-4-
false; at the time petitioner acquired the stock, Elite had a
negative net worth and its plant was in poor physical condition.
On April 2, 1990, H. Enterprises, Mr. Hargis, Elite, and
petitioner entered into an agreement pursuant to which, among other
matters, petitioner purchased an additional 2 percent of Elite
stock from H. Enterprises. As part of the agreement, Elite
forgave all debts owed it by H. Enterprises, Mr. Hargis, and
petitioner, including petitioner's $228,000 note to Elite.
Subsequently, on April 19, 1990, Elite redeemed all of its
stock owned by H. Enterprises. As a result of this redemption,
petitioner owned 100 percent of Elite stock.
Furthermore, on April 19, 1990: (1) H. Enterprises and Mr.
Hargis sold to Elite their interest in patents, trademarks,
servicemarks, logos, trade names, formulas, and paint formulations;
and (2) Mr. Hargis entered into a noncompetition agreement with
Elite.
Administrative Proceeding
The examination of petitioners' 1990 Federal income tax return
began as an offshoot of an audit of H. Enterprises and Elite. The
revenue agent questioned whether petitioners should have reported
the cancellation of the $228,000 debt as income on their 1990
return.1
1 Gross income includes income from the discharge of
indebtedness. Sec. 61(a)(12). A taxpayer may realize discharge
of indebtedness income by paying an obligation at less than its
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