JAMES C. COOPER AND LORELEI M. COOPER, PETITIONERS v.
    COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
          Docket No. 17284–12.        Filed September 23, 2014.

        In 1997 P–H, an inventor, transferred several patents to T,
      a corporation. Ps own 24% of the outstanding stock of T.
      P–W’s sister and Ps’ friend own the remaining stock. P–H
      controlled T through its officers, directors, and shareholders.
      Ps reported royalty income that P–H received from T in
      exchange for the transfer of the patents as capital gain under
      I.R.C. sec. 1235(a) for 2006, 2007, and 2008. In 2006 P–H paid
      the engineering expenses of a related corporation. Ps deducted
      these expenses as professional fees on a Schedule C, Profit or
      Loss From Business, attached to their 2006 Federal income
      tax return. Between 2005 and 2008 Ps advanced $2,046,901

194
(194)                   COOPER v. COMMISSIONER                            195


        to X, a corporation, under the terms of a working capital
        promissory note. P–H owned 24% of the outstanding stock of
        X during the years at issue. X contracted with an Indian com-
        pany to develop a new product, and it used Ps’ loans in part
        to fund the development of the new product. In 2008 the
        Indian company abandoned its development of the new
        product. Ps claimed that X was insolvent and claimed a bad
        debt deduction under I.R.C. sec. 166 of $2,046,570 for 2008.
        R determined that (1) the royalty payments P–H received
        from T did not qualify for capital gain treatment; (2) the
        engineering expenses were the ordinary and necessary
        expenses of a related corporation and Ps were not entitled to
        deduct those expenses; (3) Ps were not entitled to a bad debt
        deduction for 2008; and (4) Ps were liable for an accuracy-
        related penalty under I.R.C. sec. 6662(a) for each of the years
        at issue. Held: P–H did not transfer all substantial rights in
        the subject patents to T within the meaning of I.R.C. sec.
        1235(a) because P–H controlled T during the years at issue.
        See Charlson v. United States, 

, 1053 (Ct. Cl.
        1975). Ps are therefore not entitled to capital gain treatment
        under I.R.C. sec. 1235(a) for the royalties P–H received from
        T in exchange for the subject patents. Held, further, Ps are
        entitled to deduct the engineering expenses for 2006. Under
        Lohrke v. Commissioner, 

, 688 (1967), P–H’s pri-
        mary motive in paying the expenses was to protect or promote
        his business as an inventor, and the expenditures constituted
        ordinary and necessary expenses in the furtherance or pro-
        motion of P–H’s business. Held, further, Ps are not entitled to
        a bad debt deduction under I.R.C. sec. 166 because Ps have
        failed to prove that the promissory note became worthless in
        2008. Held, further, Ps are liable for an accuracy-related pen-
        alty under I.R.C. sec. 6662(a) for each of the years at issue.

  Lawrence T. Ullmann, for petitioners.
  Nhi T. Luu and Christian A. Speck, for respondent.
  MARVEL, Judge: Respondent determined deficiencies in
petitioners’ Federal income tax of $580,961, $384,705, and
$496,236 for 2006, 2007, and 2008, respectively, and
accuracy-related penalties under section 6662(a) 1 of
$116,192, $76,941, and $99,247 for 2006, 2007, and 2008,
respectively. After concessions, 2 the issues for decision are:
  1 Unless otherwise indicated, all section references are to the Internal
Revenue Code (Code) in effect for the years at issue, and all Rule ref-
erences are to the Tax Court Rules of Practice and Procedure. Some mone-
tary amounts have been rounded to the nearest dollar.
  2 The parties stipulated or conceded that petitioners are entitled to de-
                                                 Continued
196           143 UNITED STATES TAX COURT REPORTS                       (194)


(1) whether royalties petitioner James Cooper received
during 2006, 2007, and 2008 qualified for capital gain treat-
ment pursuant to section 1235; (2) whether petitioners may
deduct professional fees paid during 2006 that were attrib-
utable to expenses charged by Holmes Development for work
performed with respect to U.S. Patent # 5,157,489 (489 pat-
ent); 3 (3) whether petitioners’ advance of $2,046,570 4 to
Pixel Instruments Corp. (Pixel) is deductible as a nonbusi-
ness bad debt for 2008 pursuant to section 166; and (4)
whether petitioners are liable for section 6662(a) accuracy-
related penalties for the years at issue.

                           FINDINGS OF FACT

  Some of the facts have been stipulated and are so found.
The stipulations of facts are incorporated herein by this ref-
erence. Petitioners resided in Nevada when they petitioned
this Court.
I. Patent Royalties
   Mr. Cooper is an engineer and inventor. He has an under-
graduate degree in electrical engineering from Oklahoma
State University and is the named inventor on more than 75
patents in the United States. 5 His patents are primarily for
products and components used in the transmission of audio
and video signals. Petitioner Lorelei Cooper has an under-
graduate degree in communications from Kent State Univer-
sity. She is not the named inventor on any patents.
   In 1988 Mr. Cooper consulted Daniel Leckrone, an attorney
specializing in patent law and patent licensing, regarding
Mr. Cooper’s portfolio of intellectual property. These con-

duct on Schedule C, Profit or Loss From Business: (1) travel expenses of
$30,072, $18,432, and $21,444 for 2006, 2007, and 2008, respectively; and
(2) professional fees of $82,585, $241,153, and $109,007 for 2006, 2007, and
2008, respectively.
   3 The 489 patent was titled ‘‘Apparatus and Method for Reducing Quan-

tizing Distortion’’.
   4 The parties stipulated that on December 31, 2008, the outstanding bal-

ance on the promissory note was $2,046,901. However, petitioners claimed
a nonbusiness bad debt deduction for the outstanding balance on the prom-
issory note of $2,046,570 for 2008.
   5 Mr. Cooper is also a patent agent entitled to represent third parties be-

fore the U.S. Patent and Trademark Office.
(194)                 COOPER v. COMMISSIONER                            197


sultations led to an agreement (commercialization agree-
ment) 6 among Mr. Leckrone, Mr. Cooper, and Pixel wherein
Mr. Cooper and Pixel assigned their portfolio of audio and
video patents to VidPro, 7 a licensing company formed by Mr.
Leckrone.
  A number of disputes arose between Mr. Cooper and Mr.
Leckrone under the commercialization agreement. In 1997
Mr. Cooper sent Mr. Leckrone notice that he was termi-
nating the commercialization agreement. Mr. Cooper con-
tended that under the terms of the commercialization agree-
ment the patent rights held by VidPro automatically reverted
to him as a result of the termination notice. Mr. Leckrone
disagreed. Ultimately, this dispute led to litigation between
Mr. Cooper and Mr. Leckrone, VidPro, and an attorney on
VidPro’s board of directors (Cooper-Leckrone litigation). 8
  Subsequently, petitioners, believing that all rights in
VidPro’s audio and video patents reverted to Mr. Cooper,
incorporated Technology Licensing Corp., a California cor-
poration (TLC), 9 with Lois Walters and Janet Coulter. Ms.
Walters is petitioner Lorelei Cooper’s sister, and Ms. Coulter
is a longtime friend of Ms. Cooper and Ms. Walters. Ms.
Coulter and Ms. Walters resided in Ohio from 1997 through
   6 The commercialization of a patent generally includes finding companies

to manufacture products using the patent as well as finding and suing pat-
ent infringers for damages.
   7 At the time the commercialization agreement was signed, VidPro was

known as VideoTech.
   8 The Cooper-Leckrone litigation ended in 2004 when a final arbitration

award was entered determining, among other things, that the commer-
cialization agreement was properly terminated as of January 21, 1997, and
all rights, title, and interest that VidPro claimed in the patents were re-
turned to Mr. Cooper or his assignee.
   9 Petitioners moved their principal residence from California to Nevada

in November 2003. Petitioners, Ms. Walters, and Ms. Coulter then formed
a second Technology Licensing Corp. with the Nevada secretary of state
(TLC Nevada). Petitioners as cotrustees of the Cooper Trust U.D.T. Decem-
ber 11, 1991 (Cooper Trust), contributed $240 to TLC Nevada in exchange
for 240 shares in TLC Nevada, and Ms. Walters and Ms. Coulter each con-
tributed $380 to TLC Nevada in exchange for 380 shares in TLC Nevada
(38%). Ms. Walters, Ms. Cooper, and Ms. Coulter were the president and
chief financial officer, vice president, and secretary of TLC, respectively.
On February 24, 2004, TLC merged into TLC-Nevada with TLC-Nevada as
the surviving corporation. We refer to TLC Nevada as TLC unless other-
wise indicated.
198          143 UNITED STATES TAX COURT REPORTS                      (194)


2013, and both worked full time with companies other than
TLC during the years at issue. 10 Neither Ms. Coulter nor
Ms. Walters had any experience in patent licensing or patent
commercialization before their involvement with TLC.
   Petitioners incorporated TLC to engage in patent licensing
and patent commercialization. They wanted TLC to have the
‘‘aura’’ of a fully operating licensing corporation but also
wanted people Mr. Cooper could trust—such as their close
friend Ms. Coulter and their relative Ms. Walters—to be the
shareholders, officers, and directors of TLC. 11
   Petitioners engaged Attorney R. Gordon Baker, Jr., to pro-
vide advice on forming TLC. Among other things, Mr. Baker
advised petitioners on the requirements of section 1235 and
qualifying the royalty payments Mr. Cooper would receive
from TLC as capital gain under that section. Mr. Baker
advised petitioners that (1) they could not control TLC
directly or indirectly and (2) their stock ownership in TLC
had to be less than 25% of the total outstanding stock.
   Consistent with Mr. Baker’s advice, the outstanding stock
of TLC at formation was as follows: petitioners as cotrustees
of the Cooper Trust owned 240 shares (24%); (2) Lois Walters
owned 380 shares (38%); and (3) Janet Coulter owned 380
shares (38%). Ms. Walters and Ms. Coulter each made an ini-
tial contribution of $3,800 to TLC in exchange for their
shares while petitioners as cotrustees of the Cooper Trust
contributed $2,400 for the trust’s shares. Ms. Walters, Ms.
Cooper, and Ms. Coulter were the president and chief finan-
cial officer, vice president, and secretary of TLC, respec-
tively. 12 Mr. Cooper was the general manager of TLC.
  10 Ms.  Walters has a B.A. degree in finance from Cleveland State Univer-
sity. During the years at issue she was an employee of the National Mul-
tiple Sclerosis Society in Independence, Ohio. Ms. Coulter has a B.S. de-
gree in animal science from Ohio State University and an M.S. in agricul-
tural economics from the University of Wyoming. She owns her own con-
struction company, Multi-Maintenance, Inc., in Ohio and was an employee
of Multi-Maintenance during the years at issue.
   11 TLC did not have an office or other formal business location.
   12 Beginning in 2004 or 2005 and continuing through the years at issue,

Ms. Coulter performed most of Ms. Walters’ duties at TLC. At that time,
Ms. Walters was working more than 50 hours per week for the National
Multiple Sclerosis Society and spending substantial time caring for her ill
father.
(194)                 COOPER v. COMMISSIONER                           199


   On March 15, 1997, Mr. Cooper and Pixel entered into
agreements (collectively, TLC agreements) with TLC purport-
edly transferring all of Mr. Cooper’s and Pixel’s rights in the
patents (subject patents) giving rise to the royalties at issue
in this case to TLC. Under each TLC agreement, the licensor
(i.e., Mr. Cooper or Pixel) receives 40% of all gross proceeds
received by TLC for any sublicense and 40% of all damages
received in litigation or settlement of litigation. The licensor
then receives 90% of all remaining net proceeds as defined
in the TLC agreements.
   By 1999 TLC had begun experiencing financial difficulty.
It could not effectively license its patents because the patents
were the subject of the Cooper-Leckrone litigation and poten-
tial licensees were wary of TLC’s authority to license the pat-
ents. Furthermore, TLC needed legal representation to
pursue patent infringement cases.
   In an effort to solve TLC’s financial difficulties, Mr. Cooper
contacted Anthony Brown, who was in the business of
helping inventors protect and enforce their patents. Mr.
Brown owned IP Innovation, LLC (IP Innovation). Subse-
quently, TLC, Mr. Cooper, and Pixel entered into an agree-
ment (IP Innovation assignment agreement) with IP Innova-
tion assigning an undivided interest in Patent # 5,424,780
(780 patent) to IP Innovation. 13 Then, IP Innovation, Mr.
Cooper, Pixel, and TLC engaged the patent law firm of Niro,
Scavone, Haller & Niro (Niro firm) to represent their
interests with respect to the 780 patent. Mr. Cooper agreed
to provide technical assistance to the Niro firm as necessary
to assist the firm in interpreting the patents, technology, and
devices that would be the subject of the licensing and
infringement matters the firm was pursuing. Mr. Cooper was
not compensated for providing technical assistance to the
Niro firm.
   On February 28, 2003, TLC and its shareholders adopted
a stock restriction agreement providing in relevant part that
   13 On August 12, 2002, TLC, Pixel, Mr. Cooper, and IP Innovation exe-

cuted an agreement (exclusive license agreement) expanding IP Innova-
tion’s license beyond the 780 patent by providing an exclusive, perpetual,
and irrevocable license to several additional patents. TLC, Pixel, Mr. Coo-
per, and IP Innovation amended the exclusive license agreement on Octo-
ber 31, 2002, and on November 12, 2004, the exclusive license agreement
was terminated.
200            143 UNITED STATES TAX COURT REPORTS                    (194)


TLC’s shares could not be sold, assigned, or transferred
except according to the terms of the stock restriction agree-
ment. Under the agreement petitioners were permitted to
transfer shares of TLC stock to their issue or any trust for
the benefit of their issue. No other TLC shareholder (i.e., Ms.
Coulter or Ms. Walters) was permitted to transfer shares of
TLC stock to her issue or any party other than a share-
holder. Mr. Baker drafted the stock restriction agreement in
his role as petitioners’ estate planning attorney. Despite
owning a majority of TLC’s outstanding stock and being on
the board of directors, neither Ms. Coulter nor Ms. Walters
negotiated the terms of the stock restriction agreement. 14
   In 2004 Anthony Brown formed New Medium, LLC (New
Medium), and AV Technologies, LLC (AV Technologies), to
pursue patent commercialization. TLC, Pixel, and Mr. Cooper
subsequently entered into licensing agreements for certain
patents with both New Medium and AV Technologies (collec-
tively, New Medium and AV Technologies agreements). In or
about 2004 Acacia Technologies Group (Acacia) purchased IP
Innovation and IP Innovation became a subsidiary of Acacia.
On March 23, 2005, the parties to the New Medium and AV
Technologies agreements and the IP Innovation assignment
agreement clarified by agreement (letter agreement) that all
material decisions (i.e., licensing, litigation, and prosecution)
with respect to the New Medium and AV Technologies agree-
ments and the IP Innovation assignment agreement were to
be made according to a majority vote of Mr. Cooper,
Acacia, 15 and Anthony Brown. Under the letter agreement
TLC did not have a vote with respect to the material
decisions under either the IP Innovation assignment agree-
  14 Neither  Ms. Coulter nor Ms. Walters consulted an attorney before
signing the stock restriction agreement, and neither could recall the cir-
cumstances of her signing the agreement. They did not receive any consid-
eration for giving up their right to transfer their shares in TLC. Mr. Baker
testified that the restrictions on Ms. Walters’ and Ms. Coulter’s ability to
transfer shares in TLC were inadvertent and done in error. We find Mr.
Baker’s testimony unconvincing in the light of our finding that Mr. Cooper
indirectly controlled TLC. See infra p. 213. Mr. Cooper had ample motiva-
tion to ensure that the stock of TLC was not transferred to parties he
could not control.
   15 Under the letter agreement Acacia was defined as IP Innovation, New

Medium, and AV Technologies.
(194)                  COOPER v. COMMISSIONER                              201


ment or the New Medium and AV Technologies agree-
ments. 16
  Among the patents transferred by Mr. Cooper to TLC
under the terms of the TLC agreements were three patents
known as the ‘‘Lowe patents’’. The Lowe patents included the
489 patent. On January 18, 2006, TLC transferred the Lowe
patents back to Mr. Cooper. He did not pay any money or
transfer any other consideration to TLC for the return of the
Lowe patents. The agreement transferring the Lowe patents
from TLC to Mr. Cooper simply states that the parties com-
pleted the transfer because TLC had not licensed the Lowe
patents and TLC and Mr. Cooper desired to return the Lowe
patents to Mr. Cooper.
  On January 23, 2006, Mr. Cooper transferred the Lowe
patents to Watonga Technology, Inc. (Watonga). The share-
holders of Watonga were as follows: the Cooper Trust (1%);
petitioners’ son (11.5%); petitioners’ daughter (11.5%); Ms.
Coulter and Ms. Walters (76% combined). Ms. Coulter was
the president of Watonga. 17 Under the agreement transfer-
ring the Lowe patents to Watonga, Mr. Cooper received 55%
of all net revenue (as defined in the agreement), and

  16 The  letter agreement provides that ‘‘all material decisions with respect
to the * * * [IP Innovation assignment agreement and the New Medium
and AV Technologies agreements] will be made by a majority of Cooper,
the Acacia Companies, and Anthony Brown, including without limitation,
all licensing, litigation, and prosecution decisions.’’ Petitioners contend
that the above-referenced provision in the letter agreement mistakenly
uses the term Cooper instead of ‘‘Cooper Parties’’. ‘‘Cooper Parties’’ was de-
fined in the letter agreement to include TLC, while ‘‘Cooper’’ was defined
as J. Carl Cooper (petitioner James C. Cooper).
   Generally, where the terms of a contract are unambiguous, we presume
that the contracting parties intended what they stated and will interpret
the contract as written. See, e.g., Peco Foods, Inc. v. Commissioner, T.C.
Memo. 2012–18, aff ’d, 522 Fed. Appx. 840 (11th Cir. 2013); see also
Canfora v. Coast Hotels & Casinos, Inc., 

, 603 (Nev. 2005)
(holding that when a contract is clear on its face it will be enforced as writ-
ten). As a result, we presume the parties intended what they stated in the
letter agreement and infer that Mr. Cooper (and not TLC) was entitled to
vote on material decisions regarding the IP Innovation assignment agree-
ment and the New Medium and AV Technologies agreements.
   17 Although she was Watonga’s president, Ms. Coulter testified that she

did not know whether Watonga licensed any patents during 2006.
202           143 UNITED STATES TAX COURT REPORTS                       (194)


Watonga retained 20% of all net revenue. 18 Watonga
received $120,000 in gross receipts from the license of the
489 patent in 2007. 19
   The amount of the royalties paid each year to Mr. Cooper
was determined under the TLC agreements by accountants
hired by TLC. Neither Ms. Walters nor Ms. Coulter, who
were the majority shareholders as well as officers and direc-
tors, reviewed and verified the amount of royalties paid to
Mr. Cooper each year. 20 Similarly, neither Ms. Walters nor
Ms. Coulter negotiated the terms of TLC’s agreements to
license the subject patents to other companies. Instead, Ms.
Walters and Ms. Coulter relied on TLC’s attorneys and the
technical expertise of Mr. Cooper with regard to TLC’s
licensing activities. During the years at issue, Ms. Walters
and Ms. Coulter’s duties as directors and officers consisted
largely of signing checks and transferring funds as directed
by TLC’s accountants and signing agreements as directed by
TLC’s attorneys. The only compensation Ms. Walters and Ms.
Coulter received from TLC was director’s fees paid during
some years and long-term care insurance policies purchased
by TLC in 2003. TLC had no employees and paid no com-
pensation to any party.
   We infer from the record and find that substantially all of
TLC’s decisions regarding licensing, patent infringement, and
patent transfers were made either by Mr. Cooper or at his
    18 The remaining 25% of net revenue was payable to Virgil Lowe or his

nominee. Mr. Lowe was the original owner of the Lowe patents. He sold
the Lowe patents to Mr. Cooper in 1995 for $40,000 and 25% of all net
revenue received from any third party in connection with the license of the
patents.
    19 Watonga purportedly paid TLC $72,000 in 2007 with respect to the

489 patent. It is unclear from the record whether such a payment was
made and, if so, pursuant to what agreement the payment was made. Mr.
Cooper testified at trial that he could not recall the details of the payment
and was not sure whether Watonga had a licensing agreement with TLC.
He further testified that the document notating the payment could be in
error or that the payment could be the result of a prior agreement that
was not in the record. In the light of Mr. Cooper’s testimony and our re-
view of the record, we do not find credible the contention that Watonga
paid TLC anything of value with respect to the 489 patent in 2007.
    20 Ms. Coulter testified that her review of the royalties paid annually to

Mr. Cooper consisted solely of reviewing the statement provided by the ac-
countants regarding the amount of royalties to be paid and agreeing with
it.
(194)                COOPER v. COMMISSIONER                         203


direction. We further find that Mr. Cooper controlled TLC in
all material respects. Ms. Coulter and Ms. Walters acted in
their capacities as directors and officers of TLC at the direc-
tion of Mr. Cooper. They did not make independent decisions
in accordance with their fiduciary duties to TLC or act in
their best interests as shareholders.
II. Professional Fees
  During late 2005 and 2006 Mr. Cooper engaged Mike
Holmes of Holmes Development to complete reverse
engineering and related services with respect to the 489
patent (reverse engineering services). The reverse
engineering services included disassembling televisions and
DVD recorders to determine how the products were designed
and manufactured and whether any of the products were
infringing on Mr. Cooper’s patents.
  The invoices for the reverse engineering services were
addressed to Mr. Cooper individually and not to TLC or
Watonga. 21 Yet TLC and Watonga were the principal owners
of the 489 patent during the period when Mr. Holmes com-
pleted the reverse engineering services. Mr. Cooper owned
the 489 patent for only a few days in 2006. He paid Holmes
Development $108,519 in 2006 for the reverse engineering
services.
III. Pixel Instruments/Bad Debt
  Petitioners incorporated Pixel in 1983 for the purpose of
designing and manufacturing audio and video signal proc-
essing products. Specifically, Pixel designed products to
measure and correct errors in the synchronization of sound
and video images. Mr. Cooper was the president of Pixel at
all relevant times. Ms. Cooper held various positions with
Pixel from 1983 to 2004, including the position of vice presi-
dent.
  In September 1995 Pixel executed a working capital
promissory note (promissory note) wherein it promised to pay
to the Cooper Trust all sums advanced to Pixel by the Cooper
  21 Mr. Cooper transferred the 489 patent to TLC in 1997. TLC returned
the 489 patent to Mr. Cooper on January 18, 2006, and Mr. Cooper trans-
ferred the 489 patent to Watonga on January 23, 2006. See supra pp. 201–
202.
204          143 UNITED STATES TAX COURT REPORTS                    (194)


Trust up to $1.5 million. On May 14, 2004, Pixel and the
Cooper Trust amended the promissory note to increase the
maximum loan amount to $2.5 million.
  Until some point in 2006 petitioners wholly owned Pixel.
In 2006 petitioners transferred 76% of their shares in Pixel
to Mirko Vojnovic and Christopher Smith. Mr. Smith was a
longtime consultant to Pixel. He and Mr. Vojnovic owned
22% and 54% of Pixel’s shares, respectively, during the years
at issue. 22 They paid nothing or a de minimis amount for
their shares. However, in conjunction with the Cooper Trust’s
transfer of shares to Mr. Smith and Mr. Vojnovic, Pixel
transferred certain intellectual properties—including its
rights to royalties from the patents Pixel previously licensed
to TLC—to Mr. Cooper.
  When televisions changed from standard definition to high
definition in the mid-to-late 2000s, many of Pixel’s products
became obsolete. In an effort to better compete in the
marketplace, Pixel began developing a product known as
Liptracker to correct lip synchronization errors in high defi-
nition televisions. Between 2005 and 2008 petitioners as co-
trustees of the Cooper Trust advanced funds to Pixel under
the terms of the promissory note. These funds were used in
part to fund the Liptracker program.
  Pixel contracted with an Indian company to complete the
software development necessary for Liptracker. Pixel’s goal
was to have a working and salable Liptracker product for
presentation at the National Association of Broadcasters
convention in April 2008. Unfortunately, the Indian company
could not fulfill its promise to develop the Liptracker soft-
ware, and Pixel was unable to proceed with the development
on its own. Pixel met with representatives from the Indian
company in July 2008 who confirmed the company was aban-
doning its development of the Liptracker software.
  In 2008 Pixel faced financial difficulty. It had no new prod-
ucts in development—aside from the stalled Liptracker
product—and few older products that were still marketable.
Its gross receipts were in excess of $525,000 in both 2005 and
2006 but decreased significantly in 2007 and 2008.
  22 Mr. Vojnovic sold all of his Pixel shares to Mr. Smith in April 2011

for $1.
(194)                 COOPER v. COMMISSIONER                            205


  However, Pixel continued business operations through at
least 2012. It was the assignee of many patents in 2008 and
thereafter and had an active licensing agreement with
TLC. 23 Pixel’s gross receipts were $92,603, $148,968,
$26,912, $22,500, and $22,500 24 for 2008, 2009, 2010, 2011,
and 2012, respectively. Pixel had total yearend assets each
year from 2008 through 2012 in excess of $172,000, including
more than $319,000 in both 2011 and 2012.
  Mr. Cooper continued to advance funds to Pixel under the
terms of the promissory note throughout 2008. On December
31, 2008, the outstanding balance on the promissory note
was $2,046,901. Mr. Cooper concluded at that time that Pixel
could not pay the outstanding balance on the Pixel note, and
petitioners treated the balance as a nonbusiness bad debt on
petitioners’ 2008 Federal income tax return. Petitioners did
not initiate any type of litigation 25 to recover the amounts
they lent Pixel under the terms of the promissory note and
it is unclear from the record what demands, if any, they
made for payment of the outstanding balance.
IV. Petitioners’ Tax Reporting and Notice of Deficiency
   Petitioners jointly filed Forms 1040, U.S. Individual
Income Tax Return, for each of the years at issue. They
reported the royalty payments Mr. Cooper received from TLC
as capital gain on Schedules D, Capital Gains and Losses,
attached to their Forms 1040. The amounts of royalty pay-
ments petitioners reported for 2006, 2007, and 2008 were
$3,248,886, $1,933,010, and $1,597,450, respectively. Peti-
tioners also reported income and expenses from Mr. Cooper’s
patent licensing business on Schedules C attached to their
  23 Pixel was the assignee or assignor on a number of filings with the U.S.
Patent and Trademark Office from 2010 through 2012. Mr. Cooper testi-
fied that these assignments were confirming assignments that had oc-
curred many years before and did not transfer anything new of value to
Pixel. According to Mr. Cooper, these confirmatory assignments were nec-
essary to show proper chain of title.
   24 The gross receipts of $22,500 in 2011 and 2012 consisted of a single

annual trademark royalty that will continue for the foreseeable future.
   25 Mr. Cooper testified that he consulted Attorney Mitch Mitchell, who

had previously represented Mr. Cooper in the Cooper-Leckrone litigation,
regarding pursuing litigation against Pixel for the balance due on the
promissory note. Mr. Cooper claimed that he subsequently determined that
litigation against Pixel would be futile.
206           143 UNITED STATES TAX COURT REPORTS                     (194)


Form 1040 for each of the years at issue. Among the deduc-
tions claimed for 2006 was $108,519 for professional fees
paid to Holmes Development during 2006. Finally, for 2008,
petitioners claimed a bad debt deduction of $2,046,570 on a
Schedule D attached to their Form 1040. This deduction was
for the purportedly uncollectible loan to Pixel under the
terms of the promissory note.
   On April 4, 2012, respondent issued the notice of deficiency
to petitioners. Respondent determined that (1) the royalties
Mr. Cooper received from TLC did not qualify for capital gain
treatment under section 1235 because Mr. Cooper controlled
TLC; (2) petitioners could not deduct certain expenses for the
years at issue; and (3) petitioners were not entitled to a bad
debt deduction under section 166 for the promissory note
because petitioners had not shown that the promissory note
became worthless in 2008.

                                OPINION

I. Burden of Proof
  Ordinarily, the Commissioner’s determinations in a notice
of deficiency are presumed correct, and the taxpayer bears
the burden of proving that the determinations are erroneous.
Rule 142(a); Welch v. Helvering, 

, 115 (1933).
The burden of proof shifts to the Commissioner, however, if
the taxpayer produces credible evidence to support the
deduction or position, the taxpayer complied with any
substantiation requirements, and the taxpayer cooperated
with the Secretary 26 with regard to all reasonable requests
for information. Sec. 7491(a); see also Higbee v. Commis-
sioner, 

, 440–441 (2001).
  Petitioners do not assert nor have they proven that they
are entitled to a shift in the burden of proof under section
7491(a)(1). Accordingly, petitioners bear the burden of proof
with respect to respondent’s deficiency determinations.




  26 The term ‘‘Secretary’’ means the Secretary of the Treasury or his dele-

gate. Sec. 7701(a)(11)(B).
(194)                  COOPER v. COMMISSIONER                              207


II. Section 1235 Gain
  A. Whether a Holder’s Control Over an Unrelated Corporate
     Transferee Defeats Capital Gain Treatment Under Sec-
     tion 1235
  Section 1235(a) provides that a transfer (other than by gift,
inheritance, or devise) of all substantial rights to a patent by
any holder 27 shall be treated as the sale or exchange of a
capital asset held for more than 1 year, regardless of
whether the payments in consideration of such transfer are
contingent on the productivity, use, or disposition of the
property transferred. Thus, in order for the transfer of a
patent to qualify as a sale or exchange, the owner must
transfer ‘‘all substantial rights’’ 28 to the property. See sec.
1235(a); see also Juda v. Commissioner, 

, 1281
(1988), aff ’d, 

(1st Cir. 1989). For purposes of
section 1235, the term ‘‘all substantial rights’’ 29 means ‘‘all
rights * * * which are of value at the time the rights * * *
are transferred.’’ Sec. 1.1235–2(b)(1), Income Tax Regs. 30 The
retention of the right to terminate the transfer at will is the
retention of a substantial right under section 1235. 31 Sec.
   27 The term ‘‘holder’’ includes any individual whose efforts created such

property. Sec. 1235(b)(1).
   28 Generally, an assignment is a transfer of all substantial rights to a

patent, see Juda v. Commissioner, 

, 1078 (1st Cir. 1989),
aff ’g 

(1988), while a license is a transfer of less than all sub-
stantial rights in a patent, see Kueneman v. Commissioner, 

,
613 (1977), aff ’d, 

(9th Cir. 1980).
   29 We have previously stated that transactions between shareholders and

their closely held corporations should be closely scrutinized in determining
whether there has been a transfer of all substantial rights in a patent. See
McDermott v. Commissioner, 

, 59 (1963).
   30 Sec. 1.1235–1(b), Income Tax Regs., provides that if a transfer is not

one described in sec. 1.1235–1(a), Income Tax Regs. (transfer of all sub-
stantial rights to a patent by a holder to a person other than a related per-
son), then sec. 1235 does not apply to determine whether such transfer is
the sale or exchange of a capital asset. In other words, a transfer by a per-
son other than a holder or a transfer by a holder to a related person is
not governed by sec. 1235. Sec. 1.1235–1(b), Income Tax Regs. Instead, the
tax consequences of such transactions are determined under other provi-
sions of the Code. 

not contend that Mr. Cooper is enti-
tled to capital gain treatment under any provisions of the Code (e.g., sec.
1221 or sec. 1231) other than sec. 1235.
   31 In determining whether a transfer of all substantial rights to a patent
                                                 Continued
208          143 UNITED STATES TAX COURT REPORTS                    (194)


1.1235–2(b)(4), Income Tax Regs. Finally, under section
1235(d), transfers between related persons, as defined in sec-
tion 267(b), are not eligible for capital gain treatment, and
for purposes of section 1235, a corporation and an individual
owning 25% or more of the stock of such corporation directly
or indirectly are related persons. Sec. 267(b)(2), (c).
   Respondent does not dispute that (1) the transfer of the
patents to TLC under the TLC agreements was other than
by gift, inheritance, or devise; (2) Mr. Cooper qualified as a
holder of the subject patents; and (3) petitioners owned less
than 25% of TLC for purposes of section 1235(d). However,
respondent contends that Mr. Cooper effectively retained a
right to terminate the transfers under the TLC agreements,
see sec. 1.1235–2(b)(4), Income Tax Regs., because he
indirectly controlled TLC through its directors, officers, and
shareholders. Therefore, respondent contends that Mr.
Cooper did not transfer all substantial rights in the subject
patents and is not entitled to capital gain treatment. Peti-
tioners contend that Mr. Cooper did not control TLC and that
the directors, officers, and shareholders of TLC acted
independently of Mr. Cooper in their corporate decision-
making.
   Neither the Code nor applicable regulations specifically
address whether section 1235 applies to transfers to a cor-
poration that is not related to the holder but is indirectly
controlled by the holder. Whether a holder’s control over a
corporate transferee that is unrelated (within the meaning of
section 1235(d)) defeats capital gain treatment appears to be
an issue of first impression for this Court. However, the
Court of Claims 32 in Charlson v. United States, 525 F.2d

has occurred, the language of the transfer agreement is not controlling.
Sec. 1.1235–2(b)(1), Income Tax Regs. Instead, the entire agreement and
the form of the transaction must be examined to see if all substantial
rights were transferred. See Juda v. 

.
  32 The Federal Courts Improvement Act of 1982, Pub. L. No. 97–164, 96

Stat. 25, merged the United States Court of Claims into the newly created
Court of Appeals for the Federal Circuit and, in effect, reconstituted
the trial division of the Court of Claims into a newly created
United States Claims Court, a so-called Article I court. Subsequently,
the United States Claims Court was renamed the United States Court of
Federal Claims. Federal Courts Administration Act of 1992, Pub. L. No.
102–572, sec. 902(a)(1), 106 Stat. at 4516.
(194)                 COOPER v. COMMISSIONER                           209


1046, 1053 (Ct. Cl. 1975), 33 considered this issue and con-
cluded that such control could prohibit the transfer of
substantially all rights in a patent and therefore preclude
capital gain treatment under section 1235.
   The Court of Claims in Charlson examined the legislative
history of section 1235 and stated that ‘‘it is * * * clear that
retention of control by a holder over an unrelated corporation
can defeat capital gains treatment, if the retention prevents
the transfer of ‘all substantial rights.’ ’’ 

sup-
ported its conclusion by reasoning that the holder’s control
over the unrelated corporation ‘‘places him in essentially the
same position as if all substantial rights had not been trans-
ferred.’’ 

found further support for its reasoning
in the legislative history of section 1235, noting that a court
should closely examine all of the facts and circumstances of
transactions under section 1235 and not rely solely on the
terms of the transfer agreement to determine whether the
owner transferred substantially all rights in the patent to the
transferee. See 

Rept. No. 83–1622, at 439–440
(1954), 1954 U.S.C.C.A.N. 4621, 5083).
   We agree that retention of control places the holder in
essentially the same position as if the patent had not been
transferred, thereby precluding the application of section
1235. See 

agree that Congress intended for a
‘‘transferor’s acts to speak louder than his words in estab-
lishing whether a sale of a patent has occurred’’. 

we hold that retention of control by a holder over an
unrelated corporation can defeat capital gain treatment
under section 1235 because the retention prevents the
transfer of ‘‘all substantial rights’’ in the patent.
  B. Whether Mr. Cooper Retained Control Over TLC and
     Therefore Did Not Transfer All Substantial Rights
     in the Subject Patents to TLC
 Petitioners rely on the facts regarding control in Lee v.
United States, 

(E.D. Wis. 1969), and
Charlson to support their contention that the directors, offi-
  33 InCharlson v. United States, 

(Ct. Cl. 1975), the Court
of Claims found that on the facts of that case the taxpayer did not control
the transferee corporation and thus the taxpayer was not precluded from
claiming capital gain treatment under sec. 1235. See infra pp. 210–211.
210           143 UNITED STATES TAX COURT REPORTS                        (194)


cers, and shareholders of TLC acted independently of Mr.
Cooper in their corporate decisionmaking and that they are
entitled to capital gain treatment under section 1235. We dis-
agree because the facts regarding control in Lee and
Charlson are distinguishable from the facts regarding control
in this case. Here, the facts support our finding that Mr.
Cooper indirectly controlled TLC. We explain below.
   In Lee, the taxpayer transferred patents to Lee Custom
Engineering, Inc. (Lee Engineering), a closely held corpora-
tion. The three shareholders of Lee Engineering were unre-
lated but were all friends. The taxpayer owned 24% of the
outstanding stock of Lee Engineering. The Government
argued that the taxpayer had not transferred all substantial
rights in his patents because he controlled Lee Engineering—
the exclusive licensee of the patents. Therefore, the Govern-
ment argued that the taxpayer did not effectively transfer his
patents under section 1235. 34 The District Court rejected the
Government’s contentions, stating among other things, that
there was ‘‘no evidence presented which suggested * * * [the
taxpayer] was * * * able to force the other stockholders or
directors to do his bidding.’’ 

.
   In Charlson, the taxpayer transferred an exclusive license
to Germane Corp. (Germane) to use, manufacture, and sell
items incorporating his patents in exchange for 80% of the
royalties that Germane received from licensing the patents to
others. Germane was formed for the specific purpose of pur-
chasing and licensing the taxpayer’s patents, and the share-
holders and directors of Germane were all trusted business
associates, friends, and employees of the taxpayer.
   The taxpayer treated the royalties he received from Ger-
mane as capital gain under section 1235. The Government
argued that the taxpayer had not transferred all substantial
  34 The court in Lee interpreted the Government’s argument to be that no

transfer had occurred under sec. 1235 because the purported transfer was
between parties within the same economic group. Lee v. United States, 

, 950 (E.D. Wis. 1969). The court rejected the Government’s
argument because it reasoned that under sec. 1235(d) Congress considered
transfers within the same economic group to be ‘‘transfers to a corporation
in which 25% or more of the outstanding stock was owned by the trans-
feror. Congress did not at any point in the legislative history of this section
indicate an intent to prohibit as a matter of course transfers to a closed
corporation.’’ 

v. COMMISSIONER                     211


rights in the patents to Germane because he controlled Ger-
mane. In effect, the Government argued that the taxpayer
had a tacit understanding with Germane that he would have
final veto over any license agreement that Germane made
with respect to his patents.
   The court found that although the relationships among the
taxpayer, Germane, and the shareholders made more prob-
able the existence of prohibited retained control, the evidence
did not establish that the taxpayer was able to exercise such
control over Germane. 

. Instead,
the court found that Germane exercised its rights in the pat-
ents according to its own discretion even though it frequently
sought, received, and followed the taxpayer’s advice. 

   The court noted, among other things, that the shareholders
in Germane all had skills valuable to a small patent
licensing company. 

These skills included legal,
engineering, design, and business expertise. 

court found that although the taxpayer was present in many
of Germane’s licensing negotiations, this was mutually bene-
ficial to both parties since it would potentially lead to higher
royalties. Moreover, there was no evidence that the tax-
payer—and not Germane—decided the terms of the licensing
agreements. Finally, although the taxpayer participated as a
joint plaintiff with Germane in patent infringement actions,
there was no evidence that the taxpayer controlled or
directed the details of the litigation. 

In short, the
court rejected the Government’s position that the taxpayer
controlled the operation of Germane. As a result, the court
held that the taxpayer had transferred all substantial rights
in his patents to Germane—entitling him to capital gain
treatment under section 1235. 

   By contrast, TLC did not exercise its rights in the subject
patents according to its own discretion. Both Lee and
Charlson are distinguishable because the taxpayers in those
cases did not control the transferee corporations. Here, Mr.
Cooper—troubled by his deteriorated business relationship
with Mr. Leckrone—formed TLC with individuals he could
trust and ultimately control. Ms. Coulter and Ms. Walters—
the shareholders and directors of TLC (along with Ms.
Cooper)—did not have the patent, engineering, or other such
skills to make them particularly valuable to a small patent
212           143 UNITED STATES TAX COURT REPORTS                      (194)


licensing company. Instead, they were individuals whom Mr.
Cooper could trust to follow his direction on patent licensing
issues. Indeed, Ms. Coulter testified that the technical nego-
tiations regarding licensing and patent infringement were
over her head and she deferred to Mr. Cooper on such issues.
She further testified that she signed licensing and infringe-
ment agreements when directed to do so by TLC’s attorneys
and signed checks and transferred funds when directed to do
so by TLC’s accountants.
   As officers and directors of TLC, Ms. Coulter and Ms. Wal-
ters took numerous actions that are inconsistent with acting
independently and in the best interest of the corporation.
Among other things, Ms. Coulter and Ms. Walters approved
TLC’s transfer of potentially valuable patents to Mr. Cooper
for no consideration. At least in one instance, Mr. Cooper
almost immediately licensed one of these patents to another
related corporation for which that corporation received a roy-
alty of $120,000 in 2007. As shareholders Ms. Coulter and
Ms. Walters signed a stock restriction agreement placing
restrictions on their ability to transfer shares of stock in TLC
to anyone other than petitioners, without receiving any
consideration in exchange. The stock restriction agreement
did not place similar restrictions on petitioners.
   Indeed, it is unclear what material decisions, if any, the
officers and directors of TLC made independent of Mr.
Cooper. 35 Mr. Cooper—and not the officers or directors of
TLC—provided technical assistance to the Niro firm in inter-
preting the subject patents and relevant technology and in
formulating patent enforcement strategies. Mr. Cooper con-
ducted all technical matters for TLC—which in substance
was all or a large part of TLC’s activities. Furthermore, in
his role as general manager of TLC and under the terms of
the letter agreement, Mr. Cooper made all material decisions
for TLC with respect to the IP Innovation assignment agree-
ment and the New Medium and AV Technologies agree-
ments.
  35 Ms. Coulter testified that she often followed the advice of TLC’s attor-
neys, but she did not know who at TLC was directing TLC’s attorneys. We
infer from the record and find that TLC’s attorneys drafted licensing
agreements and patent infringement agreements largely at the direction of
Mr. Cooper.
(194)                 COOPER v. COMMISSIONER                           213


  We do not find credible any testimony by petitioners that
TLC was an independent corporation that Mr. Cooper did not
control. We conclude that petitioners have failed to meet
their burden of establishing that they transferred all
substantial rights in the subject patents to TLC pursuant to
section 1235(a). See Rule 142(a). Accordingly, we sustain
respondent’s determination that petitioners’ royalty income
for 2006, 2007, and 2008 did not qualify for capital gain
treatment under section 1235(a).
III. Professional Fees
   Generally, a taxpayer is entitled to deduct ordinary and
necessary expenses paid or incurred in carrying on a trade
or business. See sec. 162(a); Am. Stores Co. v. Commissioner,

, 468 (2000). 36 An expense is ordinary if it is
customary or usual within the particular trade, business, or
industry or if it relates to a transaction ‘‘of common or fre-
quent occurrence in the type of business involved.’’ Deputy v.
du Pont, 

, 495 (1940). An expense is necessary
if it is appropriate and helpful for the development of the
business. See Commissioner v. Heininger, 

, 471
(1943). To be deductible, ordinary and necessary expenses
must be ‘‘directly connected with or pertaining to the tax-
payer’s trade or business’’. Sec. 1.162–1(a), Income Tax Regs.
Deductions are a matter of legislative grace, and a taxpayer
must prove that he is entitled to the deductions he claims.
INDOPCO, Inc. v. Commissioner, 

, 84 (1992).
   Generally, a taxpayer who pays another taxpayer’s busi-
ness expenses may not treat those payments as ordinary and
necessary expenses incurred in the payor’s trade or business.
See Deputy v. du 

–495; Columbian Rope
Co. v. Commissioner, 

, 815 (1964). An exception
exists for cases in which the taxpayer paid another tax-
payer’s ordinary and necessary business expenses in order to
‘‘protect or promote’’ the taxpayer’s own business. See, e.g.,
Scruggs-Vandervoort-Barney, Inc. v. Commissioner, 

Additionally, sec. 212 generally allows a taxpayer to deduct the ordi-
nary and necessary expenses paid or incurred during the taxable year for
the production or collection of income. Such expenses must be reasonable
in amount and bear a proximate relationship to the production or collec-
tion of taxable income. Sec. 1.212–1(d), Income Tax Regs.
214        143 UNITED STATES TAX COURT REPORTS             (194)


779, 787 (1946). In Lohrke v. Commissioner, 

, 688
(1967), we articulated a two-part test for determining
whether a taxpayer’s payments are eligible for this exception:
(1) the taxpayer’s primary motive for paying the expenses
was to protect or promote the taxpayer’s business and (2) the
expenditures constituted ordinary and necessary expenses in
the furtherance or promotion of the taxpayer’s business.
   Under the Lohrke test, we must first ‘‘ascertain the pur-
pose or motive which cause[d] the taxpayer to pay the obliga-
tions of the other person.’’ 

this prong, Mr.
Cooper’s purpose in paying the Holmes Development
expenses must have been for the benefit of his business as
an inventor. We ‘‘must then judge whether it is an ordinary
and necessary expense of the * * * [taxpayer’s] trade or
business; that is, is it an appropriate expenditure for the fur-
therance or promotion of that trade or business? If so, the
expense is deductible by the individual paying it.’’ 

a deduction of $108,519 in 2006 for
professional fees paid to Mr. Holmes for reverse engineering
services. Respondent disallowed this deduction in its
entirety. Respondent contends that these expenses are prop-
erly chargeable to Watonga or TLC and are not Mr. Cooper’s
ordinary and necessary business expenses. Petitioners con-
tend that these expenses are the ordinary and necessary
expenses of Mr. Cooper’s business as an inventor. Alter-
natively, petitioners contend that even if we find that the
expenses are properly chargeable to Watonga or TLC, peti-
tioners are still entitled to deduct the expenses.
   Mr. Holmes’ reverse engineering services included the dis-
assembling of televisions and DVD recorders to determine
how the products were designed and manufactured and
whether any of the products infringed on Mr. Cooper’s pat-
ents. The invoices for the reverse engineering expenses
indicated that the services were completed with respect to
the 489 patent. However, Mr. Cooper testified that most of
these expenses were unrelated to the 489 patent. For
example, according to Mr. Cooper, the reverse engineering
services included the reverse engineering of plasma tele-
visions that use random dithering and not coherent
dithering—the subject of the 489 patent. Regardless, peti-
tioners stipulated that the reverse engineering expenses were
(194)                  COOPER v. COMMISSIONER                              215


for services performed with respect to the 489 patent. 37 Peti-
tioners are bound by their stipulation. See, e.g., Dorchester
Indus., Inc. v. Commissioner, 

, 330 (1997), aff ’d
without published opinion, 

(3d Cir. 2000); see
also Rule 91(e). Because TLC and Watonga, as applicable,
owned the 489 patent during the period in which Mr. Holmes
completed his services, see supra pp. 201–202, we conclude
that the reverse engineering expenses were the ordinary and
necessary business expenses of TLC and Watonga. Neverthe-
less, because petitioners paid the reverse engineering
expenses for TLC and Watonga, they still may be entitled to
deduct the expenses under Lohrke v. 

.
   Respondent does not dispute that Mr. Cooper was in the
trade or business of patent commercialization and being an
inventor during the years at issue. Mr. Cooper testified that
he had a long-term working relationship with Mr. Holmes.
The Holmes Development invoices, while referencing that the
services were completed with respect to the 489 patent, also
list Mr. Cooper as the obligor and account holder. Thus, it
appears Holmes Development understood its client relation-
ship to be with Mr. Cooper individually and not with
Watonga or TLC. 38 We find credible Mr. Cooper’s testimony
that Holmes Development’s business relationship was with
him personally, that Holmes Development trusted Mr.
Cooper to pay for the services completed, and that non-
payment of the Holmes Development expenses would have
adversely affected Mr. Cooper’s business reputation. See, e.g.,
   37 The parties filed a stipulation of settled issues on June 10, 2013, stat-

ing that ‘‘[t]he legal and professional services expenses not allowed by re-
spondent for taxable year 2006 in the amount of $108,518.60 are attrib-
utable to expenses charged by Holmes Development for works performed
by Holmes Development during the period from December 15, 2005
through November 30, 2006 with respect to U.S. Patent # 5,157,489.’’
   38 The Holmes Development invoices further support our conclusion that

Mr. Cooper controlled TLC and his portfolio of patents. See supra p. 212.
Although Mr. Cooper purportedly transferred all substantial rights in the
489 patent to TLC and Watonga, Holmes Development understood its rela-
tionship to be with Mr. Cooper individually. We do not believe that Holmes
Development would have considered its business relationship to be with
Mr. Cooper if TLC and Watonga, as applicable, owned all substantial
rights in the 489 patent and TLC and Watonga functioned as independent
corporations.
216          143 UNITED STATES TAX COURT REPORTS                      (194)


Jenkins v. Commissioner, T.C. Memo. 1983–667. Further-
more, Holmes Development’s work on the 489 patent owned
by Watonga had the potential to directly benefit Mr. Cooper’s
trade or business as an inventor because Mr. Cooper stood to
receive 55% of Watonga’s net revenue. Accordingly, we con-
clude that Mr. Cooper’s payment of the reverse engineering
expenses was for the benefit of his trade or business as an
inventor and his ongoing relationship with Holmes Develop-
ment. Therefore, petitioners have satisfied the first part of
Lohrke’s two-part test. See Lohrke v. 

.
   Mr. Cooper further testified that the services performed by
Holmes Development were necessary in his trade or business
to keep him apprised of current developments and current
engineering practices for audio and video technology. He fur-
ther testified that the services performed by Holmes Develop-
ment helped him ascertain whether certain products
infringed on any patents that he had developed and commer-
cialized. We conclude that the reverse engineering expenses
were proximately related to Mr. Cooper’s business as an
inventor and their payment by him was ordinary and nec-
essary. See 

Accordingly, we conclude that peti-
tioners have satisfied the second part of the Lohrke test, see

are entitled to deduct the reverse engineering
expenses.
IV. Bad Debt
   Section 166 authorizes a taxpayer to deduct any debt that
becomes worthless within the taxable year. Section 166
distinguishes between business and nonbusiness bad debts.
Nonbusiness bad debts are treated as losses resulting from
the sale or exchange of a short-term capital asset. 39 Secs.
166(d)(1), 1211(b), 1212(b). A nonbusiness debt is a debt
other than ‘‘(A) a debt created or acquired (as the case may
be) in connection with a trade or business of the taxpayer;
or (B) a debt the loss from the worthlessness of which is
incurred in the taxpayer’s trade or business.’’ Sec. 166(d)(2).
‘‘To qualify for a deduction for a worthless debt a taxpayer
  39 A business bad debt is deductible as an ordinary loss to the extent of

the taxpayer’s adjusted basis in the debt. Sec. 166(b). Petitioners do not
contend that the loan to Pixel is deductible as a business bad debt.
(194)             COOPER v. COMMISSIONER                    217


must show that he and his alleged debtor intended to create
a debtor-creditor relationship, that a genuine debt in fact
existed, and that the debt became worthless within the tax
year.’’ Andrew v. Commissioner, 

, 244–245 (1970);
see also sec. 1.166–1(c), Income Tax Regs. ‘‘The year a debt
becomes worthless is fixed by identifiable events that form
the basis of reasonable grounds for abandoning any hope of
recovery.’’ Aston v. Commissioner, 

, 415 (1997).
   The question of whether a debt became worthless during
a taxable year is determined on the basis of all the facts and
circumstances. See, e.g., Halliburton Co. v. Commissioner, 

, 774 (1989), aff ’d, 

(5th Cir. 1991).
‘‘Specifically, * * * [a taxpayer] must prove that the debt
had value at the beginning of the taxable year and that it
became worthless during that year.’’ Milenbach v. Commis-
sioner, 

, 204 (1996), aff ’d in part, rev’d in part
on other grounds, 

(9th Cir. 2003). The taxpayer
‘‘must show sufficient objective facts from which worthless-
ness could be concluded; mere belief of worthlessness is not
sufficient.’’ Fincher v. Commissioner, 

, 138
(1995). Furthermore, legal action is not required to show
worthlessness if surrounding circumstances indicate that a
debt is worthless and uncollectible and that any legal action
in all likelihood would be futile because the debtor would not
be able to satisfy a favorable judgment. Sec. 1.166–2(b),
Income Tax Regs.
   A debt is not worthless for purposes of a section 166 deduc-
tion merely because it might be difficult, or uncomfortable, to
collect. See Reading & Bates Corp. v. United States, 40 Fed.
Cl. 737, 757 (1998). A creditor’s determination that there is
no hope of recovery of a debt due and owing must be made
in the exercise of sound business judgment and must be
based upon information that is as complete as is reasonably
obtainable regarding the debtor’s financial condition or
ability to satisfy the debt. See Andrew v. Commissioner, 

.
   An analysis regarding the deductibility of a bad debt must
examine whether the debt was truly worthless, and if so,
when it became worthless. The conclusions depend on the
particular facts and circumstances of the case, and there is
no bright-line test or formula for determining worthlessness
within a given taxable year. Lucas v. Am. Code Co., 

        143 UNITED STATES TAX COURT REPORTS             (194)


445, 449 (1930). To be worthless, a debt must not only be
lacking current value and be uncollectible at the time the
taxpayer takes the deduction, but it must also be lacking
potential value due to the likelihood that it will remain
uncollectible in the future. Dustin v. Commissioner, 

, 501 (1969), aff ’d, 

(9th Cir. 1972); see also
Fox v. Commissioner, 

, 822 (1968) (‘‘Mere belief
that a debt is bad is insufficient to support a deduction for
worthlessness’’). The fact that a business is on the decline,
that it has failed to turn a profit, or that its debt obligation
may be difficult to collect does not necessarily justify treating
the debt obligation as worthless. Intergraph Corp. & Subs. v.
Commissioner, 

, 323 (1996), aff ’d without pub-
lished opinion, 

(11th Cir. 1997). This is espe-
cially true where the debtor continues to be a going concern
with the potential to earn a future profit. See Rendall v.
Commissioner, 

, 1228 (10th Cir. 2008) (citing
Roth Steel Tube Co. v. Commissioner, 

, 1182
(6th Cir. 1980), aff ’g 

(1977)), aff ’g T.C. Memo.
2006–174; ABC Beverage Corp. v. Commissioner, T.C. Memo.
2006–195.
   Petitioners contend that the promissory note became
worthless in 2008 following the Indian company’s abandon-
ment of the Liptracker program. This action, according to
petitioners, gave rise to the conclusion that there was no
hope of recovering the outstanding amounts under the
promissory note. We disagree.
   Pixel had total yearend assets each year from 2008
through 2012 in excess of $172,000, including more than
$319,000 in assets in 2011 and 2012. It appears to us that
Pixel remained a going concern well past 2008. The outcome
of Pixel’s arrangement with the Indian company and the
failure of the Liptracker program do not support petitioners’
claim that there was no longer any prospect of recovery of
their loans to Pixel. More importantly, the proper inquiry in
this case is not whether petitioners acted reasonably in their
recovery efforts, but whether sufficient objective facts show
that the debt became worthless during the year in question.
Here, the facts do not support such a determination.
   Pixel experienced a decline in its business in 2008, but its
gross receipts increased in 2009. Petitioners as cotrustees of
the Cooper Trust continued to advance funds to Pixel under
(194)                  COOPER v. COMMISSIONER                             219


the terms of the promissory note throughout 2008. Indeed,
petitioners advanced $148,255 to Pixel under the terms of
the promissory note between July and December 2008. We do
not find it credible that petitioners would have advanced
nearly $150,000 to Pixel after July 2008 if they believed the
promissory note had been rendered worthless in July 2008 by
the difficulties with the Liptracker program. 40 The evidence
shows that Pixel had substantial assets at the end of the
2008 tax year and that its gross receipts increased in 2009.
Moreover, at the very least, Pixel was entitled to an indefi-
nitely continuing annual royalty of $22,500 and owned rights
in several other patents.
   Mr. Cooper claimed that he consulted with Mr. Mitchell
and they determined that filing a lawsuit against Pixel
would be futile. Mr. Cooper then concluded that the promis-
sory note was worthless. But petitioners failed to introduce
evidence proving what information Mr. Mitchell analyzed to
determine that litigation against Pixel would be futile and
failed to introduce evidence proving the basis on which Mr.
Mitchell made his purported conclusion. Petitioners have
failed to satisfy their burden of proving that no prospect of
recovery existed in 2008 and failed to prove that the promis-
sory note became worthless in 2008. 41 See Rule 142(a).
Accordingly, we sustain respondent’s disallowance of peti-
tioners’ bad debt deduction for 2008.
V. Accuracy-Related Penalties
  A. Introduction
  Section 6662 authorizes the imposition of a 20% penalty on
the portion of an underpayment of tax that is attributable to,
among other things, (1) negligence or disregard of rules or
regulations or (2) any substantial understatement of income
tax. Sec. 6662(a) and (b)(1) and (2). Only one accuracy-
  40 Generally,  advances made to an insolvent debtor are not debts for tax
purposes but are characterized as capital contributions or gifts. See Dixie
Dairies Corp. v. Commissioner, 

, 497 (1980); Davis v. Commis-
sioner, 

, 835–836 (1978). Furthermore, advances made by an
investor to a closely held or controlled corporation may properly be charac-
terized not as a bona fide loan but as a capital contribution. See Fin Hay
Realty Co. v. United States, 

, 697 (3d Cir. 1968).
  41 Pixel’s liabilities to petitioners under the terms of the promissory note

constituted substantially all of Pixel’s liabilities in 2008.
220        143 UNITED STATES TAX COURT REPORTS               (194)


related penalty may be imposed with respect to any given
portion of an underpayment, even if that portion is attrib-
utable to more than one of the reasons identified in section
6662(b). Sec. 1.6662–2(c), Income Tax Regs.
  The Commissioner bears the initial burden of production
with respect to the taxpayer’s liability for the section 6662
penalty. Sec. 7491(c). The Commissioner must introduce
sufficient evidence ‘‘indicating that it is appropriate to
impose the relevant penalty.’’ Higbee v. Commissioner, 

. Once the Commissioner meets his burden of
production, the taxpayer must come forward with persuasive
evidence that the Commissioner’s determination is incorrect
or that the taxpayer had reasonable cause or substantial
authority for the position. 

  B. Petitioners’ Liability for the Section 6662 Penalties
  1. Substantial Understatement of Income Tax
   A substantial understatement of income tax exists if the
amount of the understatement exceeds the greater of 10% of
the tax required to be shown on the return or $5,000. Sec.
6662(d)(1)(A). The term ‘‘understatement’’ means the excess
of the amount of tax required to be shown on the return for
the taxable year over the amount of tax imposed that is
shown on the return, reduced by any rebate. Sec.
6662(d)(2)(A). The amount of the understatement is reduced
by that portion of the understatement that is attributable to
(1) the tax treatment of any item if there is or was substan-
tial authority for such treatment or (2) any item if the rel-
evant facts affecting the item’s tax treatment are adequately
disclosed in the return or in a statement attached to the
return and there is a reasonable basis for the taxpayer’s
treatment of the item. Sec. 6662(d)(2)(B).
   Respondent has introduced sufficient evidence to dem-
onstrate that petitioners have substantially understated
their income tax liability for each of the years at issue. Peti-
tioners have not alleged nor have they proven that they had
substantial authority for all or any portion of the understate-
ments or that they adequately disclosed their tax positions
on their returns. Accordingly, if the Rule 155 computations
confirm a substantial understatement, petitioners are liable
(194)              COOPER v. COMMISSIONER                     221


for the section 6662(a) underpayment penalty for a substan-
tial understatement of income tax.
  2. Negligence or Disregard of Rules or Regulations
   The term ‘‘negligence’’ includes any failure to make a
reasonable attempt to comply with the provisions of the
internal revenue laws, and the term ‘‘disregard’’ includes any
careless, reckless, or intentional disregard. Sec. 6662(c); sec.
1.6662–3(b)(1) and (2), Income Tax Regs. Negligence is
strongly indicated where a taxpayer fails to make a reason-
able attempt to ascertain the correctness of a deduction,
credit, or exclusion on a return that would seem to a reason-
able and prudent person to be ‘‘too good to be true’’ under the
circumstances. Sec. 1.6662–3(b)(1)(ii), Income Tax Regs. Dis-
regard of rules or regulations ‘‘is ‘careless’ if the taxpayer
does not exercise reasonable diligence to determine the
correctness of a return position’’ and ‘‘is ‘reckless’ if the tax-
payer makes little or no effort to determine whether a rule
or regulation exists, under circumstances which demonstrate
a substantial deviation from the standard of conduct that a
reasonable person would observe.’’ Sec. 1.6662–3(b)(2),
Income Tax Regs.; see also Neely v. Commissioner, 

, 947 (1985).
   Respondent has met his burden to show that petitioners
acted negligently or with careless disregard of rules and
regulations with respect to the royalty payments Mr. Cooper
received from TLC and with respect to the bad debt deduc-
tion for the promissory note. We have found that Mr. Cooper
did not transfer all substantial rights to TLC within the
meaning of section 1235 because Mr. Cooper indirectly con-
trolled TLC. Further, we have found that the promissory
note did not become worthless in 2008 and therefore peti-
tioners were not entitled to claim a bad debt deduction for
the promissory note on their 2008 return. Petitioners
reported the royalty payments from TLC as capital gain
without considering how Mr. Cooper’s involvement with TLC
affected their qualification for capital gain treatment under
section 1235. Similarly, petitioners reported the promissory
note as a bad debt on their 2008 return without reasonably
attempting to collect the debt and without identifying specific
events that made recovery of the debt futile in the future. We
conclude that petitioners did not make a reasonable attempt
222        143 UNITED STATES TAX COURT REPORTS             (194)


to ascertain the correctness of their bad debt deduction for
2008 or their right to treat the royalty payments received
from TLC as capital gain.
  C. Petitioners’ Reasonable Cause/Good Faith Defense
   Taxpayers may avoid liability for the section 6662 penalty
if they demonstrate that they had reasonable cause for the
underpayment and that they acted in good faith with respect
to the underpayment. Sec. 6664(c)(1). Reasonable cause and
good faith are determined on a case-by-case basis, taking into
account all pertinent facts and circumstances. Sec. 1.6664–
4(b)(1), Income Tax Regs. The most important factor is the
extent of the taxpayer’s efforts to assess his or her proper tax
liability. 

professional advice may constitute
reasonable cause and good faith, but ‘‘it must be established
that the reliance was reasonable.’’ Freytag v. Commissioner,

, 888 (1987), aff ’d on another issue, 

(5th Cir. 1990), aff ’d, 

(1991). We have pre-
viously held that the taxpayer must satisfy a three-prong
test to be found to have reasonably relied on professional
advice to negate a section 6662(a) accuracy-related penalty:
(1) the adviser was a competent professional who had suffi-
cient experience to justify the reliance; (2) the taxpayer pro-
vided necessary and accurate information to the adviser; and
(3) the taxpayer actually relied in good faith on the adviser’s
judgment. Neonatology Assocs., P.A. v. Commissioner, 

, 99 (2000), aff ’d, 

(3d Cir. 2002).
   Petitioners contend that they acted with reasonable cause
and good faith based on their reliance on professional advice
and therefore no section 6662(a) accuracy-related penalty is
applicable. With regard to the royalty payments Mr. Cooper
received from TLC, petitioners contend they sought the
advice of Mr. Baker, a tax attorney and competent profes-
sional. With regard to their bad debt deduction, petitioners
contend they sought and relied on the advice of Mr. Baker
and Mr. Mitchell. Petitioners contend that they provided Mr.
Baker and Mr. Mitchell with all necessary and accurate
information, and that they reasonably relied in good faith on
Mr. Baker and Mr. Mitchell’s advice. See Freytag v. Commis-
sioner, 

.
   Mr. Baker testified with respect to the royalty payments
and petitioners’ compliance with section 1235 that he advised
(194)             COOPER v. COMMISSIONER                    223


petitioners that Mr. Cooper could not indirectly control TLC.
Moreover, Mr. Baker did not provide advice to petitioners
before they filed their Forms 1040 for the years at issue, nor
did he provide advice to petitioners regarding whether Mr.
Cooper controlled TLC following TLC’s incorporation. Peti-
tioners did not follow Mr. Baker’s advice to ensure that Mr.
Cooper did not indirectly control TLC. Consequently, peti-
tioners cannot claim reliance on the professional advice of
Mr. Baker to negate the section 6662(a) penalty with respect
to their erroneous capital gain treatment of the royalty pay-
ments Mr. Cooper received during the years at issue.
   With regard to the bad debt deduction, petitioners have
failed to introduce evidence regarding what information they
provided to Mr. Baker and Mr. Mitchell to enable them to
determine whether the promissory note was worthless within
the meaning of section 166 in 2008. Petitioners did not call
Mr. Mitchell to testify or otherwise introduce any evidence
regarding Mr. Mitchell’s advice. Similarly, Mr. Baker did not
testify regarding any advice he may have given to petitioners
that would indicate that it was his opinion that the promis-
sory note became worthless in 2008. In short, petitioners
have failed to prove that they received or relied on the
professional advice of Mr. Baker and Mr. Mitchell with
respect to their erroneous section 166 bad debt deduction in
2008.
   Because respondent has met his initial burden of produc-
tion under section 7491(c) with respect to the section 6662(a)
penalty for each of the years at issue and petitioners have
failed to prove either that they are not liable for the pen-
alties or that they had reasonable cause and acted in good
faith, we conclude that respondent properly determined that
petitioners are liable for the penalties. Accordingly, if the
Rule 155 computations show that the understatement of tax
exceeds the greater of 10% of the tax required to be shown
on the return or $5,000, see sec. 6662(d)(1)(A), then peti-
tioners are liable for the section 6662(a) penalty for an
underpayment of tax attributable to a substantial under-
statement of income tax for each of the years at issue. Alter-
natively, petitioners are liable for the section 6662(a) penalty
for negligence or disregard of rules and regulations with
respect to the royalty payments and the section 166 bad debt
deduction.
224        143 UNITED STATES TAX COURT REPORTS           (194)


  We have considered the remaining arguments made by the
parties and, to the extent not discussed above, conclude those
arguments are irrelevant, moot, or without merit.
  To reflect the parties’ concessions and the foregoing,
                     Decision will be entered under Rule 155.

                        f