:   No, I have nothing on that.

The Court: Okay. Have you asked Mr. Petar whether he
has anything of that sort?
                               - 11 -


     The Witness:   I have not, no.


     The notice of deficiency was issued before petitioner

advised respondent of the existence of the Note.   The parties

agree that if the Note was in fact issued to Mr. Petar before the

close of FYE 5/31/90, then respondent’s disallowance of the bonus

deduction for FYE 5/31/90 was erroneous.   Petitioner bears the

burden of proof.    Rule 142(a).

     Petitioner relies on the aforementioned testimony of

Mr. Petar and his family and petitioner’s accountant.   There is

no evidence in the record that directly contradicts their

account.   Although this Court will not discount uncontradicted

     testimony on behalf of the taxpayer merely because it is

self-serving, the testimony will not satisfy the taxpayer’s

burden if it is improbable, unreasonable, or questionable.    Cf.

Loesch & Green Constr. Co. v. Commissioner, 211 F.2d 210, 212

(6th Cir. 1954), revg. and remanding a Memorandum Opinion of this

Court dated Dec. 11, 1952, with Conti v. Commissioner, 39 F.3d

658, 664 (6th Cir. 1994), affg. and remanding 99 T.C. 370 (1992);

Lerch v. Commissioner, 877 F.2d 624, 631 (7th Cir. 1989), affg.

T.C. Memo. 1987-295; Commissioner v. Smith, 285 F.2d 91, 96 (5th

Cir. 1960), affg. Griffin v. Commissioner, T.C. Memo. 1958-210.

We find the witnesses’ account of the Note to be unpersuasive for

several reasons.
                               - 12 -


     First, the witnesses failed to provide a reasonably complete

and coherent explanation of the purpose that the Note was

designed to serve.   Mr. Petar, the person who by all accounts was

in the best position to explain, recalled only after prompting

from his accountant that the Note was prepared because “we needed

some performance bonds”.    He made no attempt to clarify the

connection between the Note and the bonds or who it was that

needed them.   Nor was Mr. Cunniff able to shed much additional

light on these matters.    After explaining that Mr. Petar needed a

promissory note to substantiate a personal financial statement

and that a financial statement was needed to secure performance

bonds, he proved utterly confused as to the reasons why Mr. Petar

needed performance bonds.

     Second, petitioner’s failure to offer in evidence any

documentation corroborating the witnesses’ explanation of the

Note raises doubts about its authenticity.    Mr. Cunniff’s

testimony that the Note was the only extant document relating to

the bonding transaction of which he was aware is implausible.

Assuming that the Note was in fact prepared during FYE 5/31/90,

it would not have been retained after 1990 as evidence of

petitioner’s indebtedness, because the debt was paid on

August 14, 1990.   Nor would it have been retained for tax

purposes, if credit is given to the testimony that neither

Mr. Petar nor Mr. Cunniff realized the Note’s significance for

tax purposes until some time during or after the audit, years
                              - 13 -


later.   In all likelihood, the Note would only have been retained

as a record of the bonding transaction.   Yet, if the Note had

been retained as such, it is only reasonable to suppose that

other more important records of that transaction would also have

been retained, and it seems unlikely that these other records

would have been overlooked when the Note was discovered in

preparation for this litigation.   We find further reason for

skepticism in Mr. Cunniff’s testimony that he did not consult Mr.

Petar regarding the existence of other documents relating to the

bonding transaction.   Assuming that the Note was in fact prepared

to satisfy bonding requirements, any such documents would

obviously have been useful to refresh their recollection of the

bonding transaction and surely they would have discussed any such

documents in preparation for trial.

     Third, the witnesses’ account of the Note is difficult to

reconcile with their conduct during the audit.   If the Note is

genuine, then the only explanation for the failure of Messrs.

Cunniff and Mr. Petar to call its existence to the attention of

the revenue agent during the audit is, as Mr. Cunniff testified,

that they did not at that time realize the significance of the

Note in relation to the deductibility of the bonus.   Although the

reading material they received from the revenue agent should have

alerted them to the Note’s significance, it is conceivable that

they did not read it carefully.    However, if they did not become

aware of the significance of the Note for tax purposes until
                              - 14 -


after the audit, then, based on the governing law and the

relevant facts as Mr. Cunniff and Mr. Petar understood them after

the initial meeting with the revenue agent, they would have had

no grounds for defending petitioner’s return position in good

faith.   They conceded all other proposed adjustments.   No reason

appears why they contested the proposed disallowance of the bonus

deduction.

     The behavior of Mr. Cunniff and Mr. Petar during the audit

would make more sense if the Note was prepared only after they

learned from the revenue agent that issuance of a promissory note

during the taxable year in issue would have legitimized the

deduction.   For tactical reasons they might well have chosen not

to reveal the Note’s existence until after the audit concluded

and a notice of deficiency was issued, in order to avoid a

thorough investigation of the Note’s authenticity.    In this

connection, the unexplained failure of petitioner’s

representatives to comply with Revenue Agent Mockus’ request for

petitioner’s corporate minute book is significant.    Mr. Mockus

testified that, in his experience, when a corporation issues a

note to a shareholder, generally the transaction is recorded in

the corporate minute book.   Absent any explanation or evidence to

the contrary, we cannot rule out the possibility that the minute

book was deliberately withheld in order to conceal the fact that

no promissory note had been issued during FYE 5/31/90.
                             - 15 -


     For the aforesaid reasons, the evidence does not persuade us

that petitioner paid the accrued bonus by means of a promissory

note before the close of the taxable year in issue.     Petitioner

has not satisfied its burden of proof.   We therefore sustain

respondent’s disallowance of the deduction.

     To reflect the foregoing,


                                          Decision will be entered

                                      for respondent.
