                        T.C. Memo. 2004-257



                      UNITED STATES TAX COURT



      MAURICE E. JOHN, JR. AND JAN E. JOHN, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 10604-02.             Filed November 9, 2004.



     R. Thomas Blackburn, Jr., for petitioners.

     Mark D. Eblen, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     KROUPA, Judge:   Respondent determined a deficiency of

$179,403 in petitioners’ Federal income taxes for 1995.   The

issue to be decided is whether petitioners are entitled to deduct
                                 - 2 -

$491,054 as a business bad debt deduction under section 1661 in

1995.    We hold they are not.

                           FINDINGS OF FACT

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

The stipulation of facts and the accompanying exhibits are

incorporated by this reference.    Petitioners resided in

Louisville, Kentucky, at the time they filed the petition.

Petitioner

     Maurice E. John, Jr. (petitioner), is an eye surgeon and

ophthalmologist who has continuously engaged in the practice of

medicine since 1975.    Since 1981, petitioner has provided medical

services as a full-time employee of John Eye Clinic, Inc. (the

Clinic), a professional corporation incorporated in

Jeffersonville, Indiana.    Petitioner was, at nearly all times,

the 100-percent shareholder of the Clinic.

Evans

     Petitioner hired John Evans (Evans) in 1987 to serve as the

Clinic’s business manager.    Petitioner chose Evans from a pool of

candidates because “he was by far the most impressive and best

candidate.”    Throughout their acquaintance, petitioner was highly

impressed with Evans’ performance and abilities, describing him

as “incredibly bright” and one of the “smartest people [he had]

ever met”.    Petitioner felt that Evans “was an asset to the


     1
      All section references are to the Internal Revenue Code in
effect for the year at issue, unless otherwise indicated, and all
Rule references are to the Tax Court Rules of Practice and
Procedure.
                               - 3 -

practice” and paid for Evans to get an M.B.A. degree from

Vanderbilt University while he worked at the Clinic.   Petitioner

justified the M.B.A. expense by stating that he hoped it would

“tie [Evans] to [the Clinic] a little bit more”.   Petitioner also

gave Evans a 740 BMW car as a gift.    While Evans was manager, the

Clinic became significantly more successful and profitable.

The Companies

     Petitioner explained that sometime during 1991 he and Evans

became concerned that the ongoing reduction in Medicare

reimbursements, which had constituted over 70 percent of the

Clinic’s income, would decrease the Clinic’s revenues.    They

began exploring possible alternative sources of income.

     Given the Clinic’s success, which was at least partly due to

the management strategies used, petitioner testified that he and

Evans saw potential in offering management services to other

clinics.   The management company would offer professional

training, accounting, personnel management, marketing, insurance-

related filings, and other business services.   By offering

expertise in management and creating economies of scale, the

management company would improve the efficiency of the practices

and would charge a fee for the management.   Thus, petitioner and

Evans incorporated J.E. Stallion, Inc. (the Management Company),

in 1992.

     In addition to the economic potential in leveraging their

experience in managing medical clinics, petitioner also explained

that he and Evans saw economic opportunities in the Russian
                                - 4 -

market, which was, at that point, just opening to foreign

investment after the collapse of the Soviet bloc.    Accordingly,

petitioner and Evans formed J.E. Stallion-Russia, Inc. (Russia).

Russia became involved in selling contact lenses, operating

sausage factories, and exporting timber from Russia to Japan.

     As a third venture, petitioner and Evans incorporated J.E.

Stallion International Gallery, Inc. (Gallery) to operate an art

gallery and to purchase, sell, and exhibit works of art on a

national and international basis.    Gallery was also established

to enter into domestic and foreign ventures to carry out these

activities.

     When the Management Company, Gallery, and Russia

(collectively the companies) were formed, petitioner offered

Evans a 50-percent ownership interest in each because he “had an

incredible amount of faith in [Evans] and [was] incredibly

impressed” with him.    Thus, petitioner and Evans each became a

50-percent shareholder in the companies, and Evans became the

president of all three.

The Advances

     Although Evans became a 50-percent shareholder in each of

the companies, he did not have the financial resources to make

any capital contributions to the companies in their years of

operation.    Thus, petitioner provided the necessary capital and

Evans managed and developed the businesses.    From time to time

between 1992 and 1995, petitioner advanced funds to the

companies.    The total amount he contributed during these years
                                - 5 -

approximated $2.5 million.    Evans, on the other hand, made no

capital contributions to the companies.

     Petitioner did not know how much Evans owed him, but

testified that he expected to be repaid for the advances he made

for Evans’ 50-percent equity ownerships in each of the companies

when the companies became profitable.      Petitioner also testified

that he fully expected Evans to “work his tail off” at the Clinic

to repay him even if the companies failed.      No promissory note

exists for the advances.    Evans made no principal payments to

petitioner on the alleged loans, but petitioners did report

interest income from Evans of $37,000 and $25,000 on their 1995

tax return.

Demise of the Companies

     Petitioner decided to scale back operations in light of the

international financial environment and because the companies had

never become profitable.    Sometime in 1995, petitioner instructed

Evans to stop making certain investments and, in particular, to

stop making investments in Russia.      Evans defied petitioner’s

instruction and continued to invest in Russia.      Petitioner fired

Evans in 1995.

Settlement Agreement
     Petitioner and the Clinic filed a complaint against Evans in

the Jefferson Circuit Court in Louisville, Kentucky, on January

10, 1996 (the Lawsuit).    Petitioner and the Clinic sought

repayment of $1,354,387 that petitioner claimed was used to make

capital contributions to the companies on Evans’ behalf.      The
                                 - 6 -

complaint also alleged that Evans fraudulently and without

authority appropriated $30,000 belonging to the Management

Company and requested both punitive and compensatory damages.

The parties settled the Lawsuit.    As part of the settlement,

Evans agreed, in exchange for dismissing the Lawsuit, to pay

petitioner $50,000 and to enter into a covenant not to compete

(noncompete agreement).   Evans agreed not to engage in any

business activity competing directly with the Clinic within 150

miles of Jefferson County, Kentucky, for 5 years.    Petitioner

would pay Evans $40,000 each year during the 5-year noncompete

period, and Evans would assign his interest in these payments to

the Clinic.   The settlement further provided that Evans would

resign as an officer of the companies and would agree to have all

his shares in the companies redeemed.    Evans’ shares in the

companies were redeemed on April 5, 1996.

Deduction

     Petitioners deducted $491,0542 as a business bad debt on

their joint Federal income tax return for 1995.    Respondent

issued to petitioners a notice of deficiency on March 26, 2002,

for 1995 (the Notice), in which respondent determined to increase

petitioners’ income for 1995 by the amount petitioners claimed as

a business bad debt deduction.    The Notice stated that

petitioners had established neither the amount of the debt nor

that it was a business bad debt.    Petitioners timely filed a


     2
      This amount relates to advances petitioner claims to have
made to the Management Company on behalf of Evans.
                               - 7 -

petition with this Court contesting the disallowance of the

$491,054 they claimed as a business bad debt.

                              OPINION

     Respondent’s determination in the Notice is presumed

correct, and petitioners bear the burden of proving it is

incorrect.3   Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115
(1933).

     A taxpayer may deduct a debt that becomes wholly worthless

during the taxable year.4   Sec. 166(a)(1).   Deductions are a

matter of legislative grace, and the taxpayer has the burden of

proving that he or she is entitled to any claimed deductions.

INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992).     Thus,

petitioners have the burden of proving that the $491,054 debt

petitioner asserts Evans owed him became wholly worthless in

1995, the year in which they claimed it as a deduction.5     See

Rule 142(a); Putnam v. Commissioner, 352 U.S. 82, 85 (1956);

Intergraph Corp. & Subs. v. Commissioner, 106 T.C. 312 (1996),

affd. without published opinion 121 F.3d 723 (11th Cir. 1997);

Crown v. Commissioner, 77 T.C. 582, 598 (1981).

     3
      Sec. 7491(a) shifts the burden of proof under certain
circumstances to respondent and applies to examinations commenced
after July 22, 1998. Because the examination in this case
commenced on Jan. 6, 1998, sec. 7491(a) does not apply.
     4
      The debt must also be a bona fide debt in order to be
deductible; that is, a debt that arises from a debtor-creditor
relationship, on the basis of a legally valid and enforceable
obligation to pay a fixed sum of money. Sec. 1.166-1(c), Income
Tax Regs.
     5
      Petitioners made no claim for partial worthlessness.    Sec.
166(a)(2).
                                - 8 -

     There is no standard test or formula for determining

worthlessness, and the determination depends upon the particular

facts and circumstances of the case.      Lucas v. American Code Co.,

280 U.S. 445, 449 (1930); Crown v. Commissioner, supra.      A

taxpayer must usually show identifiable events to prove

worthlessness in the year claimed.      United States v. S.S. White

Dental Manufacturing Co., 274 U.S. 398 (1927); Crown v.

Commissioner, supra; Dallmeyer v. Commissioner, 14 T.C. 1282,

1291-1292 (1950).   Debts are wholly worthless when the taxpayer

had no reasonable expectation of repayment.      Crown v.

Commissioner, supra.

     After carefully considering all the facts, we conclude

petitioners have failed to prove that the $491,054 debt

petitioner claimed became wholly worthless in 1995.     We therefore

sustain respondent’s determination.

Whether Job Termination Can Render a Debt Worthless

     Petitioner argues that firing Evans was the “identifiable

event” that rendered the loan worthless in 1995.      We disagree.

Once Evans was fired from the Clinic, he found similar employment

at another medical clinic.    There is nothing in the record to

show that repayment was conditioned upon Evans’ continued

employment with the Clinic.   In addition, petitioner has not

pointed us to, nor have we found, any case in which terminating a

debtor’s employment alone renders a debt worthless.

     In fact, there is a case that indicates just the opposite.

An insurance company was denied bad debt deductions for unpaid
                                - 9 -

portions of loans it had made to employees where the deductions

were taken because the employees had left the company.6

Southwestern Life Ins. v. United States, 560 F.2d 627, 644 (5th

Cir. 1977).    Similarly, we find Evans’ job termination alone

insufficient to render petitioner’s debt wholly worthless.

Whether the Loan Had Future Value

     Petitioner also argues that the loan was worthless, as a

general matter, because Evans was insolvent.    Petitioner

testified that Evans had no significant assets during the entire

8-year period he was employed by the Clinic and, consequently,

his chance of collecting his debt from Evans in the future was

“incredibly remote”.    We disagree.

     First, we note that insolvency alone does not render a debt

worthless.    See Roth Steel Tube Co. v. Commissioner, 620 F.2d

1176, 1182 (6th Cir. 1980) (insolvency is merely an indicium of

uncollectibility), affg. 68 T.C. 213 (1977); see also Buchanan v.

United States, 87 F.3d 197, 200 (7th Cir. 1996) (a debt is not

worthless merely because the debtor is insolvent); Roussel v.

Commissioner, 37 T.C. 235, 245 (1961) (insolvency alone does not,

of itself, demonstrate worthlessness of a debt).

     Second, as respondent correctly points out, if Evans’

alleged longstanding insolvency rendered the loan worthless, then

the loan was worthless before 1995.     A loan must have value,


     6
      As part of its holding, the court also found that the
insurance company should have made some attempt to enforce
collection. Southwestern Life Ins. v. United States, 560 F.2d
627, 644 (5th Cir. 1977).
                                - 10 -

however, at the beginning of the year in which the taxpayer takes

the deduction and lose its value by the end of that year.    Sec.

166(a)(1); see also Dustin v. Commissioner, 53 T.C. 491, 501

(1969), affd. 467 F.2d 47 (9th Cir. 1972).     Therefore, even

assuming arguendo that the debt was worthless because of Evans’

insolvency, the insolvency was not related to any identifiable

event in 1995.    Additionally, petitioner’s argument that Evans’

insolvency rendered the loan uncollectible contradicts his

testimony that he expected Evans to “work his tail off” at the

Clinic to repay the loan, presumably from his salary, if the

companies failed.

     Third, to qualify as worthless, not only must a debt be

uncollectible at the time the taxpayer takes the deduction, but

the taxpayer has the burden to show it also lacks future value.

Dustin v. Commissioner, supra; Peraino v. Commissioner, T.C.

Memo. 1982-524, affd. without published opinion 742 F.2d 1437 (2d

Cir. 1983).     Evans’ age, educational status, income, and earning

potential are all relevant considerations in determining whether

the loan had future value.     See Cole v. Commissioner, 871 F.2d

64, 67 (7th Cir. 1989), affg. T.C. Memo. 1987-228; Dustin v.
Commissioner, supra.    Evans was in his forties in 1995 when the

deduction was taken, he had an M.B.A. from Vanderbilt University,

and he quickly found similar employment after leaving the Clinic.

These criteria lead us to conclude the loan had at least some

future value.    Petitioner has not shown otherwise.
                              - 11 -

     On the contrary, the record demonstrates that petitioner

fully appreciated Evans’ marketability and earning potential in

the medical profession.   Petitioner testified that Evans was “way

over-qualified for running [the] Clinic”, and petitioner

increased Evans’ salary from $60,000 per year in 1987 to $100,000

in 1995, the year petitioner fired Evans.   Petitioner also

testified that, precisely because of Evans’ professional

marketability, he sued Evans for the noncompete agreement.

Petitioner stated that he sought the noncompete agreement from

Evans because Evans was an “ophthalmic management guru” and

because several medical practices in the area would have hired

Evans “immediately” had they known he was available.   We

therefore find some dissonance in petitioner’s arguing, in one

instance, that it would be nearly impossible to collect the debt,

while in another arguing that Evans had highly marketable

managerial skills for which petitioner wanted the noncompete

agreement.

     Overall, the record demonstrates that petitioner could have

recovered at least some portion of the uncollected amount lent to

Evans.   See Buchanan v. United States, supra at 198-199

(criterion for worthlessness is interpreted strictly, and the

deduction is unavailable if even a modest fraction of the debt

can be recovered); Bodzy v. Commissioner, 321 F.2d 331, 335 (5th

Cir. 1963) (“last vestige of value” must have “disappeared”),

affg. in part and revg. in part T.C. Memo. 1962-40; Clanton v.

Commissioner, T.C. Memo. 1995-416 (partial worthlessness is
                                - 12 -

insufficient).     We therefore find that petitioners have failed to

meet their burden of proving the loan became wholly worthless in

1995.

Failure To Take Reasonable Steps To Collect

        Next we address whether petitioner took reasonable steps to

enforce repayment of the debt.     In the absence of reasonable

steps to enforce its collection, a debt generally is not regarded

as wholly worthless unless there is proof that steps to collect

it would be futile.     Perry v. Commissioner, 22 T.C. 968, 974

(1954); see also Newman v. Commissioner, T.C. Memo. 1982-61

(taxpayer must have exhausted all usual and reasonable means of

collecting a debt before worthlessness can be found).

        There is no evidence that petitioner took any affirmative

steps, other than the Lawsuit, to enforce collection of amounts

owed him by Evans.     For instance, petitioner testified that he

would have made a “sweetheart deal” for Evans to repay the loans

over 20 or 30 years, or “whatever time it took”.     Yet the record

is devoid of evidence that petitioner ever made Evans that offer.

        The only obvious step petitioner took was the Lawsuit.    By

petitioner’s own admission, however, he commenced the Lawsuit

primarily to subject Evans to the noncompete agreement, not to

enforce collection of the debt.     Moreover, petitioner instituted

the Lawsuit in 1996, not 1995, the year in which petitioner took

the bad debt deduction.     A bad debt is deductible only in the

year it becomes worthless and, hence, petitioner’s suit in 1996

does not render the debt worthless in 1995.     Denver & Rio Grande
                               - 13 -

W. R.R. v. Commissioner, 32 T.C. 43, 56 (1959), affd. 279 F.2d

368 (10th Cir. 1960).

     While a taxpayer need not be an “incorrigible optimist”, a

taxpayer may not substantiate the worthlessness of a debt based

on his or her own pessimism.   Petitioner must provide sufficient

evidence to meet his burden to show that the debt was worthless

and not merely surmise that collection would be futile.      See

United States v. S.S. White Dental Manufacturing Co., 274 U.S.

398 (1927); Fox v. Commissioner, 50 T.C. 813 (1968) (a taxpayer’s

subjective, good faith opinion that the debt is uncollectible,

standing alone, is not sufficient to render it worthless), affd.

per curiam 25 AFTR 2d 70-891, 70-1 USTC par. 9373 (9th Cir.

1970).   Evans’ future earning potential was indicative of his

ability to repay at least a portion of the debt.   Nor can

petitioner rely on his good nature in not wanting to destroy

Evans financially to prove that the debt was worthless.      We find,

therefore, that petitioner has not shown that steps to enforce

collection in 1995 would have been futile.   See Perry v.

Commissioner, supra at 974; Newman v. Commissioner, supra.

Conclusion
     We hold that the debt did not become “wholly worthless”

within the meaning of section 166(a)(1) in 1995.   Consequently,

petitioners are not entitled to a bad debt deduction, and we

sustain respondent’s disallowance of the claimed bad debt

deduction.   In view of our holding that petitioners failed to

prove worthlessness in 1995, we need not discuss whether the debt
                                - 14 -

was a business or nonbusiness debt, or whether it was a bona fide

debt.     See Roussel v. Commissioner, 37 T.C. at 245.

        In reaching our holding, we have considered all arguments

made, and, to the extent not mentioned, we conclude that they are

moot, irrelevant, or without merit.

        To reflect the foregoing,



                                           Decision will be entered

                                      for respondent.
