In Estate of Leavitt v. Commissioner, 90 T.C. 206">90 T.C. 206 (1988), affd. 875 F.2d 420">875 F.2d 420 (4th Cir. 1989), we reiterated our position that the guaranty of a loan without actual economic outlay does not increase a shareholder's basis in the corporation. However, the Court of Appeals for the Eleventh Circuit held in Selfe v. United States, 778 F.2d 769">778 F.2d 769 (11th Cir. 1985), that although economic outlay is required to increase a shareholder's basis, it is not always necessary for the shareholder to actually absolve the corporation's debt to pass the test. If the facts demonstrate that in substance the shareholder borrowed funds and advanced them to the corporation, an increase in basis is warranted. The instant case is appealable in the Eleventh Circuit, and we are constrained to follow the law in that circuit. Golsen v. Commissioner, 54 T.C. 742">54 T.C. 742 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971). However, the facts of the case before us do not fall within the scope of the Court of Appeals' holding in Selfe.

In Selfe, the shareholders 1997 Tax Ct. Memo LEXIS 477">*520 made loan guaranties to disinterested third parties in arm's-length transactions. Clearly, acting as a guarantor in an arm's-length loan with a disinterested party is not the same as interjecting oneself as the middleman in several loan obligations between one's wholly owned corporations. See Hitchins v. Commissioner, 103 T.C. 711">103 T.C. 711, 103 T.C. 711">718 & n.8 (1994). Consequently, the result here is not controlled by the Court of Appeals' opinion in Selfe.

In this case petitioner is attempting to alter his basis in the S corporation by way of journal entries. There does not appear to be any economic substance to these transactions. Petitioner did not introduce canceled checks, bank account records, or any other evidence to provide verification of actual payment. Cf. 63 T.C. 468">Underwood v. Commissioner, supra at 470-471 (the taxpayer and the corporation exchanged interest-bearing notes, and the taxpayer actually paid interest and principal). The only evidence of petitioner's assumption and payment of the corporate debt at issue is the journal entries made by Lavantucksin. ^{221997 Tax Ct. Memo LEXIS 477">*521}

Making journal entries attributing indebtedness to petitioner is not equivalent to economic outlay in terms of section 1366(d). Therefore, we hold petitioner has not met his burden of proving that he had any basis in the indebtedness of Development in 1990 or 1991. Accordingly, respondent is sustained on this issue.

Issue 3. Whether Petitioners Had Constructive Dividend Income, or Income From the Forgiveness of Indebtedness of $ 80,051 in 1989 From Either INI or Spalding

This issue incorporates some of the facts and the holding of INI, Inc. v. Commissioner, T.C. Memo. 1995-112. For clarity, however, we begin with a brief summary of some of the facts found therein and also make some additional findings pertinent to this opinion.

As discussed above, Spalding was the 100-percent owner of INI. The consolidated entity through Spalding was a partner in Airport Parking Venture I (Carport Partnership), a general partnership engaged in providing parking services at an airport. On September 30, 1988, as part of their agreement to splitup Spalding and INI, Jones (petitioner in this case) and Cares executed irrevocable voting 1997 Tax Ct. Memo LEXIS 477">*522 proxies that deconsolidated Spalding and INI.

In INI, Inc. v. Commissioner, supra, this Court found as fact that pursuant to the Amendment executed on March 1, 1989, Spalding was to dispose of Spalding's interest in the Carport Partnership and transfer to INI $ 100,000 less one-half of the expense associated with disposing of Spalding's interest in the partnership. Thereafter, Spalding disposed of its interest in the Carport Partnership, and pursuant to the Amendment Spalding paid INI $ 80,051. Although the payment belonged to INI, respondent introduced evidence at trial in this case which shows that the check for $ 80,051 was actually made payable to petitioner.

Respondent determined that the $ 80,051 paid by Spalding to INI was dividend income paid by Spalding to petitioner. At trial, respondent argued that petitioner received the $ 80,051 as dividend income from either Spalding or INI.

Respondent introduced the copy of the check issued by Spalding Partners, dated March 1, 1989, and made payable to Carl E. Jones for $ 80,051. Respondent concedes that this same evidence was before the Court in INI, Inc. v. Commissioner, supra. We found in INI, Inc. that petitioner was president of 1997 Tax Ct. Memo LEXIS 477">*523 INI, and as of September 29, 1988, its sole director, and that Spalding issued the $ 80,051 check to INI pursuant to the March 1, 1989, amendment to the agreement to splitup the corporations. There is no evidence that petitioner deposited the check in his personal account or any evidence that petitioner expended the money for his personal benefit. Therefore, although the check is evidence that petitioner actually received the amount at issue, it is not persuasive evidence that petitioner received the check as a shareholder of INI.

Therefore, in conformity with our holding in INI, Inc., we find that although the check was made payable to petitioner, it was payable to him in his capacity as president and director of INI pursuant to the March 1, 1989, amendment to the agreement to splitup the corporations, and that he received it on behalf of the corporation. Accordingly, it is not dividend income to petitioner.

Issue 4. Whether Petitioners Received Constructive Dividends From INI in 1989, 1990, and 1991

As part of the corporate reorganization and separation of Spalding and INI pursuant to section 355, Spalding transferred to INI the account Spalding maintained for the loans it had made 1997 Tax Ct. Memo LEXIS 477">*524 to petitioner. INI added the balance of the transferred account, $ 128,429, to the account it maintained to record the amounts INI lent to petitioner for its year ended September 30, 1988.

According to the loan summary prepared by Morrisett, the loan account balance had ballooned to $ 980,527 on December 31, 1991. The increase was due largely to petitioner's alleged assumption of his other corporations' indebtedness to INI, capitalized interest, and INI's distributions of property to petitioner that were recorded as loans.

For instance, in 1990 when Carlsgate and Development were going out of business while indebted to INI for $ 11,374 and $ 417,978, respectively, petitioner allegedly assumed Carlsgate's and Development's indebtedness. ^{231997 Tax Ct. Memo LEXIS 477">*525} These alleged assumptions were recorded on the books of INI as increases to the account it maintained to record loans made to its shareholder. Petitioner did not employ any of the traditional indicia of debt to memorialize the assumptions; the only evidence of the assumptions consists of his testimony and the loan account summary prepared by Morrisett from the journal entries which were made by Lavantucksin at the direction of petitioner.

In November 1990, Mrs. Jones purchased a townhouse (Westfair No. 6) from INI. The balance due on the townhouse, $ 34,987, was recorded as an increase to petitioner's loan account in 1991. INI also distributed a one-half interest in a lot on Spalding Drive to petitioner, which was recorded as an increase of $ 23,718 to the account. In 1991, the loan account was increased by $ 46,794 for the earlier distribution of a lot on Papermill Road to Mrs. Jones.

In 1989, petitioner as a corporate officer of INI authorized a $ 175,000 salary payment to himself. INI credited the account it maintained for loans to shareholders for $ 175,000, issued petitioner a Form W-2 for this amount, and deducted $ 175,000 as a salary expense on the consolidated return filed by Spalding for the year ended September 30, 1989. Petitioner then changed his mind about taking the $ 175,000 as a salary payment, and instead decided to take the amount as a loan. To document the reclassification of the amount as a loan, petitioner signed an interest-bearing promissory note dated December 15, 1989, for $ 175,000. INI reversed the previous journal entries by crediting salary expense and debiting the loans to shareholder 1997 Tax Ct. Memo LEXIS 477">*526 account but did not file an amended return to reflect the changed amount of the salary expense.

In preparing their individual income tax return (Form 1040) for 1989, petitioners used a corrected Form W-2 that did not include the $ 175,000 as salary income.

Respondent determined that petitioner received constructive dividend income from INI of $ 314,504, ²⁴ $ 27,298, and $ 116,163 in 1989, 1990, and 1991, respectively. In each year at issue, the adjustments to petitioners' income are due to respondent's determination that certain amounts that INI recorded as increases to the shareholder loan account were actually constructive dividends. Petitioners assert that the amounts at issue were loans, not dividends.

In determining the $ 314,504 constructive dividend income for 1989, respondent included the following as constructive dividend income: $ 11,075 of cash distributions; $ 128,429, the transferred shareholder loan account; and $ 175,000, the reclassified loan.

In determining the $ 27,298 constructive dividend income for 1990, respondent included distributions of cash and 1997 Tax Ct. Memo LEXIS 477">*527 INI's one-half interest in a lot on Spalding Drive, valued at $ 23,717, as constructive dividends.

In determining the $ 116,163 constructive dividend income for 1991, respondent included the following as constructive dividends: $ 1,241 of cash distributions; $ 46,794, the value of the lot on Papermill Road; and $ 34,987, the balance due on the townhouse.

In addition, respondent determined that INI ceased doing business in 1991; thus, respondent contends that petitioner received income from the cancellation of indebtedness for the amount of the loan account in that year. Respondent determined that the balance of the account in 1991 was $ 21,767, or in the alternative if we should decide that the earlier distributions were bona fide loans, respondent contends the balance was $ 981,202. Respondent bears the burden of proving the increased deficiency. Rule 142(a).

Section 61 defines gross income as income from whatever source derived, including dividends. Sec. 61(a)(7). In general, the term "dividend" means any distribution of property made by a corporation out of its earnings and profits of the taxable year or out of its accumulated earnings and profits. Sec. 316(a). The portion of a 1997 Tax Ct. Memo LEXIS 477">*528 distribution of property made by a corporation with respect to its stock which is a dividend shall be included in gross income. Sec. 301(c)(1). The portion of the distribution which is not a dividend shall be applied against and reduce the shareholder's adjusted basis in his stock. Sec. 301(c)(2). That portion of the distribution which is not a dividend, to the extent it exceeds the basis of the stock, shall be treated as gain from the sale or exchange of property. Sec. 301(c)(3).

When a corporation confers an economic benefit upon a shareholder, in his capacity as such, without an expectation of reimbursement, that economic benefit becomes a constructive dividend, taxable as such. Loftin & Woodard, Inc. v. United States, 577 F.2d 1206">577 F.2d 1206, 577 F.2d 1206">1214 (5th Cir. 1978). Accordingly, an expenditure made by a corporation for the personal benefit of its shareholders may result in the receipt of constructive dividends. Ireland v. United States, 621 F.2d 731">621 F.2d 731, 621 F.2d 731">735 (5th Cir. 1980); Nicholls, North, Buse Co. v. Commissioner, 56 T.C. 1225">56 T.C. 1225, 56 T.C. 1225">1238 (1971).

In determining whether constructive dividends have been received, the key factors are whether the shareholders received economic benefits from the corporation 1997 Tax Ct. Memo LEXIS 477">*529 without expectation of payment, and whether the company-provided benefits made available to the shareholders were primarily of a personal nature rather than in the business interests of the corporation. 621 F.2d 731">Ireland v. United States, supra at 735; 577 F.2d 1206">Loftin & Woodard, Inc. v. United States, supra at 1215-1217.

It is undisputed that the distributions of property to petitioner, and to Mrs. Jones through petitioner, provided petitioners economic benefit and served no business purpose of INI. Therefore, for petitioners to exclude the value of the distributed property from their gross income they must prove that INI expected payment for the property petitioners received.

Petitioner asserts that the property (including cash and real property) he and Mrs. Jones received from INI was the proceeds of loans, not dividends. As discussed above in Issue 1, for petitioners to exclude the withdrawals from their income as loans, they must prove that at the time of each withdrawal, petitioner unconditionally intended to repay the amounts received and INI unconditionally intended to require payment. Rule 142(a); Haag v. Commissioner, 88 T.C. 604">88 T.C. 615-616; Litton Bus. Sys., Inc. v. Commissioner, 61 T.C. 367">61 T.C. 377; 1997 Tax Ct. Memo LEXIS 477">*530 see also Haber v. Commissioner, 52 T.C. 255">52 T.C. 266; Saigh v. Commissioner, 36 T.C. 395">36 T.C. 419.

Whether shareholder withdrawals are bona fide loans is a question of fact, the answer to which must be based upon a consideration and evaluation of all surrounding circumstances. Alterman Foods, Inc. v. United States, 505 F.2d 873">505 F.2d at 875.

As its sole shareholder and president, petitioner was in complete control of the corporation. Petitioner made frequent withdrawals of both cash and property, and although the account balance on the records of INI steadily increased to nearly $ 1 million, there was no apparent ceiling. There was no repayment schedule, no fixed date of maturity, nor any indication that at some future point the sums advanced would be repaid. No interest was ever actually paid, nor was any collateral provided. INI made no systematic effort to obtain repayment, nor did petitioner actually make payments.

Considering the circumstances surrounding the distributions of property, we can find no support for petitioners' assertion that the distributions were loans, not dividends. The sole Alterman Foods factor favorable to petitioners' assertion is that INI apparently did not have current earnings 1997 Tax Ct. Memo LEXIS 477">*531 and profits in 1990 and 1991. ²⁵ The fact that a corporation has no current earnings and profits is a factor that weighs in favor of the shareholder's argument that the distribution was a loan. The returns filed by INI, however, indicate that it had substantial retained earnings in each of the years at issue from which it could have paid dividends. ^{261997 Tax Ct. Memo LEXIS 477">*532} Therefore, even if INI did not have earnings and profits in 1990 and 1991, that factor is outweighed by all of the other Alterman Foods factors, none of which are favorable to petitioners.

Furthermore, with only one exception, the withdrawals from INI were made without any of the standard indicia of indebtedness. The one exception was the promissory note petitioner signed for $ 175,000. Petitioner's attempt to change what was initially recorded as a loan into a salary expense, and then back into a loan, is illustrative of the game petitioner was playing with the journal entries. After considering the facts and circumstances, we are convinced that the promissory note for the $ 175,000 represented nothing other than a strategic move in petitioner's game.

Accordingly, respondent is sustained in the determination that the amounts distributed to petitioner by INI in the years at issue were made with respect to its stock and were not loans.

We note, however, that the $ 128,429 that respondent determined was a dividend received by petitioner in 1989 was not a distribution 1997 Tax Ct. Memo LEXIS 477">*533 made by INI. This amount was distributed to petitioner by Spalding, and it was recorded as a loan in an asset account that was transferred by Spalding to INI as part of the division of assets in the splitup of the two corporations.

Respondent did not contend that petitioner did not receive the funds from Spalding as a loan; rather, respondent taxed petitioner on the $ 128,429 as a constructive dividend from INI in 1989 "because he received the benefit of it" when the corporate division was completed in that year. We do not think that the splitup of INI and Spalding pursuant to section 355 by itself is an event that requires petitioner to recognize a loan he received from Spalding as dividend income from INI. Therefore, we find for petitioner on this adjustment.

Discharge of Indebtedness

Respondent determined that in 1991 petitioner received $ 21,767 from INI as income from the discharge of indebtedness. At trial respondent contended in the alternative that if we decided that the earlier distributions from petitioner's corporations were in fact loans, then petitioner had $ 981,202 of income from the discharge of indebtedness when INI went out of business in 1991. ²⁷ Respondent bears 1997 Tax Ct. Memo LEXIS 477">*534 the burden of proving the amount of the increased deficiency. Rule 142(a).

Petitioner contends that INI did not cease doing business in 1991, and that it is a corporation in good standing with the State of Georgia. Petitioner submits that INI's participation in the earlier case tried before this Court, and in an appeal of our decision in that case to the Court of Appeals for the Eleventh Circuit, is evidence of its business activity. Furthermore, petitioner contends that the Internal Revenue Service's (IRS) notice of levy issued to INI on June 18, 1992, is evidence that the IRS continues to deal with INI as an active, viable entity. Thus, petitioner asserts that he did not receive income from the discharge of indebtedness in 1991.

Both parties rely on the returns filed by INI for its fiscal years ended 1990 through 1994 to prove their respective positions.

The issue is not whether INI, Inc., was in business in 1991, but 1997 Tax Ct. Memo LEXIS 477">*535 whether petitioner received income from the discharge of indebtedness in that year. The forgiveness of an indebtedness is deemed to have occurred when it becomes reasonable to assume that the debt will probably never be paid. Exchange Sec. Bank v. United States, 492 F.2d 1096">492 F.2d 1096, 492 F.2d 1096">1099 (5th Cir. 1974) (cancellation of debt is effective upon agreement, not when removed from books); ²⁸Bear Manufacturing Co. v. United States, 430 F.2d 152">430 F.2d 152, 430 F.2d 152">154 (7th Cir. 1970) (income is realized when the liability terminates as a practical matter); Fidelity-Philadelphia Trust Co. v. Commissioner, 23 T.C. 527">23 T.C. 527, 23 T.C. 527">530 (1954) (the important consideration is that it was unlikely as a matter of fact that the obligor would have to honor its obligation to the obligee); Estate of Marcus v. Commissioner, T.C. Memo. 1975-9 (the decedent's estate realized income in the year of the decedent's death because the executors did not intend to satisfy certain debts and the creditor's management did not intend to enforce those claims). For tax purposes, it is well settled that the substance of a transaction as revealed by the evidence as a whole controls over the form employed; i.e., the veil of form is pierced and the entire 1997 Tax Ct. Memo LEXIS 477">*536 transaction is carefully scrutinized. Commissioner v. Court Holding Co., 324 U.S. 331">324 U.S. 331, 324 U.S. 331">334 (1945); Haag v. Commissioner, 334 F.2d 351">334 F.2d 351, 334 F.2d 351">355 (8th Cir. 1964), affg. 40 T.C. 488">40 T.C. 488 (1963). Thus, we consider the evidence submitted to decide whether in 1991 INI, Inc., intended to enforce repayment of petitioner's indebtedness to it.

On its return filed for fiscal year ended September 30, 1990, INI reported that it had gross receipts of $ 171,287 and total income of $ 215,187. On Schedule L of its return INI reported that at the beginning of the year it had total assets of $ 983,104; the ending balance was $ 987,027. The total asset value was composed of the following assets, and their reported beginning and ending values: Cash, $ 886 and $ 439; other current assets, $ 414,701 and $ 11,374; loans to shareholders, $ 483,144 and $ 928,420; real estate loans, $ 70,511 and $ 46,794; and buildings and other depreciable assets, $ 13,847 and zero.

The gross receipts and ending balances in the accounts in the fiscal years ending September 30, 1991 through 1995, are as follows:

Although INI reported that its business purpose is real estate development, it is clear from examining INI's returns 1997 Tax Ct. Memo LEXIS 477">*538 that since 1990 its only activities have been settling tax liabilities, disposing of business assets, and holding petitioner's loans. Furthermore, it has earned no gross receipts, and its only income has been from the sale of its assets and the return of previously deducted taxes. Moreover, the reported amount of petitioner's indebtedness to INI as well as its value relative to INI's other assets has remained very high. In fact, petitioner's loan account is almost its only asset. For instance, the reported value of the loans as a percentage of the total value of its assets was 94.06, 99.99, 97.57, 97.38, 100, and 99.42 percent for fiscal years ending 1990, 1991, 1992, 1993, 1994, and 1995, respectively.

In deciding whether INI, Inc., intended to enforce repayment of the funds advanced petitioner, we need not decide whether INI, Inc., has gone out of business. It is clear from the evidence that INI's purpose in remaining in existence is to wind up its affairs and retain petitioner's loans on its books of account. Upon consideration of all the facts and circumstances of this case, we do not find the fact that INI, Inc., retained petitioner's loans on its books of account persuasive evidence 1997 Tax Ct. Memo LEXIS 477">*539 that it intended to enforce repayment of the amounts it advanced to petitioner. To the contrary, the evidence as a whole shows that it is very unlikely that the debt will ever be paid.

Accordingly, we find that petitioner has not met his burden of proving that he did not receive income from the discharge of indebtedness in 1991, and that respondent has met the burden of proving the increased deficiency.

Issue 5. Whether Petitioners Realized a Short-Term Capital Loss in 1991

Development sold a house to Ben (Ben) and Kathy (Kathy) Johnson (the Johnsons), taking back a note. On September 30, 1990, Development distributed the note it took on the sale to petitioner, recording the distribution as a $ 22,000 increase to the shareholder loan account.

Petitioners reported a loss of $ 28,248 on Schedule D of their 1991 Individual Income Tax Return (Form 1040) as the total of three separate losses: A nonbusiness bad debt loss of $ 14,500 from Ben Johnson; a loss of $ 7,249 from "J. Bradley"; and a loss of $ 6,499 from "Ext Wall Vent".

Respondent determined that the $ 28,248 loss was not allowable because petitioners did not establish that the items were worthless or that petitioners incurred 1997 Tax Ct. Memo LEXIS 477">*540 any loss for that year. Petitioners assert that the reported items are losses from nonbusiness bad debts that became worthless during the taxable year and are deductions that are allowable under section 166.

Section 166(a) provides there shall be allowed as a deduction any debt that becomes worthless during the taxable year. The amount of the deduction for a bad debt is limited to the taxpayer's adjusted basis in the debt as provided by section 1011. Sec. 166(b); Perry v. Commissioner, 92 T.C. 470">92 T.C. 470, 92 T.C. 470">477-478 (1989), affd. without published opinion 912 F.2d 1466">912 F.2d 1466 (5th Cir. 1990).

Section 166(d)(1)(B) provides that where any nonbusiness bad debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 1 year.

There is no standard test or formula for determining worthlessness within a given taxable year; the determination must depend upon the particular facts and circumstances of the case. Crown v. Commissioner, 77 T.C. 582">77 T.C. 582, 77 T.C. 582">598 (1981); sec. 1.166-2(a), Income Tax Regs. However, it is generally accepted that the year of worthlessness is to be fixed by identifiable 1997 Tax Ct. Memo LEXIS 477">*541 events which form the basis of reasonable grounds for abandoning any hope of recovery. 77 T.C. 582">Crown v. Commissioner, supra. The taxpayer bears the burden of proving that the debt had value at the beginning of the taxable year and that it became worthless during and prior to the end of that year. Millsap v. Commissioner, 46 T.C. 751">46 T.C. 751, 46 T.C. 751">762 (1966), affd. 387 F.2d 420">387 F.2d 420 (8th Cir. 1968).

Petitioners offered no testimony or evidence about the losses from "J. Bradley" or "Ext Wall Vent" that they reported on their return. Rather, in describing the loss at trial, petitioner attributed the entire reported amount, $ 28,248, to the Johnsons' default.

Petitioner testified that in selling the house to the Johnsons, he took back a second mortgage of approximately $ 33,000, which was payable in three annual installments, and that the Johnsons defaulted after making the first payment. Petitioner further testified that he pursued collection of the debt owed him by the Johnsons, and that he obtained a $ 40,000 judgment against Ben and a $ 20,000 judgment against Kathy, which he recorded in the counties where the Johnsons now reside.

Petitioner relies on only his testimony to carry the burden of proving the 1997 Tax Ct. Memo LEXIS 477">*542 loss; he failed to produce any corroborating evidence to support his testimony. Thus, the issue is one of credibility wherein we must determine the extent to which the proffered testimony is believable. See Schad v. Commissioner, 87 T.C. 609">87 T.C. 609, 87 T.C. 609">620 (1986), affd. without published opinion 827 F.2d 774">827 F.2d 774 (11th Cir. 1987). It is well established that we are not required to accept self-serving testimony in the absence of corroborating evidence. Niedringhaus v. Commissioner, 99 T.C. 202">99 T.C. 202, 99 T.C. 202">212 (1992); Tokarski v. Commissioner, 87 T.C. 74">87 T.C. 74, 87 T.C. 74">77 (1986). Moreover, the rule is well established that the failure of a party to introduce evidence within his possession and which, if true, would be favorable to him, gives rise to the presumption that if produced it would be unfavorable to him. Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158">6 T.C. 1158, 6 T.C. 1158">1165 (1946), affd. 162 F.2d 513">162 F.2d 513 (10th Cir. 1947). This is particularly true where, as here, petitioner's testimony at trial does not agree with the return that he filed.

The unexplained inconsistency between petitioner's testimony and the return, coupled with his failure to produce any corroborating evidence of his alleged collection activities, casts doubt 1997 Tax Ct. Memo LEXIS 477">*543 upon petitioner's credibility. Furthermore, petitioner's testimony that he sold the house and took the note is contrary to Development's records, which show Development sold the house and later distributed the note to him. Thus, there is no credible evidence of petitioners' basis in the note, if any, or that they suffered losses in the amounts from the sources they reported on their return.

On the basis of the entire record, we simply do not believe that petitioners suffered the losses they reported. We find, therefore, that petitioners have not met their burden of proving they actually incurred any losses. We hold that respondent is sustained on this determination.

Issue 6. Whether Petitioners Are Liable for an Accuracy-Related Penalty Pursuant to Section 6662 for 1989, 1990, and 1991.

Respondent determined that petitioners are liable for an accuracy-related penalty pursuant to section 6662 for 1989, 1990, and 1991. Respondent asserts that the section 6662 penalty is due to either a substantial understatement of tax, or negligence or disregard of rules or regulations. Sec. 6662(b)(1) and (2). Petitioners assert that they are not liable for the section 6662 penalty because for all 1997 Tax Ct. Memo LEXIS 477">*544 of the years at issue their returns were prepared by reputable certified public accountants to whom they disclosed all relevant facts.

Section 6662(a) imposes a penalty in an amount equal to 20 percent of the portion of the underpayment of tax attributable to one or more of the items set forth in subsection (b). The accuracy-related penalty does not apply with respect to any portion of the underpayment if it is shown that there was reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion. Sec. 6664(c) (1). The determination of whether a taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all the pertinent facts and circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs. The most important factor is the extent of the taxpayer's effort to assess its proper tax liability for the year. Id.

Petitioners contend that the accuracy-related penalty is inappropriate in this case because they relied on their certified public accountant, Ricks, to prepare their tax returns accurately. Generally, the duty of filing accurate returns cannot be avoided by placing the responsibility on a tax return 1997 Tax Ct. Memo LEXIS 477">*545 preparer. Metra Chem Corp. v. Commissioner, 88 T.C. 654">88 T.C. 654, 88 T.C. 654">662 (1987). However, reliance on a qualified adviser may demonstrate reasonable cause and good faith if the evidence shows that the taxpayer relied on a competent tax adviser and provided the adviser with all necessary and relevant information. Jackson v. Commissioner, 86 T.C. 492">86 T.C. 492, 86 T.C. 492">539-540 (1986), affd. 864 F.2d 1521">864 F.2d 1521 (10th Cir. 1989); Daugherty v. Commissioner, 78 T.C. 623">78 T.C. 623, 78 T.C. 623">641 (1982); Magill v. Commissioner, 70 T.C. 465">70 T.C. 465, 70 T.C. 465">479 (1978), affd. 651 F.2d 1233">651 F.2d 1233 (6th Cir. 1981); Pessin v. Commissioner, 59 T.C. 473">59 T.C. 473, 59 T.C. 473">489 (1972).

Under section 1.6664-4(b)(1), Income Tax Regs., circumstances that may establish reasonable cause and good faith include an honest misunderstanding of fact or law that is reasonable in light of the experience, knowledge, and education of the taxpayer. Reliance on the advice of a professional (such as an attorney or an accountant) does not necessarily demonstrate reasonable cause and good faith. Reliance on professional advice constitutes reasonable cause and good faith if, under all the circumstances, such reliance was reasonable and the taxpayer acted in good faith. Id.

The record shows that petitioner directed 1997 Tax Ct. Memo LEXIS 477">*546 Lavantucksin to make certain journal entries on the corporate records which Ricks and Morrisett then used to prepare the returns. Morrisett testified that he used the journal entries made by Lavantucksin to reconcile the corporate books with petitioner's personal books, but he did not verify the entries with bank statements, canceled checks, the corporate minutes, or other external sources. Therefore, the accountants unreasonably relied on uncorroborated journal entries prepared at petitioner's direction. Under these circumstances, petitioners' reliance on the accountants was not reasonable.

Furthermore, petitioner's failure to provide his accountants all of the necessary and relevant information is an indication that he did not make an effort to assess the proper tax liability for each of the years at issue.

On the basis of the record as a whole, we conclude that petitioners have not carried their burden of proving that they acted with reasonable cause and in good faith. We hold that petitioners are liable for the accuracy-related penalty under section 6662 for 1989, 1990, and 1991.

Issue 7. Whether Mrs. Jones Qualifies Under Section 6013(e) as an Innocent Spouse

Mrs. Jones contends 1997 Tax Ct. Memo LEXIS 477">*547 that she is not liable for the understatement of tax because she qualifies as an innocent spouse pursuant to section 6013(e).

Spouses who file a joint return generally are jointly and severally liable for its accuracy and the tax due, including any additional taxes, interest, or penalties determined on audit of the return. Sec. 6013(d). However, section 6013(e) provides an exception. A spouse (commonly referred to as an innocent spouse) is relieved of tax liability if that spouse proves: (A) A joint return was filed for the years in issue; (B) the return contained a substantial understatement (defined in section 6013(e)(3) as any understatement over $ 500) of tax attributable to grossly erroneous items of the other spouse; (C) in signing the return, the spouse seeking relief did not know, and had no reason to know, of the substantial understatement; and (D) it would be inequitable to hold the relief-seeking spouse liable for the deficiency attributable to the understatement. Sec. 6013(e)(1); Flynn v. Commissioner, 93 T.C. 355">93 T.C. 355, 93 T.C. 355">359 (1989).

For purposes of section 6013(e)(1)(B), section 6013(e)(2) defines the term "grossly erroneous items" to mean, with respect to any spouse, (A) any 1997 Tax Ct. Memo LEXIS 477">*548 item of gross income attributable to such spouse that is omitted from gross income, and (B) any claim of a deduction, credit, or basis by the spouse in an amount for which there is no basis in fact or law. ²⁹ There is no basis in law or fact if the claim is fraudulent, phony, frivolous, or groundless. Feldman v. Commissioner, 20 F.3d 1128">20 F.3d 1128, 20 F.3d 1128">1135 (11th Cir. 1994), affg. T.C. Memo. 1993-17; Russo v. Commissioner, 98 T.C. 28">98 T.C. 28, 98 T.C. 28">32 (1992). The disallowance of an item is not, in and of itself, proof of the lack of basis in fact or law. 20 F.3d 1128">Feldman v. Commissioner, supra;98 T.C. 28">Russo v. Commissioner, supra.

The spouse seeking relief bears the burden of proving that each of the four requirements has been satisfied. Rule 142(a); Stevens v. Commissioner, 872 F.2d 1499">872 F.2d 1499, 872 F.2d 1499">1504 (11th Cir. 1989), affg. T.C. Memo. 1988-63; 98 T.C. 28">Russo v. Commissioner, supra at 31-32; Sonnenborn v. Commissioner, 57 T.C. 373">57 T.C. 373, 57 T.C. 373">381 (1971). 1997 Tax Ct. Memo LEXIS 477">*549 Failure to prove any one of the four statutory requirements will prevent innocent spouse relief. 872 F.2d 1499">Stevens v. Commissioner, supra;Bokum v. Commissioner, 94 T.C. 126">94 T.C. 126, 94 T.C. 126">138-139 (1990), affd. 992 F.2d 1132">992 F.2d 1132 (11th Cir. 1993).

The parties have stipulated that petitioners filed a joint return for the years at issue, and respondent concedes that except for the distributions of property that were ultimately received by Mrs. Jones, the omissions from income are attributable to petitioner. ³⁰

Thus, the controversy herein focuses on three items: (1) Whether the substantial understatement is attributable to grossly erroneous items; (2) whether Mrs. Jones did not know, and had no reason to know, of the substantial understatement when she signed the return in each of the years at issue; and (3) whether it would be inequitable to hold Mrs. Jones liable for the income tax deficiency attributable to such substantial understatement.

We conclude 1997 Tax Ct. Memo LEXIS 477">*550 that the omissions of the corporate distributions from income are grossly erroneous items, but that the claim for the bad debt deduction is not a grossly erroneous item; that Mrs. Jones knew or had reason to know of the understatements when she signed the returns; and that it is not inequitable to hold her liable for tax.

Grossly Erroneous Items

To be entitled to relief as an innocent spouse, Mrs. Jones must show that it the substantial understatement of tax is attributable to grossly erroneous items. Sec. 6013(e)(1)(B).

Respondent concedes that, except for certain distributions of property, the items of omitted income are attributable to petitioner. Therefore, these items are grossly erroneous. Sec. 6013(e)(2)(A).

However, we find that the claimed deduction in 1991 for the bad debt loss is not a grossly erroneous item. In order to be a grossly erroneous item, deductions must have been claimed without any basis in fact or law. Deductions disallowed for lack of substantiation are not per se "grossly erroneous". Douglas v. Commissioner, 86 T.C. 758">86 T.C. 758, 86 T.C. 758">763 (1986).

Mrs. Jones has not shown that the deductions disallowed by respondent were disallowed for the reason that the losses had never 1997 Tax Ct. Memo LEXIS 477">*551 in fact been incurred or that there was no basis in law for the deductions. The deductions were disallowed solely for lack of substantiation. Petitioner testified about the Johnsons' default but offered no evidence regarding losses from "J. Bradley" and "Ext Wall Vent". Petitioner maintained throughout that the Johnsons had defaulted on the note, and that he had sought payment and attempted collection, but other than petitioner's testimony, there was no evidence to substantiate the claim. The understatement of tax attributable to the claim for the bad debt loss, therefore, is not due to a grossly erroneous item. Accordingly, Mrs. Jones is not entitled to innocent spouse status with regard to this adjustment.

Knowledge of Understatements on the Returns

To be entitled to relief as an innocent spouse, Mrs. Jones must show that, in signing the joint returns for the years in issue, she did not know and had no reason to know of the substantial understatements of tax. Sec. 6013(e)(1)(C).

In 872 F.2d 1499">Stevens v. Commissioner, supra, the Court of Appeals for the Eleventh Circuit, in refusing to grant innocent spouse relief, approved our application of its "reason to know" standard. The Court of Appeals 1997 Tax Ct. Memo LEXIS 477">*552 stated that the "reason to know" standard is based on whether a "reasonably prudent taxpayer under the circumstances of the spouse at the time of signing the return could be expected to know that the tax liability stated was erroneous or that further investigation was warranted." 872 F.2d 1499">Id. at 1505; see also Sanders v. United States, 509 F.2d 162">509 F.2d 162 (5th Cir. 1975). The test establishes a "duty of inquiry" on the part of the alleged innocent spouse. 872 F.2d 1499">Stevens v. Commissioner, supra.As pointed out in Mysse v. Commissioner, 57 T.C. 680">57 T.C. 680, 57 T.C. 680">699 (1972), a spouse cannot close her eyes to facts that might give here reason to know of unreported income. Furthermore, the alleged innocent spouse's role as homemaker and complete deference to the husband's judgment concerning the couple's finances, standing alone, are insufficient to establish that a spouse had no "reason to know." 872 F.2d 1499">Stevens v. Commissioner, supra at 1506.

In deciding whether Mrs. Jones had "reason to know" of the substantial understatements when she signed the returns, we take into account: (1) Her level of education; (2) her involvement in the family's business and financial affairs; (3) the presence of expenditures that appear lavish or unusual 1997 Tax Ct. Memo LEXIS 477">*553 when compared to the family's past levels of income, standard of living, and spending pattern; and (4) the culpable spouse's evasiveness and deceit concerning the couple's finances. Kistner v. Commissioner, 18 F.3d 1521">18 F.3d 1521, 18 F.3d 1521">1525 (11th Cir. 1994), revg. T.C. Memo. 1991-463; Stevens v. Commissioner, 872 F.2d 1499">872 F.2d 1499 (11th Cir. 1989). The foregoing factors are considered "because, ordinarily, they predict what a prudent person would realize regardless of the other spouse's evasiveness or deceit." Bliss v. Commissioner, 59 F.3d 374">59 F.3d 374, 59 F.3d 374">379 (2d Cir. 1995), affg. T.C. Memo. 1993-390.

Petitioners reported that they had $ 49,976 of taxable income in 1989 and negative taxable income in 1990 and 1991. In 1990 and 1991, Mrs. Jones received the Winterchase lots and the Papermill Road property, which had fair market values of $ 166,904 and $ 46,794, respectively, and the balance due on her townhouse, $ 34,987, was effectively canceled. Petitioners did not report the value of these distributions as income on the joint returns they filed in 1990 and 1991.

Mrs. Jones was not involved in the day-to-day operation of petitioner's business; however, she was 50-percent owner of Carlsgate Properties, Inc., an S 1997 Tax Ct. Memo LEXIS 477">*554 corporation, and had been the owner of her own decorating business, Delane's Decorating Service. Although Mrs. Jones testified that she had never been a professional decorator, she listed "Decorator" as her occupation on each return for the years at issue. Therefore, in considering her level of education, we find that Mrs. Jones had a practical education in business.

Furthermore, petitioners concede that petitioner did not prevent Mrs. Jones from examining the returns, dominate or abuse her, or otherwise coerce her into signing the returns. Cf. 18 F.3d 1521">Kistner v. Commissioner, supra at 1527 (a reasonably prudent taxpayer living an affluent life for many years, fearful of physical violence, and uninvolved in the financial affairs of the business, at the time of signing the return could not be expected to know that the tax liability stated was erroneous or that further investigation was necessary).

We think that a reasonably prudent person would have inquired how she could receive distributions of valuable real estate free of encumbrances without reporting them as income. Mrs. Jones had reason to know that the tax liability stated was erroneous or that further investigation was warranted.

Not 1997 Tax Ct. Memo LEXIS 477">*555 Equitable To Hold Mrs. Jones Liable

To be entitled to relief as an innocent spouse, Mrs. Jones must show that it would be inequitable to hold her liable for the deficiencies in tax for the years at issue. Sec. 6013(e)(1)(D).

In deciding whether it is inequitable to hold a spouse liable for a deficiency, we consider whether the purported innocent spouse significantly benefited beyond normal support, either directly or indirectly, from the unreported income. Hayman v. Commissioner, 992 F.2d 1256">992 F.2d 1256, 992 F.2d 1256">1262 (2d Cir. 1993), affg. T.C. Memo. 1992-228; Belk v. Commissioner, 93 T.C. 434">93 T.C. 434, 93 T.C. 434">440 (1989); Purcell v. Commissioner, 86 T.C. 228">86 T.C. 228, 86 T.C. 228">440 (1986), affd. 826 F.2d 470">826 F.2d 470 (6th Cir. 1987); sec. 1.6013-5(b), Income Tax Regs. Evidence of direct or indirect support may consist of transfers of property, including transfers which may be received several years after the year in which the omitted income should have been included in gross income. Sec. 1.6013-5(b), Income Tax Regs.

Mrs. Jones contends that she did not enjoy any economic benefit beyond normal support, either directly or indirectly, from the substantial understatement of income by her husband. In support of her contention, Mrs. Jones points 1997 Tax Ct. Memo LEXIS 477">*556 to the fact that during the years at issue she drove an older model Mercedes with over 100,000 miles on it, and at the time of trial she was driving an older model Mercedes with approximately 240,000 miles on it. Furthermore, in contrast to the $ 900,000 house she and petitioner owned until September of 1991, at the time of trial she and petitioner were living in a house for which they paid $ 325,000.

Although Mrs. Jones may now have a less affluent standard of living than she had during the years at issue, it is not true that she did not significantly benefit from the understatements on petitioners' 1989, 1990, and 1991 returns. In 1990 and 1991, Mrs. Jones received the Winterchase lots and the Papermill Road property, which had fair market values of $ 166,904 and $ 46,794, respectively, and the balance due on her townhouse, $ 34,987, was effectively canceled. These transfers exceed normal support.

Furthermore, sometime between September of 1991 and May of 1992, petitioner transferred $ 150,000 to Mrs. Jones, which she had in a bank account in her name at the time of trial. Mrs. Jones cites Terzian v. Commissioner, 72 T.C. 1164">72 T.C. 1164 (1979), as support for her contention that the receipt 1997 Tax Ct. Memo LEXIS 477">*557 of a lump-sum payment in the nature of support from her husband does not preclude the grant of innocent spouse relief.

We agree with Mrs. Jones that a payment in the nature of ordinary support is not an equitable bar to innocent spouse relief. However, the facts in Terzian which led this Court to conclude in that case that a spouse's one-time transfer of $ 155,000 to the taxpayer was for ordinary support are not present in the instant case. At the time of trial in that case, Mrs. Terzian had been separated from her husband, Dr. Terzian, for more than 2 years and had a suit for divorce pending against him that became final shortly after the trial concluded. In the divorce proceeding no claim for alimony was made, and none was awarded. 72 T.C. 1164">Id. at 1165 n.2, 1172. In his answer to the taxpayer's complaint for divorce, Dr. Terzian alleged that he had transferred funds to the taxpayer for support. 72 T.C. 1164">Id. at 1172 n.4.

Moreover, at the time of trial, Mrs. Terzian had spent $ 20,000 of the transferred funds for living expenses and in connection with her daughter's education. Finally, Mrs. Terzian had a very modest lifestyle; she and her daughter were living in a small two-bedroom apartment with 1997 Tax Ct. Memo LEXIS 477">*558 a rent of $ 275 a month.

On the basis of the record, we concluded in Terzian that the $ 155,000 was a one-time transfer to the taxpayer of an amount in lieu of alimony or support and that these funds would not provide a woman of the taxpayer's age and lack of business experience with more than ordinary support throughout the remainder of her life. 72 T.C. 1164">Id. at 1172. In contrast, in the case at hand, there is no evidence that the transfer was made in lieu of support or alimony, or that Mrs. Jones has, or will ever, use the transferred funds for ordinary support.

We conclude that Mrs. Jones is not an innocent spouse under section 6013(e).

Decision will be entered under Rule 155.