Provost v. Commissioner

T.C. Memo. 2000-177

UNITED STATES TAX COURT

EDWARD L. PROVOST AND VICKY L. PROVOST, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 3936-97. Filed May 26, 2000.

Terrence J. Moore, for petitioners.

Lisa N. Primavera, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

MARVEL, Judge: Respondent determined a deficiency in

petitioners' 1993 Federal income tax of $68,083 and an accuracy-

related penalty of $13,617 under section 6662(a).1

1
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. Monetary amounts are
rounded to the nearest dollar.
 - 2 -

The issues for decision are: (1) Whether petitioners’

advance of $200,000 to Richard Magness is deductible as a

business bad debt under section 166 and (2) whether petitioners

are liable for an accuracy-related penalty under section 6662(a).

We hold that the advance is not deductible as a business bad debt

and that petitioners are liable for the accuracy-related penalty.

FINDINGS OF FACT

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

The stipulation of facts is incorporated herein by this

reference.

Petitioners are married and resided in Dana Point,

California, at the time the petition was filed. Unless otherwise

indicated, “petitioner” refers to Edward L. Provost.

Petitioner is a business consultant who, during 1993, also

held a real estate license. Prior to 1987, petitioner worked as

an executive in a transportation company called Industrial

Freight System (IFS).2 His employment at IFS ended in or about

1987, at which point he became a consultant to IFS. Petitioner

was not in the business of lending money in 1993.

Although petitioner received income from other sources, the

majority of his income from 1988 through 1991 was received from

consulting services. These services were performed almost

2
At one time, petitioner owned a 40-percent interest in the
corporation.
 - 3 -

exclusively for IFS. In 1992, petitioner reported income of

$20,000 from his consulting activities, and from 1993 through

1995, he reported no income from consulting activities.

In or about 1977, petitioner became acquainted with Richard

Magness, a licensed framing contractor. Petitioner hired Mr.

Magness to perform framing work on two spec houses3 petitioner

was building, one in Sherman Oaks and one in Los Angeles.

Petitioner also hired Mr. Magness to perform framing work for the

construction of petitioners’ own residence.

In 1991, Mr. Magness requested a $200,000 advance from

petitioner to be used to construct two spec houses on lots Mr.

Magness purchased in 1987-–one at 6016 Corbin Avenue and one at

6020 Corbin Avenue (hereinafter collectively referred to as the

Corbin project or Corbin properties). Mr. Magness already had

borrowed substantial funds from commercial lenders for the

purchase of the lots and construction of the residences and had

given those lenders first and second deeds of trust on the Corbin

properties. Mr. Magness knew petitioner possessed a real estate

license and had built and sold spec houses for a profit in the

past. Mr. Magness had never built a spec house of his own.

Petitioner estimated that, upon completion, the Corbin properties

3
A spec house is a house constructed by a builder to the
builder's specifications with the intention of selling it at a
profit upon completion. Since l977 petitioner has built at least
six spec houses, each of which was sold at a profit. Mr. Magness
worked as a framer on at least four of petitioner’s spec houses.
 - 4 -

would be listed for approximately $800,000 each, yielding a

profit of approximately $150,000 to $200,000.

Petitioner and Mr. Magness entered into an oral agreement in

which (1) petitioner agreed to advance Mr. Magness $200,000 in

$25,000 increments while the project was being completed,4 (2)

Mr. Magness agreed to hire petitioner as a consultant during the

construction of the Corbin project for a one-time consulting fee

of $40,000, due and payable when the Corbin properties sold, and

(3) Mr. Magness agreed to repay the $200,000 advance, plus

interest, when the project was completed and sold. At the time

petitioner advanced the money, both petitioner and Mr. Magness

understood that Mr. Magness would not be able to pay petitioner

any of the money required under the oral agreement unless the

Corbin properties sold.

On or about June 1, 1991, petitioner hired Mr. Magness to

supervise the framing and foundation of three spec houses

petitioner was building. This arrangement was not connected in

any way to petitioner's $200,000 advance. Mr. Magness was not

required to provide contracting services to petitioner as a

condition of receiving the advance, nor was he asked to provide

petitioner with any bills for his services. Petitioner paid Mr.

4
Petitioner made the $200,000 advance to Mr. Magness with
checks drawn from petitioners' personal checking account totaling
$100,000 and checks drawn from the account of P&S Leasing, Inc.
totaling $100,000. P&S Leasing, Inc. is an S corporation owned
and operated by petitioner.
 - 5 -

Magness at the rate of $25 per hour for his contracting services

upon completion of the work.

In August 1991, petitioner's attorney drafted a document

entitled "Contract for Services and Consulting Agreement"

(Contract). The Contract, made effective as of June 1, 1991,

purportedly memorialized part of the oral agreement between

petitioner and Mr. Magness. Neither petitioner nor Mr. Magness

read the Contract before signing it.

The Contract contained two main sections: (1) Contract for

Services and (2) Consulting Agreement. The Contract for Services

required Mr. Magness to perform contracting services at a rate of

$25 per hour on petitioners' family residence in Dana Point,

California, and to submit weekly bills for services performed.

The bills were payable on June 1, 1992. The Consulting Agreement

provided that petitioner would serve as a "Consultant and as an

Advisor" to Mr. Magness for a yearly salary of $40,000 due on

June 1, 1992.

Offset provisions in the Contract required that any money

payable under either section of the Contract would be offset by

money due under the other section. The Contract also contained

an automatic termination clause upon the occurrence of a

bankruptcy or insolvency of either party. This clause was

applicable to the Contract in its entirety.
 - 6 -

The Contract did not contain a reference to the Corbin

properties or to the $200,000 advance. There were, however, two

handwritten notations at the bottom of the Contract: (1) "Richard

& Carl Magness shall be responsible for framing and foundation

and supervision as per Ed Provost and Richard Magness agreement",

and (2) "If Ed Provost does not have the money to fund this

agreement there will no liability on his part."

Mr. Magness and petitioner also executed a "Secured

Promissory Note", dated June 1, 1991, wherein petitioner promised

to lend Mr. Magness $200,000 in eight equal installments of

$25,000. In return, Mr. Magness promised to repay petitioner the

principal sum of $200,000, plus interest at a rate of 10.5

percent per annum. The principal and interest were due on June

1, 1992. The note was secured by deeds of trusts on the Corbin

properties.5

Mr. Magness was unable to sell the Corbin properties. On

May 10, 1993, Mr. Magness and his wife filed Chapter 7

bankruptcy. They received their bankruptcy discharge on

September 14, 1993. Although petitioner filed a proof of claim

in the Magness bankruptcy, he did not receive any distribution

from the bankruptcy estate.

5
Although the promissory note referred to second deeds of
trust, petitioner received a second deed of trust on one of the
Corbin properties and a third deed of trust on the other.
 - 7 -

In 1993, the first mortgage lenders foreclosed on the Corbin

properties. Petitioners did not receive any distribution as a

result of the foreclosure.

Petitioner did not commence a lawsuit against Mr. Magness to

collect the money. Petitioner’s attorney advised him not to

attempt to collect the money from Mr. Magness because it would be

useless to do so. Mr. Magness never repaid any of the funds

advanced by petitioner.

On their Federal income tax return for 1993, petitioners

claimed the purported loan was worthless and deducted $200,000

from their taxable income as a business bad debt under section

166. Respondent disallowed the deduction.

OPINION

Section 166 authorizes a deduction for a business bad debt

that becomes worthless during the year. To be entitled to the

deduction, an individual taxpayer must prove (1) the existence of

a bona fide debt that obligated the debtor to pay the taxpayer a

fixed or determinable sum of money and (2) that the bad debt was

created or acquired in "proximate” relation to the taxpayer's

trade or business. United States v. Generes, 405 U.S. 93, 96

(1972); Calumet Indus., Inc. v. Commissioner, 95 T.C. 257, 284

(1990).

The Court of Appeals for the Ninth Circuit, to which this

case is appealable, has identified 11 factors to be considered
 - 8 -

when resolving whether an advance is bona fide debt or a

contribution to capital: (1) Names given to the certificates

evidencing indebtedness; (2) presence or absence of a fixed

maturity date; (3) source of payments; (4) right to enforce the

payment of principal and interest; (5) participation and

management; (6) a status equal to or inferior to that of regular

creditors; (7) intent of the parties; (8) "thin" or adequate

capitalization; (9) identity of interest between creditor and

stockholder; (10) payment of interest only out of profits; and

(11) ability to obtain loans from outside lending institutions.

See Hardman v. United States, 827 F.2d 1409, 1411-1412 (9th Cir.

1987); Bauer v. Commissioner, 748 F.2d 1365, 1368 (9th Cir.

1984), revg. T.C. Memo. 1983-120; A.R. Lantz Co. v. United

States, 424 F.2d 1330, 1333 (9th Cir. 1970); Anchor Natl. Life v.

Commissioner, 93 T.C. 382, 400 (1989). Whether an advance

constitutes debt or equity depends on the facts and circumstances

of each case. See Calumet Indus., Inc. v. Commissioner, supra at

285. No single factor is determinative. See id. "The various

factors * * * are only aids in answering the ultimate question

whether the investment, analyzed in terms of its economic

reality, constitutes risk capital entirely subject to the

fortunes of the corporate venture or represents a strict debtor-

creditor relationship." Fin Hay Realty Co. v. United States, 398
 - 9 -

F.2d 694, 697 (3d Cir. 1968). Our analysis of the factors is set

forth below.

1. Certificates Evidencing Indebtedness

The outward form of the transaction is not controlling. See

Bauer v. Commissioner, supra at 1367-1368. The Court of Appeals

for the Ninth Circuit has stated:

Although the inquiry of a court in resolving the
debt-equity issue is primarily directed at ascertaining
the intent of the parties * * * a distinction must be
made between objective and subjective expressions of
intent. An objective expression of intent, as
contained in the documentation of an advance of money,
is generally not to be afforded special weight. It
alone cannot be controlling of the debt-equity issue.
* * * [A.R. Lantz Co. v. United States, supra at
1333.]

Where the form of the advance does not correspond to the

intrinsic economic nature of the transaction, labels are not an

accurate expression of the subjective intention of parties to a

transaction and lose their meaning. See Fin Hay Realty Co. v.

United States, supra at 697 (advances were contributions to

capital where "all the formal indicia of an obligation were

meticulously made to appear" and shareholders had "power to

create whatever appearance would be of tax benefit to them

despite the economic reality of the transaction").

In this case, there were several discrepancies between the

terms of the documents and the oral agreement between petitioner

and Mr. Magness. For example, according to the Contract, the

$40,000 yearly salary for consulting was due and payable on
 - 10 -

June 1, 1992. The oral agreement between petitioner and Mr.

Magness, however, required a one-time $40,000 consulting fee to

be paid only when the Corbin project sold. Another example can

be found in petitioner’s testimony that, contrary to the terms of

the Contract, neither he nor Mr. Magness intended for an offset

provision to be included in the Contract.

Both petitioner and Mr. Magness testified that the Contract

and the promissory note, purportedly evidencing their agreement,

did not accurately reflect the agreed-upon terms. In fact, on

brief petitioner points out that “The fact that the parties did

not adhere to the terms of the documents is irrelevant, as the

documents, which were not read by the parties prior to signature,

never reflected the true intent of the parties.” Thus, we give

the documents little weight and determine the outcome of this

case based on the facts and circumstances surrounding the

transaction. See Calumet Indus., Inc. v. Commissioner, supra at

288.

2. Presence or Absence of a Fixed Maturity Date

“The presence of a fixed maturity date indicates a fixed

obligation to repay, a characteristic of a debt obligation. The

absence of the same on the other hand would indicate that

repayment was in some way tied to the fortunes of the business,

indicative of an equity advance.” Estate of Mixon v. United

States, 464 F.2d 394, 404 (5th Cir. 1972); see also sec.
 - 11 -

385(b)(1); American Offshore, Inc. v. Commissioner, 97 T.C. 579,

602 (1991). Evidence that a creditor did not intend to enforce

payment of the note or was indifferent as to the exact time the

note was to be repaid belies an arm's-length debtor-creditor

relationship. See generally Gooding Amusement Co. v.

Commissioner, 23 T.C. 408, 418-421 (1954), affd. 236 F.2d 159

(6th Cir. 1956).

In the instant case, whether or not petitioner would be

repaid was contingent upon the sale of the Corbin properties.

Although the terms of the promissory note stated that the

$200,000 principal and interest would be due and payable on June

1, 1992, both petitioner and Mr. Magness testified that the note

did not properly reflect the terms of their agreement. Under

their oral agreement, repayment of the advance was due when the

Corbin properties sold, and, in fact, neither Mr. Magness nor

petitioner anticipated the advance would be repaid on June 1,

1992. Petitioner testified: “June 1st, ‘92 the project wasn’t

done, but it was our understanding that he wasn’t going to pay-–

he had no way of paying if the project didn’t sell, and we both

understood that.” In reality, no fixed maturity date existed,

and repayment was directly linked to the success of the Corbin

project. This factor favors respondent’s position.
 - 12 -

3. Source of Payments

If the source of the debtor's repayment is dependent upon

earnings or is from a restricted source, such as a judgment

recovery, dividends, or profits, an equity investment is

indicated. See Estate of Mixon v. United States, supra at 407;

Calumet Indus., Inc. v. Commissioner, 95 T.C. at 287; Dixie

Dairies Corp. v. Commissioner, 74 T.C. 476, 495 (1980); Irbco

Corp. v. Commissioner, T.C. Memo. 1966-67. In such a case, “the

‘lender’ acts ‘as a classic capital investor hoping to make a

profit, not as a creditor expecting to be repaid regardless of

the company’s success or failure.’" Calumet Indus., Inc. v.

Commissioner, supra at 287-288 (quoting In re Larson, 862 F.2d

112, 117 (7th Cir. 1988)). When circumstances make it impossible

to estimate when an advance will be repaid because repayment is

contingent upon future profits or repayment is subject to a

condition precedent, or where a condition may terminate or

suspend the obligation to repay, an equity investment is

indicated. See Affiliated Research, Inc. v. United States, 173

Ct. Cl. 338, 351 F.2d 646, 648 (1965); Irbco Corp. v.

Commissioner, supra.

In this case, repayment of the $200,000 advance and payment

of the consulting fee were contingent upon the fortunes of the

Corbin project. See Estate of Mixon v. United States, supra at

405; Segel v. Commissioner, 89 T.C. 816, 830 (1987). At the time
 - 13 -

petitioner made the advance, both petitioner and Mr. Magness

understood that Mr. Magness had no way of repaying the money

unless the Corbin properties sold. Further, they agreed the

payments would be made from the sales proceeds of the Corbin

properties.

Petitioner contends that his agreement with Mr. Magness did

not "turn the loan into an investment" because he "was to be paid

when the project sold, not if it sold". Petitioner also stresses

that Mr. Magness’ failure to sell the Corbin properties was due

to California’s failing economy and real estate market. Although

we agree with petitioner that it is difficult to predict how the

real estate market will behave in the future, a reasonably

prudent person can foresee that the project may not be

successful, and the properties may not sell. Petitioner claims

he has sold spec houses in the past for a profit; thus,

petitioner either knew or should have known of the risks involved

in the Corbin project when he advanced Mr. Magness the money.

Petitioner knew at the time he made the advance to Mr. Magness

that repayment was impossible unless the Corbin project sold.

Under the circumstances, petitioner acted more like a "classic

capital investor" than a true creditor. Calumet Indus., Inc. v.

Commissioner, supra at 288. This factor favors respondent’s

position.
 - 14 -

4. Right To Enforce the Payment of Principal and Interest

In determining whether petitioner intended to enforce

repayment of the advance, an essential element is whether a good-

faith intent on the part of the recipient of the funds to make

repayment and a good-faith intent on the part of the person

advancing the funds to enforce repayment exists. See Fisher v.

Commissioner, 54 T.C. 905, 909-910 (1970). We must consider

whether, under the facts and circumstances of this case, there

was a reasonable expectation of repayment in light of the

economic realities of the situation. See Jack Daniel Distillery

v. United States, 180 Ct. Cl. 308, 379 F.2d 569, 583 (1967)

(citing Irbco Corp. v. Commissioner, supra).

We are not convinced petitioner had a good-faith intention

of enforcing repayment. The testimony clearly indicated that Mr.

Magness did not have the means to repay petitioner unless the

Corbin properties sold. Petitioner understood Mr. Magness’

financial situation and did not intend to require repayment of

the advance unless and until the Corbin properties sold. Given

petitioner’s interest in the Corbin project, we do not believe he

would have demanded repayment if it would have imperiled the
 - 15 -

financial condition or the potential success of the Corbin

project. See Dixie Dairies Corp. v. Commissioner, supra at 495;

Gooding Amusement Co. v. Commissioner, supra at 418-419.6

Petitioner’s right to demand repayment of the advance was

limited from its inception. Petitioner did not intend to demand

repayment of the $200,000 advance unless and until the Corbin

project was successful. This factor favors respondent’s

position.

5. Participation and Management

If petitioner received a right to participate in the

management of the Corbin project in consideration for the

advance, such participation tends to demonstrate that the advance

was not bona fide indebtedness but rather was an equity

investment. See American Offshore, Inc. v. Commissioner, 97 T.C.

at 603.

Prior to the Corbin project, petitioner and Mr. Magness did

not have a continuous business relationship; petitioner had

retained Mr. Magness approximately four times over the past 20

years to perform framing or construction services. As a

condition for advancing the money, petitioner insisted he be

retained as a consultant on the Corbin project because he “wanted

6
In addition, the promissory note was not protected by an
acceleration clause or sinking fund in the event of default. See
A.R. Lantz Co. v. United States, 424 F.2d 1330, 1334 (9th Cir.
1970).
 - 16 -

input into the project to make sure that they would be

successful.”

Respondent contends the $40,000 consulting fee was a

handsome profit on petitioner’s $200,000 investment, and the

agreement was indicative of a joint venture. We agree that

petitioner’s participation in the Corbin project and his

relationship with Mr. Magness more closely resembled a joint

venture than a debtor-creditor relationship. This factor favors

respondent’s position.

6. Status Equal to or Inferior to that of Regular Creditors

Whether an advance is subordinated to regular creditors

bears on whether the taxpayer was acting as a creditor or an

investor. See Estate of Mixon v. United States, 464 F.2d at 406.

In addition, “Failure to demand timely repayment effectively

subordinates the intercompany debt to the rights of other

creditors who receive payment in the interim.” American

Offshore, Inc. v. Commissioner, supra at 603 (citing Inductotherm

Indus., Inc. v. Commissioner, T.C. Memo. 1984-281, affd. without

published opinion 770 F.2d 1071 (3d Cir. 1985)).

Mr. Magness continued to pay other creditors in lieu of

petitioner after June 1, 1992, the date when petitioner was

entitled to repayment of the $200,000 advance, plus interest,

under the promissory note and to payment of the consulting fee

under the Contract. Petitioner did not demand or expect payment
 - 17 -

on June 1, 1992, because, as both petitioner and Mr. Magness

testified, payment was due only when the Corbin properties were

sold. This factor favors respondent’s position.

7. Intent of the Parties

“[T]he inquiry of a court in resolving the debt-equity issue

is primarily directed at ascertaining the intent of the parties”.

A.R. Lantz Co. v. United States, 424 F.2d at 1333 (citing Taft v.

Commissioner, 314 F.2d 620 (9th Cir. 1963)). In Taft the court

held that an advance constituted indebtedness where the parties

executed a "promissory note", the taxpayer’s right to enforce

payment of the note and the obligation to pay was positive and

unconditional, the note was not subordinated to any other

indebtedness, there was no change in proportionate equity

interest or voting power in the corporation, and repayment of the

note was not contingent upon earnings. The parties in Taft

intended the advance to be indebtedness, and the advance was

carried on the books as a long-term debt. As payments were made

over the years, the indebtedness was reduced on the books of the

corporation. The note was paid in full.

In this case, Mr. Magness never made a single payment on the

alleged debt, nor did he attempt to pay petitioner his $40,000

consulting fee. Moreover, there is no evidence that the debt was

carried as indebtedness on the books of the Corbin project;

indeed, the record contains no evidence that any such books
 - 18 -

existed. It is clear that Mr. Magness viewed his obligation to

repay petitioner as a conditional obligation dependent solely on

the success of the Corbin project. Mr. Magness was asked at

trial, “Are you going to repay Mr. Provost the $200,000 loan?”

Mr. Magness responded; “No.”

The relevant facts and circumstances support a conclusion

that petitioner and Mr. Magness did not intend to create a

debtor-creditor relationship. This factor favors respondent’s

position.

8. “Thin” or Adequate Capitalization

Thin capitalization is strong evidence of a capital

contribution where: (1) The debt-to-equity ratio was initially

high; (2) the parties realized that it would likely go higher;

and (3) substantial portions of these funds were used for the

purchase of capital assets and for meeting expenses needed to

commence operations. See American Offshore, Inc. v.

Commissioner, supra at 604 (citing United States v. Henderson,

375 F.2d 36, 40 (5th Cir. 1967)). We give this factor no weight,

however, because the parties did not argue that the evidence

directly supported or negated this factor, and the record does

not contain sufficient evidence to make our own analysis.

9. Identity of Interest Between Creditor and Stockholder

This factor generally compares the equity ownership of

stockholders with their position as creditors in order to
 - 19 -

determine whether there is an identity of interest between the

two positions. See American Offshore, Inc. v. Commissioner,

supra at 604-605. If stockholders’ advances to a corporation are

in substantially the same proportion as their equity ownership in

the corporation, it tends to demonstrate that the advances are

more in the nature of equity. See Estate of Mixon v. United

States, supra at 409. “On the other hand, a sharply

disproportionate ratio between a stockholder’s percentage

stockholdings and debt is strongly indicative” that the alleged

debt is bona fide. American Offshore, Inc. v. Commissioner, 97

T.C. at 604.

In this case, Mr. Magness undertook the Corbin project

ostensibly as a sole proprietor. When petitioner advanced the

funds to Mr. Magness, petitioner had no existing ownership

interest in the project. Although we view the involvement of

petitioner in the Corbin project as being more in the nature of a

joint venture, the identity of interest usually examined by this

factor simply does not exist in this case. Consequently, we do

not rely upon or apply this factor in making our analysis.

10. Payment of Interest Only From Profits

“This factor is essentially the same as the third factor,

‘the source of the payments.’” Hardman v. United States, 827

F.2d 1409, 1414 (9th Cir. 1987). It focuses, however, on how the

parties to the alleged debt treated interest. As we have stated,
 - 20 -

“A true lender is concerned with interest.” American Offshore,

Inc. v. Commissioner, supra at 605 (citing Estate of Mixon v.

United States, 464 F.2d at 409). The failure to insist on

interest payments indicates that the payors expect to be paid out

of future earnings or through the increased market value of their

equity interest. See American Offshore, Inc. v. Commissioner,

supra at 605 (citing Curry v. United States, 396 F.2d 630, 634

(5th Cir. 1968)).

The alleged debt in this case was to be paid, if at all,

from the proceeds generated when the Corbin project was sold.

Although petitioner claims that interest was due and would be

paid at that time, the critical fact is that Mr. Magness’

obligation to make any payment to petitioner was contingent on

the liquidation of the Corbin properties. Mr. Magness simply was

not required to pay for the ongoing use of petitioner’s money as

one would expect Mr. Magness to do if the advance were a bona

fide debt. Although the advance was dressed up to look like a

short-term debt payable in 1 year, petitioner and Mr. Magness did

not intend it to be so, nor did they treat it as such. We

conclude, therefore, that this factor favors respondent’s

position.

11. Ability To Obtain Loan From Outside Lending Institutions

"[T]he touchstone of economic reality is whether an outside

lender would have made the payments in the same form and on the
 - 21 -

same terms." Segel v. Commissioner, 89 T.C. at 828 (citing

Scriptomatic, Inc. v. United States, 555 F.2d 364, 367 (3d Cir.

1977)); see also Calumet Indus., Inc. v. Commissioner, 95 T.C. at

287. Petitioner’s advance was far more speculative than what an

outside lender would have made, further suggesting it was a loan

in name only. See Fin Hay Realty Co. v. United States, 398 F.2d

at 697; Dixie Dairies Corp. v. Commissioner, 74 T.C. at 497.

Conclusion

In Calumet Indus., Inc. v. Commissioner, supra at 287, we

found the advances were made at the risk of the business, and it

was unlikely that disinterested investors would have given a

similar "loan". There were no principal or interest payments and

no evidence that the obligations, in fact, bore interest.

Further, the taxpayer failed to prove (1) the existence of formal

debt instruments, (2) the presence of any fixed maturity dates

for repayment of the advances, or (3) the presence of any

security for the advances. We also found the advances were made

in proportion to the taxpayer’s interest in the venture, and the

company, which was experiencing financial problems, was unable to

establish its own lines of credit or to borrow funds from banks

without the guaranty of the taxpayer. Significantly, the

taxpayer expected to be repaid from the debtor’s future earnings

and profits. We held that the advances were in the nature of
 - 22 -

capital contributions and the taxpayer was a “classic capital

investor”. Id. at 288.

Like the alleged debt in Calumet Indus., the $200,000

advance was made at the risk of the Corbin project, and

petitioner expected to be repaid from the future profits

generated by the sale of the properties. Petitioner also

conceded on brief that Mr. Magness was unable to secure

additional loans from outside lenders. Although "the mere fact

that a loan could not be obtained from an unrelated source does

not preclude the existence of a bona fide loan”, Jack Daniel

Distillery v. United States, 379 F.2d at 584, evidence that Mr.

Magness could not obtain additional loans from outside lenders is

an indication petitioner's advance was an equity investment,

especially in light of the fact that repayment was conditioned

upon the success of the Corbin project. When the terms of the

advance by petitioner are considered, it is almost inconceivable

an outside lender would have advanced Mr. Magness money on

similar terms. This factor favors respondent’s position.

The evidence supports respondent’s contention that the

advance more closely resembled that of an investment in a joint

venture between petitioner and Mr. Magness. Upon consideration

of the above factors, we hold that petitioner’s advance was not a
 - 23 -

bona fide debt within the meaning of section 1667 and that

petitioner is not entitled to a bad debt deduction under section

166.

Accuracy-Related Penalty

Section 6662 authorizes the imposition of an accuracy-

related penalty equal to 20 percent of the portion of an

underpayment attributable to, among other things, negligence or

disregard of rules or regulations. See sec. 6662(a) and (b).

“Negligence” includes any failure to make a reasonable attempt to

comply with the provisions of the internal revenue laws, to

exercise ordinary and reasonable care in the preparation of a tax

return, to keep adequate books and records, or to substantiate

items properly. Sec. 6662(c); Allen v. Commissioner, 925 F.2d

348, 353 (9th Cir. 1991), affg. 92 T.C. 1 (1989); Bunney v.

Commissioner, 114 T.C. ___ (2000); sec. 1.6662-3(b)(1), Income

Tax Regs. The term “disregard” includes any careless, reckless,

or intentional disregard. Sec. 6662(c); sec. 1.6662-3(b)(2),

Income Tax Regs.

If a taxpayer shows there was reasonable cause for any

portion of an underpayment and the taxpayer acted in good faith

with respect to that portion, the penalty does not apply. See

sec. 6664(c)(1); sec. 1.6664-4(a), Income Tax Regs. The

7
Our holding eliminates the need to discuss whether the
advance was a business debt and, if so, whether it was worthless.
See sec. 166(a), (d).
 - 24 -

determination of whether a taxpayer acted in good faith is made

on a case-by-case basis, taking into account all the pertinent

facts and circumstances. See Compaq Computer Corp. v.

Commissioner, 113 T.C. 214, 226 (1999); sec. 1.6664-4(b)(1),

Income Tax Regs. Petitioners have the burden of proof on this

issue. See Rule 142(a); Allen v. Commissioner, supra.

Petitioners argue that they acted in good faith in

determining the correct tax treatment of the $200,000 advance.

Petitioners’ argument is that the Internal Revenue Service

audited their 1991 joint Federal income tax return, upon which

they had claimed a similar business bad debt deduction that was

ultimately allowed, and that they are entitled to rely on the

result in the prior audit. Respondent argues that petitioners

acted negligently or with disregard of the rules or regulations

because petitioner manipulated the form of the transaction in

order to obtain an ordinary loss deduction in the event the

Corbin project did not succeed. Respondent further argues

petitioners have not shown reasonable cause or that they acted in

good faith. We agree with respondent that petitioners have not

shown reasonable cause or that they acted in good faith as

required by section 6664(c).

Petitioner testified that in 1991 he was consulting for

O’Neill & Associates, which went into bankruptcy, that he claimed

a business bad debt deduction for an advance made in connection
 - 25 -

with those consulting services, and that the Internal Revenue

Service audited petitioners and ultimately issued a “no change”

on their tax return. The record is devoid of any evidence

regarding the 1991 audit except for petitioner’s brief self-

serving testimony on the topic.8 We are not obligated to accept

the self-serving and uncorroborated testimony of petitioner under

these circumstances. See Tokarski v. Commissioner, 87 T.C. 74

(1986). Other than petitioner’s testimony regarding the prior

audit, petitioner has offered no evidence to prove that

petitioners are entitled to relief from the accuracy-related

penalty. We conclude, therefore, that petitioners have failed to

carry their burden of proof and are liable for the accuracy-

related penalty under section 6662.

We have carefully considered all remaining arguments for

contrary holdings and, to the extent not discussed, find them to

be irrelevant or without merit.

To reflect the foregoing,

Decision will be entered

for respondent.

8
The additional factual assertions in petitioners’ reply
brief are not part of the evidentiary record. See Rule 143(b).