UNITED STATES TAX COURT

137 T. C. No.

5

UNITED STATES TAX COURT

ROBERT AND KIMBERLY BROZ, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 21629-06.

Filed September 1, 2011.

Ps were shareholders in a wholly owned S

corporation (S) engaged in providing wireless cellular

service. S acquired wireless cellular licenses from

the FCC and built networks to service the license

areas.

S never operated any on-air networks. Instead,

P formed related holding companies to hold title to the

licenses and equipment. Many issues raised questions

of first impression because transactions were

structured in this ever-changing technology industry.

Our holdings on these issues include:

1.

Held:

Ps were not sufficiently at risk for

sec. 465, I.R.C., purposes when stock of a related

corporation was pledged.

2.

Held, further, the mere grant of a license by

the FCC is not sufficient for an activity to qualify as

an active trade or business under sec. 197, I.R.C.

SERVED £ER

1 2011

- 2 -

Stephen M. Feldman and Eric T. Weiss, for petitioners.

Meso T. Hammoud, Elizabeth Rebecca Edberg, and Steven G.

Cappellino, for respondent.

KROUPA, Judge:

Respondent determined over $16 million of

deficiencies1 in petitioners' Federal income tax for 1996, 1998,

1999, 2000 and 2001 (years at issue).

Respondent also determined

that petitioners were liable for accuracy-related penalties of

$563,042 for 1998,

$386,489 for 1999,

and $591,213 for 2000.

After concessions,2 we are asked to decide several issues,

many of which present questions of first impression as they

relate to the ever-evolving cellular phone industry.

We must

first decide a procedural issue, whether respondent is bound by

equitable estoppel to a settlement offer made and subsequently

withdrawn by respondent's Appeals Office before the deficiency

notice was issued.

We find that respondent'is not bound by the

settlement offer.

Second, we must decide whether petitioners

properly allocated $2.5 million of the $7.2 million purchase

1Respondent determined a $100,003 deficiency for 1996, a

$4,671,608 deficiency for 1998, a $3,385,533 deficiency for 1999,

a $4,954,056 deficiency for 2000, and $3,395,214 for 2001.

2Petitioners concede that the amortization period for the

license acquired as part of the Michigan 2 acquisition should be

15 years and that the Schedule M-1 adjustment should be

disallowed. Respondent concedes a sec. 1231 adjustment and all

penalties set forth in the deficiency notice. Respondent also

concedes that petitioners are entitled to recapture for 1998

$3,548,365 of losses Alpine claimed in earlier years.

- 3 price to depreciable equipment when the allocation in the

purchase agreement remained unchanged despite a 2-year delay in

closing the transaction.

was improper.

We find that petitioners' allocation

Third, we must determine whether petitioners had

sufficient debt basis under section 1366 in stock of Alpine PCS,

Inc.

(Alpine), an S corporation, to claim flowthrough losses.

We

find that petitioners had insufficient debt basis, and therefore

cannot claim the flowthrough losses.

Fourth, we must determine

whether petitioners were at risk under section 4653 and can

therefore claim flowthrough losses from Alpine and related

holding companies.

We must decide whether petitioners' pledge of

stock in a related S corporation is excluded from the at-risk

amount because it was "property used in the business."

issue presents a question of first impression.

This

We find that

petitioners were not sufficiently at risk and therefore cannot

claim the flowthrough losses because the stock they pledged was

related to the business.

Fifth, we must decide whether Alpine

and Alpine PCS-Operating, LLC (Alpine Operating), an equipment

holding company, were engaged in an active trade or business

permitting them to deduct business expenses.

We find that

neither entity was engaged in an active trade or business and

3All section references are to the Internal Revenue Code

(Code) in effect for the years in issue, and all Rule references

are to the Tax Court Rules of Practice and Procedure, unless

otherwise indicated.

- 4 therefore may not deduct the expenses.

Finally, we must decide

whether the related license holding companies are entitled to

amortization deductions for cellular licenses from the FCC upon

the grant of the license or upon commencement of an active trade

or business.

This issue presents a question of first impression.

We hold that they are not entitled to any amortization deductions

upon the license grant because they were not engaged in an active

trade or business during the years at issue.

FINDINGS OF FACT

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

We

incorporate the stipulation of facts and the accompanying

exhibits by this reference.

Petitioners resided in Gaylord,

Michigan, at the time they filed the petition.

I.

RFB Cellular,

Inc.

(RFB)

Robert Broz (petitioner) began his career as a banker before

becoming involved with the cellular phone industry.

He was

president of Cellular Information Systems (CIS), a cellular

company, for approximately seven or eight years in the 1980s.

Petitioner decided to invest personally in the development

of cellular networks in rural statistical areas (RSAs) in the

1990s.

Most large cellular service providers, like CIS, were

focused on developing cellular networks in major statistical

areas (MSA) and were less interested in RSA networks.

The FCC

began offering RSA licenses by lottery to any interested person

to encourage development of cellular networks in rural areas. The

RSA lotteries attracted an average of 500 participants

nationwide.

Petitioner participated in approximately 400 lotteries for

RSAs across the country.

He won and purchased an RSA license for

Northern Michigan (the Michigan 4 license) in 1991.

A.

The Organization of RFB

Petitioner organized RFB Cellular, Inc.

corporation,

in 1991,

(RFB), an S

the year he acquired the license.

He

contributed the Michigan 4 license and received in exchange 100

percent of RFB's issued and outstanding stock.

Petitioner did

not contribute any other money or property, nor did he make any

loans to RFB from its inception through 2001.

Petitioner was CEO

of RFB and his brother, James Broz, served as CFO.

Petitioner

wife was involved in marketing.

RFB received between $4 and $4.2 million in vendor financing

from Motorola to cover startup expenses.

Approximately two-

thirds of the financing went to construct and install the

cellular equipment.

When Motorola constructed and installed the

equipment,.petitioner began operating the network and used the

remaining-funds for working capital.

The Michigan 4 license that petitioner contributed to RFB

serviced the northern portion of the lower Michigan peninsula by

providing analog cellular service during the years at issue.

RFB

acquired a second license, the Michigan 2 license, which serviced

the eastern upper Michigan peninsula.

Most of RFB's revenue came

from roaming charges for the use of two networks in Michigan.

RFB also sold cellular phones to people to generate airtime.

RFB made $241,500 of cash distributions to petitioner in

1996,

$613,673 in 2000 and $342,455 in 2001.

RFB made Federal

income tax payments on petitioners' behalf in 1995 and 1996.

These tax payments were reflected as shareholder loans on RFB's

tax returns.

No promissory notes were issued for the tax

payments RFB made on petitioners' behalf.

B.

The Michigan 2 Acquisition

RFB entered into a purchase agreement with Mackinac Cellular

to acquire the Michigan 2 license and related equipment in 1994

(1994 purchase agreement).

Mackinac Cellular had paid $1.6

million for the equipment in 1994.

RFB arranged to purchase the

license and equipment by issuing promissory notes and assuming

debt.

The Michigan 2 acquisition by RFB was stalled for two years.

It was stalled for various reasons but primarily because of a

lawsuit petitioner's former employer, CIS, filed against

petitioner for usurpation of a~ corporate opportunity.

The

license and equipment were transferred to Pebbles Cellular

Corporation (Pebbles), a wholly owned subsidiary of CIS, through

the negotiations.

Pebbles did not change or improve the

- 7 equipment during these two intervening years.

Pebbles sold the

Michigan 2 assets to RFB.

RFB and Pebbles entered into a purchase agreement in 1996

(1996 purchase agreement) after the lawsuit was resolved.

The

parties again undertook a series oftnegotiations and made some

adjustments to the transaction.

Nevertheless, the purchase price

and the allocations in the 1996 purchase agreement were the same

as those in the 1994 agreement.

Both purchase agreements

allocated $2.5 million of the $7.2 million purchase price to the

equipment.

Approximately $909,000 of the purchase price was,

allocated to costs incurred by Pebbles between 1994 and 1996.

Yet there was no allocation for these costs.

II.

The Alpine Entities

Petitioners sought to expand RFB's existing cellular

business to new license areas.

expansion.

RFB's lenders agreed to fund the

The lenders required, however, that RFB form a new

entity to isolate the liabilities-to the thinly capitalized new

business entities RFB would form to hold title only to the

licenses.

Petitioners formed various entities (the Alpine

entities) to further this expansion.

A.

Alpine

Petitioners organized Alpine, an S corporation, to bid on

FCC licenses in RSA lotteries and to construct and operate

digital networks to service the new license areas.

Petitioner

held a 99-percent interest in Alpine and his brother held the

remaining one percent.

Alpine bid on licenses for geographic areas with

demographics similar to those of RFB's existing network areas,

and Alpine bid on licenses for areas in Michigan where RFB was

already providing analog service.

The FCC financed the purchase

of most of the licenses Alpine won at auction.

The FCC required,

however, as a condition for financing, that the license holder

make services available to at least 25 percent of the population

in the geographic license area within five years of the grant

(build out requirement).

The FCC licenses were issued for a

period of ten years from the date of the grant.

RFB and

commercial lenders funded the bidding and constructed and

operated the new networks.

B.

The Alpine License Holding Entities

Alpine successfully bid on 12 licenses during the years at

issue.

Alpine made downpayments on the licenses and issued notes

payable to the FCC for the balance of the purchase prices. Alpine

then transferred the licenses to various single-member limited

liability companies (collectively, the license holding companies)

formed to hold the licenses and lease them to Alpine.' Petitioner

held a 99-percent interest in each license holding entity and his

4The Alpine license holding entities were Alpine-California

F, LLC, Alpine Michigan F, LLC, Alpine Hyannis F, LLC and Alpine

Fresno C, LLC.

brother owned the remaining one percent.

Each Alpine license

holding entity assumed the FCC debt in exchange for receiving the

license.

Alpine continued to make payments on the FCC debt even

after the licenses were transferred to the Alpine license holding

entities.

Alpine maintained the books and records of Alpine, the

Alpine entities and the Alpine license holding entities.

No Alpine entities operated any on-air networks during the

years at issue.

RFB operated the only on-air networks.

RFB used

Alpine's licenses to provide digital service in geographic areas

RFB's analog licenses already covered.

RFB provided digital

service by adding digital equipment onto RFB's existing cellular

towers.

RFB owned the equipment that serviced the Michigan

licenses.

RFB allocated income and expenses related to the

licenses to Alpine.

No Alpine license holding entities met the FCC's build out

requirements for any of its licenses.

Consequently, the FCC

canceled two of the three licenses Alpine retained.

Alpine

returned the third license to the FCC and forfeited its $900,000

initial downpayment.

The only income Alpine reported was income that RFB had

allocated to Alpine from RFB's use of Alpine's licenses.

Alpine

did not report income during any of the other years at issue.'

- 10 -

Alpine claimed depreciation deductionss and other deductions.'

Alpine deducted interest on debt owed to the FCC.

Alpine also

deducted interest on debt owed to RFB, even though Alpine never

made any interest payments.

Alpine amortized and deducted

expenses for alleged startup costs7 even though Alpine had not

made a formal election under section 195(b).

The only income any of the Alpine license holding entities

reported was income allocated to them from RFB's use of the

licenses.

The Alpine license holding entities each claimed

amortization deductions related to the licenses and deducted

interest paid on amounts borrowed from a related entity to

service the FCC debt.

Alpine and the license holding entities ceased all business

activities by the end of 2002.

C.

Alpine Operating and Alpine Investments, LLC

Petitioner formed Alpine Operating, a single-member limited

liability company, to hold the digital equipment and lease it to

sThe depreciation deductions were for leasehold improvements

for a California office, furniture, fixtures, computers and

vehicles.

'The other deductions were for expenses such as salaries,

office expenses, telephone and utilities, rent, insurance, and

dues and subscriptions.

7Such expenses included consulting expenses, travel and

entertainment expenses, salaries, rent, legal fees, relocation

expenses, contract labor, fringe benefits, and miscellaneous

expenses.

- 11 -

Alpine.

Petitioner wholly owned Alpine Operating, a disregarded

entity for Federal income tax purposes.

Alpine Operating

reported no income and did not claim any depreciation deductions

for the equipment during the years at issue.

Alpine Operating

claimed interest and automobile depreciation deductions for 1999

and 2000.

Petitioner formed Alpine Investments, LLC (Alpine

Investments), a single-member limited liability company, to serve

as an intermediary for transferring money to the Alpine entities.

Petitioner's tax advisers advised petitioner that he needed to

increase his bases in the Alpine entities.

Additionally, COBank

prohibited the distribution of loan proceeds to an individual.

Petitioner wholly owned Alpine Investments, a disregarded entity.

III.

The. COBank Loans

COBank was the main commercial lender to RFB and the Alpine

entities during the years at issue.

RFB used CoBank loan

proceeds to expand its existing business through Alpine and the

related entities..

CoBank specifically acknowledged that RFB

would advance the proceeds directly or indirectly to the Alpine

entities.

Alpine allocated some of the funds to other Alpine

entities.

RFB refinanced the COBank loan several times.

Petitioner

pledged his RFB stock as additional security but he never

personally guaranteed the COBank loan.

The loan was secured by

- 12 -

the assets of the Alpine license holding entities.

Several of

the Alpine entities also guaranteed the loan.

RFB recorded the advances on its general ledger as "advances

to Alpine PCS."8

payable."

Alpine recorded the same advances as "notes

Some of the advances to Alpine were allocated to other

Alpine entities, which recorded the allocations as advances or

"notes payable" on the general ledgers.

RFB, Alpine and the

other Alpine entities made yearend adjusting entries

reclassifying the advances as loans from a shareholder.

Alpine

reflected the advances as long-term liabilities on the returns

for the years at issue.

Promissory notes were executed between petitioner and RFB,

and between petitioner and Alpine, to reflect accrued but unpaid

interest on the purported loans.

RFB indicated in financial

statements for the years at issue that it would not demand

repayment of any of the advances.

No security was provided with

respect to the promissory notes.

No cash payments of either

principal or interest were ever made by any of the parties with

respect to the promissory notes.

Petitioner nevertheless

reported interest income and income expense from the promissory

notes on his individual returns.

Beginning in 1999, the advances from RFB were reclassified

through yearend adjusting entries as loans from Alpine

sRFB initially recorded the advances in its books as "other

assets".

- 13 -

Investments.

Alpine Investments assumed the promissory notes

executed between petitioner and Alpine, and between petitioner

and RFB.

Alpine Investments executed promissory notes with the

Alpine entities and RFB to document the purported loans.

IV.

IRS Appeals Proceeding

The Appeals case involved all five years at issue.

Appeals

Officer Thomas Dolce (Officer Dolce) was assigned to petitioners'

case and negotiated with petitioners' attorney, Sean Cook (Mr.

Cook).

Petitioners, RFB and the Alpine license holding entities

filed for bankruptcy protection in 2003.

Petitioners' bankruptcy

proceedings ran concurrently with their IRS Appeals case.

Officer Dolce and Mr. Cook exchanged several settlement

offers over the course of the negotiations.

proposed a "sum certain settlement"

Officer Dolce orally

(settlement offer) during a

telephone conference in October 2005.

The settlement offer made

no changes to petitioners' tax liabilities for the years at issue

but increased petitioners' tax liability for 2002, which was not

under examination.

Petitioners accepted the settlement offer.

Officer Dolce

informed petitioners that he needed his manager's approval before

the settlement could be finalized.

He also advised Mr. Cook that

the parties needed to draft a closing agreement to finalize the

settlement.

Mr. Cook provided Officer Dolce with a draft closing

agreement petitioners had reviewed, but Officer Dolce did not

- 14 -

sign it.

The parties did not enter into any written agreement

regarding the settlement offer.

Officer Dolce orally informed petitioners that he had

obtained the necessary approval but later learned that the offer

exceeded the scope of his settlement authority.

His authority

extended to litigation risk, not collectibility.

He made the

settlement offer because he determined petitioners could not

afford to pay the entire outstanding liability rather than on the

merits of the case.

Officer Dolce decided to withdraw the

settlement offer when he learned the offer had yet to be

finalized.

Officer Dolce informed Mr. Cook two weeks later that the

offer was withdrawn.

The parties waited to meet until December

2005 to discuss the withdrawal because they were in different

areas of Michigan, not close to each other.

V.

The Deficiency Notice

Respondent issued petitioners the deficiency notice for the

years at issue in 2006.

Respondent determined that petitioners

had insufficient debt basis in Alpine to claim flowthrough losses

for the years at issue.

Respondent also determined that

petitioners were not at risk. with respect to their investments in

the Alpine license holding entities and Alpine Operating and were

therefore not entitled to claim flowthrough losses.

- 15 Respondent determined that Alpine was not entitled to

interest, depreciation,

startup expense, and other deductions

because it was not engaged in an active trade or business during

those years.

Respondent also determined that Alpine Operating

was not entitled to deduct interest and depreciation because it

was not engaged in an active trade or business.

Respondent

determined that the Alpine license holding entities amortization

deductions for the licenses were disallowed because they were not

engaged in an active trade or business at the relevant time.

Petitioners timely filed a petition.

OPINION

We are asked to resolve the tax consequences of the ever

evolving cellular phone industry with rapidly changing

technology.

Several issues raise questions of first impression.

These include whether in an S corporation there is a separate

definition in the at-risk rules involving whether the

shareholder's pledge of stock of a related corporation is

excluded from the at-risk amount because it was property used in

the business.

We must also focus on when a cellular phone entity

begins business for purposes of deducting beginning expenses and

for amortization-of the FCC license under section 197.

Specifically, we must decide whether a cellular phone business

begins upon the grant of the license from the FCC or when

- 16 -

contracts for wireless services are sold.

We address these

substantive issues in turn.

I.

The Settlement Offer

We must first decide a procedural issue of whether

respondent is bound to an oral settlement offer made and

subsequently withdrawn by respondent's Appeals Office before the

deficiency notice was issued.

Petitioners argue that the oral

settlement offer is enforceable, notwithstanding the lack of a

written closing agreement, because Officer Dolce's supervisor

approved the offer.

They argue alternatively that respondent

should be bound by equitable estoppel to the settlement offer

because Officer Dolce recklessly withdrew the offer after

petitioners had relied on it.

Respondent denies that the oral

settlement offer is enforceable because it was not memorialized

in a written closing agreement.

Respondent also argues that

petitioners have not established the elements necessary for us to

apply equitable estoppel.

We address the parties' arguments in

turn.

A.

Enforceability of the Settlement Offer

We begin with petitioners' argument that the oral settlement

offer is an enforceable agreement.

The compromise and settlement

of tax cases is governed by general principles of contract law.

Dorchester Indus. Inc. v. Commissioner, 108 T.C. 320, 330 (1997)

affd. without published opinion 208, F.3d 205 (3d Cir. 2000).

- 17 -

The law for administrative, or pre-petition, settlement offers is

well established.

See Dormer v. Commissioner, T.C. Memo. 2004-

167; Rohn v. Commissioner, T.C. Memo. 1994-244.

The procedures

for closing agreements and compromises are set forth in section

7121 (relating to closing agreements), section 7122

compromises) and the regulations thereunder.

71'22; secs.

301.7121-1,

301.7122-1,

Proced.

(relating to

See secs. 7121 and

& Admin. Regs.

These

procedures are exclusive and must be satisfied for a compromise

or settlement to be binding on both a taxpayer and the

Commissioner.

Rohn v. Commissioner, supra; see also Urbano v.

Commissioner,

122 T.C.

384,

393

(2004).

Negotiations with the

IRS are enforceable only if they comply with the procedures.

Rohn v. Commissioner, supra.

A settlement offer must be .

submitted on one of two special forms the Commissioner

prescribes.

Regs.

Id.; sec. 301.7122-1(d) (1),

(3),

Proced. & Admin.

Form 866, Agreement as to Final Determination of Tax

Liability, is a type of closing agreement that is to be a final

determination of a taxpayer's liability for a past taxable year

or years.

Form 906, Closing Agreement on Final Determination

Covering Specific Matters, is a second type of closing agreement

that finally determines one or more separate items affecting the

taxpayer's liability.

The parties never put the sum certain

settlement in writing, let alone on one of the prescribed forms.

- 18 -

Officer Dolce's oral settlement offer is therefore not legally

enforceable.

B.

Equitable Enforcement of the Settlement Offer

We now address whether equity principles nonetheless require

us to enforce the settlement offer.

Equitable estoppel is a

judicial doctrine that requires finding the taxpayer relied on the

Government's representations and suffered a detriment because of

that reliance.

Estoppel precludes the IRS from denying its own

representations if those representations induced the taxpayer to

act to his or her detriment.

695, 700 (1992).

Hofstetter v. Commissioner, 98 T.C.

The doctrine of equitable estoppel is applied

against the Government with utmost caution and restraint.

Boulez

v. Commissioner,

76 T.C.

209

810 F.2d 209,

218

(D.C. Cir.

(1981); Kronish v. Commissioner,

90 T.C.

1987), affg.

684,

695

(1988).

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

case is appealable, requires a litigant to establish affirmative

misconduct on the Government's part as a threshold to proving

estoppel.

1992).

See United States v. Guy,

978 F.2d 934,

937

(6th Cir.

Affirmative misconduct is more than mere negligence.

Id.

It requires an affirmative act by the Government to either

intentionally or recklessly mislead the taxpayer.

Mich. Express,

Inc. v. United States,

2004).

374 F.3d 424, 427

(6th Cir.

taxpayer must also prove the traditional three elements of

estoppel.

These three traditional elements include (1) a

The

- 19 -

misrepresentation by Government;

(2) reasonable reliance on that

misrepresentation by the taxpayer; and (3) detriment to the

taxpayer.

See Heckler v. Community Health Servs., 467 U.S. 51, 59

(1984).

Petitioners' equitable estoppel'argument fails for several

reasons.

First and foremost, we find that petitioners failed to

meet the threshold in the Sixth Circuit of showing any affirmative

misconduct on respondent's part.

They argue that Officer Dolce's

failure to personally notify them for 40 days that the offer was

withdrawn constituted "affirmatively reckless conduct."

We

disagree.

We find instead that the delay was due to the considerable

geographical distance between Officer Dolce and petitioners rather

than to any affirmative misconduct on the part of Officer Dolce.

Moreover, even though Officer Dolce failed to notify petitioners

in person for 40 days, Officer Dolce notified petitioners'

counsel, Mr. Cook, within two weeks that the offer was withdrawn.

We find that Officer Dolce's actions do not rise to the level of

affirmative misconduct.

Additionally, petitioners have failed to prove the

.

traditional elements of equitable estoppel.

Petitioners have

failed to establish that Officer Dolce made any misrepresentations

to them regarding the settlement offer.

Officer Dolce made a

conditional settlement offer to petitioners that needed to be

- 20 -

approved by Officer Dolce's supervisor.

He withdrew the offer,

which had yet to be finalized, upon realizing that a sum certain

settlement was beyond his authority.

Officer.Dolce notified

petitioners that the offer was withdrawn.

He also explained to

petitioners his reasons for withdrawing the offer.

Petitioners' reliance, if any, on the oral settlement offer

was unreasonable.

Petitioners knew that the settlement offer was

not final until they entered into a written closing agreement.

They discussed the need for a written closing agreement with.Mr.

Dolce and reviewed a draft closing agreement Mr. Cook prepared.

Finally, respondent did not induce petitioners to take any

adverse action.

Petitioners claim they conceded certain rights in

the bankruptcy proceeding in reliance on the oral settlement

offer.

Petitioners have not established what rights, if any, they

conceded attributable to the bankruptcy proceeding.

Accordingly, we conclude that equitable estoppel principles

do not require respondent to be bound by the sum certain

settlement offer.

II.

Valuation of the Michigan 2 Acquisition

Next, we must determine whether petitioners properly

allocated $2.5 million of the $7.2 million Michigan 2 purchase

price to equipment for depreciation purposes.

Petitioners relied

on the allocations made in the Michigan 2 purchase agreement even

- 21 -

though there was a 2-year delay in acquiring the equipment and

license.

RFB acquired both depreciable and nondepreciable property

when it paid $7.2 million to acquire the cellular phone equipment

and license from Pebbles, the seller.

When a combination of

depreciable and nondepreciable property is purchased for a lump

sum, the lump sum must be apportioned between the two types of

property to determine their respective costs.

The cost of the

depreciable property is used to determine the amount of the

depreciation deduction.

The relevant inquiry is the respective

fair market values of the depreciable and nondepreciable property

at the time of acquisition.

482-483

Weis v. Commissioner, 94 T.C. 473,

(1990); Randolph Bldg. Corp. v. Commissioner,

807 (1977).

67 T.C.

804,

Petitioners bear the burden of proving that

respondent's allocation is incorrect.

See Rule 142(a); see

Elliott ·v.

313

Commissioner, 40 T.C.

304,

(1963).

Petitioners contend that the $2.5 million allocation to

depreciable assets is proper.

They first argue it is proper

because it is the amount the parties agreed to in the 1994 and

1996 purchase agreements.9

An allocation in a purchase agreement

9PetitiOners also rely on the Michigan 4 acquisition as best

evidence of the value of the Michigan 2 equipment. Petitioners

estimated the value of the,Michigan 4 equipment using only the

costs they incurred and the vendor financing they received. They

have not provided sufficient evidence of the equipment's value.

Moreover, petitioners have not established that the Michigan 4

equipment is comparable to the Michigan 2 equipment.

- 22 -

is not necessarily determinative, however, if it fails to reflect

a bargained-for amount.

1352,

1361

(11th Cir.

See Sleiman v. Commissioner, 187 F.3d

1999),

affg. T.C. Memo. 1997-530.

Petitioners further argue that the $2.5 million allocation to

depreciable assets is proper because it represents the cost they

would have to pay to replace the wireless cellular equipment.

Petitioners have not provided any evidence beyond their own selfserving testimony to substantiate the replacement cost.

We need

not accept the taxpayer's self-serving testimony when the taxpayer

fails to present corroborative evidence.

T.C. Memo.

77

1990-304

Beam v. Commissioner,

(citing Tokarski v. Commissioner,

87 T.C.

(1986)), affd. without published opinion 956 F.2d 1166

Cir.

74,

(9th

1992).

Moreover, we find it implausible that the equipment had a

value of $2.5 million at the time RFB acquired it from Pebbles.

Mackinac's original purchase of the Michigan 2 equipment for $1.6

million in 1994 indicates that the equipment was worth, at most,

only $1.6 million when RFB purchased it in 1996.

See Estate of

Cartwright v. Commissioner, T.C. Memo. 1996-286.

Moreover,

petitioners testified that the equipment was rapidly depreciating

on account of advancing cellular technology.

In fact, some of the

Michigan 2 equipment became obsolete between 1994 and 1996 and had

to be decommissioned after RFB's acquisition.

Nevertheless, the

allocation amount remained unchanged between the 1994 and 1996

- 23 -

purchase agreements.

Petitioners have not shown that they made

any additions or improvements to explain why the allocation amount

remained unchanged over the 2-year period.

We accordingly find

that petitioners' allocation of $2.5 million to equipment was

improper and instead sustain respondent's determination that $1.5

million be allocated to the equipment.

III.

Basis Limitations on Flowthrough Losses

We now turn to basis in Alpine.

We must determine whether

petitioners, shareholders of Alpine, an S corporation, had

sufficient debt basis to claim flowthrough losses during the years

at issue.

Petitioners argue that the payments petitioner made to

Alpine with the loan proceeds from COBank gave them basis in

Alpine.

Respondent contends that the payments did not create

basis.

Instead, petitioners served as a mere conduit to the

transfer of loan proceeds from RFB to Alpine.

"Respondent further

asserts that petitioners did not make any economic outlay that

would entitle them to increase their basis in the S corporation.

A.

Basis to S Corporation Shareholder

First, we state the general rules 'governing when a

shareholder in an S corporation is entitled to deduct losses the S

corporation sustained.

A shareholder of an S corporation can

directly deduct his or her share of entity-level losses in

accordance with the flowthrough rules of subchapter S.

1366(a).

See sec.

The losses cannot exceed the sum of the shareholder's

- 24 adjusted basis in his or her stock and the shareholder's adjusted

basis in any indebtedness of the S corporation to the shareholder.

Sec. 1366(d) (1) (A) and (B).

This restriction applies because the

disallowed amount exceeds the shareholder's economic investment in

the S corporation and, because of the limited liability accorded

to S corporations, the amount does not have to be repaid.

The

shareholder bears the burden of establishing his or her basis.

Estate of Bean v. Commissioner,

affg. T.C. Memo.

1102

(8th Cir.

268 F.3d 553,

557

(8th Cir. 2001),

2000-355; Parrish v. Commissioner,

1999), affg. T.C. Memo.

168 F.3d 1098,

1997-474.

A shareholder who makes a loan to an S corporation generally

acquires debt basis if the shareholder makes an.economic outlay

for the loan.

The indebtedness must run directly from the S

corporation to the shareholder and the shareholder must make an

actual economic outlay for debt basis to arise.

Commissioner, T.C. Memo. 2009-76.

Kerzner v.

When the taxpayer claims debt

basis through payments made by an entity related to the taxpayer

and then from the taxpayer to the S corporation (back-to-back

loans), the taxpayer must prove that the related entity was acting

on behalf of the taxpayer and that the taxpayer was the actual

lender to the S corporation.

Memo. 2006-78.

Ruckriegel v. Commissioner, T.C.

If the taxpayer is a mere conduit and if the

transfer of funds was in substance a loan from the related entity

to the S corporation, the Court will apply the step transaction

doctrine and ignore the taxpayer's participation.

Id.

- 25 A taxpayer makes an economic outlay for purposes of debt

basis when he or she incurs a "cost" on a loan or is left poorer

in a material sense after the transaction.

Putnam v.

Commissioner, 352 U.S..82 (1956); Estate of Bean v. Commissioner,

supra at 558; Bergman v. United States,

Cir.

174 F.3d 928,

1999); Estate of Leavitt v. Commissioner,

(4th Cir.

1989),

affg.

90 T.C.

206

(1988).

930 n.6

(8th

875 F.2d 420, 422

The taxpayer may fund

the loan to the S corporation with money borrowed from a thirdparty lender in a back-to-back loan arrangement.

Commissioner,

468

535 F.2d 309,

312 n.2

(5th Cir.

(1975); Hitchins v. Commissioner,

(1994); Raynor v.

Commissioner,

1976), affg.

103 T.C.

50 T.C.

762,

Underwood v.

711,

771

63 T.C.

718 & n.8

(1968).

The

taxpayer.has not made an economic outlay, however, if the lender

is a related party and if repayment of the funds is uncertain.

See, e.g., Oren v.

Commissioner,

357 F.3d 854

(8th Cir. 2004),

affg. T.C. Memo. 2002-172; Underwood v. Commissioner, supra at

312.

B.

Direct Loan From RFB

Against this background, we now address whether petitioner

acquired basis in Alpine in the amount of the loan.

Petitioners

claim they advanced the CoBank loan proceeds to the Alpine

entities as part of a back-to-back loan arrangement."

Petitioners

have not established that they lent, rather than advanced,

the

Petitioners substituted themselves for Alpine Investments,

a disregarded entity they wholly owned, beginning in 1999.

- 26 -

COBank loan proceeds to Alpine.

See Yates v. Commissioner, T.C.

Memo. 2001-280; Culnen v. Commissioner, T.C. Memo. 2000-139, revd.

and remanded 28 Fed. Appx. 116 (3d Cir. 2002).

Petitioner never

substituted himself as "lender" in the place of RFB.

There is no

evidence that the Alpine entities were indebted to petitioner

rather than to RFB.

Interest on the unsecured notes accrued and

was added to the outstanding loan balances.

made.

No payments were ever

Moreover, petitioners signed the promissory notes on behalf

of all the entities, making it unlikely that any of the entities

would seek payment from petitioners.

supra at 859.

See Oren v. Commissioner,

The promissory notes, therefore, do not establish

bona fide indebtedness between petitioners and Alpine.

Moreover, the payments petitioners made to Alpine from the

COBank loan proceeds were characterized as advances, rather than

loan distributions, at the time the payments were made.

Ruckriegel v. Commissioner, supra.

See

The payments were

recharacterized as loans only through yearend reclassifying

journal entries and other documents.

The loan ran from RFB to the

Alpine entities, and petitioners served as a mere conduit for the

funds.

Accordingly, we find that the Alpine entities were not

directly indebted to petitioners.

Petitioners also have not shown that RFB made the payments to

Alpine on petitioners' behalf.

We have found that direct payments

from a related entity to the taxpayer's S corporation constituted

payments on the taxpayer's behalf where the taxpayer used the

- 27 -

related entity as an "incorporated pocketbook."

See Yates v.

Commissioner, supra; Culnen v.~Commissioner, supra.

The term

"incorporated pocketbook" refers to the taxpayer's habitual

practice of having his wholly owned corporation pay money to third

parties on his behalf.

See Ruckriegel v. Commissioner, supra.

Whether an entity is an incorporated pocketbook is a question of

fact.

Id.

Petitioners have not established that RFB habitually

or routinely paid petitioners' expenses so as to make RFB an

incorporated pocketbook.

C.

Economic Outlay

We now turn to the economic outlay requirement.

Petitioners

also contend that their pledge of RFB stock as collateral for the

COBank loan constituted an economic outlay justifying an increase

in petitioners' basis in their Alpine entities.

A pledge of

personal assets is insufficient to create basis until and unless

the shareholder pays all or part of the obligation that the

shareholder guaranteed.

See Estate of Leavitt v. Commissioner,

supra at 423; Maloof v. Commissioner, T.C. Memo.

456 F.3d 645

(6th Cir. 2006).

2005-75, affd.

Petitioners have not shown that

they incurred any cost with regard to their pledge of RFB stock.

Moreover, petitioners have not shown that they incurred a

cost with respect to the loan or were otherwise left poorer in a

material sense."

See Maloof v'. Commissioner, supra.

Petitioners

Petitioners contend that they suffered actual economic

loss with respect to the pledge of stock when the banks obtained

(continued...)

- 28 never personally guaranteed or were otherwise personally liable on

the CoBank loan.

See id.

Petitioners signed the promissory notes

on behalf of all the entities, making it unlikely that any of the

entities would seek payment from petitioners.

Commissioner, supra at 859.

See Oren.v.

Furthermore, RFB indicated in its

financial statements that it would not demand repayment on any

advances made to petitioners.

We therefore will apply the step transaction doctrine and

ignore petitioners' participation in the advances from RFB to

Alpine.

We find that petitioners had insufficient debt basis in

Alpine to claim flowthrough losses during the years at issue.

IV.

At-Risk Limitation on Flowthrough Losses

We now focus on whether petitioners were at risk with respect

to Alpine, Alpine Operating and the Alpine license holding

entities because of the unique way the transactions were

structured.

We must decide for the first time whether stock in a

related S corporation is property used in the business to preclude

"(...continued)

RFB's assets in the bankruptcy proceedings.

The bankruptcy case

was settled after the years at issue, however, and is therefore

irrelevant for purposes of determining economic outlay at the

time the payments were made. Petitioners also argue that they

were left "poorer in a material sense" by RFB's use of

undistributed after-tax profits for advances to the Alpine

entities.

Petitioners' argument is irrelevant because we have

determined that RFB was not an "incorporated pocketbook" for

petitioners.

Cf. Yates v. Commissioner, T.C. Memo. 2001-280;

Culnen v. Commissioner, T.C. Memo. 2000-139, revd. and remanded

28 Fed. Appx. 116 (3d Cir. 2002).

- 29 petitioners from being at risk for any pledge of property used in

the business.

We begin with an overview of the at-risk rules.

The at-risk

rules ensure that a taxpayer deducts losses only to the extent he

or she is economically or actually at risk for the investment.

Sec. 465(a); Follender v. Commissioner,

89 T.C

943

(1987).

The

amount at risk includes cash contributions and certain amounts

borrowed with respect to the activity for which the taxpayer is

personally liable for repayment.

Sec. 465(b) (2) (A).

Pledges of

personal property as security for borrowed amounts are also

included in the at-risk amount.

is not at risk, however

business.

Sec. 465(b) (2) (B).

The taxpayer

for any pledge of property used in the

Id.

The parties disagree whether the RFB stock petitioners

pledged constitutes property used in the business.

Petitioners

contend that RFB stock is not property used in the business for.

at-risk purposes because the stock represents an ownership

interest in the business that can be ·sold or transferred without

affecting corporate assets.

According to petitioners, stock is

therefore inherently separate and distinct from the activities of

a corporation and the pledge of stock of the related corporation

should allow petitioners to be treated as at risk.

We disagree.

We reject petitioners' narrow interpretation of property used

in the business.

Pledged property must be "unrelated to the

business" if it is to be included in the taxpayer's at-risk

- 30 amount.

See sec. 465(b) (2) (A)

and (B); Krause v. Commissioner,

92

T.C. 1003, 1016-1017 (1989), affd. sub nom. Hildebrand v.

Commissioner, 28 F.3d 1024

(10th Cir.

Commissioner, T.C. Memo. 2006-125."

1994); Miller v.

The Alpine entities were

formed by petitioner to expand RFB's existing cellular networks.

RFB also used some of Alpine's digital licenses to provide digital

service to RFB's analog network areas.

from the licenses back to Alpine.

Alpine entities.

Cf.

Regs., 44 Fed. Reg.

sec.

32244

RFB then allocated income

The RFB stock is related to the

1.465-25(b) (1) (1),

(June 5,

Proposed Income Tax

1979).

Moreover, even if the RFB stock is unrelated to the cellular

phone business, petitioners were not economically or actually at

risk with respect to their involvement with the Alpine entities.

Petitioners contend that petitioner was the obligor of last resort

on the COBank loan.

Petitioners were not actually at risk because

they never personally guaranteed the COBank loan, nor were they

ever personally liable on the purported loans to the Alpine

entities.

risk.

Additionally, petitioners were not economically at-

We have held that where the transaction has been structured

so as to remove any realistic possibility of loss, the taxpayer is

"Furthermore, the flush language of sec. 465(b) (2) provides

that no property shall be taken into account as security for

borrowed amounts if such property is directly or indirectly

financed by indebtedness which is secured by the property. The

RFB stock qualifies as "property * * * directly or indirectly

financed by indebtedness" because RFB borrowed the funds from

COBank. Petitioners' pledge of RFB stock therefore cannot be

taken into account to determine whether petitioners were at risk.

- 31 -

not. at risk for the borrowed amounts.

See Oren v. Commissioner,

357 F.3d at 859; Levien v. Commissioner,

103 T.C.

120,

126

(1994),

affd. without published opinion 77 F.3d 497 (11th Cir. 1996).

We

have already determined that the structured transaction made it

highly unlikely that petitioners would experience a loss.

We find that petitioners' pledge of RFB stock did not put

them at risk in Alpine and the other Alpine entities to allow them

passthrough losses.

V.

Business and $tartup Expenses

A.

Business Expenses

We now must decide whether Alpine and Alpine Operating were

engaged in an active trade or business for purposes of deducting

certain expenses.

Alpine and Alpine Operating deducted interest,

depreciation, startup and certain other business expenses

(beginning expenses).

Respondent argues that none of the Alpine

entities are entitled to deductions for the beginning expenses

because they were not involved in an active trade or business

during the years at issue.

Petitioners contend that the Alpine

entities acquired licenses and related equipment to expand RFB's

existing cellular business and are therefore entitled to the

deductions for the beginning expenses.

We begin with the general

rules for deducting business expenses.

Taxpayers may deduct ordinary and necessary expenses paid or

incurred during the taxable year in carrying on a trade or

business.

Sec. 162(a).

The taxpayer is not entitled to deduct

- 32 expenses incurred before actual business operations commence and

the activities for which the trade or business was formed are

performed.

Johnsen v.

Commissioner,

revd. 794 F.2d 1157 (6th Cir. 1986).

83 T.C.

103,

114

(1984),

Whether the taxpayer is

actively carrying on a trade or business depends on the facts and

circumstances.

(1987).

Commissioner v. Groetzinger, 480 U.S. 23, 36

A taxpayer is not engaged in a trade or business even if

he has made a firm decision to enter into business and over a

considerable period of time spent money in preparing to enter that

business.

901,

907

Richmond Television Corp. v. United States, 345 F.2d

(4th Cir.

1965).

The taxpayer is not engaged in any

trade or business until the business has begun to function as a

going concern and has performed the activities for which it was

organized.

Id. at 907.

The determination of whether an entity is actively engaged in

a trade or business must be made by viewing the entity in a standalone capacity and not in conjunction with other entities.

Bennett Paper Corp.

(1982), affd.

& Subs. v. Commissioner,

699 F.2d 450

(8th Cir. 1983).

78 T.C.

458,

See

463-465

RFB's business

therefore cannot be attributed to Alpine and Alpine Operating.

Instead, we must examine the Alpine entities individually to

determine whether they were engaged in a trade or business during

the years at issue.

We begin with Alpine.

Petitioners organized Alpine to obtain FCC licenses and to

construct and operate networks to service the new license areas.

- 33 -

Petitioners claim that Alpine had two on-air networks in September

2001.

Petitioners failed to provide any evidence beyond

petitioner's own self-serving testimony to substantiate this.

claim, however.

Instead, the record reflects that the on-air

networks were operated by RFB rather than Alpine.

RFB used

Alpine's Michigan licenses and allocated any income earned from

the licenses to Alpine or the Alpine license holding entities.

Petitioners failed to establish here that Alpine was engaged in an

active trade or business during the years at issue, and it is not

entitled to any deductions for beginning expenses.

We now turn to Alpine Operating.

Alpine Operating was formed

for the sole purpose of serving Alpine's business and depended on

Alpine for revenue.

We have already.determined that petitioners

failed to establish that Alpine was engaged in an active trade or

business during the years at issue.

We therefore find, by

extension, that Alpine Operating was not engaged in an active

trade or business and is not entitled to deduct any beginning

expenses.

B.

Startup Expenses

Petitioners alternatively argue that they are entitled to

amortize and deduct the beginning expenses as startup expenses.

We find compelling that Alpine did not meet the FCC's

build out requirement to make service available to at least 25

percent of the population in any license areas within five years

of the grant.

The FCC canceled two of the three licenses Alpine

retained, and Alpine returned the third license to the FCC and

forfeited the downpayment.

- 34 -

Taxpayers are entitled to amortize and deduct startup expenses

only if they attach a statement to the return for the taxable year

in which the trade or business begins.

See sec. 195(b) (1),

(c).

Petitioners did not file the appropriate statement with their

returns and are only now electing to amortize and deduct the

expenses.

We find therefore that they are ineligible to amortize

and deduct the beginning expenses.

VI.

Amortization of the FCC Licenses

We now turn to amortization of the FCC licenses.

The parties

agree that the licenses are amortizable but disagree on when

amortization should begin.

Their dispute is based on their

different interpretations of section 197.

Respondent contends

that the licenses are amortizable upon commencement of a trade or

business.

Petitioners argue that the licenses are amortizable

upon acquisition.

We must decide for the first time whether

section 197 requires that the taxpayer be engaged in a trade or

business to claim amortization deductions.

If we determine that

section 197 imposes a trade or business requirement, we must also

determine the extent of that requirement.

We begin with the

general rules for amortizing intangibles.

Intangibles were amortized and depreciated under section 167

before the enactment of section 197.

Regs.

Sec. 1.167(a)-3, Income Tax

Taxpayers could claim depreciation deductions for

intangible property used in a trade or business or held for the

production of income if the property had a useful life that was

- 35 limited and reasonably determinable.

Id.

There was some

uncertainty, however, over.what constituted an amortizable

intangible asset and the proper method and period for

depreciation.

See Omnibus Budget Reconciliation Act of 1993, Pub.

L. 103-66, sec. 13261, 107 Stat. 532.

Congress enacted section 197 to resolve some of the

uncertainty surrounding the regulation.

(1993),

1993-3 C.B.

167,

353.

H. Rept. 103-111, at 777

An "amortizable intangible" is now

defined as an intangible acquired by and held in connection with

the conduct of a trade or business.

Sec. 197(c) (1).

Such

intangibles include "any license, permit or other right granted by

a governmental unit or an agency or instrumentality thereof" that

is held in connection with the conduct of a trade or business.

See sec. 197(c) (1) (B),

(d) (1) (D).

The cost of the intangible is

amortizable over a fixed 15-year period.

Sec. 197(a).

Petitioners contend that section 197 lacks a specific trade

or business requirement.

Thus, petitioners argue that they may

begin amortizing the FCC licenses upon grant even though no trade

or business has begun.

They argue that the statute lacks a

specific trade or business requirement because the phrase "trade

or business" does not appear in subsection (a), which provides the

general rule.

They argue that the plain meaning of the statute

permits them to begin amortizing the licenses in the month of the

license grant regardless of whether any business had begun.

- 36 -

-

We turn to the language of section 197.

It is a central

tenet of statutory construction that, when any provision of a

statute is interpreted, the entire statute must be considered.

See,. e.g., Lexecon Inc. v. Milberg Bershad Hynes & Lerach, 523

U.S.

26,

36

(1998); Huffman v. Commissioner,

978 F.2d 1139,

1145

(9th Cir. 1992), affg. in part and revg. in part T.C. Memo. 1991-

144.

The phrase "trade or business" appears five times in section

197.

An intangible is not amortizable under the general rule of

subsection (a) unless it is an "amortizable section 197

intangible."

See sec. 197(a).

An amortizable section 197

intangible is defined as an intangible that is held "in connection

with the conduct of a trade or business."

See sec. 197(c) (1) (B).

The statute requires that there be a trade or business for

amortization purposes.

Mere grant of an FCC license does not

satisfy the requirement.

Moreover, to interpret section 197 as allowing amortization

without regard to the taxpayer's trade or business ignores the

purpose behind section 197.

Section 197 was enacted to provide

taxpayers acquiring intangible assets with a deduction similar to

the depreciation deduction under section 167 for tangible assets.

Taxpayers are allowed a depreciation deduction for property used

in a trade or business.

See sec. 167(a).

There is no indication

in the legislative history of section 197 that Congress intended

to change depreciation principles established in section 167 to

- 37 -

allow taxpayers to amortize intangible assets without regard to

whether there was a trade or business.

We now must determine the nature of the section 197 trade or

business requirement.

Several Code sections impose an active

trade or business requirement.

For example, taxpayers are allowed

to deduct business expenses incurred in carrying on a trade or

business, sec. 162, depreciation expenses for tangible personal

property used in a trade or business, sec. 167, and startup

expenses for an "active trade or business", sec. 195.

The

taxpayer must be carrying on or engaged in a trade or business at

the time of the expenditure to be eligible for the deduction.

Weaver v. Commissioner, T.C. Memo. 2004-108.

See

In contrast, only a

passive trade or business is required for deductibility of

research and development costs under section 174

with a trade or business").

("in connection

Moreover, the taxpayer claiming a

research and development cost need not be engaged in a trade or

business at the time of the expenditure to qualify for the

deduction.

Smith v. Commissioner,

Cir. 1991)

(quoting Diamond v. Commissioner, 930 F.2d 372 (4th

Cir.

1991)), revg.

91 T.C.

733

937 F.2d 1089,

1097 n.9

(6th

(1988).

Petitioners argue that the trade or business requirement

imposed by section 197 is similar to the less stringent

requirement imposed by section 174.

U.S. 500 (1974).

See Snow v. Commissioner, 416

They argue that both sections 174 and 197

contain the phrase "in connection with" and both should therefore

- 38 -

have the same meaning.

Petitioners'

interpretation fails,

however, to consider the entire phrase.

The entire phrase in

section 197 is "in connection with the conduct of a trade or

business."

(Emphasis added.)

The inclusion of the word "conduct"

indicates to us that the intangibles must be used in connection

with a business that is being conducted.

We find, therefore, that

section 197 contains an active trade or business requirement

similar to the requirement imposed by section 162."

We have already determined that Alpine was not engaged in an

active trade or business.

The Alpine license holding entities

were formed for the sole purpose of serving Alpine's business and

depended on Alpine for revenue.

We therefore find, by extension,

that the Alpine license holding entities were not engaged in an

active trade or business and are not entitled to amortization

deductions for the licenses.

"Moreover, regulations have been promulgated that reinforce

the trade or business requirement in sec. 197.

The regulations

clarify that amortization under sec. 197 begins on the later of-(A) The first day of the month in which the property is

acquired; or

(B) In the case of property held in connection with the

conduct of a trade or business or in an activity described

in section 212, the first day of the month in which * * *

the activity begins.

Sec. 1.197-2(f) (1) (i), Income Tax Regs.

The regulations apply

only to property acquired after Jan. 25, 2000.

Nevertheless, the

regulations further support our determination that intangible

property cannot be amortized if the trade or business or activity

to which it relates has yet to commence.

See Frontier Chevrolet

Co. v. Commissioner,

116 T.C.

289,

294 n.10

(2001).

- 39 -

We earlier issued an Opinion, Broz v. Commissioner, 137 T.C.

___ (2011), in which we found for respondent as to the class life

for depreciation purposes.

We have considered all arguments made in reaching our

decision, and, to the extent not mentioned, we conclude that they

are moot, irrelevant, or without merit.

To reflect the foregoing,

Decision will be entered

under Rule 155.