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https://www.courtlistener.com/api/rest/v3/opinions/4624490/	Paul A. Teschner and Barbara M. Teschner, Petitioners, v. Commissioner of Internal Revenue, RespondentTeschner v. CommissionerDocket No. 90023United States Tax Court38 T.C. 1003; 1962 U.S. Tax Ct. LEXIS 65; September 28, 1962, Filed 65 Decision will be entered for the petitioners. The taxpayer entered a contest the rules of which precluded him from being the recipient of a prize and which required him to designate, at the time of entry in the contest, a recipient under the age of 17 years and 1 month. Taxpayer designated his 7-year-old daughter. Subsequently, his entry won a prize payable to his daughter at age 18, without restriction as to the use to which she applied said prize. Held, the prize is not includible in the gross income of the taxpayer. Paul A. Teschner, pro se.Seymour I. Sherman, Esq., for the respondent. Train, Judge. Dawson, J., concurring. Mulroney, J., agrees with this concurring opinion. Atkins, J., dissenting. Tietjens, Opper, Raum, Withey, Pierce, and Scott, JJ., agree with this dissent. TRAIN1004 Respondent determined a deficiency in the 1957 income tax liability of petitioners in the amount of $ 283.16.The sole question is whether petitioners are taxable on a prize received by their daughter.FINDINGS OF FACT.Some of the facts have been stipulated and are found hereby as facts.Petitioners Paul A. (hereinafter referred to as Paul) and Barbara M. Teschner are husband and wife. They filed a joint Federal income tax return on the cash basis for the calendar year 1957 with the director of internal revenue, Chicago, Illinois.Sometime prior to October 2, 1957, Johnson & Johnson, Inc. (hereinafter referred to as Johnson & Johnson), in cooperation with the Mutual Benefit Life Insurance Company of Newark, New Jersey (hereinafter referred to as Mutual), announced a contest called the "Annual Youth Scholarship Contest" (hereinafter67 referred to as the contest). An entrant was required to complete in fifty additional words or less the statement "A good education is important because * ."Any person in the United States or Canada was entitled to enter the contest with the exception of employees or their families of either Johnson & Johnson or Mutual. The prizes listed, totaling $ 75,000, were as follows:Grand prize$ 10,000Two second prizes5,000 each Four third prizes2,500 each Six fourth prizes1,500 each Thirty-six fifth prizes1,000 each The prizes consisted of annuity policies in the face amount of the respective prizes. Rule 4 of the contest stated that:Only persons under age 17 years and 1 month (as of May 14, 1957) are eligible to receive the policies for education. A contestant over that age must designate a person below the age of 17 years and 1 month to receive the policy for education. In naming somebody else, name, address and age of both contestant and designee must be filled in on entry blank.As of May 14, 1957, both petitioners were over the age of 17 years and 1 month.The preclusion of Paul from eligibility to receive any of the policies was neither directly68 nor indirectly attributable to any action taken by him. He had not suggested such a contest to anyone; had never discussed 1005 such a contest with representatives of either Johnson & Johnson or Mutual; and had no knowledge of the contest until the official announcement of it was first brought to his attention. Neither at the time Paul prepared and submitted the entry nor at any other time has there been any arrangement or agreement between petitioners and their daughter to divide or share in anything of value she might receive.Paul, an attorney, entered the contest, submitting two statements on the form supplied by Johnson & Johnson. At that time, he designated his daughter, Karen Janette Teschner (hereinafter referred to as Karen), age 7, as the recipient should either of the entries be selected.One of the statements submitted by Paul was selected, and on October 2, 1957, petitioners' daughter received the following telegraph notification addressed to her:JOHNSON & JOHNSON AND THE MUTUAL BENEFIT LIFE INSURANCE COMPANY TAKE GREAT PLEASURE IN INFORMING YOU THAT YOU HAVE BEEN AWARDED THE FOURTH PRIZE OF A ONE THOUSAND FIVE HUNDRED DOLLAR PAID-UP INSURANCE POLICY IN THEIR69 NATIONAL YOUTH SCHOLARSHIP CONTEST. YOU WILL BE CONTACTED WITH FURTHER DETAILS AS SOON AS POSSIBLE --NATIONAL YOUTH SCHOLARSHIP COMMITTEEThereafter, Johnson & Johnson filed an application and paid Mutual $ 1,287.12. As the result thereof, petitioners' daughter received from Mutual, during 1957, a fully paid-up annuity policy, having a face value of $ 1,500. This policy contained no limitation whatsoever on the manner in which Karen would be entitled to use the proceeds or any other benefits available under the policy. Specifically, the use of these proceeds or benefits was not limited to educational or similar purposes.Petitioners did not include any amount in their 1957 income tax return with regard to the foregoing annuity policy. Respondent determined that the policy constituted gross income to petitioners, and assigned a value thereto of $ 1,287.12, the consideration paid by Johnson & Johnson.OPINION.While the taxability of prizes and awards may have been in doubt prior to the enactment of the Internal Revenue Code of 1954, 1 it is now clear that they are includible in gross income, 2 with certain exceptions 1006 not here applicable. Sec. 74 I.R.C. 1954. 370 The sole question in this case is whether the prize (annuity policy) is taxable to petitioners.71 Respondent, relying on Lucas v. Earl, 281 U.S. 111">281 U.S. 111 (1930), and Rev. Rul. 58-127, 1 C.B. 42">1958-1 C.B. 42, contends that the annuity policy which Karen received is includible in petitioners' gross income. Respondent states on brief that the issue here "is whether a prize attributable to a taxpayer's contest efforts, which, if received by him, would constitute taxable income in the nature of compensation for services rendered, may be excluded by him because paid to his designee." Respondent declares his theory of the case to be "that whenever A receives something of value attributable to services performed by B, B, the earner, is the proper taxpayer."Petitioners contend that the value of the annuity policy should not be included in their gross income because they did not receive anything either actually or constructively and never had a right, at anytime, to receive anything that could have been the subject of an anticipatory assignment or similar arrangement.We agree with the petitioners.In the instant case, we are not confronted with the question of whether the prize is income. The sole question is whether72 it is the petitioners' income for tax purposes. Certainly, it was Paul's effort that generated the income, to whomever it is to be attributed. However, as we have found, he could not under any circumstances whatsoever receive the income so generated, himself. He had no right to either its receipt or its enjoyment. He could only designate another individual to be the beneficiary of that right. Moreover, under the facts of this case, the payment to the daughter was not in discharge of an obligation of petitioners. Cf. Douglas v. Willcutts, 296 U.S. 1 (1935). At age 18, Karen will be entitled to $ 1,500. She can use that money, in her uncontrolled and unfettered discretion, for any purpose she chooses. Nor does respondent here contend that petitioners received income by virtue of a satisfaction of an obligation to support. Finally, there is no evidence whatsoever that the arrangement here involved was a sham or the product of connivance.As pointed out above, respondent relies, in part, on Rev. Rul. 58-127, supra, and a consideration of that ruling is useful because it reveals the error into which73 the respondent has here fallen. Under the circumstances 1007 stated by that ruling, the taxpayer prepared and submitted a winning entry in an essay contest. Pursuant to the terms of that contest, the taxpayer received a check payable to his child, the use of which was entirely without restriction imposed by the sponsors of the contest. The respondent ruled that, under such circumstances, the amount of the prize was includible in the gross income of the taxpayer. While the facts set out in that ruling do not disclose whether the taxpayer could himself have received the prize, it would seem that in all salient respects the facts therein are identical to those before us.In his ruling, the respondent declared, "The basic rule in determining to whom an item of income is taxable is that income is taxable to the one who earns it." If by this statement the respondent means that income is in all events includible in the gross income of whomsoever generates or creates the income by virtue of his own effort, the respondent is wrong. If this were the law, agents, conduits, fiduciaries, and others in a similar capacity would be personally taxable on the proceeds of their efforts. 74 The charity fund-raiser would be taxable on sums contributed as the result of his efforts. The employee would be taxable on income generated for his employer by his efforts. Such results, completely at variance with every accepted concept of Federal income taxation, demonstrate the fallacy of the premise.If, on the other hand, the respondent used the term "earn," not in such a broad sense, but in the commonly accepted usage of "to acquire by labor, service, or performance; to deserve and receive compensation" (Webster's New International Dictionary), 4 then the rule is intelligible but does not support the conclusion reached by the respondent either in the ruling in question or in the case before us. The taxpayer there, as here, acquired nothing himself; he received nothing nor did he have a right to receive anything.In Rev. Rul. 58-127, supra, respondent75 relied heavily, as he does here, on Helvering v. Horst, 311 U.S. 112">311 U.S. 112 (1940), especially the language of the opinion to the effect that -- "The power to dispose of income is the equivalent of ownership of it. The exercise of that power to procure the payment of income to another is the enjoyment, and hence the realization, of the income by him who exercises it." The respondent's reliance on this language is misplaced. The power of disposition assumes possession or the right of possession. To dispose is to part with. Where there is neither possession nor the right to possession, there can be no disposition. In Helvering v. Horst, supra, the taxpayer, the owner of negotiable bonds, detached from them negotiable interest coupons shortly before their due date and delivered them as gifts to his son who in the same year collected them at maturity. The language of the Court, quoted above and relied upon by respondent, mistakenly we believe, must be read in relation to the facts 1008 then before the Court. In this connection, the Court in Horst stated unequivocally: "The question here is, whether because76 one who in fact receives payment for services or interest payments is taxable only on his receipt of the payments, he can escape all tax by giving away his right to income in advance of payment." Plainly, here, petitioners have not given away any right of theirs whatsoever. Further, in Horst, at page 119, the Supreme Court stated:The dominant purpose of the revenue laws is the taxation of income to those who earn or otherwise create the right to receive it and enjoy the benefit of it when paid. * * * The tax laid * * * upon income "derived from * * * wages, or compensation for personal service, * * * in whatever form paid, * * " * * cannot fairly be interpreted as not applying to income derived from interest or compensation when he who is entitled to receive it makes use of his power to dispose of it in procuring satisfactions which he would otherwise procure only by the use of the money when received. [Emphasis supplied.]In Lucas v. Earl, 281 U.S. 111 (1930), upon which respondent heavily relies, the Supreme Court refused to allow a husband to escape taxes on his income by way of salaries and attorney fees through a contractual77 arrangement by which he and his wife were to receive, hold, and own such earnings as joint tenants. The Court declared that tax on a salary could not be avoided by the person earning the salary by anticipatory arrangements and contracts. Shortly thereafter, in Poe v. Seaborn, 282 U.S. 101">282 U.S. 101, 117 (1930), the Supreme Court stated:In the Earl case * * the husband's professional fees, earned in years subsequent to the date of the contract, were his individual income * * . The very assignment in that case was bottomed on the fact that the earnings would be the husband's property, else there would have been nothing on which it could operate. That case presents quite a different question from this, because here, by law, the earnings are never the property of the husband, * In Harrison v. Schaffner, 312 U.S. 579">312 U.S. 579, 580, 582 (1941), the Supreme Court stated that the rule applicable to an anticipatory assignment of income applies when the assignor is entitled at the time of the assignment to receive the income at a future date and is vested with such a right. In the instant case, petitioners themselves received78 nothing and were never entitled to anything. What was said in the early case of Marion Stone Burt Lansill, 17 B.T.A. 413">17 B.T.A. 413, 423 (1929), affd. 58 F. 2d 512 (C.A.D.C. 1932), seems appropriate here:The right in the taxpayer to receive the income at the time it is attributed and taxed to him is likewise not essential, where, as in the Old Colony, Boston & Maine, and Rensselaer and Rosenwald cases, supra, the taxpayer has by his own volition chosen to dispose of the right to receive income while retaining that from which the income is derived. The volition in disposing of the right is important, for while all will agree that one who never received or had a right to receive or who has involuntarily lost it should not be taxed, it is also plain that his voluntary exercise of the right to dispose of the income before receipt may be just as valuable and important practically as its exercise after receipt. * * * [Emphasis supplied.]1009 It cannot be argued that Paul voluntarily gave up his right to get the annuity policy and designated his daughter to receive it in his place. There was no discretion79 on his part; the choice was to accept the terms of the contest or reject them.In the case before us, the taxpayer, while he had no power to dispose of income, had a power to appoint or designate its recipient. Does the existence or exercise of such a power alone give rise to taxable income in his hands? We think clearly not. In Nicholas A. Stavroudes, 27 T.C. 583">27 T.C. 583, 590 (1956), we found it to be settled doctrine that a power to direct the distribution of trust income to others is not alone sufficient to justify the taxation of that income to the possessor of such a power. See also Bateman v. Commissioner, 127 F. 2d 266 (C.A. 1, 1942).Granted that an individual cannot escape taxation on income to which he is entitled by "turning his back" upon that income, the fact remains that he must have received the income or had a right to do so before he is taxable thereon. As stated by the court in United States v. Pierce, 137 F.2d 428">137 F. 2d 428, 431 (C.A. 8, 1943):The sum of the holdings of all cases is that for purposes of taxation income is attributable to the person entitled to receive80 it, although he assigns his right in advance of realization, and although, in the case of income derived from the ownership of property, he transfers the property producing the income to another as trustee or agent, in either case retaining all the practical benefits of ownership.Section 1(a) of the 1954 Code imposes a tax on the "income of every individual." Where an individual neither receives nor has the right to receive income, he is not the taxable individual within the contemplation of the statute. There is no basis in the statute or in the decided cases for a construction at variance with this fundamental rule.Decision will be entered for the petitioners. DAWSONDawson, J., concurring: Harrison v. Shaffner, 312 U.S. 579">312 U.S. 579 (1941), settled the proposition that there can be no anticipatory assignment of income unless the assignor is entitled at the time of assignment to receive the income at a future date and is vested with such a right. Paul Teschner was at no time "vested with the right to receive income" under the rules of the contest and, therefore, could not possibly "escape the tax by any kind of anticipatory arrangement." Consequently, 81 the cases cited by the dissent, Lucas v. Earl, 281 U.S. 111 (1930), Helvering v. Horst, 311 U.S. 112 (1940), and Helvering v. Eubank, 311 U.S. 122 (1940), all of which held that "one vested with the right to receive income [does] not escape the tax by any kind of 1010 anticipatory arrangement, however skillfully devised," Harrison v. Shaffner, supra at 582 (emphasis supplied), are inapposite here.It is true that a taxpayer having the right to dispose of income would be taxable on the exercise of such a right where the disposition results in an economic benefit to him. However, in the instant case Paul Teschner had no right of disposition, but only a duty under the contest rules to designate a person under the age of 17 years, 1 month. Compliance with this duty was a condition precedent for entry of persons over that age into the contest. While it might be said concomitantly that there was a right to designate to whom the prize would go if it were, won, no economic benefit could be conferred upon anyone when this82 right was exercised since there was no income upon which such a right of designation could operate at the time the designation was made. If those who disagree with this result fear the prize (annuity policy) will escape taxation, there is no problem because it would appear to be taxable to the daughter under the provisions of section 74, I.R.C. 1954. ATKINSAtkins, J., dissenting: It is a well-settled principle of our income tax law that personal earnings are taxable to the earner, and that cases involving the taxation of personal earnings are not to be decided by attenuated subtleties. Lucas v. Earl, 281 U.S. 111">281 U.S. 111, in which the Supreme Court held an anticipatory assignment of future personal earnings to be ineffective to relieve the earner of tax. The Court stated:A very forcible argument is presented to the effect that the statute seeks to tax only income beneficially received, and that taking the question more technically the salary and fees became the joint property of Earl and his wife on the very first instant on which they were received. We well might hesitate upon the latter proposition, because however the matter might stand between83 husband and wife he was the only party to the contracts by which the salary and fees were earned, and it is somewhat hard to say that the last step in the performance of those contracts could be taken by anyone but himself alone. But this case is not to be decided by attenuated subtleties. It turns on the import and reasonable construction of the taxing act. There is no doubt that the statute could tax salaries to those who earned them and provide that the tax could not be escaped by anticipatory arrangements and contracts however skilfully devised to prevent the salary when paid from vesting even for a second in the man who earned it. That seems to us the import of the statute before us and we think that no distinction can be taken according to the motives leading to the arrangement by which the fruits are attributed to a different tree from that on which they grew.The annuity policy which Paul won resulted from his personal efforts. The fruit of his labor consisted of the payment of the award to his designee, his daughter. His efforts alone generated the income in question; and it is a matter of no consequence that, under the rules of the contest, such income could not 84 be paid to him, for he had the *1011 power to control its disposition. He in fact exercised that power when he entered the contest, by designating the natural object of his bounty, his daughter, as the recipient of any prize which he might win. The exercise of such power, with resultant payment to the daughter, constituted the enjoyment and hence the realization of the income by Paul. In the circumstances he should be fully charged with the income. Cf. Helvering v. Horst, 311 U.S. 112">311 U.S. 112, and Helvering v. Eubank, 311 U.S. 122">311 U.S. 122. There is no more basis here for narrowing the broad scope of the holding in Lucas v. Earl than there was in the Horst and Eubank cases. The decision of the majority herein rests upon "attenuated subtleties" similar to those disapproved, first in Lucas v. Earl and then again in Burnet v. Leininger, 285 U.S. 136">285 U.S. 136, Helvering v. Horst, Helvering v. Eubank, Harrison v. Schaffner, 312 U.S. 579">312 U.S. 579, and Commissioner v. P. G. Lake, Inc., 356 U.S. 260">356 U.S. 260. Footnotes1. Compare such cases as Pauline C. Washburn, 5 T.C. 1333 (1945) ("Pot O'Gold" case); McDermott v. Commissioner, 150 F. 2d 585 (C.A. D.C. 1954) (Ross Essay contest); Glenn v. Bates, 217 F. 2d 535 (C.A. 6, 1954) (car giveaway); Ray W. Campeau, 24 T.C. 370">24 T.C. 370 (1955) ("Hollywood Calling -- Film of Fortune") with Herbert Stein, 14 T.C. 494 (1950), and Robertson v. United States, 343 U.S. 711↩ (1952).2. See H. Rept. No. 1337, 83d Cong., 2d Sess., pp. 11, A27 (1954). S. Rept. No. 1622, 83d Cong., 2d Sess., pp. 13, 178 (1954). Finance Committee Hearing, 83d Cong., 2d Sess., pp. 12, 482 (1954).↩3. SEC. 74. PRIZES AND AWARDS.(a) General Rule. -- Except as provided in subsection (b) and in section 117 (relating to scholarships and fellowship grants), gross income includes amounts received as prizes and awards.(b) Exception. -- Gross income does not include amounts received as prizes and awards made primarily in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievement, but only if -- (1) the recipient was selected without any action on his part to enter the contest or proceeding; and(2) the recipient is not required to render substantial future services as a condition to receiving the prize or award.↩4. Cf. Cold Metal Process Co. v. Commissioner, 247 F.2d 864">247 F. 2d 864, 872↩ (C.A. 6, 1957).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624491/	JAY M. BARRASH AND SANDRA BARRASH, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentBarrash v. CommissionerDocket No. 15873-86.United States Tax CourtT.C. Memo 1987-592; 1987 Tax Ct. Memo LEXIS 591; 54 T.C.M. (CCH) 1230; T.C.M. (RIA) 87592; December 2, 1987. Bruce Locke and George W. Connelly, Jr., for the petitioners. Ana G. Cummings, for the respondent. FEATHERSTONMEMORANDUM OPINION FEATHERSON, Judge: The parties' cross motions to dismiss for lack of jurisdiction were assigned to Special Trial Judge Joan Seitz Pate1 for hearing, consideration and ruling thereon pursuant to the provisions of section 7456(d) (redesignated as section 7443A(b) by the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2755) and Rules 180 and 181. 2 The Court agrees with and adopts her opinion which is set forth below. 593 OPINION OF THE SPECIAL TRIAL JUDGE PATE, Special Trial Judge: Respondent determined the following deficiencies in and additions to petitioners' Federal income taxes: 197919801981Deficiency$ 88,761.00$ 52,850.00$ 45,087.00Additions to Tax:Sec. 6653(a)(1)4,438.052,642.502,254.35Sec. 6653(a)(2)--Sec. 6659--10,926.60Respondent has moved to dismiss for lack of jurisdiction on the grounds that the petition was not filed within the time prescribed by law. Petitioners have also moved to dismiss for lack of jurisdiction alleging that respondent failed to properly mail or deliver the notice of deficiency, thereby rendering it invalid. Alternatively, petitioners ask us to extend the time for filing a petition with this Court to 90 days after the date petitioners received a copy of the notice of deficiency. A ruling in favor of petitioners on this alternative argument would result in our having jurisdiction to determine this case on its merits. Jay M. Barrash and Sandra Barrash (Hereinafter collectively "petitioners"), 594 husband and wife, filed joint Federal income tax returns for 1979, 1980 and 1981, which were received by respondent on May 9, 1980, June 15, 1981, and July 23, 1982, respectively. Dr. Barrash styled himself as "Jay M. Barrash" on his 1979 return and "J. Martin Barrash" on his 1980 and 1981 returns. 3 At all times relevant to this litigation, petitioners resided at 5106 Glenmeadow, Houston, Texas 77096 (hereinafter "Glenmeadow address"). During the years in issue, Dr. Barrash, a physician, maintained offices at 7000 Fannin, Suite 1570, Houston, Texas 77030 (hereinafter "Fannin Street address"). During all of these years, petitioners deducted losses attributable to a purported "tax shelter" entitled DJL Arts. Petitioners also deducted losses from several other activities and partnerships including, for 1980 and 1981, a partnership entitled SCJ Enterprises #1 Crude (hereinafter "SCJ"). Dr. Barrash was listed as "Dr. Martin Barrash" at the Fannin Street address on Schedule K1 of SCJ's partnership return. By letter dated November 15, 1982, respondent595 notified petitioners that their 1979 and 1980 income tax returns had been selected for audit. 4 At that time, petitioners executed a Form 2848, Power of Attorney, appointing their Certified Public Accountant (hereinafter "CPA") as their representative. On that form they requested that their CPA be sent copies of notices and other written communications concerning their 1979 and 1980 tax liabilities. 596 On February 17, 1983, their CPA executed a Form 872-A, which extended the statute of limitations on petitioners' 1979 return but restricted the consent to specific items, including DJL Arts. In March 1984, respondent's Examination Support Staff (hereinafter "ESS") requested that petitioners sign a Form 872-A consenting to extend the limitations period on their 1980 income tax return. Their CPA requested that the extension be limited to particular areas of concern. In response, the ESS stated, in a letter dated April 27, 1984, that a notice of deficiency would be prepared on "May 10, 1984 if we have not received the signed consents at that time." Signed consents were never submitted. A notice of deficiency dated June 13, 1984, determining deficiencies in petitioners' income tax lisbilities for 1979, 1980 and 1981 was prepared by respondent. The year 1981 was included because of respondent's policy of including all years affected by a tax shelter when issuing a notice of deficiency involving that shelter. Respondent claims that he sent such notice to petitioners at their Glenmeadow address. Petitioners maintain that neither they nor their CPA received the original or a copy597 of the notice of deficiency. Moreover, the Postal Service has no record of delivery nor was the notice of deficiency returned to respondent as undeliverable or refused. 5On July 30, 1984, the ESS was notified by the Examination Division that petitioners' 1981 income tax return was under examination because of their investment in SCJ. The ESS, assuming that the statute of limitations on petitioners' 1981 income tax return would expire on April 15, 1985, sent petitioners a letter dated September 5, 1984 requesting that they sign Form 872-A consenting to extend the statute of limitations for 1981. Petitioners' CPA again proposed that the parties limit the extension to particular areas of concern. In a letter dated October 4, 1984, the ESS stated that it had not yet received a copy of petitioners' 1981 return and requested that petitioners provide a copy to expedite matters. On October 18, 1984, respondent sent a letter entitled "Final Request" 598 to petitioners explaining that he had not received an extension from petitioners for the 1981 return and that ESS would "have to act" on the return before the statute of limitations expired. A second "Final Request" letter, dated November 15, 1984, was mailed to petitioners. Therein, the ESS again informed petitioners that it had no record of a reply and stated that "If we do not receive the Form 872-A within 15 days, a statutory notice of deficiency will be issued." In response thereto, on November 17, 1984, petitioners' CPA sent respondent a copy of petitioners' 1981 income tax return together with a Form 872-A for that year, signed by petitioners, containing the same restrictions agreed to with regard to their 1979 return. Apart from the extension requests regarding 1981 caused by petitioners' investment in SCJ, respondent independently assessed the tax and additions to tax reflected in the June 13, 1984 notice of deficiency on November 8, 1984. After the statement of the assessment was sent to petitioners in the middle of November, their CPA contacted respondent in an attempt to ascertain the basis for the assessment, but was unsuccessful in determining its origin. In fact, 599 a letter addressed to respondent by petitioners' attorney showed that petitioners were still attempting to obtain a copy of the notice of deficiency on February 24, 1985. After additional communications with petitioners' representative, respondent finally sent petitioners' attorney a copy of the notice of deficiency on March 5, 1986. In the meantime, petitioners filed a complaint in the United States District Court for the southern District of Texas on March 13, 1985 to set aside the assessment and enjoin the collection of taxes for 1979, 1980 and 1981. On May 27, 1986 a petition was filed in this Court contesting respondent's determinations for 1979, 1980 and 1981. Following a motion in the District Court by the United States to dismiss petitioners' case or for summary judgment therein, the District Court issued an order on approximately June 18, 1986 deferring any action in that case until we reach a decision in the present case. Basically, petitioners maintain that respondent did not properly prepare and mail the notice of deficiency, that the Postal Service did not properly deliver it, and, therefore, it is invalid to establish our jurisdiction over this case. Conversely, 600 respondent maintains that the notice of deficiency was properly mailed to petitioners' last known address, that it is valid regardless of actual receipt, that the petition was not filed within 90 days of that mailing; and therefore, we must grant his motion to dismiss for lack of jurisdiction. 6The law is well settled that both a valid notice of deficiency and a timely filed petition are necessary to maintain an action in this Court. Secs. 6212 and 6213; e.g., Pyo v. Commissioner,83 T.C. 626">83 T.C. 626, 632 (1984); Mollet v. Commissioner,82 T.C. 618">82 T.C. 618, 623 (1984), affd. without published opinion 757 F.2d 286">757 F.2d 286 (11th Cir. 1985); Keeton v. Commissioner,74 T.C. 377">74 T.C. 377, 379 (1980). Generally, a notice of deficiency is issued when mailed to the taxpayer's last known address by certified or registered mail. Sec. 6212(a) and (b)(1); sec. 301.6212-1(a) and (b), Proced. & Admin. Regs. A petition must be filed601 with this Court within 90 days after the mailing of the notice of deficiency.7Sec. 6213(a). Respondent has the burden of proving that the notice of deficiency was properly sent by certified or registered mail. August v. Commissioner,54 T.C. 1535">54 T.C. 1535, 1536 (1970); see Cataldo v. Commissioner,60 T.C. 522">60 T.C. 522 (1973), affd. per curiam 499 F.2d 550">499 F.2d 550 (2d Cir. 1974). To this end, we have considered respondent's standard procedure for preparing and mailing notices of deficiency in his Houston Office during 1984. This procedure began with a 90-day notices clerk reviewing a draft notice of deficiency for correctness, directing that the notice be typed, proofreading the typed notice, and submitting it to the ESS for further review. When satisfactory, the ESS initialed and returned it to the 90-day notices clerk, who then completed the Forms 3877 (a list of the notices of deficiency mailed on that particular day) which included listing the name and address of petitioners, the years covered by the notice of deficiency,602 the insertion of the total number of notices listed on that particular form, checking the box for certified mail, and initialing the top right hand corner signifying that all clerical tasks were completed and checked. Then, each line item was assigned a consecutive certified mail number, each notice of deficiency was placed in a window envelope, and the certified mail number was written on the envelope. The names and addresses showing through the envelope window was once again checked against the Form 3877. Quality Management Program 8 personnel then compared the address on the notice of deficiency with the envelope and, in turn, to the information recorded on Form 3877. If no changes were required, the 90-day notices clerk sealed the envelopes and contacted the mail room for pickup. The mail room clerk delivered the certified letters to the post office only after independently verifying that the number of envelopes coincided with the number of entries on Form 3877 and after comparing the name, address and certified number on each envelope to that listed on the Form 3877. Upon receipt, the Postal Service verified the count, entered the number of envelopes on Form 3877, and matched603 the certified on each envelope to the number listed on Form 3877. Thereafter, the Postal Service postmarked and signed the Form 3877 and returned it to the mail room clerk. Finally, the mail room clerk initialed the Form 3877 before returning it to the Houston Office. A small number of errors were discovered and corrected at each stage of this process. The Form 3877 dated June 13, 1984 contains petitioners' names; the Glenmeadow address; notations of tax years "8112, 8012 and 7912;" initials of the ESS employee and the 90-day notices clerk; the total number of envelopes listed by respondent (15); the total number of envelopes received at the Post Office (15); a June 13, 1984 postmark; the initials of the mail clerk and the signature of the Postal Service employee accepting the certified mail. In the absence of contrary evidence, this Form 3877 alone is proof that respondent mailed the notice of deficiency by certified mail to petitioners' last known address. 604 United States v. Zolla,724 F.2d 808">724 F.2d 808, 810 (9th Cir. 1984), cert. denied 469 U.S. 830">469 U.S. 830 (1984). Cf. Magazine v. Commissioner,89 T.C. 321">89 T.C. 321 (1987). Therefore, petitioners must show that respondent did not follow these procedures with regard to the notice of deficiency addressed to them. See United States v. Ahrens,530 F.2d 781">530 F.2d 781, 785 (8th Cir. 1976); August v. Commissioner,54 T.C. at 1538-1539. Petitioners first contend that an error made at any stage of respondent's standard processing procedures could have resulted in an error in issuing the notice of deficiency in this case. We recognize that there is always a possibility of human error. However, errors discovered in a small number of notices do not prove that an error was made in this case. See United States v. Ahrens, supra at 785-786. Quite the contrary, we are convinced that respondent's procedures effectively minimized errors in such notices; thus, lowering the probability of error in this case. Second, petitioners argue that respondent would not have requested that petitioners consent to extend the statute of limitations on605 1981 in September of 1984 had respondent previously issued a notice of deficiency covering that year. Respondent admits that these requests were unnecessary, and we might add that they do not add to the sound administration of the tax law. We note, however, that Dr. Barrash may have been partially responsible for this confusion inasmuch as he styled himself as "Jay M. Barrash" at the Glenmeadow address on his 1979 income tax return (resulting in the notice of deficiency being so issued) and as "Dr. Martin Barrash" at the Fannin Street address on SCJ's partnership return (which gave rise to respondent's September 1984 requests for extension of the statute of limitations). Cf. Lifter v. Commissioner,59 T.C. 818">59 T.C. 818, 821 (1973). However, petitioner's taxpayer identification number was identical on all these forms and this alone should have adequately identified petitioner. Admittedly, the September 1984 extension request coupled with the alleged lack of delivery of the notice of deficiency was confusing to petitioners. Nevertheless, these factors do not control our jurisdiction. Rather, our determination is predicated on whether the notice of deficiency was mailed606 to petitioners by respondent and as we stated earlier, respondent has presented sufficient evidence to show the notice of deficiency was mailed. Consequently, we surmise that it was respondent's system for processing consents to extend the statute of limitations that failed in this case. Either the information regarding the notice of deficiency covering 1981 had not been properly entered into all of respondent's records necessary for consistent treatment, or those records were not adequately consulted prior to the ESS making their requests to extend the statute of limitations for 1981. Third, petitioners argue that respondent would not have issued a notice of deficiency for 1981 because he had not yet audited that return. However, there is no requirement that respondent audit a return before issuing a notice of deficiency. See Boyer v. Commissioner,69 T.C. 521">69 T.C. 521, 543-544 (1977). Moreover, including 1981 on the notice of deficiency was consistent with respondent's policy of issuing a notice of deficiency for all years relating to a particular tax shelter. The statute of limitations on petitioners' 1980 return was due to expire on June 15, 1984. Consistent with this607 policy, respondent included all years in which petitioners had claimed losses relating to DJL Arts when he issued the notice of deficiency dated June 13, 1984. Finally petitioners put forth what we deem their most persuasive argument. They contend that the notice of deficiency was never mailed because: (a) it was not received by either petitioners or their CPA; (b) it was never returned to respondent; and (c) the postal service has no record of delivery. For the reasons stated below, we disagree. First, it is unclear from the record whether respondent even attempted to mail a copy of the notice of deficiency to petitioners' CPA. Although the power of attorney petitioners filed with respondent requested that copies of correspondence be sent to their CPA, such copies are a matter of courtesy and in no way affect the mailing requirements of section 6212. McDonald v. Commissioner,76 T.C. 750">76 T.C. 750, 753 (1981); Houghton v. Commissioner,48 T.C. 656">48 T.C. 656, 661 (1967); Allen v. Commissioner,29 T.C. 113">29 T.C. 113, 117 (1957). Moreover, since respondent issued the notice of deficiency for 1979, 1980 and 1981, while their CPA's power of attorney covered608 only 1979 and 1980, respondent may have been precluded from sending the CPA a copy. See sec. 6103. Second, we are satisfied that the standard procedures respondent used in Houston during the summer of 1984 contained sufficient safeguards to assure that notices of deficiencies were addressed and mailed as reflected on Form 3877. Petitioners have presented no evidence directly contradicting the testimony of various persons involved with the preparation and mailing of the notice of deficiency or the result of these procedures reflected on Form 3877. Therefore, we hold that respondent mailed the notice of deficiency covering the taxable years 1979, 1980 and 1981 by certified mail to petitioners' last known address on June 13, 1984. Nevertheless, petitioners alternatively contend that their failure to receive the notice of deficiency was due to mishandling by the Postal Service and a technical construction of the statute limiting respondent's duty to placing their notice in the hands of the Postal Service would penalize them in a manner which is inequitable, unnecessary, inappropriate and improper. Petitioners rely on the fact that they allegedly never received the notice, that609 it was never returned to respondent, and that the Postal Service has no record of delivery, as evidence of the Postal Service's mishandling. since we have found that respondent delivered a properly addressed notice of deficiency to the Postal Service, petitioners had to overcome a strong presumption in the law that it was delivered or offered for delivery to them. Zenco Engineering Corp. v. Commissioner,75 T.C. 318">75 T.C. 318, 323 (1980), affd. without published opinion 673 F.2d 1332">673 F.2d 1332 (7th Cir. 1981). After due consideration, we find that petitioners have not overcome this presumption. The record simply does not show what happened to the notice of deficiency. Further, as previously stated, section 6212 only requires that respondent send, by certified or registered mail, a properly addressed notice of deficiency. It does not require that the taxpayer receive such notice. Therefore, if the Postal Servie mishandles a notice in such a way that both parties are unaware of the mishandling, the risk of nondelivery falls on the taxpayer. See 610 United States v. Ahrens,530 F.2d at 785. 9This result may seem unfair and may even be harsh. We recognize that, although other litigating forums are available to the taxpayer to challenge the amount of his tax, they are only available after payment of the tax. Advance payment may be very difficult or even impossible in some instances. Yet, as harsh as the result may seem, the extent of our jurisdiction is determined by Congress. The result we reach here is the only one which gives full meaning to the clear language of section 6212. Cataldo v. Commissioner, supra.See, e.g., DeWelles v. United States,378 F.2d 37">378 F.2d 37, 39 (9th Cir. 1967), cert. denied 389 U.S. 996">389 U.S. 996 (1967); Brown v. Lethert,360 F.2d 560">360 F.2d 560, 562 (8th Cir. 1966); Frieling v. Commissioner,81 T.C. 42">81 T.C. 42, 52 (1983); Lifter v. Commissioner,59 T.C. at 820-821. This Court has no right to extend our jurisdiction on equitable grounds. 10611 Finally, petitioners argue that they were "lulled to sleep" by respondent requesting a consent to extend the statute after issuance of the notice of deficiency and they should not suffer the consequences of respondent's actions. It is well established that the 90-day period commences with the mailing of a properly addressed notice of deficiency, irrespective of the date of actual receipt by the taxpayer. Wilson v. Commissioner,564 F.2d 1317">564 F.2d 1317, 1319 (9th Cir. 1977), affg. per curiam on this issue an unreported order of this Court; Teel v. Commissioner,248 F.2d 749">248 F.2d 749, 751 (10th Cir. 1957), affg. 27 T.C. 375">27 T.C. 375 (1956); Roszkos v. Commissioner,87 T.C. 1255">87 T.C. 1255, 1266 (1986), on appeal (9th Cir., July 14, 1987); cf. Frieling v. Commissioner,81 T.C. 42">81 T.C. 42, 48 (1983). This Court has no authority to grant petitioners' motion to extend the 90-day period for filing a petition, "whatever the equities of a particular case may be and regardless of the cause for its not being filed within the required time period." 612 Axe v. Commissioner,58 T.C. 256">58 T.C. 256, 259 (1972). Therefore, even assuming respondent's actions put petitioners into a soporific state, we have no power to confer jurisdiction upon ourselves as a result. Ruby v. Commissioner,2 B.T.A. 377">2 B.T.A. 377, 378 (1925). The long and short of it is that respondent mailed a notice of deficiency by certified mail to petitioners at their last known address on June 13, 1984. Petitioners allege that for some unknown reason it was not delivered to them. Nonetheless, petitioners had 90 days from June 13, 1984 to file a petition with this Court. In fact, the petition herein was not filed until May 27, 1986, almost two years later. Therefore, by clear statutory mandate the petition was not timely filed. Accordingly, respondent's motion to dismiss for lack of jurisdiction is granted and petitioners' motion to dismiss for lack of jurisdiction is denied. An appropriate order will be entered.Footnotes1. These cross motions were originally assigned to Special Trail Judge Carlton D. Powell. After hearing part of the testimony, he recused himself and this case was reassigned to Special Trial Judge Joan Seitz Pate. The parties have stipulated that this Court may rule on these cross motions using the record introduced before Judge Powell, as supplemented by the additional evidence the parties introduced at a further hearing before Judge Pate↩. 2. Unless otherwise stated, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the years in issue, and all rule references are to the Tax Court Rules of Practice and Procedure. ↩. Fifty percent of the interest due on the underpayment of $ 45,087.00. ↩3. Dr. Barrash signed his 1979 and 1981 income tax returns as "J. Martin Barrash" and his 1980 income tax return as "Jay M. Barrash." ↩4. At trial, respondent objected to the admission into evidence of the November 15, 1982 letter, and to the admission of various other documents prepared by respondent thereafter, correspondence between respondent and petitioners, and a Postal Service letter responding to inquiries regarding the mailing of the notice of deficiency. We reserved ruling on respondent's objections. Respondent contends that the letter, documents, and correspondence are irrelevant because they do not tend to prove or disprove the mailing of the notice of deficiency in this case. Respondent further argues that the letter concerning the audit of petitioners' 1979 and 1980 returns is inadmissible because it relates to the practices and procedures respondent employed in determining the deficiencies in this case. Generally, this Court will not look behind a notice of deficiency at respondent's practices and procedures in making his determinations. Vallone v. Commissioner,88 T.C. 794">88 T.C. 794, 806 (1987), and the cases cited therein. However, for purposes of these cross motions we are not determining the amount of a deficiency, but rather whether respondent properly produced and mailed a notice of deficiency. Respondent's practices and procedures are relevant for that purpose. Fed. R. Evid. 401. See Shelton v. Commissioner,63 T.C. 193">63 T.C. 193, 198 (1974); Cataldo v. Commissioner,60 T.C. 522">60 T.C. 522, 524 (1973), affd. per curiam 499 F.2d 550">499 F.2d 550 (2d Cir. 1974). Moreover, although respondent objected to admitting the Postal Service letter as hearsay, he did not argue this position on brief and, consequently, we deem it abandoned. See Rule 151(e); Strasser v. Commissioner,T.C. Memo. 1986-579, n.13. See also Calcutt v. Commissioner,84 T.C. 716">84 T.C. 716, 721-722↩ (1985). Accordingly, the foregoing letters and documents are admitted into evidence for purposes of these cross motions. 5. The post office's failure to have a record of delivery of a piece of certified mail means only that there is no delivery record of the letter; it does not necessarily mean that the post office did not receive or deliver the letter. ↩6. This Court has jurisdiction to determine whether we have jurisdiction. Pyo v. Commissioner,83 T.C. 626">83 T.C. 626, 632 (1984); Brannon's of Shawnee, Inc. v. Commissioner,69 T.C. 999">69 T.C. 999, 1002↩ (1978). 7. A petition must be filed within 150 days if the notice of deficiency is addressed to a person outside the United States. ↩8. This was a special review program conducted at respondent's Houston Office in 1984. ↩9. See also Brooks v. Commissioner,T.C. Memo. 1984-20↩, on appeal (9th Cir., Sept. 13, 1984). 10. See Shipley v. Commissioner,572 F.2d 212">572 F.2d 212, 214↩ (9th Cir. 1977), affg. a Memorandum Opinion of this Court.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624492/	APPEAL OF CLARENCE STRECKER, EXECUTOR OF ESTATE OF EDWARD STRECKER.Strecker v. CommissionerDocket No. 5382.United States Board of Tax Appeals6 B.T.A. 19; 1927 BTA LEXIS 3624; February 2, 1927, Promulgated 3624 By his will decedent devised his real estate to his executor in trust for the use of his widow during her life, and directed the executor, upon her death, to sell such real estate and divide the proceeds among his children. Held, that while the interest of the children vested at the death of decedent, their sole interest, in the absence of any election to take the real estate, was in the proceeds of sale and was personal property, and that the gain from the sale was taxable to the executor as income to the corpus of the estate. Samuel Freedman, C.P.A., for the petitioner. M. N. Fisher, Esq., for the Commissioner. PHILLIPS 19 This is an appeal from the determination of a deficiency in income tax in the amount of $2,446.21 for the calendar year 1920. The question involved is whether the executor is subject to tax on the profit realized from the sale of real estate in 1920. FINDINGS OF FACT. The appellant is a resident of Greenfield, Mass., and is the duly appointed executor of the estate of Edward Strecker, who died testate on December 2, 1913. By his will the decedent devised certain real estate to the executor in trust for the3625 use of his widow during her life, and directed the executor, upon the death of the widow, to convert the property into cash and distribute the proceeds equally among the decedent's nine children, or their representatives. The widow died December 8, 1916. The real estate was sold by the executor in 1920. In computing the deficiency the Commissioner has included the profit from the sale as income of the estate. 20 OPINION. PHILLIPS: It is the contention of the petitioner that no part of the profit resulting from the sale of the real estate in question is taxable to the estate of the decedent. The only authority cited by counsel for the petitioner is the opinion of the Solicitor of Internal Revenue, No. 35, published in Cumulative Bulletin No. 3, p. 50. It appears that the facts before the Solicitor were substantially the same as those involved in the present proceeding. The principal question under discussion in the opinion was the basis for measuring the gain or loss. It appears, however, that the Solicitor also had under consideration the question whether any taxable gain resulted to the beneficiaries of the will for, after quoting the provisions of law governing3626 the measurement of gain or loss, the opinion reads: In applying the statutory rule in this case it is necessary to determine the character of the respective interests involved and when they were acquired. The problem is somewhat confused by the fact that the testator directed the sale of the land and the distribution of the proceeds among his children after the death of the life tenant instead of devising to them the land itself, subject to the life estate, without any direction for its sale. While, under the doctrine of equitable conversion, the interest of the children is regarded as personalty instead of realty, yet the estate which they acquired was a remainder and vested at the death of the testator. ; ; . Also, their interest was such that if they had so elected prior to its sale they could have taken the actual land itself after the death of the life tenant instead of the proceeds from its sale. Jarman on Wills, p. 562 and cases there cited. It is believed, therefore, that the question is the same for the purposes of3627 our present inquiry as if the land itself had been devised to the widow for life with remainder in fee to the children and without any direction for its sale. There is nothing in the opinion from which we may learn under the laws of which State the case before the Solicitor arose, nor has counsel for the petitioner cited any authorities which might help us in determining what is the legal effect in Massachusetts of the provisions of the will of this decedent. The investigation which we have been able to make of the Massachusetts decisions leads us to believe that the position taken by the Commissioner in the instant appeal in assessing gain to the executor of the estate is correct. Under the Revenune Act of 1918 estates and trusts are taxable as separate entities under certain circumstances. Section 219 of that Act provides that the tax shall be imposed upon the net income of the estate or trust and shall be paid by the fiduciary in the following instances: (1) Income received by estates of deceased persons during the period of the administration or settlement of the estate; (2) income accumulated in trust for the benefit of unborn or unascertained persons or persons with contingent3628 interests; and (3) income held for future distribution under the terms of the will or trust. In the 21 case of income which is to be distributed to the beneficiaries periodically, whether or not at regular intervals, the income is to be returned and the tax paid by the beneficiary. There are certain refinements of these provisions with which we are not here concerned. It appears to be the theory of the Solicitor's opinion, cited above, that the property which was sold belonged to the children of the testator and that the sale was in effect a sale by them and not a sale by the fiduciary of the state. With this theory, certainly as applied under the decisions of Massachusetts which we have examined, we can not agree. While the children might by joint action have elected to receive the real estate in lieu of the proceeds thereof, until such an election was made the property remained a part of the decedent's estate, and so far as the estate was concerned was personalty for all purposes. Prior to any such election a sale by any of the children of his interest in the estate would not have made the purchaser a tenant in common of the land or given such purchaser any right*3629 to convey an interest in the land, but would have given only an interest in the proceeds of the sale. In the event of the death of any of the children his rights under the will would have passed to his next of kin as personalty and not to his heirs-at-law as realty. ; ; ; . No election to take the real estate having ever been made by the children, and the property having been sold by the executor pursuant to the terms of the will, it appears that any gain or loss is to be accounted as a gain or loss to the corpus of the estate and taxed to the executor as income received during the period of settlement of the estate. Decision will be entered for the Commissioner.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624495/	Frank Ix & Sons Virginia Corporation (N.J.), Petitioner, v. Commissioner of Internal Revenue, RespondentFrank Ix & Sons Virginia Corp. v. CommissionerDocket No. 3955-64United States Tax Court45 T.C. 533; 1966 U.S. Tax Ct. LEXIS 131; March 11, 1966, Filed 131 Decision will be entered under Rule 50. During its taxable years ended March 31, 1953 and 1954, the petitioner operated the Cornelius mill at a loss. On September 30, 1953, in a tax-free reorganization, it acquired in exchange for stock the assets of another corporation, owned by the same interests, which had operated the Charlottesville mill at a profit. After the reorganization the petitioner continued to operate the Cornelius mill at a loss until July 22, 1954, when it terminated the operation of that mill. From the time of the reorganization through its taxable years ended March 31, 1957, March 29, 1958, and March 28, 1959, it operated the Charlottesville mill at a profit. Held, under the principle of Libson Shops, Inc. v. Koehler, 353 U.S. 382">353 U.S. 382, that the petitioner is not entitled to carry over and deduct from its income for its taxable years ended March 31, 1957, March 29, 1958, and March 28, 1959, the net losses sustained in its taxable years ended March 31, 1953 and 1954. Benjamin Nadel and Norman Nadel, for petitioner.Leo A. Burgoyne, for respondent. Atkins, Judge. ATKINS534 The respondent determined deficiencies in income tax for the taxable years ended March 31, 1957, 132 March 29, 1958, and March 28, 1959, in the respective amounts of $ 84,309.62, $ 115,954.90, and $ 22,329.76.The parties having reached agreement with respect to certain issues, the only issue remaining is whether net operating losses sustained by the petitioner for the taxable years ended March 31, 1953 and 1954, may be carried over and deducted from income earned by it in the taxable years ended March 31, 1957, March 29, 1958, and March 28, 1959, in the light of the principles of Libson Shops, Inc. v. Koehler, 353 U.S. 382">353 U.S. 382.FINDINGS OF FACTSome of the facts have been stipulated and the stipulations are incorporated herein by this reference.The petitioner is a corporation organized under the laws of New Jersey on or about May 15, 1944, to engage in the manufacture, sale, and distribution of textiles, with its principal office at 3300 Hudson Avenue, Union City, N.J. During the years in issue, it maintained its books and records and filed its Federal income tax returns on an accrual method of accounting and on the basis of a fiscal year consisting of 52 or 53 weeks ending nearest to March 31. It filed its returns with the district director of internal revenue at Newark, N.J.Petitioner's 133 name when organized was Cornelius Mills, Inc. On or about November 24, 1948, its name was changed to Frank Ix & Sons Carolina Corp., and on or about August 8, 1950, its name was changed to Frank Ix & Sons Sheraton Mills Corp. The change to the present name of petitioner, Frank Ix & Sons Virginia Corp., was made on or about August 2, 1954, after a reorganization described hereinafter.Another corporation, Frank Ix & Sons of Virginia Inc., was organized under the laws of Virginia on November 18, 1948. On February 14, 1949, its name was changed to Frank Ix & Sons Virginia Corp. (hereinafter referred to as the Virginia Corp.). It was dissolved on October 7, 1954.When the Virginia Corp. was organized on November 18, 1948, the persons who owned its stock had also owned, in the same proportions, 535 the stock of the petitioner at its organization. The principal officers and directors of petitioner and of the Virginia Corp. were the same until April 29, 1953, namely:PresidentAlexander F. IxVice presidentFrank J. Ix, Jr.Vice presidentWilliam E. IxVice presidentCharles W. IxTreasurerAlexander F. IxSecretaryEdward P. IxAlexander F. Ix died on April 29, 1953. On May 14, 1953, Edward P. Ix was 134 elected president and treasurer of each of the corporations to succeed him and Charles W. Ix was elected secretary. Mary Hill Ix, widow of Alexander, was elected a vice president. Thereafter, and during all pertinent times, those individuals continued to occupy these positions.Petitioner and the Virginia Corp. were, during all times pertinent, engaged in the manufacture and sale of woven synthetic fibers, including nylon, dacron, acetate, and rayon.Petitioner maintained and operated a factory at Cornelius, N.C. (hereinafter referred to as the Cornelius mill). The Virginia Corp. maintained and operated a factory at Charlottesville, Va. (hereinafter referred to as the Charlottesville mill). The Cornelius mill had spinning and twisting machinery and the Charlottesville mill had throwing machinery. The spinning and twisting machinery and the throwing machinery performed the same functions with respect to the yarn before weaving. Both had similar weaving machinery. The same types and styles of cloth were manufactured in the Cornelius mill as in the Charlottesville mill.The Ix family group had several corporations, including Frank Ix & Sons, Inc.; Frank Ix & Sons Pennsylvania Corp.; 135 Frank Ix & Sons Carolina Corp.; Frank Ix & Sons New York Corp.; and Frank Ix & Sons Administrative Corp.Petitioner owned a building located at 3300 Hudson Avenue, Union City, N.J., which at all pertinent times was used by it, the Virginia Corp., and other Ix companies as a central office for accounting, bookkeeping, inventory control, and yarn purchasing. The same staff of employees performed these services for all the corporations. During the years 1949 to 1959 an office was maintained by Frank Ix & Sons New York Corp. at 1441 Broadway, N.Y. Such office maintained a complete technical staff, a production and control staff, and a sales force, which served all the Ix corporations, including the petitioner and the Virginia Corp. The technical staff, consisting of about 10 employees, did the styling and technical layouts; the production planning and control staff scheduled and laid out all the production work for all the plants; and the sales staff, consisting of a sales manager. 536 2 assistant sales managers, and about 8 salesmen, operated out of the Broadway, New York, office and solicited orders for the manufacture of cloth. Business was solicited throughout the United States. 136 About 70 percent of the business was from customers in the New York City area. The orders so solicited were returned to the New York office where the production and control department determined which of the Ix companies, including petitioner and the Virginia Corp., would manufacture the cloth. Such determination was based in part upon the workload of the various plants as well as the availability of skilled operators in the particular type of fabric to be manufactured. Frank Ix & Sons New York Corp. charged a fee to the various companies for the services it performed as selling agent.During the time it was in operation, the petitioner's Cornelius mill operated approximately 600 looms and employed 400 to 500 persons. The Virginia Corp.'s Charlottesville mill operated approximately 1,000 looms and employed between 600 and 700 persons. In each mill there were single box looms and multiple box looms. Of the 1,000 looms operated by the Charlottesville mill 352 had been purchased for the petitioner's Cornelius mill over the period 1948 to 1951.On March 5, 1952, Frank Ix & Sons, Inc., borrowed $ 3 million at 3 1/2-percent interest from the Guaranty Trust Co. of New York, evidenced 137 by a promissory note with a maturity date of March 1, 1957. That corporation borrowed the money in order to make loans to other Ix family corporations, including the petitioner and the Virginia Corp. As collateral the borrower pledged all the capital stock which it owned in such other corporations, 1 and the promissory notes which it received from them. Among the conditions for the loan was an agreement that during the period the note to the bank remained unpaid the working capital of the various corporations would not be reduced below a specified figure. The amount of working capital required of petitioner under such loan agreement was $ 2,800,000. It was provided that in the event the working capital of the corporations fell below the specified amount, the borrower would be deemed to be in default.The amount which the petitioner borrowed from Frank Ix & Sons, Inc., on March 5, 1952, was $ 2,550,000 138 at 3 1/2-percent interest which was evidenced by several promissory notes, each with a maturity date of March 1, 1957. Petitioner agreed that during the period the notes remained unpaid, it would maintain working capital in the amount of $ 2,800,000, and it was provided that failure to maintain such amount of working capital would constitute an act of default. Pursuant 537 to the loan agreement with Guaranty Trust Co., Frank Ix & Sons, Inc., assigned petitioner's promissory notes to the bank.By September 30, 1953, the petitioner's working capital had diminished to $ 1,863,021.29. Thereupon negotiations were carried on with the Guaranty Trust Co. of New York, and a plan of reorganization involving the petitioner and the Virginia Corp. was agreed upon. At that time the common stock of each of those corporations was owned by the same persons (namely the members of the Ix family, Frank Ix & Sons, Inc., and two other companies). Their holdings in the petitioner were in the same proportions (with one small exception) as their holdings in the Virginia Corp. Frank Ix & Sons, Inc., owned all the preferred stock of each corporation. The estimated net worth of the petitioner at September 139 30, 1953, was $ 768,438, and of the Virginia Corp. as of the same date was $ 4,138,674, which included working capital in excess of $ 1 million. The plan of reorganization provided that the petitioner should increase the amount of its class B common stock and its preferred stock; that the Virginia Corp. would transfer to petitioner all of its properties, assets, and business subject to its debts, liabilities, and obligations; that in consideration of such transfer the petitioner would assume all the debts, liabilities, and obligations of the Virginia Corp. and would issue to it shares of its preferred stock and shares of its class B common stock; that the amount of common stock to be issued should be calculated on the basis that the common stock of the Virginia Corp. had a value of 13 times the value of the common stock of the petitioner; that the Virginia Corp. should distribute the stock so acquired to its stockholders in complete liquidation and dissolution of the Virginia Corp.; and that the petitioner should change its name to Frank Ix & Sons Virginia Corp. The plan of reorganization was fully consummated, including the execution and delivery of a "Bill of Sale and Agreement" 140 dated as of September 30, 1953. After the reorganization the same persons, with minor exceptions, continued to hold the stock of the petitioner at all times material in the same proportion that they had held its stock and the stock of the Virginia Corp. prior to the reorganization. The petitioner and the respondent agree that the reorganization was a nontaxable reorganization under the provisions of the Internal Revenue Code of 1939.Following the reorganization, the petitioner operated the Cornelius mill and the Charlottesville mill in the same fashion as they had been operated prior to the reorganization. Separate records were kept for each plant. Such records show that the Cornelius mill operated at a net loss of $ 450,599.51 from October 1, 1953, to March 31, 1954, and at a net loss of $ 347,083.80 from April 1, 1954, to September 30, 1954. The Ix interests decided that in view of the condition of the textile industry it was advisable to close down one of their mills. Petitioner was having management problems in connection with the Cornelius 538 mill and it was decided to close down such mill. Accordingly, the manufacturing operations of the Cornelius mill were terminated on or about 141 July 22, 1954. The president of the petitioner did not think the adverse business conditions would continue indefinitely. However, operation of the Cornelius mill was never resumed. All orders then on hand at the Cornelius mill were allocated to the other mills owned by the Ix interest, including the Charlottesville mill.On March 31, 1954, the Cornelius mill had assets of a book cost of $ 2,479,000, which included weaving and twisting machinery of a book cost of $ 1,986,000. On the same date the Charlottesville mill had assets of a book cost of $ 3,646,000, of which $ 3,203,000 consisted of weaving and throwing machinery. During the taxable years ended March 31, 1955, to March 28, 1959, there were transferred from the Cornelius mill to the Charlottesville mill various assets having a book cost of approximately $ 163,000, which included weaving and twisting machinery of a book cost of approximately $ 157,000.For the taxable years ended September 30, 1951, to September 30, 1953, the Virginia Corp. realized taxable income as follows:T.Y.E. Sept. 30 --Taxable income1951$ 498,753.751952377,295.4419531,507,861.04For the taxable years ended March 31, 1947, through March 31, 1953, during 142 which time the petitioner was operating only the Cornelius mill, it realized taxable income and sustained net operating losses as follows:Taxable year ended Mar. 31 --TaxableNet operatingincomeloss1947$ 947,778.4019481,559,150.921949320,788.5019502,689.4619511 80,796.9619522 $ 566,437.531953904,596.84 For the taxable year ended March 31, 1954, during which the petitioner operated the Cornelius mill and during a part of which it also operated the Charlottesville mill, the petitioner sustained a net loss of $ 211,012.93. 2For its taxable years ended March 31, 1955, through March 28, 1959 (without regard to any deductions on account of any net operating 539 143 losses of prior years), the petitioner realized taxable income, as follows:Taxable year endedTaxable incomeMar. 31, 19551 $ 340,004.15Mar. 31, 1956385,628.29Mar. 31, 1957162,781.75Mar. 29, 1958579,541.09Mar. 28, 1959354,721.30 The reported amount of petitioner's net operating loss for the taxable year ended March 31, 1952 (after subtracting the portion carried back to prior years), and a portion of its reported net operating loss for the taxable year ended March 31, 1953, were carried over by it and claimed as deductions for its taxable years ended March 31, 1955 and 1956, to the extent of taxable income reported for those years. Respondent did not make any determination of deficiencies for those years. The remaining portion of petitioner's reported net operating loss for the taxable year ended March 31, 1953, and the entire amount of its reported net operating loss for the taxable year 144 ended March 31, 1954, were carried over by it and claimed as deductions from its income of its taxable years ended March 31, 1957, March 29, 1958, and March 28, 1959. In the notice of deficiencies for the latter 3 years the respondent determined that "you are not entitled to net operating loss deductions in the taxable years ended March 31, 1957, to March 28, 1959, inclusive, based upon losses sustained in the taxable years ended March 31, 1953, to March 31, 1954."OPINIONThe question presented is whether the petitioner, in computing its taxable income for the taxable years ended March 31, 1957, March 29, 1958, and March 28, 1959, may deduct, pursuant to sections 23(s) and 122 of the Internal Revenue Code of 1939, and section 172 of the Internal Revenue Code of 1954, 3145 146 net losses sustained by it in its taxable 540 years ended March 31, 1953, and March 31, 1954. 4It is the respondent's position that the business in which the net operating losses were sustained was not substantially the same business which gave rise to the income sought to be offset by the carryovers, and that, under the principle of Libson Shops, Inc. v. Koehler, 353 U.S. 382">353 U.S. 382, the net operating losses are not deductible. The petitioner, on the other hand, contends that under the circumstances here presented it should be considered that the same business gave rise to the losses and to the income sought to be offset, and that the principle of the Libson Shops case is not applicable.In Libson Shops, Inc. v. Koehler, supra, 147 the same interests owned 17 corporations, 16 of which were engaged in the retail clothing business and 1 of which was engaged in rendering management services to the others. Each of these 17 corporations filed separate income tax returns. The 16 sales corporations were merged into the managing corporation (the same interests continuing in control), and the surviving corporation conducted the entire business as a single enterprise. Prior to the merger three of the sales corporations had net operating losses, and the year following the merger each of the retail units formerly operated by these three corporations continued to sustain operating losses. In its income tax return for the first year after the merger the surviving corporation claimed deductions for the net operating losses of these three constituent corporations. The Supreme Court held that the claimed deductions were not allowable, stating in part:The requirement of a continuity of business enterprise as applied to this case is in accord with the legislative history of the carry-over and carry-back provisions. Those provisions were enacted to ameliorate the unduly drastic consequences of taxing income strictly on an 148 annual basis. They were designed to permit a taxpayer to set off its lean years against its lush years, and to strike something like an average taxable income computed over a period longer than one year. There is, however, no indication in their legislative history that these provisions were designed to permit the averaging of the pre-merger losses of one business with the post-merger income of some other business which had been operated and taxed separately before the merger. What history there is suggests 541 that Congress primarily was concerned with the fluctuating income of a single business. [6]* * * Petitioner is attempting to carry over the pre-merger losses of three business units which continued to have losses after the merger. Had there been no merger, these businesses would have had no opportunity to carry over their losses. * ** * * The fact that § 129(a) is inapplicable does not mean that petitioner is automatically entitled to a carry-over. The availability of this privilege depends on the proper interpretation to be given to the carry-over provisions. We find nothing in those provisions which suggest that they should be construed to give a "windfall" to a taxpayer 149 who happens to have merged with other corporations. The purpose of these provisions is not to give a merged taxpayer a tax advantage over others who have not merged. We conclude that petitioner is not entitled to a carry-over since the income against which the offset is claimed was not produced by substantially the same businesses which incurred the losses. [9] [Footnotes omitted.]In the instant case both the petitioner and the Virginia Corp. were owned by the same interests, principally the Ix family. During its fiscal years ended March 31, 1951, 1952, and 1953, the petitioner had suffered large operating losses from the operation of the Cornelius mill. The Virginia Corp. for its taxable years ended September 30, 1951, 1952, and 1953, had operated the Charlottesville mill at substantial profits. As of September 30, 1953, pursuant to a tax-free reorganization, the petitioner acquired the assets of the Virginia Corp. and continued, for a time, to operate both mills. Each was operated as a separate division and separate records of the operations were kept. The Cornelius mill continued to operate at a loss, while the Charlottesville mill operated at a profit. On July 22, 1954, the 150 petitioner terminated its operation of the Cornelius mill, but continued to operate the Charlottesville mill at a profit throughout the following years, including the taxable years in question, namely, the taxable years ended March 31, 1957, March 29, 1958, and March 28, 1959. During the time that the two mills were in operation, both before and after the reorganization, each manufactured the same types of products, woven synthetic fibers; each used similar equipment; and another Ix family controlled corporation, Frank Ix & Sons New York Corp., provided the staff which rendered services to each of them, including production planning, styling and technical layouts, sales solicitations, yarn purchasing, and bookkeeping, accounting, and inventory control. Orders from customers were allocated by Frank Ix & Sons New York Corp. among the Cornelius mill, the Charlottesville mill, and other mills operated by the Ix interests.The petitioner contends that the operation, prior to the reorganization, of the Cornelius mill by the petitioner and the operation by the Virginia Corp. of the Charlottesville mill constituted substantially the 542 same business (even though operated by different corporations), 151 and that the petitioner operated the same business in its taxable years ended March 31, 1957, March 29, 1958, and March 28, 1959, even though in those years it was operating only the prosperous Charlottesville mill. It is its contention that the shutdown of the Cornelius mill on July 22, 1954, was not the termination of a business, but was merely the termination of one of the business' manufacturing plants, and that the same business continued on thereafter, using only the Charlottesville mill to fill orders.We cannot agree with the petitioner that there was here the requisite continuity of business enterprise. Even though, prior to the reorganization, the operation of the two mills constituted similar businesses and each business utilized the same management facilities, the fact remains that each mill constituted a separate business operated by a different corporation, and each business was taxed separately. The net operating losses sought to be carried over were sustained entirely in the petitioner's operation of the Cornelius mill. The income against which the deduction is sought to be taken was derived entirely from the operation of the Charlottesville mill. Such deduction is 152 precluded under the principle of the Libson Shops case. To paraphrase the language of the Supreme Court in that case, petitioner is attempting to carry over the prereorganization losses of a business unit which continued to have losses after the reorganization; had there been no reorganization, and the acquisition by the petitioner of the prosperous Charlottesville mill in connection therewith, there would have been no opportunity to carry over the losses of the Cornelius mill. And it is now well established that the fact that the continuing corporation is the same corporation which sustained the operating losses in the prior years, does not serve to render inapplicable the rule of the Libson Shops case. J. G. Dudley Co., 36 T.C. 1122">36 T.C. 1122, affd. (C.A. 4) 298 F. 2d 750; Huyler's, 38 T.C. 773">38 T.C. 773, affd. (C.A. 7) 327 F.2d 767">327 F. 2d 767; Julius Garfinckel & Co., 40 T.C. 870">40 T.C. 870, affd. (C.A. 2) 335 F.2d 744">335 F. 2d 744; and Federal Cement Tile Co., 40 T.C. 1028">40 T.C. 1028, affd. (C.A. 7) 338 F.2d 691">338 F. 2d 691.The Garfinckel case is closely in point. There Garfinckel & Co. had acquired in 1946 and 1947 all the stock of Brooks Bros., a New York corporation long engaged in the manufacture and retail sale of men's wear. By 1952 Garfinckel 153 & Co. had acquired 58 percent of the stock of A. DePinna, a New York corporation engaged in the manufacture and retail sale of both men's and women's clothing. In February 1952, it caused Brooks Bros. to merge into DePinna, the latter corporation surviving, with Garfinckel & Co. owning 95 percent of its stock. For several years preceding the merger DePinna had sustained substantial net operating losses, while Brooks Bros. had made substantial profits. After the merger the two businesses were operated 543 as separate divisions. The DePinna division continued to suffer losses and the Brooks Bros. division continued to operate at a profit. In its returns filed for its taxable years ended July 31, 1952, 1953, and 1954, the surviving corporation claimed as a deduction its premerger net operating losses. We there held, and the Court of Appeals agreed, that the principle of the Libson Shops case prevented the allowance of the claimed net operating losses, it being immaterial that it was the loss corporation which survived the merger. There the Court of Appeals stated "We find no reason to think the Supreme Court would have decided Libson Shops differently if the 14 profit-making corporations 154 had been merged into the 3 losing corporations and these had survived."Petitioner makes much of the fact that at all times material the same interests owned the petitioner and the Virginia Corp. in the same proportions. We cannot attach any significance to that fact since in the Libson Shops case the same interests which controlled all the corporations before the merger continued to control the surviving corporation.The petitioner further argues that it is entitled to the beneficial treatment accorded by Rev. Rul. 63-40, 1963-1, C. B. 46, wherein the respondent announced that he would not rely upon the Libson Shops doctrine to bar a corporation from carrying over losses from a discontinued business against income from a new business enterprise acquired through a cash purchase of assets of an unrelated corporation, there being no change in the stock ownership of the corporation. We see no basis for applying that ruling in the instant situation. The instant case does not involve the cash purchase of assets of an unrelated corporation.We have given careful consideration to the contention made by the petitioner that to allow the carryover and deduction of the net loss of $ 211,012.93 155 for the taxable year ended March 31, 1954, would not violate the principle of the Libson Shops case. It is its contention that such net loss was realized after the reorganization and that there is no reason for disallowing such a post-reorganization loss from profits of its subsequent years. It argues that since in the last 6 months of the taxable year ended March 31, 1954, the Cornelius mill operation resulted in a net loss of $ 450,599.51 and that since this is far in excess of the $ 211,012.93 net operating loss for the entire taxable year ended March 31, 1954, such net operating loss of $ 211,012.93 must have been sustained after September 30, 1953. We cannot agree with this reasoning. The Cornelius mill may have had substantial losses during the first half of that taxable year. Indeed, the parties to the reorganization estimated that the Cornelius mill operated at a loss of $ 50,000 for the period April 1, 1953, to September 30, 1953. Accordingly, 544 we are forced to conclude that at least some portion (which we cannot determine) of the net loss would be attributable to that portion of the taxable year prior to the reorganization. Thus, to allow the net operating loss for the 156 taxable year ended May 30, 1953, to be carried over and deducted from income of the taxable years ended March 31, 1957, March 29, 1958, and March 28, 1959, would, at least to some extent, result in applying the prereorganization loss from one business against the post-reorganization income of a different business, contrary to the principle of the Libson Shops case. Even if we were able upon this record to calculate the portion of petitioner's net operating loss sustained in the last half of its taxable year ended March 31, 1954, it is our opinion that the annual accounting principle upon which our tax system is based ( Burnet v. Sanford & Brooks Co., 282 U.S. 359">282 U.S. 359) would preclude us from fragmentizing such taxable year and treating such portion as a net operating loss which may be carried over to another year and deducted. Section 122 of the Internal Revenue Code of 1939 refers to the net operating loss "for any taxable year," and section 48(a) of that Code defines "taxable year" as "the calendar year, or the fiscal year ending during such calendar year, upon the basis of which the net income is computed."We hold that the respondent did not err in disallowing the claimed net operating 157 loss deductions.Decision will be entered under Rule 50. Footnotes1. Frank Ix & Sons, Inc., owned all the preferred stock of both petitioner and the Virginia Corp. It owned 100 of the 606 outstanding shares of class B nonvoting common stock of petitioner, and 140 of the 646 outstanding shares of class B nonvoting common stock of the Virginia Corp.↩1. Before deduction resulting from carryback of net operating loss for the fiscal year ended Mar. 31, 1952.↩2. Remainder after deducting the portion carried back to prior years.↩2. As found hereinabove, the Cornelius mill operated at a net loss of $ 450,599.51 from Oct. 1, 1953, to Mar. 31, 1954. Also, in connection with the reorganization, the parties thereto estimated that the Cornelius mill operated at a loss of $ 50,000 for the period Apr. 1, 1953, to Sept. 30, 1953.↩1. From Apr. 1, 1954, until July 22, 1954, the petitioner operated both the Cornelius mill and the Charlottesville mill, and thereafter operated only the latter. As found hereinabove the Cornelius mill operated at a net loss of $ 347,083.80 from Apr. 1, 1954, until it ceased operating on July 22, 1954.↩3. Sec. 23(s) of the 1939 Code provides for the deduction of the net operating loss deduction computed under sec. 122. Sec. 122(b) (2) (B) of the 1939 Code provides in part:Loss for Taxable Year Beginning After 1949. -- If for any taxable year beginning after December 31, 1949, the taxpayer has a net operating loss, such net operating loss shall be a net operating loss carry-over for each of the five succeeding taxable years, * * Sec. 172 of the Internal Revenue Code of 1954 provides in part:(a) Deduction Allowed. -- There shall be allowed as a deduction for the taxable year an amount equal to the aggregate of (1) the net operating loss carryovers to such year, plus (2) the net operating loss carrybacks to such year. * ** * * *(g) Special Transitional Rules. -- (1) Losses for taxable years ending before January 1, 1954. -- For purposes of this section, the determination of the taxable years ending after December 31, 1953, to which a net operating loss for any taxable year ending before January 1, 1954, may be carried shall be made under the Internal Revenue Code of 1939.It should be pointed out that sec. 381 of the 1954 Code contains special provisions for carryovers in certain corporate acquisitions, and that sec. 382 contains special limitations on net operating loss carryovers. However, it is clear that the transaction here involved occurred before the effective date of those sections. See secs. 393 and 394 of the 1954 Code; Irving-Kolmar Corporation, 35 T.C. 712">35 T.C. 712; Allied Central Stores, Inc. v. Commissioner, (C.A. 2) 329 F. 2d 503, certiorari denied 381 U.S. 903">381 U.S. 903, affirming a Memorandum Opinion of this Court; and Federal Cement Tile Co., 40 T.C. 1028">40 T.C. 1028, affd. (C.A. 7) 338 F. 2d 691↩. It may be added that apparently the petitioner does not contend that secs. 381 and 382 are applicable.4. On brief the petitioner refers to the carryover to such years of its net operating loss for its taxable year ended Mar. 31, 1952. However, it seems apparent that its net loss for that year has been exhausted by having been carried over and deducted from income of the taxable years ended Mar. 31, 1955, and Mar. 31, 1956.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624496/	ESTATE OF FRANK MARTIN PERRY, SR., DECEASED, MICHAEL C. PERRY, WHIT S. PERRY, AND ROBERT S. PERRY, CO-EXECUTORS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Perry v. CommissionerDocket No. 4132-88United States Tax CourtT.C. Memo 1990-123; 1990 Tax Ct. Memo LEXIS 123; 59 T.C.M. (CCH) 65; T.C.M. (RIA) 90123; March 8, 1990Hugh C. Montgomery, Jr., David P. Webb, and Charles L. Brocato, for the petitioner. J. Craig Young and Helen C. T. Smith, for the respondent. COHEN187 MEMORANDUM OPINION COHEN, Judge: Respondent determined a deficiency of $ 320,957 in the Federal estate tax of the estate of Frank Martin Perry, Sr., deceased, Michael C. Perry, Whit S. Perry, and Robert S. Perry, co-executors. After concessions, the sole issue for decision is whether proceeds totaling $ 600,000 from life insurance policies purchased within 3 years of decedent's death are includable in decedent's gross estate pursuant to section 2035(a). The parties have agreed that the issue in this case is the same as the issue in , affd. , and , on appeal (6th Cir., Jan. 19, 1990). Unless otherwise indicated, all section125 references are to the Internal Revenue Code, as amended and in effect as of the date of decedent's death, and all Rule references are to the Tax Court Rules of Practice and Procedure. After trial, the parties submitted a Stipulation of Joint Proposed Findings of Fact. Thus the material facts are not disputed. Petitioner is the Estate of Frank Martin Perry, Sr. Petitioner 188 is represented by Michael C. Perry, Whit S. Perry, and Robert S. Perry, co-executors of the estate and the sons of decedent, Frank Martin Perry, Sr. The co-executors resided in Tunica, Mississippi, at the time the petition was filed. Decedent died on March 19, 1984, from gunshot wounds sustained in a hunting accident. At the time of his death, decedent was a resident of Tunica, Mississippi. A number of insurance policies on decedent's life were in effect at the time of his death. The proceeds of all but two of these policies were included in the gross estate on decedent's Federal estate tax return. The two insurance policies excluded from the return, which were purchased within 3 years of decedent's death, were as follows: DateInsurer/Policy Owners/Amount ofAcquiredPolicy No.BeneficiariesProceeds5-04-83Lloyd's, LondonMichael, Whit,$ 400,000#L-26502& Robert Perry6-08-83Integon LifeMichael, Whit,$ 200,000#848082& Robert PerryTotal$ 600,000126 On April 16, 1983, decedent signed an application form for $ 400,000 of life insurance from Underwriters at Lloyd's, London (Lloyd's). Decedent signed this application as Applicant (Person to be Insured). Decedent's three sons, Michael C. Perry, Whit S. Perry, and Robert S. Perry, signed the application as the proposed policy owners. Lloyd's policy #L-26502 was issued on May 4, 1983. Under the terms of the policy and Mississippi law, decedent's sons were the policy owners at all times from the time of the issuance of the policy. Decedent paid all of the premiums on Lloyd's policy #L-26502. The annual premium on this policy was $ 512. Decedent paid the initial annual premium on or about April 27, 1983, by a check drawn on his personal checking account, account #03-362-16, at the Planters Bank of Tunica, Mississippi. Decedent died before the second annual premium on this policy became due. On May 4, 1983, decedent signed an application for $ 250,000 of life insurance from Integon Life Insurance Corporation (Integon). Decedent signed this application as Proposed Insured. Decedent's three sons signed the application as Applicant or Owner if not Proposed Insured. The application127 designated decedent's sons as co-owners of $ 200,000 of the insurance and decedent as the owner of the remaining $ 50,000. As both applicant and proposed insured, decedent also signed a medical questionnaire filed in connection with the application for life insurance from Integon. In lieu of issuing a single $ 250,000 life insurance policy, Integon issued two separate policies. One of these policies was Integon policy #848082 in the amount of $ 200,000. The other Integon policy, in the amount of $ 50,000, is not in dispute. Integon policy #848082 was issued on June 8, 1983. Under the terms of the policy and Mississippi law, decedent's sons were the policy owners at all times from the time of the issuance of the policy. Decedent paid all of the premiums on this policy. The initial premium was paid by a check in the amount of $ 140 drawn on checking account #03-362-16 at the Planters Bank. Thereafter, the premiums of $ 127.28 per month were paid by preauthorized withdrawals from decedent's personal checking account, account #021-585-6, at the Tunica County Bank, Tunica, Mississippi. The final monthly premium was paid on March 12, 1984, 1 week before decedent's death. Decedent's128 payments of the premiums on Lloyd's policy #L-26502 and Integon policy #848082 were not loans to decedent's sons, the beneficiaries. Upon decedent's death, the proceeds of Lloyd's policy #L-26502 in the amount of $ 400,000 and Integon policy #848082 in the amount of $ 200,000 (plus accrued interest of $ 1,767.15) were paid in lump sums to decedent's sons as beneficiaries. Respondent determined that the proceeds of these two insurance policies in the total amount of $ 600,000 were includable in decedent's gross estate. During the pendency of this case, the Court filed its opinions in the cases of ; and . In addition, the Court of Appeals for the Tenth Circuit affirmed our opinion in , affd. . Respondent has acknowledged that the legal issues in those cases and the issue in this case are virtually identical. Respondent does not contend that the instant case is distinguishable from Estate of Headrick or Estate of Leder. Respondent, however, 129 maintains that those cases were wrongly decided and asks that we reconsider our refusal to apply the "beamed transfer" theory of . 189 Section 2035Section 2035(a) generally requires that the gross estate of a decedent include the value of any property in which the decedent had an interest or had transferred within 3 years of death (the 3-year inclusionary rule). Section 2035(b) excepts bona fide sales for adequate and full consideration and gifts for which gift tax returns need not be filed (except any transfer with respect to a life insurance policy). Section 2035(d), which applies to decedents dying after 1981, was added by the Economic Recovery Tax Act of 1981 (ERTA), Pub. L. 97-34, sec. 424, 95 Stat. 172, 317. Because decedent herein died in 1984, section 2035(d) applies to his estate. Section 2035(d)(1) provides that the general rule of section 2035(a) shall not apply to the estates of decedents dying after December 31, 1981, except in cases of those transfers enumerated in section 2035(d)(2). Section 2035(d)(2) excepts transfers of an interest in property that is included in the value of130 the gross estate under section 2042 (or various other sections not applicable here) or that would have been included under any of those sections "if such interest had been retained by the decedent." Thus, in order to determine whether section 2035(d)(2) applies, we must determine whether decedent possessed any interest under the terms of section 2042. Section 2042Section 2042 provides that the gross estate includes (1) the proceeds of insurance on decedent's life receivable by or for the benefit of the estate, and (2) the proceeds of insurance on decedent's life receivable by other beneficiaries if decedent possessed at his death any "incidents of ownership" in that insurance policy. Sec. 2042; sec. 20.2042-1(b) and (c), Estate Tax Regs. The term "incidents of ownership" refers to the right of the insured or his estate to the economic benefits of the policy. Sec. 20.2042-1(c)(2), Estate Tax Regs. Incidents of ownership listed in the regulations include the power to change the beneficiary, to surrender or cancel the policy, to assign the policy, to revoke an assignment, to pledge the policy for a loan, or to obtain from the insurer a loan against the surrender value of the131 policy. Sec. 20.2042-1(c)(2), Estate Tax Regs. We must also look to state law to determine whether decedent had any rights that might be incidents of ownership taxable under section 2042. ; . In Estate of Leder, we held that the proceeds from an insurance policy were not includable in the insured's gross estate where the insured did not possess at the time of his death, or at any time within the 3 years preceding his death, any of the incidents of ownership in the policy. Specifically, we held that section 2035(d)(1) overrides section 2035(a). Because the proceeds of the policy were not includable under section 2042, we held that the section 2035(d)(2) exception to section 2035(d)(1) was not applicable. Similarly, in Estate of Headrick, we held that the proceeds from an insurance policy were not includable in the insured's gross estate because the insured never possessed incidents of ownership in the policy within the meaning of section 2042. Although the decedent contributed cash annually to an irrevocable inter vivos trust in amounts132 sufficient to meet the trust's cumulative monthly premium obligations, we held that "the premium payment test is 'now abandoned' under section 2042." . Under section 2035(a), a "'transfer' is not limited to the passing of property directly from the donor to the transferee, but encompasses a donation 'procured through expenditures by the decedent with the purpose, effected at his death, of having it pass to another.'" . In Estate of Leder, respondent asked us to construe the term "transfer" for purposes of section 2035(d) to include any transfer whether direct or indirect. Similarly, in Estate of Headrick, respondent asked us to apply a beamed transfer theory to impute to the insured a transfer of the life insurance policy acquired by the trust. In the instant case, respondent asks that we reconsider our refusal to apply the Bel beamed transfer theory of section 2035(a). In both Estate of Leder and Estate of Headrick, we rejected respondent's arguments that we should incorporate into section 2042 the constructive transfer doctrine. In view of respondent's acknowledgment that this133 case cannot be distinguished from Estate of Leder or Estate of Headrick, we decline to apply the beamed transfer theory to the facts of this case. The parties have stipulated that, under the terms of the policies and Mississippi law, decedent's sons were the policy owners at all times from the time of the issuance of the two policies in question. The parties have also stipulated that decedent paid all of the premiums on the policies in issue. Under section 2042, however, decedent's payment of premiums is irrelevant in determining whether he retained any incidents of ownership in the policy proceeds. , affg. ; . Under the section 2042 definition of "incidents of ownership," decedent never held any ownership, economic, or other contractual rights in the policies. Decedent's sons were the legal and equitable owners of the policies. On these facts, we hold that the proceeds of the insurance policies 190 are not includable in decedent's gross estate under section 2042. To reflect the foregoing134 and concessions by the parties, Decision will be entered under Rule 155.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624498/	JACK C. EDWARDS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEdwards v. CommissionerDocket No. 2753-73.United States Tax CourtT.C. Memo 1975-72; 1975 Tax Ct. Memo LEXIS 300; 34 T.C.M. (CCH) 373; T.C.M. (RIA) 750072; March 24, 1975, Filed Jack C. Edwards, pro se. Douglas K. Cook, for the respondent. FORRESTERMEMORANDUM FINDINGS OF FACT AND OPINION FORRESTER, Judge: Respondent has determined a deficiency of $995.60 in petitioner's 1971 Federal income tax. Petitioner having made a number of concessions, the following two issues remain for our decision: (1) whether petitioner is entitled to dependency exemptions for his three children by a former marriage; (2) whether he may deduct, as a theft loss, amounts allegedly taken from him by a state trooper during an allegedly unlawful arrest. FINDINGS OF FACT Some of the facts have been stipulated and are so found. Jack C. Edwards (petitioner) resided in Glendale, Arizona, on the date of the filing of the petition herein. He filed his 1971 Federal income tax return with the district director of internal revenue, Phoenix, Arizona. Petitioner married Shirley M. Edwards (Shirley) in Wichita, Kansas, in August of 1954. During the marriage three children were born to the couple: Jack D. Edwards (Jack), born July 1, 1958; Kevin S. Edwards (Kevin), born April 11, 1961; and Korey302 G. Edwards (Korey), born February 8, 1964. The couple was divorced on April 16, 1970, and the divorce decree gave custody of the three above-mentioned children to Shirley. The decree required petitioner to pay Shirley $150 a month as support for the three children, an amount which was revised upwards to $200 a month by a court order entered on May 13, 1971. During 1971, pursuant to these court orders, petitioner paid to Shirley $1,425 for the support of the couple's three children. During 1971 petitioner exercised his visitation rights with respect to the three children for an approximately three-week period running from the latter part of July to early August. Because petitioner resided at that time in Phoenix, Arizona, he had to make during such three-week period two round trips by automobile to Wichita where the children resided with their mother. The first such round trip was to pick up the children in Wichita and bring them to Phoenix, the second, to return the children at the conclusion of their visit. The children spent the first week of the visit with petitioner and his wife at petitioner's house in Phoenix. Groceries for the five cost approximately $60 for such week, and303 petitioner also spent approximately $20 for clothing for each of his children. Petitioner, for the remaining two weeks of the visitation period, took his spouse and children on an automobile tour through Utah and California, spending some time at Disneyland in Anaheim, California. The total expenditure by petitioner during the visitation period was approximately $600, excluding the amounts for groceries and clothing described above, and including automobile expenses incurred by him in transporting his children from and to the home of their mother in Wichita. Except for the three-week period described above, the children resided in Wichita with Shirley and her 19-year old son by a former marriage. Shirley received in 1971 $3,733 of Aid to Dependent Children funds (ADC) from the State of Kansas and Sedgwick County. In addition, the State of Kansas made the following medical payments on behalf of the children during 1971: Jack$ 81.60Kevin1,473.61Korey40.40 The record is silent as to whether Shirley or any of her children worked or received support from any other sources during 1971. On July 10, 1972, petitioner filed a complaint in the Superior Court of Arizona, 304 Maricopa County, against an Arizona State Highway Department patrolman and the City of Peoria. In such complaint petitioner alleged, together with other allegations, that the patrolman, without justification, had taken $900 from petitioner's person during an allegedly unlawful arrest, and that such patrolman had failed to return such money. The suit was scheduled to be tried on February 9, 1975. On his 1971 return petitioner claimed dependency exemptions for each of his three children and, in addition, claimed a $900 theft loss arising out of his alleged encounter with the patrolman. In his statutory notice of deficiency respondent disallowed in full all these claimed deductions. OPINION The first issue to be decided is whether or not petitioner is entitled under section 151(e) 1 to dependency exemptions in 1971 for his three children by his marriage with Shriley. For petitioner to establish such entitlement, he must demonstrate that it was he who provided over one-half of the support of each of such children during 1971. Sec. 152(a). Respondent first contends that petitioner, 305 in order to show that he provided over one-half of the support of such children, must first demonstrate what was the total amount expended on the support of the children during 1971. On this contention, respondent is clearly correct, Bernard C. Rivers,33 T.C. 935">33 T.C. 935, 937-8 (1960), James E. Stafford,46 T.C. 515">46 T.C. 515, 518 (1966), Edward J. Pillis,47 T.C. 707">47 T.C. 707, 709 (1967), affirmed per curiam 390 F. 2d 659 (C.A. 4, 1968), and equally as clearly, petitioner has failed to carry his burden as to this matter. The record before us establishes only that petitioner made certain payments in support of the children in 1971, and that Shirley received $3,733 of ADC funds from state and local institutions in 1971. The record is entirely silent as to whether or not Shirley, any of petitioner's three children, or Shirley's child by a former marriage contributed anything further to the support of such three children. The detriment arising from such a gap in the record must, of course, fall on petitioner, who, as described above, had the burden of proof on the issue of his three children's total support in 1971. We need not, however, rest our306 holding as to the issue before us on the failure by petitioner to produce or even approximate a total support figure for his three children during 1971. For, even assuming that the amount demonstrated in the record as having been used for their support represents their total support, petitioner has also failed to show that one-half of such amount was contributed by him. From the record before us, we have found that petitioner contributed $1,620 in 1971. Of this amount $1,425 was the sum paid in 1971 pursuant to the court orders for child support entered against petitioner in 1970 and 1971. Petitioner also bought $60 of clothing for his three children while they were visiting him during the summer of 1971. During the first week of such visit petitioner spent $60 for groceries for himself, his spouse and his three children, and we find $35 of such amount as a reasonable allocation to the support of his children. As to the $600 spent in bringing the children to and from their mother's home in Wichita, and in taking them and his spouse on a two-week automobile trip through Utah and California, the part of such amount which represents petitioner's cost of transporting his children to307 and from Wichita, at the commencement and termination of the three-week visit, may not be deemed an amount spent to support the children. Aaron F. Vance,36 T.C. 547">36 T.C. 547, 550 (1961), Harvey L. Hopkins,55 T.C. 538">55 T.C. 538, 542 (1970). Using our best judgment, we find that $100 of this $600 is allocable to the support of his children on their two-week vacation tour. Petitioner also claimed that some part of the rent on his house, and some part of the utilities expense he incurred while the children were at his house for one week, should be considered as a contribution by him to their support. It is well established, however, that such expenses do not constitute support of a dependent for purposes of section 152. Aaron F. Vance,36 T.C. at 550, Harvey L. Hopkins,55 T.C. at 542. Thus, we have found that petitioner contributed $1,620 to the support of his children during 1971, or $540 per child. In addition to the amounts contributed by petitioner, Shirley received in 1971 $3,733 of ADC funds from state and local agencies in Kansas, and petitioner has given us no reason why respondent's allocation of three-fifths of this amount, 308 or approximately $2,240, to the support of petitioner's three children should not be accepted. 2 When we add to each child's pro-rata share of such ADC support, the additional amounts contributed by the State of Kansas for medical expenses for such children--$81.60 for Jack, $1,473.61 for Kevin, and $40.40 for Korey, it is abundantly clear that petitioner has failed to show that he contributed more than one-half of his children's 1971 support. The special rule of section 152(e)(2)(B) is of no avail to petitioner in the instant case. 3 For, before the special presumption enacted by such provision becomes applicable, a taxpayer must show that his children received at least one-half of their total support from the taxpayer and his former spouse during the year at issue, Harvey L. Hopkins,55 T.C. at 540-1, Jewell D. Godbehere,57 T.C. 349">57 T.C. 349, 351 (1971), a showing petitioner has clearly failed to make in the instant case. Thus, it is our holding that respondent correctly disallowed dependency exemptions to petitioner for any of his three children. 309 Petitioner also claimed a theft loss of $900 in 1971. It is his contention that an Arizona state patrolman unlawfully took such amount from him in 1971, and has never returned such $900 to petitioner. We need not decide whether the patrolman, in fact, took such money from petitioner during the course of an allegedly unlawful arrest. For, even accepting this assertion of petitioner, he has not established the lack of a reasonable prospect of recovering such amount from the patrolman or the patrolman's employer. Indeed, petitioner is in the midst of using the patrolman and his employer in order to recover such amount together with additional damages. Petitioner's failure to establish this lack of a reasonable prospect of recovery precludes him from deducting the $900 as a theft loss. Ramsay Scarlett & Co., 61 T.C. 795">61 T.C. 795, 807 (1974), on appeal (C.A. 4, June 6, 1974). Rainbow Inn, Inc. v. Commissioner,433 F. 2d 640, 642-3 (C.A. 3, 1970), reversing on another issue a Memorandum Opinion of this Court; sec. 1.165-1(d)(3), Income Tax Regs.Decision will be entered for the respondent.Footnotes1. All statutory references are to the Internal Revenue Code of 1954, unless otherwise specified.↩2. As found above, there were five individuals in Shirley's household during 1971.↩3. (e) Support Test in Case of Child of Divorced Parents, etc.-- * * * * * (2) Special rule.--The child of parents described in paragraph (1) shall be treated as having received over half of his support during the calendar year from the parent not having custody if-- * * * * * (B)(i) the parent not having custody provides $1,200 or more for the support of such child (or if there is more than one such child, $1,200 or more for all of such children) for the calendar year, and (ii) the parent having custody of such child does not clearly establish that he provided more for the support of such child during the calendar year than the parent not having custody.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624499/	John Green and Roslyn Green v. Commissioner.Green v. CommissionerDocket No. 3294-62.United States Tax CourtT.C. Memo 1964-113; 1964 Tax Ct. Memo LEXIS 220; 23 T.C.M. (CCH) 649; T.C.M. (RIA) 64113; April 28, 1964Sidney J. Matzner, 9465 Wilshire Blvd., Beverly Hills, Calif., for the petitioners. Robert L. Gnaizda, for the respondent. FAYMemorandum Opinion FAY, Judge: The Commissioner determined a deficiency in petitioners' 223 income tax for the taxable year 1957 in the amount of $3,124.07. The parties have agreed to certain adjustments with respect to the deficiency. 1 The principal issue for decision is whether the loss resulting from the sale by petitioners of a piece of real property is deductible in full as an ordinary loss. If this issue is decided adversely to petitioners, then a secondary issue arises concerning whether the petitioners elected to capitalize certain interest payments. If petitioners did not elect to capitalize certain interest payments, then a further question arises as to when certain interest was paid. All of the facts have been stipulated and are so found. Petitioners are husband and wife with their residence at 169 North McCadden Place, Los Angeles, California. They filed their joint income tax return for the taxable year 1957 with the district director of internal revenue at Los Angeles, California. Petitioner John Green is a practicing physician. Of the $56,141.91 shown on petitioners' return for 1957 as adjusted gross income, $49,222.48 was derived224 from his medical practice. On or about December 6, 1955, petitioners purchased a note secured by a second deed of trust on property located at 4814 Vista De Oro, Los Angeles, California. The purchase price was $13,718,06. The maturity value of the note at the time of purchase was $17,147.57. Petitioners, during 1955 and 1956, received five payments of $109 each on the note. Of the $545 received, $426.93 represented a reduction of the principal balance of the note. No other payments were received by petitioners on the note. Petitioners thereafter foreclosed on the security and acquired title to the property which secured the second deed of trust. Petitioners made the following expenditures regarding said property in the years as indicated: 19561957Painting$ 612.00Attorney fees100.00$100.00Plumbing61.25Property taxes549.54126.55Insurance9.29Water2.507.25Gardener85.0070.00Termite7.50Interest141.11Total$1,358.33$513.66In addition to the above expenditures, petitioners made payments to Home Savings & Loan Association on the first deed in the total amount of $2,014. Payment was made by three checks, one for225 $1,632 and two checks for $191 each. Petitioners' check for $1,632 was dated December 12, 1956, but did not clear the bank until January 17, 1957. The two checks for $191 were dated with a 1957 date. The payments to Home Savings & Loan Association consisted of the payment of principal and interest as follows: PrincipalInterestTotal$581.93$1,050.07$1,632.0068.10122.90191.0068.10122.90191.00$718.13$1,295.87$2,014.00Immediately upon acquisition of the property, petitioners listed it for sale. The property was never resided in by the petitioners. Petitioners' return for 1957 does not reflect the receipt of rental income. The property was sold on March 29, 1957, for $33,083.87. Petitioners' return for 1957 does not reflect the sale of any other piece of real property during the year. At the date of sale the principal balance of the first deed of trust was $19,243.56, which amount was paid out of the sale proceeds. The expenses of sale were as follows: Commissions$1,650.00Title Insurance144.00Recording4.50Internal Revenue stamps15.40Escrow fee53.00Insurance.50Miscellaneous fee10.00Total$1,877.40226 Petitioners did not separately deduct any of the expenses incurred in connection with the property either on their 1956 return or on their 1957 return, but instead they took into account all such expenses in computing the loss on the sale of the property. Petitioners deducted the loss on their 1957 income tax return as an ordinary loss. Petitioners did not attach to their return for 1957 a statement indicating that they elected to treat interest expense in connection with the real property as a capital expenditure. Respondent adjusted the amount of the loss and determined that the loss was a capital loss. In computing the amount of the loss, respondent treated all the expenditures made by petitioners in both 1956 and 1957 as capital expenditures. 2Petitioners' primary position is twofold: (1) that the loss on the sale of the piece of real227 property was a loss on a transaction entered into for a profit and is deductible in full under section 165(c)(2); 3 and (2) that the real property sold was a "section 1231 asset" 4 and the loss is therefore deductible in full. Respondent claims that the real property was a capital asset as defined in section 12215 and, accordingly, the loss was a capital loss subject to the limitations of section 1211(b). 6 We must agree with respondent. 228 The gist of petitioners' argument is that a transaction which falls under section 165(c)(2) is not limited by section 165(f)7 or section 1211(b). This is where petitioners err. The limitations imposed by sections 165(f) and 1211 apply alike to any losses under section 165(c) if from sales or exchanges of capital assets. Estate of Maria Assmann, 16 T.C. 632">16 T.C. 632 (1951). 8 Whether petitioners are allowed an ordinary loss deduction depends upon whether the real property at the time of sale was not a capital asset in their hands. Section 1221 starts by defining a "capital asset" as "property held by the taxpayer." The property here involved was held by the taxpayers. It was therefore a capital asset unless it can be shown to fall within the exceptions provided for in section 1221. The only possible exceptions petitioners could rely upon are that the property was "stock in trade," "held * * * primarily for sale to customers in the ordinary course of his trade or business," or "property, used in his trade or business." 229 Whether property is "stock in trade" or "held * * primarily for sale to customers in the ordinary course of his trade or business" is a question of fact. In determining the answer to this question the courts have evolved a number of criteria, none of which are conclusive within themselves. Some of the factors most often relied upon are the intent of the seller with respect to the particular asset in question; the purpose for which the property was acquired, held and sold; the volume of sales; the frequency of sales; the time relation to the purchase and sale; the number of sales and the substantiality of the sales when compared to the taxpayer's other business interests; the amount of advertising; and the holding of a real estate license by the taxpayer. Ralph J. Oace, 39 T.C. 743">39 T.C. 743 (1963). 230 Applying these tests here, we find that petitioner did not acquire the property for the purpose of dealing in real estate. They purchased the realty to protect their investment in the second deed of trust when their debtor failed to keep up the payments on the note. This was an isolated sale. Petitioner John Green was a physician. Eighty-eight percent of his income was from his practice of medicine. The remaining twelve percent was from dividend and interest income. Petitioners presented no evidence, other than the fact of this sale, that they were actively engaged in the real estate business. We hold, on the basis of this record, that petitioners did not hold this property as "stock in trade" nor was the property "held * * primarily for sale to customers in the ordinary course of his trade or business." Petitioners were not in the trade or business of selling real estate. Ralph J. Oace, supra; and Estate of Maria Assman, supra.It is evident that since petitioners were not in the trade or business of selling real estate, and since there was no evidence introduced indicating that the property was used in John Green's medical business, the property does231 not qualify as an exception to a capital asset under section 1221(2). Furthermore, for the same reason petitioners derive no benefit from section 1231. Estate of Maria Assmann, supra.Accordingly, the property in the hands of petitioners was a capital asset making the loss derived from the sale thereof limited by section 1211. The cases relied upon by petitioners are either not applicable or are distinguishable on their facts. Henry J. Gordon, 12 B.T.A. 1191">12 B.T.A. 1191 (1928) and Marjorie G. Randall, 27 B.T.A. 475">27 B.T.A. 475 (1932), cited by petitioners for the proposition that a loss on the sale of residential property which was purchased in a transaction entered into for profit is deductible, are not applicable here. Section 165(f) and 1211 did not become part of our taxing laws until the Revenue Act of 1934. Prior to 1934, losses arising from a transaction entered into for profit were deductible without any limitations even if the property sold was a capital asset. S. Rept. No. 558, 73rd Cong., 2d Sess., pp. 13, 25 (1934), 1939-1 C.B. (Part 2) 586; H. Rept. No. 704, 73rd Cong., 2d Sess., pp. 22, 31 (1934), 1939-1 C.B. (Part 2) 554.232 The case of John D. Fackler, 45 B.T.A. 708">45 B.T.A. 708 (1941), affd. 133 F. 2d 509 (C.A. 6, 1943), is distinguishable on the ground that the property there involved was used in the taxpayer's trade or business. The same applies to Leland Hazard, 7 T.C. 372">7 T.C. 372 (1946) and Mary E. Crawford, 16 T.C. 678">16 T.C. 678 (1951). The case of Westmore Willcox, 20 T.C. 305">20 T.C. 305 (1953) held that the loss resulting from the sale of real property was deductible under section 23(e)(2) of the Internal Revenue Code of 1939 (predecessor of 165(c)(2)) as a loss resulting from a transaction entered into for profit. It did not hold that the loss was an ordinary loss. Petitioners, in the instant case, are entitled to a loss deduction under section 165(c)(2). However, the amount of the loss is limited by section 1211. Estate of Maria Assman, supra. Having established that the loss is a capital loss, we must next decide whether petitioners can take a deduction for certain expenditures on their return for the year 1957. Petitioners maintain that if the loss is not an ordinary loss, then all of the expenditures incurred in 1956 and 1957, including the costs233 of sale, in connection with the property are deductible in full in the year 1957. They cite section 2129 as authority for this position. Respondent concedes that the expenditures for repairs and real property taxes totalling $272.55 paid in 1957 are deductible. However, respondent claims there is no authority in the Code to allow as deductions in 1957 expenses incurred and paid in 1956. Furthermore, respondent contends the costs of sale are not a deduction but are a reduction of the sales price and must be treated as such. Regarding the interest, respondent argues that petitioners have elected to capitalize interest expenses under section 26610 and cannot now change their election. We agree with respondent except as to the interest expense. In support of his position, respondent points to the fact that the mere failure of petitioners to deduct the interest expense in either 1956 or 1957 establishes an election under the Code. Respondent pays no mind to his own regulations 11 which provide: If the taxpayer elects to capitalize an item or items under this section, such election shall be234 exercised by filing with the original return for the year for which the election is made a statement indicating the item or items * * * which the taxpayer elects to treat as chargeable to capital account. * * * There was no statement attached to petitioners' return for the year 1957. The mere failure of petitioners to deduct an item of interest separately on their return for 1957 was not an indication that they elected to capitalize this expense. Furthermore, as we will discuss infra, petitioners did not have an interest expense deduction in 1956 which could have been deducted. The noncompliance with the regulations prohibits a valid election. Smyth v. Sullivan, 227 F. 2d 12 (C.A. 9, 1955); Gulf Atlantic Transportation Co. v. United States, an unreported case ( S.D. Fla. 1956, 52 A.F.T.R. (P-H) 2011">52 A.F.T.R. 2011, 56-2 USTC [] 10,052). 12 We hold, therefore, that petitioners, not having elected to capitalize their interest expense, can deduct the amount of interest paid during 1957.13235 We find no merit in petitioners' argument regarding the other expenditures made in connection with the property. Assuming that the $1,358.33 paid in 1956 was for ordinary and necessary expenses, petitioners did not choose to deduct them on their return for 1956. They cannot now deduct them on their 1957 return. They were not "paid or incurred" during the year 1957. Accordingly, section 212 does not aid petitioners. We have found that the costs of sale totalled $1,877.40. These items were properly treated by respondent as a reduction of the selling price. The only other item paid by petitioners in 1957 was $100 for attorney's fees. This amount was also treated by respondent as a capital charge. Petitioners' having the burden to establish that this was an ordinary and necessary expense rather than a capital expenditure and not having offered any evidence to show what the legal fees were paid for, we must sustain respondent's treatment of this amount. Cf. Charlotte M. Douglas, 33 T.C. 349">33 T.C. 349 (1959). The remaining question concerns the amount of interest actually paid in 1957. Since we have already decided that petitioners are entitled to deduct as an expense interest paid236 in the year 1957, it becomes necessary to determine the amount paid in that year. The total interest paid was $1,436.98. 14 This amount is not in dispute. However, respondent contends that $1,050.07, representing the interest contained in the check made payable to Home Savings & Loan Association dated December 12, 1956, was paid in 1956 and not in 1957. The check cleared the drawee bank on January 17, 1957. Delivery of a check may constitute payment for purposes of determining the year in which a sum is deductible by a cash basis taxpayer. Estate of Modie J. Spiegel, 12 T.C. 524">12 T.C. 524 (1949). The mailing of a check, properly addressed, can constitute delivery to the addressee. Witt's Estate v. Fahs, 160 F. Supp. 521">160 F. Supp. 521 (S.D.Fla., 1956). Here we are without any information as to the date when the check in question was actually delivered to the Association or if mailed, as to the actual date of mailing. However, we know that Home Savings & Loan Association is a financial institution. It deals with checks in great numbers every day of its existence. It would be highly237 unusual, to say the least, for a financial institution not to present a check for payment within a very short time after its receipt, especially in view of the applicable sections of the Negotiable Instruments Law. 15 The check was cleared on January 17, 1957, which would indicate receipt on a date some time immediately prior thereto. We conclude from the evidence that delivery of the check took place in January 1957. The Negotiable Instruments Law, 16 although providing that the date on an instrument is deemed to be the true date of execution, does not contain nor provide for any presumptions regarding the date of delivery. 17 In Smith's Estate v. Commissioner, 208 F. 2d 349 (C.A. 3, 1953), affirming on this issue a Memorandum Opinion of this Court, the Court of Appeals, in holding that a check dated December 16, 1947, and cashed on January 10, 1949, was not paid in 1947, stated: We think it would be an undesirable tax rule to let the mere date on an instrument, in the absence of showing of the time it was delivered, carry with it a conclusion that the instrument was delivered on the date put upon it by the drawer. 238 While it is true that the time lapse between the date of execution and the date of clearing is not as great in the instant case and even though the petitioners here are arguing that payment was made in the later year, we nevertheless find that the quoted language of the Court of Appeals is applicable here. Accordingly, having concluded that the check was paid in 1957, the portion thereof representing interest is a proper deduction in that year. Decision will be entered under Rule 50. Footnotes1. Petitioners concede that the disallowance by respondent of $870.46 claimed as entertainment expenses was proper.↩2. On this basis, the parties agreed that the amount of the loss was $5,214.21. However, on brief, respondent conceded that if the loss is a capital loss, expenses for real property taxes and repairs totaling $272.55 paid in 1957 are proper deductions in that year. This would correspondingly reduce the amount of the loss to $4,941.66.↩3. Unless otherwise indicated, all section references are to the Internal Revenue Code, as amended. SEC. 165. LOSSES. (a) General Rule. - There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise. * (c) Limitation on Losses of Individuals. - In the case of an individual, the deduction under subsection (a) shall be limited to - * (2) losses incurred in any transaction entered into for profit, though not connected with a trade or business; * * ↩4. Sec. 1231. PROPERTY USED IN THE TRADE OR BUSINESS AND INVOLUNTARY CONVERSIONS. (a) General Rule. - If, during the taxable year, the recognized gains on sales or exchanges of property used in the trade or business, plus the recognized gains from the compulsory or involuntary conversion (as a result of destruction in whole or in part, theft or seizure, or an exercise of the power of requisition or condemnation or the threat or imminence thereof) of property used in the trade or business and capital assets held for more than 6 months into other property or money, exceed the recognized losses from such sales, exchanges, and conversions, such gains and losses shall be considered as gains and losses from sales or exchanges of capital assets held for more than 6 months. If such gains do not exceed such losses, such gains and losses shall not be considered as gains and losses from sales or exchanges of capital assets. * * * ↩5. SEC. 1221. CAPITAL ASSET DEFINED. For purposes of this subtitle, the term "capital asset" means property held by the taxpayer (whether or not connected with his trade or business), but does not include - (1) stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxpayer year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business; (2) property, used in his trade or business, of a character which is subject to the allowance for depreciation provided in section 167↩, or real property used in his trade or business; 6. SEC. 1211. LIMITATION ON CAPITAL LOSSES. (b) Other Taxpayers. - In the case of a taxpayer other than a corporation, losses from sales or exchanges of capital assets shall be allowed only to the extent of the gains from such sales or exchanges, plus the taxable income of the taxpayer or $1,000, whichever is smaller. For purposes of this subsection, taxable income shall be computed without regard to gains or losses from sales or exchanges of capital assets and without regard to the deductions provided in section 151↩ (relating to personal exemptions) or any deduction in lieu thereof. If the taxpayer elects to pay the optional tax imposed by section 3, "taxable income" as used in this subsection shall be read as "adjusted gross income."7. SEC. 165. LOSSES. (f) Capital Losses. - Losses from sales or exchanges of capital assets shall be allowed only to the extent allowed in sections 1211 and 1212↩. 8. The cited case involved secs. 23(e), 23(g) and 117(d), I.R.C. 1939, which sections were carried over to I.R.C. 1954 without substantive change as secs. 165(c), 165(f) and 1211↩. S. Rept. No. 1622, to accompany H.R. 8300 (Pub. L. 591), 83rd Cong., 2d Sess., p. 198; H. Rept. No. 1337, to accompany H.R. 8300 (Pub. L. 591), 83rd Cong., 2d Sess., pp. A46, A272, A273.9. SEC. 212. EXPENSES FOR PRODUCTION OF INCOME. In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year - (1) for the production or collection of income; (2) for the management, conservation, or maintenance of property held for the production of income; or (3) in connection with the determination, collection, or refund of any tax. ↩10. SEC. 266. CARRYING CHARGES. No deduction shall be allowed for amounts paid or accrued for such taxes and carrying charges as, under regulations prescribed by the Secretary or his delegate, are chargeable to capital account with respect to property, if the taxpayer elects, in accordance with such regulations, to treat such taxes or charges as so chargeable. ↩11. Sec. 1.266-1(c)(3), Income Tax Regs.↩12. Both cited cases were decided under sec. 24(a)(7), I.R.C. 1939, which was the predecessor of sec. 266↩. 13. With interest paid in 1957 being a proper deduction, the amount of the loss as determined in footnote 2, supra, must be adjusted accordingly.↩14. The entire amount was paid to Home Savings & Loan Association, the holder of the first deed of trust, $1,295.87 being paid by check and $141.11 being paid out of the sale proceeds. ↩15. Sec. 3265(b), California Civil Code, provides: A check must be presented for payment within a reasonable time after its issue or the drawer will be discharged from liability thereon to the extent of the loss caused by the delay. Sec. 3266, California Civil Code, defines "issue" as "the first delivery * * *." A "reasonable time," though varying depending on the facts, is usually interpreted to mean the next day when drawer, drawee and payee are all in the same town. 5 U.L.A. § 186. ↩16. Adopted by California as Civil Code, Title 15, sec. 3082 et seq. in 1917. These sections were in effect during the year in issue. California has subsequently repealed the Negotiable Instruments Law, effective January 1, 1965, and adopted the Uniform Commercial Code. Stats. 1963, c. 819. ↩17. Sec. 3092, California Civil Code. Sec. 3097, California Civil Code↩, states that a negotiable instrument in the hands of a holder in due course is presumed to have been validly delivered. However, this situation is not applicable herein. Furthermore, this section does not provide for a presumption as to the date of delivery.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624447/	Edward R. Bacon Company v. Commissioner. Edward R. Bacon v. Commissioner.Edward R. Bacon Co. v. CommissionerDocket Nos. 4043, 4044.United States Tax Court1945 Tax Ct. Memo LEXIS 86; 4 T.C.M. (CCH) 868; T.C.M. (RIA) 45289; September 10, 194586 1. Petitioner, an individual, was the majority stockholder in Edward R. Bacon Company, a corporation. On March 31, 1941, the corporation transferred all its assets to petitioner in exchange for his note in the amount of their net value and his assumption of the corporation's debts and liabilities. On the same date the corporation resolved to terminate and dissolve. At the same time, the petitioner acquired all the other outstanding shares of the corporation's stock. Held, (a) the transfer of the corporation's assets to the petitioner constituted a distribution in liquidation, the petitioner receiving long-term and short-term capital gain thereon; (b) amount of petitioner's gain determined. 2. Held, Edward R. Bacon Company, California, was, for Federal tax purposes, a partnership during 1941, the income of which is taxable to the various partners in proportion to the interest of each therein. 3. Petitioner, on January 7, 1938, subscribed for 448 shares of stock in a corporation organized January 10, 1938, payment for the stock was not completed until November 12, 1940, and the stock certificates were issued December 2, 1940. The corporation was dissolved February 28, 1941. Held, 87 petitioner became a stockholder in the corporation on January 10, 1938, and his gain on liquidation is a long-term capital gain. 4. Gain on the sale of a mining venture, known as South Gulch Placers, was realized in a prior year and should not have been reported in 1941. 5. Salary and commissions paid to petitioner in 1941 by a partnership, of which he and his wife are both members, constitute community property under California law, and are taxable on that basis. 6. Held, Edward R. Bacon Company, a California corporation, was liquidated on March 31, 1941; held, further, petitioner is entitled, under section 711(a)(3)(B), Internal Revenue Code, to use its actual excess profits income for the 12 months prior to its liquidation as a basis for computing its excess profits tax. Louis Janin, Esq., 1190 Mills Tower, San Francisco 4, Calif., for the petitioners. T. M. Mather, Esq., for the respondent. VAN FOSSAN Memorandum Findings of Fact and Opinion The respondent determined deficiencies as follows: Docket No.PetitionerYearTaxDeficiency4043Edward R. Bacon Co.1940Income$ 222.574043Edward R. Bacon Co.1941Income2,274.91Declared value4043Edward R. Bacon Co.1941Excess profits959.234043Edward R. Bacon Co.1941Excess profits5,465.674044Edward R. Bacon1941Income69,021.71The issues in controversy in Docket No. 4043 are whether the Edward R. Bacon Company was liquidated on March 31, 1941, and, if it was, whether, pursuant to the provisions of section 711(a)(3)(B) of the Internal Revenue Code, it is entitled to use its actual excess profits income for the 12 months prior to its liquidation as a basis for computing its excess profits tax. The issues in Docket No. 4044 are: (1) whether property received by the petitioner from the Edward R. Bacon Company, in exchange for his note, constituted a distribution in liquidation; 89 if this is decided in the affirmative, we must determine the amount of the petitioner's gain thereon; (2) whether the respondent erred in determining the amount of the liquidating dividend of the Edward R. Bacon Company, if any, by failing to allow as deductions additional capital stock tax, Califorria franchise tax and Federal income and excess profits taxes; (3) whether or not the income from Edward R. Bacon Company, unincorporated, is taxable to the petitioner in its entirety; (4) whether the petitioner is entitled to a deduction for 1941 of the difference between the value of interests in the business of Edward R. Bacon Company, unincorporated, transferred to certain persons by the petitioner, and the value of the consideration given by such persons in exchange for such interests; (5) whether the petitioner's gain on the liquidation of Edward R. Bacon Company, Ltd., Honolulu, T.H., was a long- or short-term capital gain; (6) whether or not the gain on the sale of certain mining properties, known as South Gulch Placers, was realized in 1941; and (7) whether salary and commissions received by the petitioner from a partnership are taxable as his separate property or as the income90 of his marital community. The petitioner claims an overpayment. Certain of the respondent's adjustments were not contested. Other issues raised by the pleadings were disposed of by concession and abandonment. Findings of Fact The following facts were stipulated or admitted in the pleadings: Edward R. Bacon, hereinafter called the petitioner, is an individual residing at 1940 Vallejo Street, San Francisco, California. He maintained no formal books of account. His return was prepared and filed on the cash basis with the collector of internal revenue for the first district of California. Edward R. Bacon Company, hereinafter sometimes called the San Francisco corporation, is a California corporation organized in 1913, with its principal place of business at Folsom and 17th Streets, San Francisco, California. It kept its books and prepared its tax returns on the accrual basis. The returns for the periods here in controversy were filed with the collector of internal revenue for the first district of California. The excess profits net income of the San Francisco corporation for the 12 months ending March 31, 1941, was $58,685.45. Its excess profits tax credit for 1941 is $35,515.7291 and its excess profits credit carry-over for 1941 is $4,070.62, as shown in the notice of deficiency. The San Francisco corporation filed an excess profits tax return for the calendar year 1941 showing no tax due. The respondent determined that the corporation was liquidated March 31, 1941, and annualized its income for the three-months period January 1, 1941 to March 31, 1941, in accordance with section 711 (a) (3) (A) of the Internal Revenue Code. On December 18, 1943, at 9:30 A.M., after the notice of deficiency had been mailed, the San Francisco corporation filed an "amended final return" for the three-months period in which it computed its excess profits tax in accordance with section 711 (a) (3) (B). On January 1, 1941, the San Francisco corporation had outstanding 8,340 shares of common stock of the par value of $10 per share. Of such shares, the petitioner held 5,495 and his wife, Estelle T. Bacon, 1,800 shares. The shares held by the petitioner had a cost basis to him of $55,400.60, as set forth in the notice of deficiency. On February 1, 1941, the petitioner purchased 500 shares of stock from two stockholders at a cash cost of $10,000, or $2092 per share. The common shareholders, other than the petitioner and his wife, were then Milton R. Clark, owning 400 shares; A. B. Hartley, an employee, owning 110 shares; W. F. McGouirk, an employee, owning 30 shares; and H. J. Learn, an employee, owning five shares. On March 31, 1941, pursuant to resolution of its shareholders, the San Francisco corporation transferred all its assets to the petitioner in exchange for his promissory note of $209,644.87, the agreed net book value of the corporation's assets, and his assumption of all of its indebtedness and liabilities. At the same meeting and on the same date, the stockholders of the San Francisco corporation passed the following resolution: "WHEREAS it is deemed advisable and for the best benefit of this corporation that it be wound up and dissolved, "NOW, THEREFORE BE IT RESOLVED that the shareholders of this corporation hereby elected to terminate the business of this corporation as of the 1st day of April, 1941, to wind up its affairs, and voluntarily to dissolve it. "BE IT FURTHER RESOLVED that the officers or directors of this corporation be and they are hereby authorized and directed to file the certificate, give the93 notice, and file the affidavit of mailing of notice in accordance with the provisions of Section 400 of the Civil Code of the State of California; and "BE IT FURTHER RESOLVED that the officers or directors of this corporation be and they are hereby authorized and directed to take such further action as may be necessary or proper to terminate the business of this corporation, wind up its affairs and to dissolve it; and "BE IT FURTHER RESOLVED that upon the complete and final dissolution of this corporation the Board of Directors of this corporation be and they are hereby authorized and directed to divide the assets of this corporation, which shall consist and be limited solely to the proceeds derived from the note of Edward R. Bacon, to be received by this corporation for the sale of its assets as provided in the resolution of the stockholders of this corporation this day adopted, as required by law." The petitioner acquired all of the preferred shares of the San Francisco corporation not theretofore owned by him at their $10 par value for cash, the certificates bearing assignments sometimes undated, but more frequently dated, with dates as late as June 7, 1941. He also acquired94 all the common stock not theretofore owned by him. On April 1, 1941, the petitioner executed letters to Estelle T. Bacon, his wife, and to Milton R. Clark, former shareholders of the San Francisco corporation who were not employees. The material portions of the letter to the petitioner's wife, are as follows: "In full consideration of your assignment to the undersigned of all of your common stock in Edward R. Bacon Company, a California corporation, the undersigned, doing business as Edward R. Bacon Company, agrees as follows: "1. You are to hereafter participate in any and all net profits of the business of Edward R. Bacon Company to the extent of thirty-seven and one-half (37 1/2%) per cent after deductions have first been made for compensation to me for my services; "2. You are to receive thirty-seven and one-half (37 1/2%) per cent of any and all remaining assets on the dissolution or termination of said business of Edward R. Bacon Company, as, if and when the same are distributed; "3. You shall have no right of assignment of this agreement or any rights hereunder, without first receiving my written consent so to do." The letter to Milton R. Clark was similar in all95 respects except that the interest therein granted was five per cent. On April 1, 1941, petitioner executed letters to W. F. McGouirk, Alfred B. Hartley and Harry J. Learn, former shareholders of the San Francisco corporation, who were also employees. The material portions of the letter to W. F. McGouirk are as follows: "In consideration of the assignment to me by you of all of your common stock in Edward R. Bacon Company, a California corporation, and your continuance in my employ, doing business as Edward R. Bacon Company, IT IS AGREED: "1. You are to hereafter participate in any and all net profits of the business of Edward R. Bacon Company, to the extent of five percent (5%) after deductions have first been made for compensation to me for my services; "2. You are to receive five per cent (5%) of any and all remaining assets upon the dissolution or termination of said business of Edward R. Bacon Company, as, if and when the same are actually distributed; "3. In the event of the termination of your employment with the undersigned, doing business as aforesaid, for any cause whatsoever, I shall have the right or option for a period of sixty (60) days thereafter to pay you96 the sum of Five Thousand and 00/100 Dollars ($5,000.00) in lieu and in full of any and all obligations due you hereunder, in four equal annual installments,without interest. "4. You shall have no right of assignment of this agreement, or any rights hereunder, without first receiving my written consent so to do." The letter to Alfred B. Hartley was similar in all respects to the letter to W. F. McGouirk and that to Harry J. Learn was similar with the exception that the interest therein granted was 2 1/2 per cent. On the same date Bacon executed letters to Mrs. S. Foster and Paul W. Mohr, former employees of the San Francisco corporation who had not been shareholders. The material portions of the letter to Mrs. Foster are as follows: "In consideration of your former employment by Edward R. Bacon Company, a California corporation, and your continuance in my employ, doing business as Edward R. Bacon Company, IT IS AGREED: "1. You are to hereafter participate in any and all net profits of the business of Edward R. Bacon Company to the extent of two and one-half per cent (2 1/2%) after deductions have been made for compensation to me for my services; "2. You are to receive two97 and one-half per cent (2 1/2%) of any and all remaining assets upon the dissolution or termination of said business of Edward R. Bacon Company, as, if and when the same may be actually distributed; "3. In the event of the termination of your employment with the undersigned, doing business as aforesaid, for any cause whatsoever, I shall have the right or option for a period of sixty (60) days thereafter to pay you the sum of Five Thousand and 00/100 Dollars ($5,000.00) in lieu and in full of any and all obligations due or to become due you hereunder, in four equal annual installments, without interest. "4. You shall have no right of assignment of this agreement or any rights hereunder, without first receiving my written consent so to do." The letter to Paul W. Mohr was similar except that the interest therein recited was five per cent. The written acceptance of the addressee was executed on each of these letters. The common shares transferred to the petitioner, the percentage interests granted by him, the dates of written acceptance of the petitioner's offer and the dates of assignments of the stock certificates to him are as follows: CommonInterestDate ofDate commonNamesharesofferedwritten acceptancestock assignedW. F. McGouirk305 %June 6, 1941No dateA. B. Hartley1105 %June 9, 1941June 11, 1941Stella FosterNone2 1/2%June 6, 1941Paul W. MohrNone5 %June 7, 1941H. J. Learn52 1/2%June 9, 1941June 9, 1941Estelle T. Bacon180037 1/2%April 1, 1941April 1, 1941Milton R. Clark4005 %Not datedNo date98 The San Francisco corporation paid salaries to certain of its officers and employees in prior years, as follows: Person1937193819391940Edward R. Bacon$15,750$15,750$15,500$20,000A. B. Hartley6,7756,7756,5256,525W. F. McGouirk4,6254,6504,1005,450Stella Foster3,1753,7253,5253,500From April 1939 to August 1939, the petitioner Bacon operated as an individual a gold dredging project under the title of South Gulch Placers, sustaining an operating loss of $3,880.28. On August 31, 1939, he agreed to sell all the assets used in the project for the sum of $26,458.98, of which selling price $9,458.98 was then paid in cash or other credits and the balance of the agreed price was evidenced by 17 promissory notes of $1,000 each, bearing interest at six per cent per annum and payable on each succeeding month, commencing with September 30, 1939. These notes were secured by a mortgage of all the assets. The petitioner discounted 12 of these notes for cash in 1939, being required to endorse them. On or about January 7, 1938, the petitioner subscribed for 448 shares of the common stock of a corporation, hereinafter called99 the Honolulu corporation, which was organized under the laws of the Territory of Hawaii on January 10, 1938, with an authorized capital of 1,000 shares of $10 par value. The petitioner's wife subscribed for 165 shares and others subscribed for 97 shares. On or about January 29, 1938, the sum of $1,100 was paid in by the petitioner. No further payments were made on the subscriptions until November 12, 1940, when petitioner paid in $8,900 to complete the authorized capital. The petitioner was reimbursed for so much of this payment as was for the benefit of other shareholders by their endorsement to him of the dividend of $10 per share paid by the Honolulu corporation in the total amount of $10,000 on or about December 1, 1940. On November 12, 1940, the petitioner advised the Honolulu corporation that capital stock certificates should be issued as follows: Edward R. Bacon and Estelle T.Bacon820 sharesH. J. Roblee100 sharesM. R. Clark50 sharesA. B. Hartley10 sharesH. J. Learn10 sharesW. F. McGouirk10 shares The actual certificates were dated December 2, 1940 and were issued in accordance with petitioner's instructions except the 10 shares which100 were to have been issued to A. B. Hartley were issued to petitioner. The distributable income of the partnership of Edward R. Bacon Company of Honolulu, a partnership, for its year ended November 30, 1941 was $74,232.18. Petitioner's interest in this partnership was 42 1/2 per cent. Included in the profits of $74,232.18 is partnership salary and commissions paid petitioner amounting to $3,780. Petitioner's wife, Estelle T. Bacon was also a partner, her interest likewise being 42 1/2 per cent. The notices of deficiencies were mailed December 17, 1943. The record discloses the following additional facts: The San Francisco corporation was never formally dissolved but was quiescent after March 31, 1941. Its only business consisted in filing returns and receiving interest on the petitioner's note. A meeting of the corporation was held on December 31, 1942. Since March 31, 1941, the corporation's only assets have been the petitioner's note and a small bank account. The amount of the note was reduced subsequent to March 31, 1941, by the retirement by the petitioner of $24,700 of preferred stock which had been held by him. The petitioner was married to Estelle T. Bacon in 1907, and101 at all times material herein they have resided in San Francisco, California. The petitioner filed gift tax returns in 1943 in which he reported the gift to his wife in 1936 of 1,800 shares of stock of the San Francisco corporation and the gift in 1941 of an interest in Edward R. Bacon Company, unincorporated, to the extent that such interest exceeded the value of the 1,800 shares of stock of the San Francisco corporation. The tax due was paid. The San Francisco corporation and the unincorporated company succeeding it, were engaged in the business of selling and distributing construction equipment. The balance sheet of the unincorporated business showed assets and liabilities as of April 1, 1941, as follows: ASSETSCash$ 10,826.67Accounts and notes re-ceivable147,954.84Inventories290,118.01Real estate and building49,572.70Leasehold improvements3,708.73Equipment, net of re-serve for depreciation: Shop tools141.97Service cars and trucks4,254.06Office furn. and fix-tures5,637.56$ 10,033.59Deferred charges to op-erations and personalaccounts$ 2,099.36Total$514,313.90LIABILITIES AND CAPITALNotes and accounts pay-able$269,253.22First deed of trust20,358.05Dividends payable, prede-cessor company247.00Unrealized profits14,810.76Capital209,644.87Undistributed profits$514,313.90102 The partnership reported a net income of $104,188.98 for the period April 1, 1941 to August 31, 1941. The petitioner, who was the majority stockholder of the San Francisco corporation prior to March 31, 1941, desired to convert the business from a corporation to a partnership because he believed it would be advantageous to the operation of the business to do so. The corporation had several key employees whose services the petitioner desired to retain. Other methods of retaining their employment had been tried which, however, had proved unsuccessful. A stock bonus plan had been tried but this failed since the corporation paid only one dividend during its entire existence and hence the small stock interest an employee would have was not attractive. In 1939 the petitioner entered into an agreement under which certain of the employees would be enabled to acquire stock on the petitioner's death. Under this agreement, the petitioner placed in trust 1,875 shares of stock of the San Francisco corporation and also a policy of insurance on his life in the amount of $30,000, the premiums on which were to be paid by the employees. The trust was revocable by the petitioner upon his payment103 of the gross premiums paid by the employees. If the plan was in full force on the petitioner's death, the insurance proceeds would be delivered to the petitioner's wife, with some adjustments, and the shares of stock and possibly some of the insurance proceeds, would be distributed among the participating employees. This plan was offered to several of the employees, but only three of them took advantage of it. The petitioner also had in mind the fact that he was approaching an age where it would be advisable to let someone else assume the burden of the business. The salaries which certain of the key employees had received were, in the petitioner's opinion, insufficient to keep them in the business. Therefore, he desired to take them in with him on a partnership basis in order to hold them as integral units of the organization. The petitioner's wife was given a 37 1/2 per cent interest in the new business, because of the petitioner's desire that she should share equally with him in all things acquired during their marriage. She contributed no services to the business. The petitioner has never attempted in any manner to control the funds paid to his wife under this agreement. She104 has her own bank account, which the petitioner has no right to draw upon. On and after March 31, 1941, the petitioner paid the household expenses of his wife and himself. The letters set forth in the stipulated facts are the only partnership agreements ever entered into between the petitioner and the others. The petitioner has never exercised any of the options retained by him. All the interests granted therein have remained outstanding and in effect. Distributions of profits have been made in accordance with the proportionate interest of each in the business. After the formation of the partnership the petitioner executed a sworn statement, which was filed with the clerk of courts on April 2, 1941, and published in the newspaper, in which he stated that he was sole owner of the Edward R. Bacon Company. A partnership return was filed for the fiscal year ended August 31, 1941, in which the following statement appeared: "These individuals, although participating in the net proceeds, have no voice in the management of the business and no equity in the assets. Accordingly, the salaries paid them as distinguished from their profit participation, have been treated as expenses of the105 business." This statement was inserted by the accountant who prepared the return and was not read by the petitioner before he executed the return. The petitioner executed instruments authorizing Stella Foster to sign documents as treasurer of the partnership, appointing W. F. McGouirk as general manager, and appointing Stella Foster, W. F. McGouirk and Alfred B. Hartley his attorneys in fact. In his return for 1939, the petitioner did not report either the operating loss nor the gain on the sale of South Gulch Placers. He included therein the following explanation: "Taxpayer entered into a contract for sale of these mining claims and certain equipment coupled with an interest in the operations of the property. It is the taxpayer's understanding that until his investment has been recovered the profit or loss on the transaction cannot be determined. All books and record are in the possession of the taxpayer." In his return for 1941, the petitioner reported gain on the sale in the amount of $3,858.68 to which he had added interest received in the sum of $174.80. From the total thus obtained, he deducted the operating loss of $3,880.28, leaving a net gain of $153.20. The respondent106 determined that the operating loss was deductible in 1939, the year in which it was sustained, and that the gain on the sale in the sum of $3,858.68 was taxable in its entirety in 1941. The Honolulu corporation commenced business after the advanced payment by the petitioner. No other payments of capital were made at that time. The corporation was dissolved on February 28, 1941. Opinion VAN FOSSAN, Judge: Several issues are here presented for our determination. We consider first those relating to the individual petitioner, Edward R. Bacon. The first of these issues is whether property received by the petitioner from the San Francisco corporation in exchange for his note constituted a distribution in liquidation. The facts show that on March 31, 1941, the corporation transferred all its assets to the petitioner in exchange for his note in the amount of their net value and his promise to assume all the corporation's debts and liabilities. On the same date the stockholders resolved to terminate the business of the corporation as of April 1, 1941, to wind up its affairs and voluntarily to dissolve it. The corporation was not formally dissolved but thereafter it conducted no business, 107 remaining inactive except for the filing of returns and the collection of interest on the petitioner's note. It had no assets except the petitioner's note and a small bank account. At the same time the petitioner became the sole stockholder of the corporation by acquiring from the other stockholders their shares of stock. We think it evident that the transfer to the petitioner of the corporation's assets constituted a distribution in liquidation. The petitioner does not seriously contend otherwise and admits on brief that on this issue the respondent has the better of the argument. The purported sale to the petitioner can not be recognized as relieving him for taxation upon the liquidating dividend. It must be treated as a mere bookkeeping transaction rather than a sale. Cook v. United States, 3 Fed. Supp. 47; Cf. Benjamin H. Read, 6 B.T.A. 407">6 B.T.A. 407. We hold there was a liquidation of the San Francisco corporation on which the petitioner realized long-term capital gain. There remains for determination the amount of gain realized. In his notice of deficiency the respondent determined that the petitioner received longterm capital gain of $76,212.97, representing108 the gain on 5,495 shares of common stock which he had held for over two years, and short-term capital gain of $11,242.06 on 2,845 shares held by the petitioner less than two years. The latter shares consist of 500 shares purchased by the petitioner on February 1, 1941, concerning which there is no dispute, and 2345 shares which the petitioner received from the other stockholders on or about March 31, 1941, in consideration of his assigning to them interests in the business. The respondent determined the petitioner's cost of these last shares as follows: As no fixed consideration was named in this agreement, it is held that you were obligated to pay fair market value, which is set at $20.00, the price paid February 1, 1941, in the cash purchase of 500 shares. The above finding by the Commissioner placed on petitioner the burden of proving that $20 did not represent the fair market value of the shares, i.e., that some figure other than $20 was the correct value. We have searched the record and are unable to find any basis for fixing a different figure. Consequently, on this question we have no alternative to sustaining the Commissioner. A cost of $20 per share will be used in the109 computation of gain to petitioner on the 2,345 shares. The petitioner offered no evidence and makes no argument in his brief that his gain should be reduced because of additional capital stock tax and California franchise tax. He does contend, however, that his gain should be reduced by the amount by which the value of the corporation's assets will be reduced by reason of the deficiencies in its income and excess profits taxes, a part of which is conceded to be due. He is entitled to this adjustment, effect to which will be given in the recomputation under Rule 50. The next issue is whether or not the petitioner is taxable on the entire net income of Edward R. Bacon Company, unincorporated. The respondent contends that the so-called partnership was merely an arrangement whereby the petitioner assigned a portion of the profits of the business to each of the alleged partners as payment for their stock which they had assigned to him. The petitioner contends that, whether or not a partnership in the technical sense was created, he is taxable on only 37 1/2 per cent of the net income of the company, the remaining income being taxable to the various partners according to their respective110 interests in the business. Briefly, the facts show that in consideration of their assignment to him of stock, or for other considerations, the petitioner granted to certain persons specified interests in the unincorporated business, including a corresponding interest in the assets on termination of the business. The interests in the assets were absolute in the case of Estelle T. Bacon and Paul W. Mohr. With respect to the others, the petitioner reserved the option to purchase for $5,000 the interest of each in the event of cessation of his employment. Distribution of the profits was thereafter made on the basis of the proportionate interest of each in the business. The fundamental issue thus presented is not whether this arrangement gave rise to a technical partnership under State law but rather it is a question of determining who were the owners of the income which the respondent seeks to tax to the petitioner. The rule which applies here is that tax liability on income attaches to ownership of the property producing the income. Justin Potter, 47 B.T.A. 607">47 B.T.A. 607. See Robert P. Scherer, 3 T.C. 776">3 T.C. 776.111 In our opinion a real partnership was created. Clearly each of the persons contributed the property producing his share of the income and is taxable upon that income. Each of them had an interest not only in the profits of the business but in its assets, which were an important income-producing factor in the business. While the petitioner had the option to purchase the shares of all but two of the partners for $5,000 each, this contingency would not arise unless the person affected actually terminated his employment and the petitioner exercised the option. It is admitted that the profits were actually distributed to the partners. The respondent contends, however, that this distribution was merely the method chosen by the petitioner to pay for the stock assigned to him by the others. This argument, of course, is wholly inconsistent with his contention on the previous issue. There he contended that the petitioner had purchased the stock for $20 per share and determined the amount of his gain thereon. Here, however, he in effect asserts that the petitioner is still purchasing the stock. The term of the partnership is indefinite and if the respondent's argument were carried to its112 logical conclusion the petitioner might conceivably sustain a loss on the sale of the stock rather than realize a gain. The respondent's argument overlooks the fact that the partners acquired interests in the assets of the business as well as its profits. Furthermore, two of the partners did not own any stock of the San Francisco corporation but had been merely its employees. As to these it could not be argued that their distributable shares of the profits constituted payment for stock. The respondent also relies upon the sworn statement of the petitioner that he was the owner of the business and upon the statement inserted in the partnership return. While such statements are factors to be considered along with all the other evidence, they are not controlling in and of themselves. Nor do we attach controlling importance to the statement in the partnership return which the petitioner testified was inserted by the accountant who prepared the return and was not read by the petitioner before he executed it. Each of the partners gave something of value for his interest in the business, either in the way of stock or services, or both. If the interest received was greater than that given, 113 the fact that the difference might be a gift does not control the issue. J. D. Johnston, Jr., 3 T.C. 799">3 T.C. 799; Justin Potter, supra; Walter W. Moyer, 35 B.T.A. 1155">35 B.T.A. 1155. On this issue we, therefore, hold in favor of the petitioner. The petitioner contends next that he is entitled to a deduction for 1941 of the difference between the value of the interests in the business of Edward R. Bacon Company, transferred to the employees by him, and the value of the consideration given by the employees in exchange for their interests. This position is inconsistent with his previous contention that a partnership was in existence during 1941. We have already held that for Federal tax purposes the Edward R. Bacon Company was a partnership during that year. Consequently, we reject this contention. The next issue is whether or not the respondent erred in his determination that the petitioner received short-term capital gain in the amount of $3,030.88 upon the liquidation of the Honolulu corporation. The facts show that on January 7, 1938, the petitioner subscribed for 448 shares of stock in the corporation, which was organized on January 10, 1938, and his wife114 subscribed for 165 shares. On or about January 29, 1938, petitioner paid in $1,100 to the corporation. No further payments were made until November 12, 1940, when the petitioner paid in $8,900 to complete the authorized capital. The stock certificates were then issued as of December 2, 1940. On February 28, 1941, the corporation was dissolved. Petitioner contends that as to the 448 shares he was a stockholder in the Honolulu corporation from the date of stock subscription and that his gain on its liquidation was a long-term capital gain. The respondent, on the other hand, contends that the petitioner did not become a stockholder until the date stock certificates were issued and that his gain is consequently a short-term capital gain, taxable in its entirety. We do not agree with the respondent. The issuance of a certificate of stock is not necessary to make one a stockholder in a corporation. It is well settled as a general rule of corporation law that in the absence of a statutory or charter provision or agreement to the contrary a subscriber for stock in a corporation becomes a stockholder115 as soon as his subscription is accepted by the corporation, whether a certificate of stock is issued to him or not, and, although he may have no certificate, he is thereupon entitled to all the rights and is subject to all the liabilities of a stockholder. Fletcher Cyclopedia of Corporations (Per. Ed.), section 5094. In Schwartz v. Manufacturers' Casualty Insurance Co., 335 Pa. 130">335 Pa. 130, 6 Atl. (2d) 299, it was held that by the act of incorporation, with nothing more, the original subscribers become members of the corporation. The petitioner subscribed for his stock on January 7, 1938, and the corporation was organized and commenced doing business on January 10, 1938. Consequently, in the absence of some agreement to the contrary, and there is no evidence of any such agreement in the instant case, the petitioner became a stockholder in the corporation on the latter date. The situation is not altered by the fact that the petitioner did not complete the payment for his stock until 1940 since, in the absence of a contrary agreement, actual payment is not necessary to make a subscriber a stockholder. Fletcher Op. Cit., section 1375. We hold, therefore, that the petitioner116 became a stockholder in the Honolulu corporation on January 10, 1938, the date of its incorporation, and that as to the 448 shares his gain on the liquidation of that corporation was a long-term capital gain, 50 per cent of which is taxable. The next issue is whether the gain on the sale of South Gulch Placers is taxable to the petitioner in 1941. The petitioner does not contest the respondent's action in determining that the operating loss from this venture should be deducted in 1939 instead of 1941. He contends, however, that his gain from the sale was realized in 1939 and should have been reported in that year and that it was erroneously included in his 1941 return. It is a well established principle that where property is exchanged for notes, income is realized to the extent that the fair market value of the notes exceeds the basis of the property. Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U.S. 462">287 U.S. 462. The respondent contends that there is no evidence that the notes were worth face value when they were received by the petitioner in 1939 or that it was a closed117 transaction in that year instead of in 1941, when the last of the notes were actually paid. He contends that, in the absence of such evidence, or evidence that the payments were not of a contingent character, the gain must be reported on the return of capital theory, citing Burnet v. Logan, 283 U.S. 404">283 U.S. 404. While the facts are not as complete as we might desire, we think them sufficient to show that the sale of the assets was a closed transaction in 1939. So far as appears from the record, the sale was completed at that time. Title to the properties was passed and the purchaser paid the sale price, partially in cash or other credits, and partially in promissory notes. At the same time the petitioner took back a chattel mortgage on the assets to secure the payment of the notes. There is nothing to show that the payments of those notes were in any way of a contingent nature and the fact that the petitioner discounted 12 of them for cash in 1939 indicates they were not of this character. Consequently, Burnet v. Logan, supra, is not applicable. It follows then that the petitioner's gain was realized in the year 1939, measured by the amount of cash or its equivalent, 118 received by the petitioner in that year in excess of his basis. Pinellas Ice & Cold Storage Co. v. Commissioner, supra. The evidence shows sufficiently, we think, that the notes were worth their face value when received by the petitioner in 1939. The sale price of the properties, which had a cost basis to the petitioner of $22,600.30, was $26,458.98. Of this $9,458.98 was paid in cash or other credits, leaving a balance of $17,000, evidenced by 17 promissory notes of $1,000 each, which were secured by a chattel mortgage on all the assets. Under the mortgage the petitioner had the usual rights of reentry and also in case of default on the notes. The mortgaged assets were clearly sufficient to secure full payment of the notes. Therefore, the petitioner received income in 1939 of the full amount of the cash and notes and such income should have been reported in that year. We hold that it was error to include it in his 1941 income. H. G. Stevens, 14 B.T.A. 1120">14 B.T.A. 1120; George Antonoplos, 3 B.T.A. 1236">3 B.T.A. 1236. The next issue is whether salary and commissions paid to the petitioner in 1941 by Edward R. Bacon Company of Honolulu, T. H., a partnership, constitute119 the separate income of the petitioner or whether the income is that of his marital community. The petitioner and his wife were both members of the partnership, each having a 42 1/2 per cent interest therein. We have frequently held that a husband and wife may be members of a partnership under California law and that their respective interests in the profits thereof are the separate property of each. L. S. Cobb, 9 B.T.A. 547">9 B.T.A. 547., Elihu Clement Wilson, et al., 11 B.T.A. 963">11 B.T.A. 963; Charles Brown, et al., 13 B.T.A. 981">13 B.T.A. 981. During 1941, in addition to his distributive share of the partnership profits, the petitioner received a salary and commissions totaling $3,780. The respondent contends that this latter amount must also be included in the petitioner's separate income. In support of this he relies upon T. H. Banfield, 42 B.T.A. 769">42 B.T.A. 769. In that case it is said that "the profits of a partnership which are credited or paid out as interest on partner's capital contributions, 120 or salaries paid to partners, constitute distributable income of the partnership to the person entitled to the interest or salary." Consequently, argues the respondent, since the distributable interest of the petitioner in the partnership is his separate property, the salary and commissions paid to him being a part of such distributable interest, also constitute his separate property. This argument can not be sustained. The Banfield case, supra, involved facts entirely different from those before us, having nothing to do with community property law. Whether the amounts in question constitute separate property or community property is a matter of State law. Poe v. Seaborn, 282 U.S. 101">282 U.S. 101. Under California law, the earnings of the husband or wife ordinarily constitute community property. H. A. Belcher, 11 B.T.A. 1294">11 B.T.A. 1294; Wren v. Wren, 100 Cal. 276">100 Cal. 276, 34 Pac. 775. By agreement between the parties, the earnings of one may become his or her separate property, Wren v. Wren, supra,121 but we find no evidence of such an agreement here, and the rule is not altered by the fact that the petitioner's distributable share of the partnership profits, other than his salary and commissions, constitute his separate property. Thus in Heck v. Heck, 147 Pac. (2d) 110, it was held that where a husband acquired an interest in a partnership out of his separate property, his distributive share of the partnership profits was his separate property but the salary paid to him by the partnership, being his earnings, constituted community property. It thus clearly appears that the salary and commissions paid to the petitioner in 1941 are community property and are to be taxed as such. We so hold. The final issues relate to the excess profits tax liability for the year 1941 of the San Francisco corporation which, for convenience, will hereinafter be called the petitioner. The petitioner filed an excess profits tax return for the calendar year 1941, reporting no tax due. In his notice of deficiency the respondent determined that the petitioner had been liquidated on March 31, 1941, and computed its excess profits tax by placing its excess profits net income for the period122 January 1, 1941 to March 31, 1941 on an annual basis, as provided in section 711(a)(3)(A) of the Internal Revenue Code. On December 18, 1943, the day after the mailing of the notice of deficiency herein, the petitioner mailed for filing an "amended final return" in which it computed its excess profits tax for the same period in accordance with the provisions of section 711(a)(3)(B), I.R.C.Section 711(a)(3) provides as follows: SEC. 711. EXCESS PROFITS NET INCOME. (a) Taxable Years Beginning After December 31, 1939. - * * * * * (3) Taxable Year Less Than Twelve Months. - (A) General Rule. - If the taxable year is a period of less than twelve months the excess profits net income for such taxable year (referred to in this paragraph as the "short taxable year") shall be placed on an annual basis by multiplying the amount thereof by the number of days in the twelve months ending with the close of the short taxable year and dividing by the number of days in the short taxable year. The tax shall be such part of the tax computed on such123 annual basis as the number of days in the short taxable year as of the number of days in the twelve months ending with the close of the short taxable year. (B) Exception. - If the taxpayer establishes its adjusted excess profits net income for the period of twelve months beginning with the first day of the short taxable year, computed as if such twelve-month period were a taxable year, under the law applicable to the short taxable year, and using the credits applicable in determining the adjusted excess profits net income for such short taxable year, then the tax for the short taxable year shall be reduced to an amount which is such part of the tax computed on such adjusted excess profits net income so established as the excess profits net income for the short taxable year is of the excess profits net income for such twelve-month period. The taxpayer (other than a taxpayer to which the next sentence applies) shall compute the tax and file its return without the application of this subparagraph. 124 If, prior to one year from the date of the beginning of the short taxable year, the taxpayer has disposed of substantially all its assets, in lieu of the twelve-month period provided in the preceding provisions of this subparagraph, the twelve-month period ending with the close of the short taxable year shall be used. For the purposes of this subparagraph, the excess profits net income for the short taxable year shall not be placed on an annual basis as provided in subparagraph (A), and the excess profits net income for the twelve-month period used shall in no case be considered less than the excess profits net income for the short taxable year. The benefits of this subparagraph shall not be allowed unless the taxpayer, at such time as regulations prescribed hereunder require, makes application therefor in accordance with such regulations, and such application, in case the return was filed without regard to this subparagraph, shall be considered a claim for credit or refund. The Commissioner, with the approval of the Secretary, shall prescribe such regulations as he may deem necessary for the application of this subparagraph. The petitioner does not seriously press its contention125 that it was not liquidated on March 31, 1941. In its reply brief it concedes that for excess profits tax purposes it must be regarded as having disposed of all its assets on that date. We have already held that the corporation was liquidated on March 31, 1941. Consequently, it is not entitled to compute its excess profits tax for 1941 on the calendar year basis. General Aniline & Film Corporation, 3 T.C. 1070">3 T.C. 1070; Kamin Chevrolet Co., 3 T.C. 1076">3 T.C. 1076. The petitioner contends, however, that it is entitled to compute its excess profits tax in accordance with the provisions of section 711(a)(3)(B). That section is a relief measure and consequently is to be construed liberally in favor of the taxpayer. Bonwit Teller & Co. v. United States, 283 U.S. 258">283 U.S. 258. However, it is provided therein that in order to avail itself of the benefits of the section the taxpayer must make application therefor to the Commissioner in such manner as the regulations prescribe. The regulations (Regulations 112), which are printed in full in the margin, 1 provide generally that126 if, at the time the return for the short taxable year is filed, the taxpayer is able to determine that the 12-month period ending with the close of the short taxable year will be used in the computation under subsection (B) of section 711(a)(3), then the tax on the return for the short taxable year may be determined under the provisions of subsection (B). In such a case, an excess profits tax return form covering the 12-month period is to be attached to the return as a part thereof and the return will then be considered the application for the benefits of subsection (B). In all other cases the taxpayer must file its return and compute its tax according to subsection (A) and the application for the benefits of subsection (B) shall consist of a notice to the Commissioner setting forth the facts involved, together with an excess profits tax return form, covering the 12-month period used. The claim or other application for the benefits of subsection (B) must set forth the computation of the adjusted excess profits net income and the tax thereon for the 12-month period. An application for the benefit of subsection (B), other than a claim for credit or refund, made in any case in which the127 tax liability computed under subsection (A) has not been paid, may be filed at any time before the tax liability for the taxable year is finally determined. 128 Thus the regulations prescribe no specific form in which the application for benefits of subsection (B) must be made. The return itself is sufficient if, at the time it is filed, the taxpayer is able to determine that the 12-month period, ending with the close of the short taxable year, will be used in the computation of the tax under subsection (B). In other cases the application is to consist of a notice to the Commissioner setting forth the facts involved, together with a return computing the tax in accordance with the provisions of subsection (B). In the instant case the original return was filed on the basis of the calendar year, the petitioner contending that it was not liquidated on March 31, 1941. However, on December 18, 1943, the petitioner filed an amended return in which it computed its tax liability in accordance with subsection (B). No separate notice was attached to the return but this was not necessary since the respondent was already apprised of all the facts. See Germantown Trust Co. v. Commissioner, 309 U.S. 304">309 U.S. 304. The regulations provide that the application129 may be made at any time before the tax liability for the taxable year is finally determined. We think the petitioner made application for the benefits of subsection (B) in substantial compliance with the requirements of the statute and regulations. The respondent does not contend that the petitioner is not otherwise entitled to the benefits of the subsection and we can see no reason for denying to it the relief it seeks. Consequently, we hold that the petitioner is entitled to compute its excess profits tax for the period January 1, 1941 to March 31, 1941, in accordance with the provisions of section 711(a)(3)(B). Subsequent to the hearing in this proceeding the petitioner, pursuant to leave of Court, filed an amendment to its petition in which it alleged as follows: 5(k) On January 11, 1945, petitioner received a Notice and Demand from the Collector of Internal Revenue at San Francisco, California, for $2,056.46 for additional taxes and interest due in accordance with the Amended Final Returns (Exhibit 16 in the proceeding consolidated for hearing with Docket No. 4044). This sum with additional interest of $25.70 was paid to the Collector on or about March 24, 1945. On September 7, 1945, the130 respondent filed an amended answer to the above amendment to petition in which he admits the allegations contained in subparagraph (k) of paragraph 5 of the amendment to petition. Due recognition will be given to this admission in the computation under Rule 50. Decisions will be entered under Rule 50. Footnotes1. Sec. 35.711(a)-4. Tax for Period of Less Than 12 Months. * * * (d) Application to Compute Tax Under Section 711 (a) (3) (B). - A taxpayer desiring the benefit of section 711 (a) (3) (B) must file an application therefor. If at the time the return for the short taxable year is filed the taxpayer is able to determine that the 12-month period ending with the close of the short taxable year will be used in the computations under section 711 (a) (3) (B), then the tax on the return for the short taxable year may be determined under the provisions of section 711 (a) (3) (B). In such a case, an excess profits tax return form covering the 12-month period shall be attached to the return as a part thereof, and the return will then be considered the application for the benefits of section 711 (a) (3) (B) required by that section. In all other cases, the taxpayer shall file its return and compute its tax as provided in subsection (b) of this section, and the application for the benefit of section 711 (a) (3) (B) shall be made in the form of a claim for credit or refund if the tax computed under section 711 (a) (3) (A) has been paid, or, if the tax computed under section 711 (a) (3) (A) has not been paid, the application shall consist of a notice to the Commissioner setting forth the facts involved together with an excess profits tax return form covering the 12-month period used. The claim or other application for the benefit of section 711 (a) (3) (B) shall set forth the computation of the adjusted excess profits net income and the tax thereon for the 12-month period and, if credit or refund is sought for taxes paid before the application for the benefit of section 711 (a) (3) (B) is filed, the claim must be filed not later than June 15, 1943, or the time prescribed for filing the return for the first taxable year (or for the period which would be its taxable year if it continued in existence) ending with or after the twelfth month after the beginning of the short taxable year, whichever date is later. For example, the taxpayer changes its accounting period from the calendar year basis to the fiscal year basis ending September 30, and files a return for the period from January 1, 1942, to September 30, 1942. At the time it files its return, it pays the tax computed thereon under the provisions of section 711 (a) (3) (A). Its claim for credit or refund of the overpayment which would result from the application of section 711 (a) (3) (B) must be filed not later than the time prescribed for filing its return for the first taxable year which ends on or after the last day of December, 1942, the twelfth month after the beginning of the short taxable year. In this case, the taxpayer must file its claim for credit or refund not later than December 15, 1943, the time prescribed for filing the return for its fiscal year ending September 30, 1943. However, if it obtains an extension of time for filing the return for such fiscal year, it may file its claim during the period of such extension. If the Commissioner determines that the taxpayer has established the amount of the adjusted excess profits net income for the 12-month period, any excess of the tax paid for the short taxable year over the tax computed under section 711 (a) (3) (B) will be credited or refunded to the taxpayer in the same manner as in the case of any other overpayment. An application for the benefit of section 711 (a) (3) (B), other than a claim for credit or refund, made in any case in which the tax liability computed under section 711 (a) (3) (A)↩ has not been paid, may be filed at any time before the tax liability for the taxable year is finally determined. Such application does not constitute a claim for credit, refund, or abatement. If credit or refund is sought for taxes paid after such application is filed, a claim therefor on Form 843 should be filed after such payment and within the period prescribed in section 322.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624450/	Romy Hammes, Inc., Petitioner v. Commissioner of Internal Revenue, RespondentRomy Hammes, Inc. v. CommissionerDocket No. 7444-73United States Tax Court68 T.C. 900; 1977 U.S. Tax Ct. LEXIS 47; September 13, 1977, Filed 47 Decision will be entered for the respondent. In 1968 four active corporations, A, B, C, and D merged into a fifth active corporation, P. The premerger corporations engaged in disparate and nonintegrated business activities which activities were continued as separate divisions of the postmerger corporation. The premerger and postmerger corporations had one common shareholder, but there was a significant difference in the shareholders and their proprietary interests among the premerger corporations and between the premerger and postmerger corporations. The postmerger corporation sustained a net operating loss during 1970 due to a business formerly carried on by P and seeks to carry the loss back to offset the premerger income of A. Held: The merger of four active corporations into a fifth active corporation, each with disparate, nonintegrated business operations and with significantly different shareholder interests, does not constitute a sec. 368(a)(1)(F) reorganization. Accordingly, a postmerger net operating loss incurred by a business formerly operated by corporation P may not be carried back against the premerger income of corporation A under sec. 381(b)(3). Charles M. Boynton, 48 for the petitioner.James F. Hanley, Jr., for the respondent. Wilbur, Judge. WILBUR901 Respondent has determined a deficiency in petitioner's Federal income tax for the taxable year 1967 in the amount of $ 19,210.85. The issue for decision is whether petitioner, as successor by merger, is entitled to carry back a portion of its net operating loss to the 1967 premerger income of Romy Hammes, Inc., an Illinois corporation. The resolution of this issue depends largely on whether the multicorporate merger in 1967, of which petitioner is the surviving corporation, qualified as a reorganization under the provisions of section 368(a)(1)(F). 1FINDINGS OF FACTSome of the facts have been stipulated and are found accordingly.Petitioner Romy Hammes, Inc. (hereinafter referred to as Nevada), was organized under the laws of the State of Nevada on May 7, 1951, and conducted its business from its principal office in Kankakee, Ill., where it maintained its books and records at the time of filing the petition herein.Nevada was inactive until December 15, 1967, at which time Romy Hammes (Romy) transferred 49 certain of his assets and liabilities having a net asset value of $ 350,000 to Nevada in exchange for its initial issue of 3,500 shares.On December 29, 1967, the following four operating corporations entered into a merger agreement with Nevada for the purposes of merging these corporations into Nevada:(1) Romy Hammes Co., Inc., an Indiana corporation (Company); (2) Romy Hammes Corp., an Indiana corporation (Corporation);(3) Hammes Enterprises, Inc., an Illinois corporation (Enterprises);(4) Romy Hammes, Inc., an Illinois corporation (Illinois).Company was organized and incorporated in Indiana on June 17, 1946. It acquired the Singer property located in South Bend, Ind., in 1955 which consisted of approximately 50 acres and which had been used as a woodworking facility for the Singer Co. Company then tore down the brick and frame 902 buildings but left the reinforced concrete building which was converted into office and warehouse space which it rented. In addition, it constructed an A & P store which it rented under a long-term lease and a one-floor retail facility which it held for rent. On the Singer property it also constructed an automobile agency facility which it rented to Corporation. 50 It conducted and managed the Maytag appliance franchise for Indiana and Michigan. Company's income was derived from the rental properties and from the sale of Maytag appliances to dealers in Indiana and Michigan under its franchise agreement with the Maytag Co.Corporation was organized and incorporated under the laws of the State of Indiana on July 22, 1950, and operated, managed, and engaged in the business of the sale of Ford Motor products in South Bend, Ind. It operated the dealership which sold at retail Ford automobiles and trucks and tractors. It was located at 244 South Olive Street, South Bend, Ind., and leased its premises from Company which owned the real estate. The dealership was sold in 1974.Enterprises was organized and incorporated in Illinois on July 1, 1946, to deal in real estate. It acquired land and caused to have constructed commercial buildings in the area of Kankakee, Ill., which it leased. On February 6, 1962, Romy Hammes Homes, Inc., an Illinois corporation, (Homes-Kankakee) was merged into Enterprises. Prior to the merger, Homes-Kankakee had built homes for rent and sale in Kankakee, Ill. Among the assets transferred to Enterprises as a result of 51 the merger were the rental houses and the installment contracts on the homes previously built and sold by Homes-Kankakee.Illinois was organized under the laws of the State of Illinois on July 2, 1946. Prior to its 1968 merger into Nevada, Illinois constructed, then rented, various commercial buildings, among them a shopping center in Joliet, Ill.2The shareholders of the merging corporations and the survivor, Nevada, as of December 29, 1967, were as follows: 352 903 Shares(1) NevadaRomy Hammes 3,500 (2) CompanyRomy Hammes 179 1/4Gerald Hammes 124 Romy Hammes Trust 726 3/4(3) CorporationRomy Hammes 4,000 Gerald Hammes 1,000 30 Employees 590 (4) EnterprisesRomy Hammes 1,589 1/2Gerald Hammes 575 Romy Hammes Trust 335 1/2(5) IllinoisRomy Hammes 1,112 1/2Gerald Hammes 200 Romy Hammes Trust 383 1/2Hammes Enterprises, Inc. 400 Eighteen of the individual employee shareholders of Corporation did not desire to go along with the merger and, prior to the finalization of the merger, Corporation redeemed 155 shares of Corporation stock from the dissenting shareholders for a total purchase price of $ 3,467.Upon the merger of the four corporations into Nevada, the survivor issued its stock as follows: 453 Romy Hammes25,340Gerald Hammes8,078Romy Hammes Trust9,668Hammes Enterprises, Inc.5 2,052Harry Greer171.47Floyd Parisot47.63Mrs. Don L. Cira47.63Mr. and Mrs. Wesley D. Glaser, Jr.33.34Mrs. Harvey Sult23.81Mr. and Mrs. Fred A. Root23.81Mr. and Mrs. Harold J. Smith23.81Mr. and Mrs. Hubert Stults19.05Mr. Carl A. Weinzetl9.53Mr. and Mrs. A. J. Hoerstman4.76Mr. and Mrs. Merle A. Durbin4.76Mr. and Mrs. John C. Lenko4.76The Romy Hammes Corp.6 147.64904 Thirty-five hundred shares had previously been issued to Romy.The stock holdings in Nevada were arrived at by first determining the net worth of Corporation, Company, Enterprises, and Illinois on the basis of book value as of December 27, 1967. These figures were then used to determine the respective values per share of each of the four corporations. The holders of these shares were given an equivalent equity interest in Nevada.After the merger, the merging corporations were designated as divisions, and each kept separate books and records to reflect its continuing operations. In addition, Nevada54 kept two more sets of divisional books and records; one for the operation of its Hawaiian project and one for the rest of Nevada's assets which were transferred by Romy to Nevada on December 15, 1967. Finally, Nevada kept a consolidated account which reflected the total operations of all divisions.In 1965, Romy, in his individual capacity, and Bruce McNeil (McNeil) acquired an option on a sublease of an existing four-story structure in Honolulu, Hawaii, with the intent to build a hotel over the existing structure. The construction was to be done by the McNeil Construction Co. On August 26, 1966, the option lapsed but McNeil and Romy obtained a new option on the subleasehold from Standard Oil of California on March 12, 1968. In June 1968, they exercised the option and acquired the subleasehold.Romy had transferred his interest in the Hawaiian transaction to Nevada as part of the net asset transfer from Romy to Nevada on December 15, 1967, for which he received the initial issue of Nevada's common stock.Nevada's original intent was to maintain ownership of the hotel, and have it managed by Hyatt Corp., but Nevada905 subsequently decided to sell the project. On March 29, 1969, while 55 the hotel was still under construction, Cinerama, Inc., a New York corporation, agreed to buy the hotel. The hotel was constructed and nearing completion, when on February 27, 1970, a fire took place in the upper stories and Cinerama, Inc., refused to go through with the purchase. The operation of the hotel from March 1970 through the end of the year resulted in a loss sufficient to offset all of Nevada's other taxable income and still produce Nevada's net operating loss for 1970 of $ 735,859. Nevada filed an application for a tentative refund (Form 1139) from a carryback of its 1970 net operating loss to Illinois' 1967 taxable year in which Illinois had premerger taxable income of $ 50,439. At the time of the application for the carryback, Illinois had been merged into Nevada. On December 29, 1971, a tentative carryback allowance was made to Nevada in the amount of $ 19,211.12.OPINIONThe sole issue to be decided is whether Nevada is entitled to carry back its 1970 net operating loss to the 1967 premerger income of Illinois.Section 381(b)(3)7 provides that the acquiring corporation in certain described reorganizations shall not be entitled to carry back a post-reorganization net 56 operating loss to a taxable year of a transferor corporation. This carryback prohibition, however, does not apply "in the case of an acquisition in connection with a reorganization described in subparagraph (F) of section 368(a)(1)." Petitioner contends that the merger of Company, Corporation, Enterprises, and Illinois into Nevada was an (F) reorganization, and that Nevada, as the acquiring corporation, is entitled to carry back its net operating loss to the premerger income of Illinois.An (F) reorganization is one of the six types of reorganizations described in section 368(a)(1). The (F) reorganization is defined as "a mere change in identity, form or place of 906 organization, 57 however effected." We note at the outset that the language of the statute and the legislative history of the reorganization provisions 858 59 strongly suggest that (F) reorganizations were meant to be limited to only minor corporate adjustments. The tax-free treatment accorded to the reorganizations described in section 368(a)(1)(A) through (F) is rooted in the philosophy that where there is a sufficient degree of continuity in the business enterprise, the corporate adjustment will be an inappropriate occasion for the reckoning of gain or loss on the taxpayer's investment. As noted in section 1.1002-1(c), Income Tax Regs., the underlying assumption behind such treatment "is that the new property is substantially a continuation of the old investment still unliquidated; and, in the case of reorganizations, that the new enterprise, the new 907 corporate structure, and the new property are substantially continuations of the old still unliquidated."In addition to the question whether gain or loss should be recognized, other problems surface in the corporate reorganization. One of the most prominent of these difficulties is the determination of the extent to which corporate characteristics should be carried over from the old business enterprise to the new. Congress provided in section 381 that in the case of certain tax-free 60 acquisitions, the acquiring corporation would succeed and take into account such corporate attributes of the transferor as net operating loss carryovers, earnings and profits, methods of accounting, and basis in inventory. Many of these items 9 are described in section 381(c), together with the limitations and conditions on each.In section 381(b), Congress precluded the continuity of certain items. Thus, except in the case of an (F) reorganization, section 381(b)(1) provides that the taxable year of the transferor corporation shall end on the date of distribution, and section 381(b)(3) (with which we are here concerned) prohibits the acquiring corporation from carrying back a postmerger net operating loss to a taxable year of the transferor.In enacting section 381(b)(3), therefore, Congress was generally unwilling to allow the carryback described therein, despite the continuity of business enterprise present in all qualifying reorganizations. 61 The theory behind exempting (F) reorganizations from this carryback prohibition is that the change between the old and the new enterprises is so inconsequential in the (F) reorganization that the acquiring corporation should be treated as if no reorganization had taken place. This view is reflected in the section 381 regulations:Sec. 1.381(b)-1. Operating rules applicable to carryovers in certain corporate acquisitions.(2) Reorganizations under section 368(a)(1)(F). In the case of a reorganization qualifying under section 368(a)(1)(F) (whether or not such reorganization also qualifies under any other provision of section 368(a)(1)), the acquiring corporation shall be treated (for purposes of section 381) just as the 908 transferor corporation would have been treated if there had been no reorganization. Thus, the taxable year of the transferor corporation shall not end on the date of transfer merely because of the transfer; a net operating loss of the acquiring corporation for any taxable year ending after the date of transfer shall be carried back in accordance with section 172(b) in computing the taxable income of the transferor corporation for a taxable year ending before the date 62 of transfer; and the tax attributes of the transferor corporation enumerated in section 381(c) shall be taken into account by the acquiring corporation as if there had been no reorganization. [Emphasis added.]The comparatively minor role envisioned for (F) reorganizations is underscored by the fact that the House recommended it be dropped from the proposed 1954 Code as unnecessary since the minor corporate adjustments it permitted could be accomplished by other reorganization provisions. 10 The provision was retained, however, after it was pointed out in the Senate hearings by representatives of the tax bar that certain reincorporations of the same corporate business in another State might still require the (F) reorganization for tax-free treatment. 11Against this background, prior decisions of this Court concurred in respondent's view that 63 the merger of two or more operating companies could not meet the definition of a reorganization under section 368(a)(1)(F). Estate of Stauffer v. Commissioner, 48 T.C. 277">48 T.C. 277 (1967), revd. 403 F.2d 611">403 F.2d 611 (9th Cir. 1968); Associated Machine v. Commissioner, 48 T.C. 318 (1967), revd. 403 F.2d 622">403 F.2d 622 (9th Cir. 1968).In view of an avalanche of subsequent decisions to the contrary, including decisions by the Fifth, Sixth, and Ninth Circuit Courts of Appeals, and the Court of Claims ( Estate of Stauffer v. Commissioner, 403 F.2d 611">403 F.2d 611 (9th Cir. 1968); Associated Machine v. Commissioner, 403 F.2d 622 (9th Cir. 1968); Davant v. Commissioner, 366 F.2d 874">366 F.2d 874 (5th Cir. 1966), cert. denied 386 U.S. 1022">386 U.S. 1022 (1967); Home Construction Corp. of America v. United States, 439 F.2d 1165">439 F.2d 1165 (5th Cir. 1971); Movielab, Inc. v. United States, 494 F.2d 693">494 F.2d 693 (Ct. Cl. 1974); Performance Systems, Inc. v. United States, 382 F. Supp. 525">382 F. Supp. 525 (M.D. Tenn. 1973), affd. per curiam 501 F.2d 1338">501 F.2d 1338 (6th Cir. 909 1974)), respondent abandoned his position that section 368(a)(1)(F) excludes per se the combination of two or more operating companies. Respondent announced his new position in Rev. Rul. 75-561, 2 C.B. 129">1975-2 C.B. 129, which states:In conformance 64 with the rules of these decisions, it is now the position of the Service that the combination of two or more corporations may qualify as a reorganization within the meaning of section 368(a)(1)(F) of the Code, provided certain requirements are satisfied. * * [Emphasis added.]By its terms, the ruling applies only when there is a complete identity of shareholders and their proprietary interests in the combined corporations; the corporations combined are engaged in the same or integrated activities before the combination; and the business enterprise of the combined corporations is continued unchanged after the combination. Additionally, the loss carried back must be from a separate business unit or division that may be reunitized with pre-reorganization income earned by a transferor corporation. We have recently discussed and applied the general rules set out in Rev. Rul. 75-561. See Berger Machine Products, Inc. v. Commissioner, 68 T.C. 358">68 T.C. 358 (1977), in which we held that petitioner failed to meet the requirement that the combined operating corporations have "'complete identity of shareholders and their proprietary interests' in the acquiring corporation." 68 T.C. at 363.Similarly, 65 petitioner herein fails to meet the requirement that there must be an identity of proprietary interest. This failure is readily discerned from the following chart which reflects the percentage ownership in the merged corporations before and after the reorganization:Percentage of Stock Ownership(Dec. 29, 1967)CorporationShareholderNevadaCompanyRomy Hammes10017.4071.56Gerald Hammes012.0417.89Hammes Trust070.560 Enterprise00 0 18 Employees of Corporation00 2.77Harry Greer00 3.22Floyd Parisot00 .89Mrs. Don L. Cira00 .89Mr. and Mrs. Wesley D. Glaser, Jr.00 .63Mrs. Harvey Sult00 .45Mr. and Mrs. Fred A. Root00 .45Mr. and Mrs. Harold J. Smith00 .45Mr. and Mrs. Hubert Stults00 .36Mr. Carl A. Weinzetl00 .18Mr. and Mrs. A. J. Hoerstman00 .09Mr. and Mrs. Merle A. Durbin00 .09Mr. and Mrs. John C. Lenko00 .09Total 100100 100 Percentage of Stock Ownership(May 6,1968)ShareholderEnterpriseIllinoisNevadaRomy Hammes63.5853.0861.36Gerald Hammes23.009.5417.19Hammes Trust13.4218.3020.57Enterprise0 19.080 18 Employees of Corporation0 0 0 Harry Greer0 0 .36Floyd Parisot0 0 .10Mrs. Don L. Cira0 0 .10Mr. and Mrs. Wesley D. Glaser, Jr.0 0 .08Mrs. Harvey Sult0 0 .05Mr. and Mrs. Fred A. Root0 0 .05Mr. and Mrs. Harold J. Smith0 0 .05Mr. and Mrs. Hubert Stults0 0 .04Mr. Carl A. Weinzetl0 0 .02Mr. and Mrs. A. J. Hoerstman0 0 .01Mr. and Mrs. Merle A. Durbin0 0 .01Mr. and Mrs. John C. Lenko0 0 .01Total 100 100 100 910 66 For example, Romy Hammes prior to the merger owned 17.4 percent of Company, 71.56 percent of Corporation, 63.58 of Enterprises, 53.08 of Illinois, and 100 percent of Nevada. After the merger he owned 61.36 of Nevada. These varying percentages represent significant 12 differences in proprietary interest in the five corporations involved. This shift in proprietary interest, hardly complies with the requirement that there be an identity of shareholders and their proprietary interests.In rejecting petitioner's argument that the merger here constituted an (F) reorganization, we also note that the different corporations merged were engaged in disparate business activities. In order to effect an (F) reorganization, respondent's ruling requires that the merging corporations be engaged in the same or integrated business activities. While Company, Enterprises, and Illinois all maintained some form of rental property, Corporation's sole business activity was the operation 67 of a Ford dealership, and Company also had a Maytag appliance franchise. Nevada held option rights on its Hawaiian subleasehold before the merger of the five corporations. The combination of these corporations, therefore, created a multidimensional enterprise, one which was hardly identical to any of the individual premerger corporations. These circumstances serve to prevent the merger here from qualifying as an (F) reorganization.Finally, we note that even where an (F) reorganization is present, the section 381 carrybacks may only be used to offset income generated by the same business unit or division that sustained the loss. Respondent's ruling adopts the rule 911 articulated by the Fifth Circuit in Home Construction Corp. of America v. United States, 439 F.2d 1165">439 F.2d 1165, 1172 (5th Cir. 1971):the taxpayer may offset net operating loss carry-backs only if it can establish that the losses of the new corporation can be reunitized for the sake of tax accountability into the same taxable units which existed before the reorganization. Thus, only such portion of the overall loss as can be shown to be attributable to each respective separate division within the new structure may be carried back, 68 and then only be offset against gains of such division's premerger counterpart. * * * 13 It is clear that in the instant case, petitioner does not meet the requirements of the ruling for the section 381 carryback. The Hawaiian operation was completely separate from any of the premerger activities of Illinois. Moreover, the Hawaiian hotel operation and Illinois activities were each treated as a separate division of Nevada after the merger. 14In the excellent briefs filed on its behalf, petitioner contends that in surveying the precedential landscape, respondent has drawn the boundaries too restrictively. The short answer is that the boundaries include a good deal more territory than is required by the precedents of this Court and still fall acres short of encompassing petitioner's circumstances. See Berger Machine Products, Inc. v. Commissioner, 68 T.C. 358">68 T.C. 358 (1977). We recognize, however, that the issue before us has 69 spawned recurring and protracted litigation productive of uncertainty. This uncertainty impairs mobility of capital, increases compliance costs, and imposes inequities. In an area where predictability is important to business planning, respondent's concession is an attempt to articulate a clear and consistent ruling and litigating position "in conformance with the rules of these [adverse] decisions." Rev. Rul. 75-561, supra, 1975-2 C.B at 129.However, as in Berger, the case before us does not present the occasion to delineate the precise boundaries of the many precedents respondent analyzes in Rev. Rul. 75-561, nor to reconsider the viability of previous decisions of this Court that are in conflict. That task must await another day for even 912 were we to embrace the precedents that respondent's ruling distills, no reasonable reading of these precedents would encompass petitioner's circumstances.Decision will be entered for the respondent. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise stated.↩2. On Apr. 12, 1961, three Illinois corporations, Romy Hammes Sales, Inc., Romy Hammes Joliet-Homes, Inc., and Hammes Leasing Corp. were merged into Illinois.↩3. In addition to the shares shown on this chart as of Dec. 29, 1967, Company had 415 shares of treasury stock, Enterprises had 36 shares of treasury stock, and Illinoishad 8 shares of treasury stock.4. Harry Greer, Floyd Parisot, Mrs. Don L. Cira, Mr. and Mrs. Wesley D. Glaser, Jr., Mrs. Harvey Sult, Mr. and Mrs. Fred A. Root, Mr. and Mrs. Harold J. Smith, Mr. and Mrs. Hubert Stults, Mr. Carl A. Weinzetl, Mr. and Mrs. A.J. Hoerstman, Mr. and Mrs. Merle A. Durbin, and Mr. and Mrs. John C. Lenko are the remaining shareholders of the original 30 employee shareholders of Corporation who maintained their ownership in the merged Nevada.5. Common stock certificate number 5 representing 2,052 shares of stock in Nevada, was issued in the name of Hammes Enterprises, Inc., and was treated by Nevada as treasury stock.↩6. Common stock certificate number 19 of Nevada, representing 147.64 shares was issued in the name of Romy Hammes Corp. and was treated by Nevada as treasury stock. These shares resulted from the redemption by Corporation of its own 155 shares of stock which it redeemed from its dissenting shareholder employees before its merger into Nevada.↩7. SEC. 381. CARRYOVERS IN CERTAIN CORPORATE ACQUISITIONS.(b) Operating Rules. -- Except in the case of an acquisition in connection with a reorganization described in subparagraph (F) of section 368(a)(1) -- * * *(3) The corporation acquiring property in a distribution or transfer described in subsection (a) shall not be entitled to carry back a net operating loss or a net capital loss for a taxable year ending after the date of distribution or transfer to a taxable year of the distributor or transferor corporation.↩8. The definition of what is now an (F) reorganization has been included in the income tax statutes since the Revenue Act of 1921. It has been suggested that the provision was enacted to provide for situations similar to that presented by Marr v. United States, 268 U.S. 536 (1925), in which it was held that the reincorporation of General Motors Corp. in another State was a taxable transaction. Paul, Studies in Federal Taxation 82 (3d series, 1940). See also United States v. Phellis, 257 U.S. 156">257 U.S. 156 (1921).The (F) reorganization was defined in sec. 202(c)(2) of the Revenue Act of 1921 as a "mere change in identity, form or place of organization of a corporation (however effected)." When the subsection was revised by the Revenue Act of 1924, sec. 203(h)(1)(D), the words "of a corporation" were dropped. The statutory definition of the (F) reorganization was otherwise identical, and the House report explained that the deletion was part of certain "minor changes in phraseology." H. Rept. 179, 68th Cong., 1st Sess. 13 (1924).The (F) reorganization received relatively little judicial or administrative attention until respondent began to use the (F) reorganization as a weapon in the liquidation-reincorporation area. See, e.g., Davant v. Commissioner, 366 F.2d 874">366 F.2d 874 (5th Cir. 1966), cert. denied, 386 U.S. 1022">386 U.S. 1022 (1967); Reef Corp. v. Commissioner, 368 F.2d 125 (5th Cir. 1966), cert. denied 386 U.S. 1018">386 U.S. 1018 (1967); Berghash v. Commissioner, 43 T.C. 743">43 T.C. 743 (1965), affd. 361 F.2d 257">361 F.2d 257 (2d Cir. 1966); Pridemark, Inc. v. Commissioner, 42 T.C. 510">42 T.C. 510 (1964), revd. in part 345 F.2d 35">345 F.2d 35 (4th Cir. 1965).Although the litigating positions of the Service and the taxpayer are reversed when the scope of the (F) reorganization is to be determined for purposes of the sec. 381(b)(3) loss carryback, the judicial interpretation of 368(a) (1)(F) must obviously be consistent.For further discussions on the emergence of the (F) reorganization see generally Pugh, "The F Reorganization: Reveille for a Sleeping Giant?" 24 Tax L. Rev. 437">24 Tax L. Rev. 437 (1969); Comments, "(F) Reorganizations and Proposed Alternate Routes for Post-Reorganization Net Operating Loss Carrybacks," 66 Mich. L. Rev. 498">66 Mich. L. Rev. 498 (1968); Comments, "Section 368(a)(1)(F) and Loss Carrybacks in Corporate Reorganizations," 117 U. Pa. L. Rev. 764">117 U. Pa. L. Rev. 764↩ (1969).9. The list of items described in sec. 381(c)↩ is not meant to be all inclusive. See H. Rept. 1337, to accompany H.R. 8300 (Pub. L. 591) 83d Cong., 2d Sess. A135 (1954); S. Rept. 1622, to accompany H.R. 8300 (Pub. L. 591), 83d Cong., 2d Sess. 277 (1954).10. H. Rept. 1337, to accompany H.R. 8300 (Pub. L. 591), 83d Cong., 2d Sess. A115 (1954); Hearings on H.R. 8300 Before the Senate Comm. on Finance, 83d Cong., 2d Sess, 403 (1954) (American Bar Association Report).↩11. Hearings on H.R. 8300 Before the Senate Comm. on Finance, 83d Cong., 2d Sess. 403, 539 (1954) (New York State Bar Association Report).↩12. Although we do not have such a situation before us, there may be some circumstances in which a de minimus shift in shareholder interest may be ignored for (F) reorganization purposes. See Rev. Rul. 66-284, 2 C.B. 115">1966-2 C.B. 115↩.13. See Rev. Rul. 75-561, 2 C.B. 129">1975-2 C.B. 129↩.14. We note that in the absence of the merger, Nevada would not have been entitled to a loss carryback, and we do not believe the merger should or does provide it with one. See Libson Shops, Inc. v. Koehler, 382">353 U.S. 382↩ (1957).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624451/	Richard C. Richardson v. Commissioner.Richardson v. CommissionerDocket No. 48536.United States Tax CourtT.C. Memo 1955-234; 1955 Tax Ct. Memo LEXIS 102; 14 T.C.M. (CCH) 941; T.C.M. (RIA) 55234; August 23, 1955102 Petitioner's wife instituted a suit against him for separate maintenance in connection with which she asked the court to enjoin petitioner from transferring his property. The court awarded alimony, pendente lite, and directed that petitioner pay her court costs and the fees of her attorneys. No decree of legal separation was entered in the proceedings. Held, that the amounts paid by the petitioner under the decrees of the court are nondeductible under section 23(u), I.R.C. of 1939. Held, further, that the court costs and counsel fees incurred by petitioner on his own behalf in defense of the suit are not deductible as nonbusiness expenses under section 23(a)(2). George W. Reilly, Esq., 14 North 8th Street, Richmond, Va., and Francis L. Worcester, C.P.A., for the petitioner. Robert L. Liken, Esq., for the respondent. JOHNSON Memorandum Findings of Fact and Opinion JOHNSON, Judge: This proceeding involves deficiencies in income tax for the years 1949 and 1950 in the amounts of $3,026.89 and $5,437.03, respectively, and an addition to income tax under section 294(d)(2) of the 1939 Code in the amount of $886.53. Respondent concedes that the penalty imposed under section 294(d)(2) was erroneously imposed. The issues are whether certain payments made by petitioner to his wife as alimony pendente lite, and court costs and attorney fees paid in connection with the suit in which the alimony was awarded, are deductible from gross income. Findings of Fact The facts set forth in a stipulation of facts are so found. Petitioner, a resident of New Kent County, Virginia, filed his returns for the taxable years with the collector of internal revenue at Richmond, Virginia. On August 10, 1943, petitioner was married to Doris Catherine104 Clark, hereinafter for convenience referred to as Doris. No children were born of the marriage. In or about June 1946, Doris filed a complaint against petitioner in the Chancery Court of the City of Richmond, Virginia, in which she alleged, among other things, that petitioner deserted her about August 1, 1945, and thereafter refused further cohabitation with her, and prayed that the court award to her "such sums by way of alimony pendente lite, suit money and preliminary counsel fees as to the court may seem just and proper in the circumstances," and at the proper time require petitioner to pay her "by way of permanent alimony for her support" such sums as the court may determine to be reasonable for her needs, and that petitioner be enjoined from disposing of any of his property during the pendency of the suit. On December 11, 1946, Doris filed a supplemental bill in the same court in which she alleged that petitioner had recently instituted a suit against her in the Law and Equity Court of the City of Richmond, seeking a declaratory judgment to the effect that the marriage was invalid, and prayed that petitioner be enjoined from prosecuting the suit in the Law and Equity Court. 105 In January 1947 petitioner and Doris were reconciled and lived together until June 1947. On November 22, 1948, Doris filed a second supplemental bill of complaint against petitioner in the Chancery Court in which she alleged that petitioner deserted her on June 7, 1947, and had informed her that he no longer intended to live with her, and prayed that the court award to her "such sums by way of alimony pendente lite, suit money and preliminary counsel fees as to the court may seem just and proper in the circumstances," and at the proper time require petitioner to pay to her by way of permanent alimony for her support such sums as the court determined to be reasonable for her needs; that petitioner be required to pay reasonable attorney fees to her counsel for their services in conducting the proceeding, and that petitioner be enjoined from disposing of any of his property, and from prosecuting the suit then pending in the Law and Equity Court against Doris concerning the validity of their marriage. Petitioner answered the complaint by filing a plea in abatement. The proceeding was heard by the Chancery Court on February 9, 1949, on the pleadings and motions filed therein. During106 the course of the hearing counsel for Doris made a motion in open court "for the allowance to her of money for support, pendente lite, money on account of her attorney's fees and suit and expense money." Thereafter, on February 17, 1949, the court entered a decree in the proceeding striking the plea in abatement, overruling the motion of petitioner to dismiss the bill of complaint, and ordering that petitioner pay to Doris "for alimony pendente lite, until further order of this Court, the sum of $250.00 per month, the first payment to be made forthwith and as of the 1st day of February, 1949," her suit and expense money, and $500 on account of attorney fees. Pursuant to the court's decree of February 17, 1949, petitioner paid to Doris in 1949, $2,750 for alimony and $500 for attorney fees, and $2,500 in 1950, through October 1, for alimony. On July 24, 1950, pursuant to a decree of the court entered on the same day, petitioner paid to Doris the additional amount of $1,000 for attorney fees. On October 25, 1950, after hearing, the Chancery Court decided from the bench that petitioner had on two occasions deliberately deserted Doris, the last time on June 7, 1947, with the announced107 intention that it would be permanent; that Doris was "entitled to a separate maintenance"; and that no reason appeared for not continuing the allowance of $250 per month for separate maintenance. Accordingly, on October 28, 1950, the court entered a decree entitled "Decree Awarding Separate Maintenance," denying the motion of petitioner to dismiss the suit, adjudging that petitioner and Doris were lawfully married on August 10, 1943, and that the petitioner had wilfully deserted and abandoned Doris on June 7, 1947, without just cause, and ordering that petitioner pay to Doris "a separate maintenance" of $250 per month until further order of the court, or the death of either party, the first payment to be made November 1, 1950; that petitioner pay to her or her counsel suit money and expenses incurred in the litigation in the amount of $87.28, and $1,500 for attorney fees for services of counsel in the proceeding. Payment of the amount of suit money and expenses and attorney fees ordered by the decree was made by petitioner on November 1, 1950. During the taxable years petitioner paid to his attorneys in the litigation with Doris, and court costs, as follows: 19491950Attorney fees$1,875.00$2,450.00Court costs101.20644.40108 Petitioner reported in his returns for the taxable years gross income as follows, cents omitted: 19491950Compensation$ 9,600$ 8,100Dividends and interest34,89944,643Farm( 3,499)( 1,916)Rents( 323)222General store( 2,462)( 2,791)Capital gain( 1,000)7,114Partnership15,05817,650Petitioner claimed as deductions in his returns for 1949 and 1950 the amounts of $5,226.20 and $8,681.28, respectively, for alimony, attorney fees, and court costs paid on account of the litigation with his wife. Except for $500 paid as alimony in November and December 1950 under the court's decree of October 28, 1950, the respondent disallowed all of the amounts as deductions in his determination of the deficiencies. Opinion The amounts involved as deductions in the alimony question were paid pursuant to the court decree entered on February 17, 1949. 1 Petitioner asserts that the deductions are authorized by sections 22(k) and 23(u), I.R.C. of 1939. Section 22(k) provides, to the extent material, that: "In the case of a wife who is divorced109 or legally separated from her husband under a decree of divorce or of separate maintenance, periodic payments * * received subsequent to such decree in discharge of, * * * a legal obligation which because of the marital or family relationship, is imposed upon or incurred by such husband under such decree * * * shall be includible in the gross income of such wife, * * ." [Italics supplied]. Section 23(u) provides: "In computing net income there shall be allowed as deductions: * "(u) Alimony, Etc., Payments. - In the case of a husband described in section 22(k), amounts includible under section 22(k), in the gross income of his wife, payment of which is made within the husband's taxable year. If the amount of any such payment is, under section 22(k) or section 171, stated to be not includible in such husband's gross income, no deduction shall be allowed with respect to such payment under this subsection." The payments in question are not includible in the gross income of Doris under section 22(k), a requirement to be deductible from gross income of petitioner under section 23(u), unless there has been an alteration of the marital status by judicial process in at110 least the following instances: "* * * The wife must be 'divorced or legally separated from her husband under a decree of divorce or of separate maintenance.' The payments in question must have been 'received subsequent to such decree.' And they must discharge an obligation 'under such decree or under a written instrument incident to such divorce or separation.'" [Charles L. Brown, 7 T.C. 715">7 T.C. 715]. See also Frank J. Kalchthaler, 7 T.C. 625">7 T.C. 625; George D. Wick, 7 T.C. 723">7 T.C. 723, affd. 161 Fed. (2d) 732; Robert A. McKinney, 16 T.C. 916">16 T.C. 916. In short, the periodic payments here may not be deducted unless they were made under a decree of divorce or of separate maintenance. Smith v. Commissioner, 168 Fed. (2d) 446; Commissioner v. Walsh, 183 Fed. (2d) 803, affirming 11 T.C. 1093">11 T.C. 1093. None of the decrees granted a divorce and petitioner makes no contention to the contrary. The only decree with which we are concerned is the one entered February 17, 1949. That decree resulted from a hearing on complaints of Doris in which she prayed for "alimony, pendente lite," and an oral motion of her counsel at the111 hearing for an allowance "of money for support, pendente lite." The decree ordered that petitioner pay to Doris "for alimony pendente lite, until further order of this Court, the sum of $250.00 per month." Petitioner argues on brief that the decree was for separate maintenance based upon a legal separation of the parties under the laws of Virginia, to which we must look to learn whether the decree altered the marital status of petitioner and his wife. Marriner S. Eccles, 19 T.C. 1049">19 T.C. 1049, affd. per curiam, 208 Fed. (2d) 796. A deserted wife in Virginia has, as petitioner concedes, several courses of action against her husband for his misconduct, including the proceeding instituted by Doris. That suit was in equity independent of her statutory right to file a suit for divorce or legal separation. Heflin v. Heflin, 177 Va. 385">177 Va. 385, 14 S.E. (2d) 317; Montgomery v. Montgomery, 183 Va. 96">183 Va. 96, 31 S.E. (2d) 284. Doris did not pray for an alteration of her marital status, and none was made by the court in its decree. She did ask for an allowance for maintenance, and the court, clearly within its jurisdiction, awarded her alimony, pendente lite, 112 which was made permanent in October 1950, after a hearing on the merits, without disturbing the marital relationship of the parties. No decree of legal separation having been entered, Doris did not receive the payments as "a wife who is divorced or legally separated." We have held that payments of alimony, pendente lite, are not within section 22(k), and consequently are not deductible under section 23(u). George A. Wick, supra; Joseph A. Fields, 14 T.C. 1202">14 T.C. 1202; Robert A. McKinney, supra. The same conclusion is reached here. Petitioner concedes that the payments he made to his wife for attorney fees and court costs are a part of the allowance made by the court as alimony and contends that they were a part of his regular periodic payments. Assuming that the amounts paid in lump sums constitute periodic payments, as part of the allowance as alimony the amounts are not deductible by petitioner for the reasons given in our discussion of the deductibility of the monthly payments. The counsel fees paid by petitioner to his attorneys, and the court costs incurred by him in the proceedings, are being claimed as nonbusiness expense deductions under113 section 23(a)(2), I.R.C. of 1939, upon the ground that they constitute expenses "of protecting income production when that property is held for that purpose." Like questions involving similar facts have been before us for consideration and in each instance deduction of the expense was denied. See Lindsay C. Howard, 16 T.C. 157">16 T.C. 157, affd. 202 Fed. (2d) 28, and Thorne Donnelley, 16 T.C. 1196">16 T.C. 1196, in which payment of alimony awarded by court decrees was resisted, and Andrew Jergens, 17 T.C. 806">17 T.C. 806, involving attorney fees paid in defense of a suit brought by the taxpayer's former wife for specific performance under a separation agreement. The primary object of the complaints filed by Doris was to obtain a reasonable allowance by the court for her maintenance as the deserted wife of petitioner. The expenses in question were incurred by petitioner in an effort to defeat her claim and thereby avoid his legal and moral obligation to support his wife. Successful defense against the claim for Doris for support money would have defeated her demand that petitioner be enjoined from transferring his property. The injunction relief sought was not granted114 and, therefore, the threat to full economic enjoyment of his property was no greater than the possibility of seizure in Thorne Donnelley, supra.Petitioner regarded the move of his wife as no more than an attempt to "vex and harass" him. That it was never seriously pressed is borne out by the fact that the court never formally ruled on the motion. In Baer v. Commissioner, 196 Fed. (2d) 646, the court thought that because of the substantial threat of the litigation to the capacity of the taxpayer to earn income, the legal expense had sufficient relationship to the management and conservation of property held for the production of income to be within the statute, contrary to the view we expressed. Arthur B. Baer, 16 T.C. 1418">16 T.C. 1418. Such a situation does not prevail here. The rationale of the cases heretofore decided by us on like issues controls the answer here. Accordingly, we find for respondent on this issue. Except for the penalty, which respondent concedes was erroneously imposed, Decision will be entered for the respondent. Footnotes1. Any payments made by petitioner under the decree of October 28, 1950, are not at issue.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624452/	Barth Smelting Corporation, Petitioner, v. Commissioner of Internal Revenue, RespondentBarth Smelting Corp. v. CommissionerDocket No. 35819United States Tax Court30 T.C. 1073; 1958 U.S. Tax Ct. LEXIS 102; August 18, 1958, Filed 102 Decision will be entered under Rule 50. Held, the petitioner is not entitled to section 722 (b) (4), I. R. C. 1939, relief. The petitioner has not shown that its average base period net income was inadequate as a result of its commencing business during the base period. Furthermore, the purchase of a new plant in 1941 by a corporation newly incorporated in 1941, with the same stockholders as petitioner, is not, within the meaning of section 722 (b) (4), the consummation of a plan by the petitioner to which said petitioner had been committed prior to January 1, 1940. Philip A. Brenner, Esq., for the petitioner.Arnold I. Weber, Esq., for the respondent. Mulroney, Judge. MULRONEY 1073 The respondent disallowed petitioner's claims for relief from excess profits tax under sections 722 (a) and 722 (b) (4) of the103 Internal Revenue Code of 1939 for the fiscal years ended September 30, 1942 through 1946. The excess profits taxes involved are as follows:Taxable year ended September 30Excess profits tax1942$ 838.331943126,215.511944225,308.27194584,521.55194612,504.081074 Included in these amounts are the deficiencies in excess profits tax determined by the respondent in his notice of disallowance under date of April 25, 1951, in the amounts of $ 47,886.18 and $ 42,269.05 for the fiscal years ended September 30, 1943 and 1944, respectively. Respondent also determined a deficiency in declared value excess-profits tax of $ 1,960.43 for the fiscal year ended September 30, 1943, and an overassessment of $ 152.70 for the fiscal year ended September 30, 1942.The issues are whether petitioner was entitled to section 722 (b) (4) relief because of commencing business during the base period and whether there was a change in the capacity for production or operation of petitioner's business consummated during a taxable year ended after December 31, 1939, as a result of a course of action to which it was committed prior to January 1, 1940, within the provisions of section104 722 (b) (4), I. R. C. 1939.FINDINGS OF FACT.Some of the facts were stipulated and such facts are found accordingly.Otto Barth and his two brothers, Lazare and Ernest, formed three corporations for the purpose of engaging in what might broadly be termed the metals business. Barth Metals Co., Inc., was formed under the laws of the State of New York on February 4, 1926. Barth Smelting Corporation, petitioner here, was formed under the laws of the State of New York on September 29, 1937. Barth Smelting & Refining Works, Inc., was formed under the laws of the State of New Jersey on July 18, 1941. It will be simpler to call these three corporations Barth Metals, Barth Smelting or petitioner, and Barth Refining. All of the common stock of Barth Metals and Barth Smelting was owned by the Barth brothers except for a few shares of petitioner corporation which were owned by other persons in 1938.The only business Barth Metals and petitioner ever engaged in was that of jobbing nonferrous scrap metals dealing in industrial scrap metal business, or securing the smelting of its nonferrous scrap metals into nonferrous ingots and nonferrous alloy ingots and selling them to the consuming industry. 105 These corporations, in the years prior to 1941, secured their ingots by a toll arrangement with the Coleman Smelting & Refining Company (hereinafter called Coleman), which means the corporations would supply the scrap and Coleman would make the scrap into the ingots on a fee basis. Coleman 1075 also prepared some of this scrap for petitioner for industrial use.Petitioner was formed by the Barths in order to get into the production end of scrap metal ingots and alloy ingots as the toll system with Coleman was not very satisfactory. However, the toll method previously outlined was continued while the incorporators of petitioner looked around for a smelting plant to buy that would be suitable for the operation they wanted to conduct with petitioner corporation. They and others acting for them or for petitioner inspected several plants. They were still looking for a plant to buy in 1940 and it was not until May 16, 1941, that petitioner entered into a contract to purchase a plant in Newark, New Jersey, from the General Lead Batteries Company, its owner, deed to be delivered July 31, 1941.At this time the Barths were advised by an official of the City of Newark that because106 of the New Jersey personal property tax law, they would benefit by forming a New Jersey corporation to operate the facilities in Newark. On July 18, 1941, Barth Smelting & Refining Works, Inc., was incorporated under the laws of the State of New Jersey with an authorized capital stock of 2,000 shares of preferred, $ 100 par value, and 200 shares of voting common without nominal or par value. Ten shares were issued as qualifying shares, and, as of September 30, 1942, the balance of the outstanding stockholdings in Barth Refining were as follows:Otto BarthLazare BarthErnest BarthHugh SimonCommon40222216Preferred400220220160On July 29, 1941, the petitioner assigned to Barth Refining all of its right, title, and interest in and to the above contract of sale and authorized General Lead Batteries Company to deliver its deed to the plant in Newark directly to Barth Refining.Barth Refining, after the completion of the plant facilities, assumed the smelting of ingots for petitioner which had been done previously by the Coleman plant. Petitioner retained title to the raw materials, paying a fee to Barth Refining for the smelting under contract. 107 The fee was fixed at a level sufficient for Barth Refining to amortize its plant, machinery, and equipment and to pay dividends on its preferred stock.Barth Metals, Barth Smelting, and Barth Refining continued in existence as separate corporate entities from the dates of their incorporation through the taxable years in issue, all actively engaged in business and filing separate tax returns during the base period and the taxable years in issue.1076 Gross sales of Barth Metals, as reported in its tax returns for the calendar years 1933 through 1945, were as follows:1933$ 213,779.761934232,610.201935291,733.611936546,343.251937985,173.691938224,830.481939279,139.071940$ 220,164.971941169,115.531942149,018.881943233,131.761944241,725.881945377,533.45Gross sales of petitioner as reported in its tax returns for the fiscal years ended September 30, 1938, through September 30, 1946, were as follows:1938$ 304,350.081939464,951.421940687,691.1419411,293,751.5419421,587,933.581943$ 3,530,964.1219445,417,789.7119454,539,563.1819463,992,424.99Gross receipts of Barth Refining, as reported in its tax returns108 for the fiscal years ended June 30, 1942 through 1945, were as follows:1942$ 121,626.041943376,793.191944562,364.961945623,761.22The excess profits net income of the petitioner, under the invested capital method as adjusted by revenue agents' reports during the years in issue, was as follows:Excess profitsYear ended September 30net income1942$ 19,654.941943182,490.091944309,146.681945131,146.83194692,963.39The excess profits credits of the petitioner, under the invested capital method as adjusted by the revenue agents' reports during the years in issue, were as follows:Year ended September 30Excess profits credit1942$ 12,939.28194314,747.26194416,098.39194522,291.22194624,941.68Petitioner filed applications for relief under section 722 for the fiscal years ending September 30, 1942, through September 30, 1946. In schedule B of these applications petitioner checked item 4 as the reason why it claimed its excess profits tax was excessive and discriminatory, which was to the effect that petitioner's business commenced 1077 or there was a change in the character of its business immediately109 prior to or during the base period. Petitioner submitted information, purporting to support these reasons, that it had commenced business on October 8, 1937, and that there was a change in petitioner's capacity for production or operation consummated during a taxable year ending after December 31, 1939, as a result of a course of action to which petitioner was committed prior to January 1, 1940. Petitioner also filed claims for refund for the years September 30, 1942, 1943, and 1944. These claims were protective in nature and they did not furnish any further information relative to petitioner's applications for relief under section 722. On April 25, 1951, the respondent denied these claims for relief made by the petitioner, disallowed the claims for refund, and determined the deficiencies and overassessments, previously stated.OPINION.Petitioner argues that its average base period net income is an inadequate standard of normal earnings because it changed the character of its business during the base period within the meaning of section 722 (b) (4), I. R. C. 1939. 1110 Section 722 (b) (4) provides, "Any change in the capacity for production or operation of the business consummated during any taxable year ending after December 31, 1939, as a result of a course of action to which the taxpayer was committed prior to January 1, 1940, * * * shall be deemed to be a change on December 31, 1939, in the character of the business." Petitioner contends that it was committed to purchase the smelting plant, which was actually purchased in mid-1941 (by another corporation), prior to January 1, 1940, and that consequently it comes within the commitment provisions of the relief section above.The respondent, in Regulations 112, section 35.722-3 (d) (5), has specified that "a commitment may be proved by a contract for the construction, purchase, or other acquisition of facilities resulting in such change, by the expenditure of money in the commencement of the desired change, by the institution of legal action looking toward such change, or by any other change in position unequivocally establishing the intent to make the change and commitment to a course of action leading to such change." See also E. P. C. 15, 1947-1 C. B. 89, amending 111 Bulletin on Section 722, p. 58: "Progress to the point where the taxpayer could not withdraw without substantial detriment may be given substantial weight in determining whether or not taxpayer has committed itself * . On the other hand, commitment 1078 claims are not to be rejected solely on the ground that taxpayers which have otherwise complied with all of the essentials in commitment cases may, nevertheless, be in a position where they might have withdrawn without substantial detriment prior to January 1, 1940."Nothing in the record indicates that the petitioner itself was committed to any course of action prior to January 1, 1940, within the meaning of the section. The Barths, together with a man named Simon, did manifest some desire to go into the smelting business. There were discussions over several years, but mostly exploratory in nature. At various times the parties, in their individual capacity, did look at some plants in the metropolitan area and they incurred some expenses in their search for a plant, but as a rule, their expenses were their own. At least the books of petitioner do not show the payment of any such expenses. There was no fixed idea as to112 the exact nature of the plant or facilities sought by the parties. Undoubtedly, the Barths and Simon sensed the possibilities of the smelting business but their plans, as far as the record shows, at no time in the base period took any fixed form. By the end of the base period the parties still were engaged in a search for a plant or facilities which would strike them as suitable for the smelting venture. We do not consider such a search for a profitable business opportunity as a commitment within the intendment of section 722 (b) (4). As we pointed out in Robinson Terminal Warehouse Corporation, 19 T. C. 1185, at 1191, "something more than hope, desire, and expectation is needed to demonstrate a commitment under section 722 (b) (4). A definite plan, together with action taken on the strength of such plan, must be shown."Petitioner makes an argument that there was a contract between all of petitioner's promoters (Barth brothers and Simon) that they engage in the smelting business and petitioner was obligated to carry out this contract by reason of the application of the general rule as to liability of a corporation for promoters' contracts. By 113 this reasoning petitioner argues the petitioner was committed to buy a plant. There is no merit in the argument. The contract, which petitioner states was oral, was no more than the usual agreement between promoters, present in every case where promoters decide to launch a business enterprise by means of a corporate entity. The rule petitioner cites has no application to such agreements between promoters. That rule is applicable to obligate the corporation for the promoters' preincorporation contracts entered into by the promoters in behalf of the corporation they are forming. It has no application to render the corporation liable for contracts entered into between the promoters for individual benefits.1079 We hold, on the facts of this case, that the petitioner was not committed to any course of action prior to January 1, 1940, within the meaning of section 722 (b) (4).The statute requires this commitment (here, under petitioner's argument, that it buy a plant) be consummated during any taxable year ending after December 31, 1939. Petitioner never did buy a plant. The plant was purchased and operated by Barth Refining, a corporation distinct and apart from the petitioner. 114 Petitioner cannot be said to have changed the character of its business through the purchase of a plant by another corporation. Irwin B. Schwabe Co., 12 T.C. 606">12 T. C. 606. Petitioner agrees that the two corporations are to be treated as separate entities for tax purposes under the authority of many decisions of this and other courts. Petitioner merely states that, for the purpose of this case, Barth Refining should be treated as the operating or producing division of petitioner's scope of operation. No authority is cited for petitioner's position, and, in fact, no argument advanced in support of the mere statement that the entity of Barth Refining should be ignored.It is clearly apparent from this record that petitioner failed to establish either commitment or consummation by petitioner and therefore we hold petitioner not entitled to any relief under the provisions of section 722 (b) (4) by reason of a change in the capacity for production as a result of a commitment before and consummation after the end of the base years.Petitioner makes a short argument that it is entitled to relief on the ground that it commenced business during the base period, in115 1937, and that it did not reach, by the end of the base period, the earning level which it would have reached if it had commenced business 2 years earlier. It is not enough, however, for petitioner to show that it commenced business during the base period. Union Parts Mfg. Co., 24 T.C. 775">24 T. C. 775. To obtain relief the petitioner must show that because of this incorporation the actual average base period net income is an inadequate standard of normal earnings. Persuasive reasons, supported by adequate evidence, must be shown by the petitioner in order to reconstruct base period net income under the "pushback" rule. Stonhard Co., 13 T.C. 790">13 T. C. 790. We have examined the record and are not convinced that there would have been an improvement in petitioner's earnings if it had commenced operation 2 years earlier. Petitioner's excess profits credit under the invested capital method during the years before us ranged from $ 12,939.28 in the fiscal year 1942 to $ 24,941.68 in the fiscal year 1946. To obtain relief under section 722, the petitioner must show that its constructive earnings figure would exceed these credits. Petitioner 116 has not done so. When the petitioner commenced business in 1937 Otto Barth had been active, through 1080 Barth Metals, in the jobbing field since 1926, and even before that he had been active in the metals field in one capacity or another. It was a field in which Otto Barth was thoroughly versed and we do not see how any argument can be made that 2 additional years of experience would have any material effect on the petitioner's earnings record. Long, previous experience in a similar field is a factor which we can consider. Pabst Air Conditioning Corporation, 14 T.C. 427">14 T. C. 427. Barth Metals had been in business since 1926 and in 1937 the petitioner was formed. Petitioner's activities for the rest of the base period were, for the most part, similar to those of Barth Metals. In fact, an examination of the gross sales of Barth Metals and the petitioner during the years 1936 through 1940 reveals graphically that petitioner's activities did little more than decrease the sales of Barth Metals:YearBarth MetalsBarth SmeltingCombinedgross salesgross salesgross sales1936$ 546,343$ 546,3431937985,173985,1731938224,830$ 304,350529,1801939279,139464,951744,0901940220,164687,691907,855117 Furthermore, an examination of the gross sales of the petitioner does not indicate any growth which would indicate that petitioner's business, if commenced 2 years earlier, would have produced an earnings record during the base period which would afford it a greater credit than the one it already has. Any growth indicated in the gross sales figures in 1939, that is, toward the end of the base period, was clearly the result of an upward economic trend in the field of nonferrous metals. This is indicated by the Federal Reserve Board index of nonferrous metals as well as by other evidence in the record. We hold that the petitioner is not entitled to section 722 relief on the ground that average base period net income is an inadequate standard of normal earnings because it commenced business during the base period.Petitioner invites us to search the record and see if it is entitled to relief under other provisions of section 722 (b) (4), and if so, grant it any relief which this Court may deem proper. This we cannot do. In its application for relief under section 722, petitioner sets forth as ground for 722 (b) (4) relief only commencement of business in the base years and change118 in capacity for production or operation consummated during a taxable year ending after December 31, 1939, as a result of a course of action to which petitioner was committed prior to January 1, 1940. Petitioner's brief is confined to a 1081 discussion of these contentions. We will consider no other. Burwell Motor Co., 29 T. C. 224; Blum Folding Paper Box Co., 4 T.C. 795">4 T. C. 795.Reviewed by the Special Division.Decision will be entered under Rule 50. Footnotes1. All section references are to the Internal Revenue Code of 1939, as amended, unless otherwise noted.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624502/	Ruth K. Wild, Petitioner, v. Commissioner of Internal Revenue, RespondentWild v. CommissionerDocket No. 1427-63United States Tax Court42 T.C. 706; 1964 U.S. Tax Ct. LEXIS 76; July 13, 196476 Decision will be entered for the petitioner. Held, amounts paid by a wife to her attorneys allocable to obtaining alimony includable in her gross income are deductible under section 212(1), 1954 Code. 77 Richard W. Leonard, for the petitioner.Raoul E. Paradis, for the respondent. Kern, Judge. Raum, J., dissenting. Tietjens and Pierce, J.J., agree with this dissent. Pierce, J., dissenting. Tietjens and Raum, J.J., agree with this dissent. KERN 706 OPINIONRespondent determined a deficiency of $ 1,541.90 in petitioner's Federal income tax for the year 1960. The only issue presented for our decision is whether respondent correctly determined that petitioner is not entitled to a claimed deduction of $ 6,000 for legal fees in obtaining monthly alimony payments incident to a divorce proceeding as an ordinary and necessary expense for the production or collection of income pursuant to section 212(1) of the Internal Revenue Code of 1954. 1All of the facts have been stipulated and are found accordingly.Petitioner Ruth K. Wild is an individual residing at Hollis, N.H. She filed78 an individual Federal income tax return for the year 1960 with the district director of internal revenue for the district of New Hampshire.In 1959 petitioner sued her husband for a legal separation. Subsequently her action was changed to one of divorce. In 1960 a divorce was granted to the petitioner and a stipulation relative to child custody and support and property was made a part of the divorce decree.707 In explanation of a deduction taken by petitioner on her return for "Atty. fees re negotiating alimony payments and Court hearings" in the amount of $ 6,000 there is attached to petitioner's return a photostatic copy of a statement dated May 26, 1960, from the law offices of Leonard and Leonard to petitioner reading as follows:Professional services re Wild v Wild Eq. #1618 May 1959 to May 1960Divorce, custody, property settlement$ 4,000.00Consultations, Agreements, Court Hearings, etc., re monthlyalimony payments 6,000.00Forward$ 10,000.00Total brought forward$ 10,000.00ExpensesTelephone charges1.70Mileage & tolls12.60Court, Sheriff and Deposition costs64.0278.32Total$ 10,078.321 6/2/60Paid in fullLeonard & LeonardF79 On her individual income tax return for 1960 petitioner claimed a deduction of $ 6,000 under "Other Deductions" for "Atty. fees re negotiating alimony payments and Court hearings." In Schedule H of her individual income tax return for 1960 petitioner included in her gross income $ 9,850 as "Alimony payments from Norman R. Wild."Respondent disallowed the claimed deduction for legal fees in the amount of $ 6,000 with the following explanation:The claimed legal fees have not been demonstrated to be expenses ordinary and necessary and closely related to the production, maintenance or protection of taxable income as required under section 212 of the Internal Revenue Code.Petitioner contends that the amount of the legal fees claimed as a deduction was an ordinary and necessary expense incurred for the production of income which is deductible under section 212(1). 2 Respondent contends that such expense is not deductible pursuant 708 to section 2623 because it was a personal expense arising from the marital relationship and was thus "the product of her [petitioner's] personal and family life and not a profit-seeking activity." Respondent relies80 on United States v. Gilmore, 372 U.S. 39">372 U.S. 39, and United States v. Patrick, 372 U.S. 53">372 U.S. 53. Respondent also raises the contention in the latter part of his brief and in his reply brief that petitioner has failed to prove that the legal fees in question were actually paid, or that $ 6,000 of the total bill for legal services allocated to "Consultations, Agreements, Court Hearings, etc., re monthly alimony payments" was reasonable in amount.Respondent's notice of deficiency did not disallow the claimed deduction to petitioner81 for the reason that she failed to substantiate the amount of her claimed deduction or for the reason that the payment in question was in an unreasonable amount. The deduction was disallowed for the stated reason that the "legal fees have not been demonstrated to be expenses ordinary and necessary and closely related to the production, maintenance or protection of taxable income as required under section 212 of the Internal Revenue Code."In his brief respondent stated that the "QUESTION PRESENTED" is: "Whether legal fees occasioned by proceedings growing out of marital relationships constitute nonbusiness expenses deductible under section 212 of the Internal Revenue Code of 1954, or personal expenses not deductible under section 262 of the 1954 Code." In the answer to the petition respondent affirmatively alleged that petitioner obtained a divorce from her husband and that a "stipulation relative to child custody and property was incorporated in an order in the divorce decree." Respondent admitted in his answer certain allegations made in the petition regarding custody and support of petitioner's child. Nothing in the pleadings or in any statement made by respondent's counsel at82 the time this case was called for trial suggests in any way that the reasonableness of the amount of the payment deducted was in issue. When this case was called for trial on March 16, 1964, at Boston, Mass., counsel for respondent made the following statement: "Your Honor, we have agreed to fully stipulate this case and the stipulation is being brought over here by my secretary and will be here in a few minutes. It will be filed as Exhibit 1(a) [sic] * * ." A few minutes later when the case was called up again, counsel for the respondent, in the presence of counsel for petitioner, made the following statement: "We have the actual stipulation of facts in this case and have accordingly filed a stipulation of facts with Exhibit 1(a)." 709 Except for a colloquy with the Court with regard to times for the filing of briefs, no other statements were made by counsel. The stipulation of facts referred to above, and evidently prepared by respondent's counsel, reads in its entirety as follows:It is hereby stipulated that, for the purpose of this case, the following statement may be accepted as fact and the exhibit referred to herein and attached hereto is incorporated in this83 stipulation and made a part thereof; provided, however, that either party may introduce other and further evidence not inconsistent with the facts herein stipulated:1. Attached hereto as Exhibit 1-A and made a part hereof is a photostatic copy of the individual federal income tax return (Form 1040) of Ruth K. Wild for the taxable year 1960, filed with the District Director of Internal Revenue for the District of New Hampshire.We interpret the stipulation of facts as establishing as facts for purposes of this proceeding the matters stated as facts in the return, 4 among which were the fact that during the year 1960 petitioner had taxable income from alimony payments in the amount of $ 9,850, and the fact that petitioner paid her attorneys $ 10,078.32 with respect to her divorce action against her husband, of which $ 6,000 was allocated by the attorneys to consultations, agreements, and court hearings with respect to the monthly alimony payments awarded to petitioner. Any other interpretation would cause us to question the fairness and good faith of counsel for the respondent. Accordingly, we reject respondent's contention that petitioner failed to sustain her burden of proving84 the payment of the amount deducted. With regard to the reasonableness of the amount of such payment, we conclude that this is not fairly in issue herein and therefore decline to consider respondent's contentions in connection therewith. See Estate of Rebecca Edelman, 38 T.C. 972">38 T.C. 972, 979; Leo R. Cohn, 38 T.C. 387">38 T.C. 387, 392; Eleanor C. Shomaker, 38 T.C. 192">38 T.C. 192, 201; and F. H. Philbrick, 27 T.C. 346">27 T.C. 346, 353.Section 1.262-1(b)(7), Income Tax Regulations, 5 which has never been withdrawn or modified by respondent, provides as follows:Sec. 1.262-1 Personal, living, and family expenses.(b) Examples of personal, living, and family expenses. Personal, living, 85 and family expenses are illustrated in the following examples: * * (7) Generally, attorney's fees and other costs paid in connection with a divorce, separation, or decree for support are not deductible by either the husband 710 or the wife. However, the part of an attorney's fee and the part of the other costs paid in connection with a divorce, legal separation, written separation agreement, or a decree for support, which are properly attributable to the production or collection of amounts includible in gross income under section 71 are deductible by the wife under section 212.In Jane U. Elliott, 40 T.C. 304">40 T.C. 304 (filed May 15, 1963), acq. 1964-1 C.B. (Part 1) 4, we held that legal fees paid for the collection of alimony from the taxpayer's former husband were deductible under section86 212(1). See also Estate of Daniel Buckley, 37 T.C. 664">37 T.C. 664, 674; Barbara B. LeMond, 13 T.C. 670">13 T.C. 670; and Elsie B. Gale, 13 T.C. 661">13 T.C. 661, affirmed on other grounds 191 F.2d 79">191 F. 2d 79.Respondent argues that these cases are no longer applicable in view of the Supreme Court's decisions in United States v. Gilmore, supra, and United States v. Patrick, supra (both decided on February 18, 1963). In those cases the husbands incurred and sought to deduct legal fees in resisting their wives' claims to their income-producing property incident to divorce proceedings. In the Patrick case the husband claimed the legal fees were deductible as expenses incurred for the "management, conservation, or maintenance" of property held for the production of income within the meaning of section 212(2). In the Gilmore case the applicable statute was section 23(a)(2) of the Internal Revenue Code of 1939 which was substantially to the same effect as section 212(2). In those cases it was held that expenses of husbands in connection87 with resisting money demands of their wives in divorce actions could not be deducted under section 212(2) as expenses paid for the management, conservation, or maintenance of property held for the production of income. In the instant case the deduction is claimed under section 212(1), which expressly provides for the deduction of expenses "paid or incurred * * * for the production or collection of income." Here the expenses were paid "for the production or collection" of alimony which was reported, when paid to petitioner, as her taxable income in conformity with the provisions of the Internal Revenue Code.In view of the fact that respondent has never changed or modified his regulation as above quoted since the Supreme Court's decisions in the Gilmore and Patrick cases were handed down on February 18, 1963, the fact that we decided the case of Jane U. Elliott, supra, some 3 months after February 18, 1963, and the fact that respondent noted his acquiescence in that case on March 16, 1964, and has never withdrawn it, we would be disinclined to overrule our holding in the Elliott case and to disapprove respondent's pertinent and outstanding88 regulation unless we were compelled to do so by the decisions of the Supreme Court in the Gilmore and Patrick cases. Since those cases dealt with another subsection of the Internal Revenue Code in the 711 context of another factual background, 6 it is our opinion that we are not compelled by them to reach such a result.89 On the authority of the cases and regulations referred to above, it is our conclusion that the legal fees in issue which represented the cost to petitioner of producing monthly alimony payments, which were included in her gross income, are deductible under section 212(1) as ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of taxable income.Decision will be entered for the petitioner. RAUM; PIERCE Raum, J., dissenting: I think that a fair reading of United States v. Gilmore, 372 U.S. 39">372 U.S. 39, and United States v. Patrick, 372 U.S. 53">372 U.S. 53, calls for a result contrary to that reached in the prevailing opinion, and that the distinction between sections 212 (1) and (2) relied upon by the majority is spurious.Sections 212 (1) and (2) of the 1954 Code, here involved, are merely fragmented parts of what was formerly section 23(a)(2) of the 1939 Code, the history of which was outlined in Gilmore. At one time section 23(a) provided merely for the deduction of expenses in carrying on a trade or business. It was then amended so as to add deductions for like expenses90 not connected with trade or business. The old trade or business deductions were continued in section 23(a)(1), and the new deductions were contained in section 23(a)(2). These new deductions were spelled out in section 23(a)(2) as follows:(2) Non-trade or Non-business Expenses. -- In the case of an individual, all the ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income, or for the management, conservation, or maintenance of property held for the production of income.The Supreme Court in Gilmore held that section 24(a)(1), which specifically denied any deduction for "personal" or "family" expenses, was a limitation upon section 23(a)(2), and that, accordingly, expenses incurred by a husband in a divorce action to protect his income-producing property were not deductible even though the situation were otherwise literally covered by section 23(a)(2). The theory of the decision in that case and in Patrick was that the claims in respect of which the expenses were incurred arose from the taxpayer's 712 "marital relationship * * and were thus the product of [his] * * * personal or family life * * ." 372 U.S. at 56.91 That theory was plainly applicable to all parts of section 23(a)(2), which had the identical legislative history, and I can conceive of no justification for reaching a different result in respect of that portion of section 23(a)(2) that became section 212(1) of the 1954 Code from that portion which became section 212(2). Section 24(a)(1) is just as much a limitation upon that part of section 23(a)(2) which deals with deduction of expenses incurred "for the management, conservation, or maintenance of property held for the production of income" as it is upon that part which involves expenses "for the production or collection of income." If the fact that the claim grew out of the marital relationship required classification of the expenses as "personal" or "family" under section 24(a)(1) in the one situation, the same must obtain in the other. And there is no suggestion whatever that a contrary result must be reached merely because section 23(a)(2) was itself divided into two parts as section 212(1) and (2) of the 1954 Code, obviously for the purpose of drafting convenience only. Section 24(a)(1) of the 1939 Code became section 262 of the 1954 Code, and the limitations in respect92 of deductions for "personal" and "family" deductions in section 262 are just as much a gloss on section 212 as the corresponding provisions of section 24(a)(1) were a restriction on section 23(a)(2).Gilmore and Patrick make it clear that such limitations are operative when the claim arises out of the marital relationship in a divorce proceeding, and I think it quixotic to reach a different result here. The mere fact that the Treasury has not withdrawn the regulation upon which the majority rely is of no controlling significance. The Gilmore and Patrick cases were decided only last year, and it is notorious that the wheels of administration often turn slowly.Pierce, J., dissenting: I agree with the dissenting opinion of Judge Raum, but I wish to add a word about Jane U. Elliott, 40 T.C. 304">40 T.C. 304, upon which the majority relies in part. I regard it as distinguishable. In the instant case, expenses were incurred in order to establish petitioner's right to alimony, plainly a "personal" or "family" right. In Elliott, on the other hand, the right to alimony had already been established, and the expenses were incurred merely in93 order to effect collection of a fixed obligation, just as they might have been incurred by a noteholder seeking to collect interest on his note or a lessor seeking to collect rent from his lessee. Since Elliott is distinguishable I see no reason to extend it to reach an unsound result. Footnotes1. All sction references will hereinafter refer to the Internal Revenue Code of 1954 unless otherwise noted.↩1. This portion in writing.↩2. SEC. 212. EXPENSES FOR PRODUCTION OF INCOME.In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year -- (1) for the production or collection of income;↩3. SEC. 262. PERSONAL, LIVING, AND FAMILY EXPENSES.Except as otherwise expressly provided in this chapter, no deduction shall be allowed for personal, living, or family expenses.↩4. This conclusion is based upon the particular facts in this record and is not to be construed as holding in general that where the parties have placed returns before the Court by stipulation the matters contained therein are to be taken as facts.↩5. Although respondent cites sec. 1.262-1(b)(7), Income Tax Regs.↩, on brief, he makes no attempt to explain the inconsistency of his position in this case with the regulations.6. It is significant that the Supreme Court in fn. 19 to its opinion in United States v. Gilmore, 372 U.S. 39">372 U.S. 39, 50, quoted the first sentence in sec. 1.262-1(b)(7), Income Tax Regs., which we have quoted in its entirety, and omitted the following second sentence: However, the part of an attorney's fee and the part of the other costs paid in connection with a divorce, legal separation, written separation agreement, or a decree for support, which are properly attributable to the production or collection of amounts includible in gross income under section 71 are deductible by the wife under section 212.This is an unmistakable indication that the Supreme Court in that case was not considering the problem of the deductibility of expenses paid or incurred by the wife in securing the payment to her of alimony which would be includable in her gross income under sec. 71↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624507/	Francis Thompson and Mable Thompson v. Commissioner.Thompson v. CommissionerDocket No. 48097.United States Tax CourtT.C. Memo 1955-266; 1955 Tax Ct. Memo LEXIS 69; 14 T.C.M. (CCH) 1058; T.C.M. (RIA) 55266; September 29, 195569 Dependency exemptions: Minor daughters of former marriage: Proof of existence. - A father was allowed a dependency exemption for two minor daughters by a former marriage. The Commissioner completely failed to overcome the prima facie proof of the taxpayer as to the existence of the daughters. Chas. D. Hunter, Jr., Esq., for the petitioners. John H. Welch, Esq., for the respondent. WITHEYMemorandum Opinion WITHEY, Judge: The Commissioner has determined deficiencies against petitioners Francis Thompson and Mable Thompson, his wife, for the years 1949, 1950 and 1951 in the respective sums of $200, $209 and $245. The basis for the deficiencies, which is also the issue for decision, is the existence of Beulah Mae Thompson and Valerie Thompson, contended by petitioner to be his minor daughters by a former marriage and because of whom he took a dependency credit in each of said years, claiming to have furnished more than 50 per cent of the support of said children during said years. The petitioners filed joint income tax returns for the years involved with the collector at Tacoma, Washington. Upon the issue of the existence of Beulah Mae Thompson and Valerie70 Thompson and petitioners' justification for naming them in their 1949, 1950 and 1951 income tax returns as dependents, we find for petitioners because respondent has completely failed to overcome the prima facie proof of petitioners as to this question. Petitioner, Francis Thompson, a man of no formal education whatsoever, prior to 1946 was married to Beulah Thompson but obtained a divorce from her in the year 1938. Whether by decree or otherwise, he retained custody of their children Beulah Mae Thompson and Valerie Thompson who were born in 1936 and 1937, respectively. In 1946 petitioner married his present wife, one of the petitioners in this case, Mable Thompson. During all three of the years at issue, petitioners with the two children lived at 2246 East Fairbanks Street in Tacoma, Washington. Beulah Mae and Valerie Thompson were both born with badly defective eyesight and were because thereof unable at any time to attend public schools. They remained in and about petitioner's home under the constant supervision of a neighbor after petitioner's divorce and before his remarriage and under the supervision of petitioner Mable Thompson thereafter until December of 1951. They were71 able to help with housework but never, to that time, worked or earned money outside the home. Petitioner worked at the Tacoma Millwork & Supply Company and was the sole support of the family. The neighborhood in which the home of petitioner was located was fairly sparsely settled, the nearest house on his side of the street being three lots away, although a residence did exist directly across the street. Petitioner and his wife, with the exception of the next door neighbor who had been in supervision of the children immediately subsequent to petitioner's divorce, were not acquainted with others in the neighborhood and did not associate generally therein. On an undisclosed date in December of 1951 petitioner advised his two daughters that he could no longer support them and that it would be necessary for them to obtain work. The next day they left home apparently without notice to either of petitioners and, except for one letter, he has not seen them since, although he believes he knows their present address and prior to the hearing hereof so advised respondent's agent. Respondent's position as evidenced by his opening statement and by the statement attached to his deficiency72 notice is simply that he has a complete lack of information as to the existence of the two dependents here involved. However, upon the hearing he produced the testimony of Tom Hicker who during the years at issue lived in the residence directly across the street from that of petitioners. Although at the time of his testimony he was 17 years old, during 1949, 1950 and 1951 he was, respectively, 11, 12 and 13 years of age. He testified that he had known petitioner for approximately five years and that during that time he had made three visits at widely separated occasions to petitioner's home in order to deliver misdirected mail. His testimony generally is in the negative and of little probative force. He did not during his visits to the Thompson home see the two dependents here involved. In his playing around the neighborhood he did not see them. He attended primary, junior and high school but did not see them. In short, his testimony is that he did not know of the existence of Beulah Mae and Valerie Thompson. Such testimony falls far short of that required to overcome the straightforward positive evidence presented to the Court by petitioner in his testimony at the time of hearing, *73 yet it seems to be the only basis upon which respondent's deficiency notice was issued. Decision will be entered for the petitioners.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624508/	David A. Aylsworth and Julia A. Aylsworth v. Commissioner.Aylsworth v. CommissionerDocket No. 92547.United States Tax CourtT.C. Memo 1963-221; 1963 Tax Ct. Memo LEXIS 121; 22 T.C.M. (CCH) 1111; T.C.M. (RIA) 63221; August 21, 1963121 Albert J. Huddleston, for the petitioners. David E. Mills, for the respondent. WITHEYMemorandum Findings of Fact and Opinion WITHEY, Judge: Respondent determined a deficiency in petitioners' income tax for 1957 in the amount of $11,264.06. The sole issue presented for our decision is the correctness of the respondent's action in determining that certain cash distributions made by Westley Shipping Company, Inc., to Caribbean Line, S.A., during 1957 resulted in a constructive dividend to petitioner David A. Aylsworth. Findings of Fact Some of the facts have been stipulated and are found accordingly. Petitioners are husband and wife residing at New Orleans, Louisiana. They filed a joint income tax return for 1957 with the director at New Orleans. Westley Shipping Company, Inc., sometimes hereinafter referred to as Westley, is a corporation organized under the laws of the State of Louisiana on January 6, 1950. Petitioner David A. Aylsworth and David T. Duncan each owned 50 percent of the outstanding stock of Westley. During 1957 Duncan served as president of Westley and petitioner was its vice president. At all times here pertinent the business of Westley122 consisted principally of acting as a freight steamship agent for chartered (rented) vessels operating in the Gulf of Mexico and in the Caribbean Sea. Its function consisted of the complete handling of chartered ships for their owners including soliciting freight and securing cargo, obtaining crews, arranging for ports, berthing space, stevedores, watchmen, checkers, etc. Westley also acted occasionally as operator of chartered steamships in the Gulf of Mexico and the Caribbean Sea, controlling the stevedoring, loading, port entry, and payment of crews on specific voyages. On November 29, 1954, Westley entered into a joint venture with William Pennington, a resident of Guatemala City, Guatemala. The joint venture was known as Guatemala Line, and Pennington and Westley were 50 percent partners therein. The principal business of Guatemala Line was the operation of vessels between ports in the United States and Guatemala. Guatemala Line realized net profits for 1955 and 1956 in the amounts of $23,984.87 and $94,238.49, respectively. The partnership sustained a net loss for 1957 in the amount of $4,661.38. On July 27, 1956, petitioner with David T. Duncan formed a corporation under123 the laws of the Republic of Panama known as West Line, S.A., which had an authorized capital of 5,000 shares of common stock having a par value of $10 per share. One thousand shares of common stock were issued by West Line, 500 shares each to petitioner and Duncan. On July 27, 1956, petitioner with David T. Duncan formed amother corporation under the laws of the Republic of Panama known as Guatemala Line, S.A., with an authorized capital stock of 5,000 shares of common stock having a par value of $10 per share. Guatemala Line issued 1,000 shares of its common stock, 500 shares each to William Pennington and West Line. On July 1, 1957, petitioner and David Duncan formed another corporation under the laws of the Republic of Panama known as Caribbean Line, S.A., sometimes hereinafter referred to as Caribbean, with an authorized capital stock of 7,500 shares of common stock having a par value of $10 per share. A resolution adopted by the directors of Caribbean Line authorized the issuance of a total of 6,000 shares of its capital stock for cash at a price of $10 per share. The resolution also accepted and approved the subscription of Guatemala Line and West Line each to 50 percent124 of the 6,000 shares of stock authorized for issuance by Caribbean Line. The General Journal of Caribbean Line carries the following entry under date of July 1, 1957: JournalGeneralLedger7-1-57Dr.Cr.Subscriptions Receivable$60,000.00Capital Stock - Common$60,000.00To record the following Com. StockSubGuatemala Line, S.A. 3,000 sharesat $10.00 Ea.West Line, S.A. 3,000 shares at$10.00 Ea.During the early part of July 1957, Caribbean Line purchased in Holland a motor vessel known as the "Moby Dick" for $215,000. The vessel was later renamed the "West Gulf." The joint venture Guatemala Line made a down payment on the purchase of the motor vessel Moby Dick in the amount of $72,000. Such payment was made by the issuance of two checks on July 1, 1957 and July 10, 1957, in the amounts of $5,000 and $67,000, respectively. A ledger asset account of Guatemala Line joint venture reflects a receivable in the amount of $72,000 from Caribbean Line as of July 31, 1957. Caribbean Line carried on its books a liability account to the partnership Guatemala Line in the amount of $72,000 under date of July 10, 1957. The books of Guatemala Line125 joint venture disclose that the $72,000 receivable from Caribbean Line was eliminated on June 30, 1958, by charges to the partners Westley and Pennington in the amounts of $54,000 and $18,000, respectively. The elimination of the $72,000 receivable on the books of the partnership Guatemala Line was accompanied by an explanatory entry stating: "To charge partners with their pro rata advances made to Caribbean Line, S.A." The General Journal of Westley contains an entry made on June 30, 1958, showing "$54,000 to form affiliate Caribbean Line, S.A." The books of Westley also contain a balancing credit as of that date in the amount of $54,000 desigated "Investment - Guatemala Line." This entry was explained by a note reading: "To reflect cash advanced for Down Payment on M/V 'West Gulf'." The balance of the purchase price of the motor vessel West Gulf was financed by a mortgage loan in the amount of $143,000 obtained from the National Bank of Commerce at New Orleans. Westley made additional advances to Caribbean Line during 1957 in the total amount of $8,665.92. These advances were made for the purpose of assisting Caribbean Line to obtain capital needed by it to operate its business. 126 Caribbean subsequently repaid these advances to the extent of $2,665.92. On October 6, 1957, a charter agreement was executed by Caribbean and Westley. The agreement provided, in substance, for the charter of the motor vessel West Gulf by Westley for a period of 30 months commencing on or about July 15, 1957. It agreed to pay hire for the vessel at the rate of $7,000 per month. Westley had an option under the agreement to subcharter the West Gulf; however, it remained liable for the performance of the charter agreement. The balance sheet of Westley for 1957 shows as a current asset an amount due from its, affiliate, Caribbean Line, in the amount of $10,666. Its 1957 balance sheet does not disclose an amount attributable to the $54,000 which it had advanced to Caribbean Line. Westley's 1958 balance sheet discloses no amount due and owing from Caribbean Line. Westley had earnings and profits as of December 31, 1957, in the amount of $38,126. In his deficiency notice the respondent has determined that petitioner received a dividend distribution from Westley during 1957 which is taxable to petitioners as ordinary income in the amount of $19,063 and as long-term capital gain to127 the extent of $3,758.25. Ultimate Finding Petitioners received a dividend distribution from Westley Shipping Co., Inc., during 1957 of $30,000. Opinion Petitioners contend that the advances made by Westley during 1957 in the total amount of $60,000 1 to Caribbean Line constitute loans by Westley to Caribbean. The respondent has taken the position that these advances constitute dividend distributions, one-half of which was constructively received by petitioner in 1957. Petitioner, together with David T. Duncan and William Pennington, organized three foreign corporations, West Line, Guatemala Line, and Caribbean Line under the laws of the Republic of Panama in order to acquire the seagoing motor vessel Moby Dick (subsequently renamed West Gulf) which they intended to charter and operate in a manner similar to that under which they had previously operated chartered vessels through a single United States corporation, Westley Shipping Co., Inc., as well as a partnership128 consisting of that corporation and William Pennington, doing business as Guatemala Line. Although it appears from the record that West Line and Guatemala Line had each agreed to subscribe to one-half of the proposed issuance of the stock of Caribbean Line, we are unable to find from the record that any of the stock of the latter corporation was ever actually purchased or that it had acquired even $1 of operating capital prior to the advances made to it by Westley and Pennington. Petitioner stated at the trial that the $54,000 advance to Caribbean Line by Westley during July 1957 and the $18,000 amount contemporaneously advanced to Caribbean Line by William Pennington were intended by the parties to represent loans which eventually would be repaid out of the profits of Caribbean. However, in making the advances in question to Caribbean during 1957, the parties did not even adopt the form of a loan transaction. No note or other instrument purporting to show an indebtedness was executed. There is no indication that any time was fixed for the repayment of these advances. The record fails to suggest that any interest was ever to be charged Caribbean for the use of the money advanced. No129 security for the advances in question was ever received or even requested by Westley and Pennington. If there was any agreement existing between petitioner and Caribbean that these advances were in the nature of loans, the terms of such agreement are not disclosed by the record. If, as petitioner contends, these advances were to be repaid, the only source of repayment would have been the future profits of Caribbean. In view of the almost total absence of evidence indicating that the transaction in question was intended by the parties to constitute a bona fide indebtedness, we are unable to accept the petitioner's contention that such an indebtedness was created by this transaction. We are in agreement with the respondent's determination that the advances made by Westley in the amount of $54,000 during July 1957, together with advances subsequently made during that year in the amount of $6,000, constitute dividend distributions by Westley which, to the extent of one-half thereof, are chargeable to petitioner. Petitioners make no contention here that the distribution in question qualifies as the sale or exchange of a capital asset. A resolution adopted by the directors of Caribbean130 Line authorized the issuance of 6,000 shares of its stock and accepted the subscription of Guatemala and West Line each to one-half the 6,000 shares authorized for issuance. However, it does not appear that either of the subscribers to the stock of Caribbean paid it any consideration. 2So far as appears from the record herein, at the time of the purchase of the motor vessel Moby Dick during July 1957, Caribbean Line was totally without capital. Accordingly, the distribution of $60,000 by Westley to Caribbean for the purpose of providing it with funds for making a down payment on the purchase of the Moby Dick had the effect of discharging the obligations of West Line and Guatemala Line to purchase $60,000 worth of capital stock of Caribbean. Such distributions of corporate funds made to a shareholder or to a prospective shareholder who was obligated to purchase stock in the same corporation or in another corporation consistently have been held to constitute dividend distributions to him. ;131 ; , affd. - F. 2d - (C.A. 8, July 3, 1963). Such a constructive distribution of dividends to West Line and Guatemala Line would inure to the direct financial benefit of petitioner because of the increase in value of his equity therein. In substance, the transaction here in question was the same as if the petitioner had personally withdrawn $30,000 from the earnings ofwestley and subsequently invested it as risk capital in Caribbean Line. He cannot be permitted to avoid the consequences of such a withdrawal of corporate funds from Westley by the expedient of causing it to pay the advances in question directly to Caribbean without passing through his hands. For the above-stated reasons we are of the opinion that the withdrawal of $60,000 from the earnings and profits of Westley during July 1957 and the investment of such funds as risk capital in Caribbean Line constitute a dividend distribution to petitioner to the extent of one-half thereof, or $30,000. The earnings and profits of Westley as of December 31, 1957, were $38,126. One-half thereof, or $19,063, is taxable to petitioner as ordinary income, 132 and the balance of the distribution in excess of his basis in the stock of Westley is taxable as long-term capital gain, in accordance with the respondent's determination, which we here sustain. Decision will be entered for the respondent. Footnotes1. Consisting of $54,000 advanced during July 1957 to provide funds for the down payment needed to purchase the Moby Dick, plus $8,665.92 later advanced for operating funds, less $2,665.92 which was repaid.↩2. Whether or not certificates of its shares of stock were ever actually issued by Caribbean to West Line and Guatemala Line is not disclosed by the record.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4512584/	FILED United States Court of Appeals UNITED STATES COURT OF APPEALS Tenth Circuit FOR THE TENTH CIRCUIT March 4, 2020 _________________________________ Christopher M. Wolpert Clerk of Court IGOR LAVRENOV, a/k/a Igor Vladislavovich Lavrenov, Petitioner, v. No. 19-9535 (Petition for Review) WILLIAM P. BARR, United States Attorney General, Respondent. _________________________________ ORDER AND JUDGMENT * _________________________________ Before HOLMES, PHILLIPS, and CARSON, Circuit Judges. _________________________________ Igor Lavrenov, a native and citizen of Russia, seeks review of a decision by the Board of Immigration Appeals (BIA) that dismissed Lavrenov’s appeal from a removal order entered by an Immigration Judge (IJ). Exercising jurisdiction under 8 U.S.C. § 1252, we deny review. * After examining the briefs and appellate record, this panel has determined unanimously to honor the parties’ request for a decision on the briefs without oral argument. See Fed. R. App. P. 34(f); 10th Cir. R. 34.1(G). The case is therefore submitted without oral argument. This order and judgment is not binding precedent, except under the doctrines of law of the case, res judicata, and collateral estoppel. It may be cited, however, for its persuasive value consistent with Fed. R. App. P. 32.1 and 10th Cir. R. 32.1. I. Background Lavrenov seeks asylum in the United States for the third time. United States Citizenship and Immigration Services denied his first application in 2009 because it deemed him not credible. Lavrenov applied again in 2017, but that application was never adjudicated. Lavrenov filed the operative application defensively in 2018, seeking asylum, withholding of removal, and relief under the United Nations Convention Against Torture (CAT). In connection with his 2018 application, Lavrenov asserted that in 2015 men dressed in black military-style uniforms broke into his apartment, attacked him and his family, kidnapped him, further beat him at an unknown location, and deposited him at the entrance to a hospital. He claimed the attack resulted from his work investigating corruption as an unpaid assistant to a local elected official and that the FSB, Russia’s federal security service, must have been behind the attack in part because ordinary citizens in Russia cannot purchase the black military-style uniforms worn by his attackers. He further speculated that despite reports the local official died of a stroke, government operatives in Moscow directed the official’s assassination. The IJ observed strong similarities between this story and the one Lavrenov told in his 2009 application, except that in his 2009 application Lavrenov claimed that the Russian mafia sponsored the attack. And, as recounted by the BIA: [T]he [IJ] noted the following material and significant inconsistencies: 1) [Lavrenov] testified that the Russian mafia took over his company, although he recanted this assertion when confronted with his contrary 2 statement in his 2009 asylum application and claimed that he was able to regain ownership; 2) he returned to Russia after visiting the United States even though he claimed to have experienced a violent abduction in 2009 in Russia and he testified that his reason for returning was to reclaim his business, although he indicated in his 2017 application that he returned because his father’s health was deteriorating; and 3) he testified, and indicated in his 2018 application, that he met [the local elected official] in 2006, although his 2017 application indicated that he met him in 2012. Furthermore, the [IJ] noted the following omissions: 1) he failed to include the 2009 violent attack against him by the Russian mafia (which he included in his 2009 asylum application) in both his 2017 and 2018 applications; and 2) he failed to include many of the details contained in his 2017 application regarding numerous phone calls, a police detention following a 2012 march against President Putin and several beatings, in his 2018 application. In addition, she found him nonresponsive and evasive when asked on cross-examination about why he omitted these details from his 2018 application. Finally, the [IJ] found his explanations implausible regarding: 1) why he attempted to disavow the first page of his declaration in his 2017 application, even though it contained many of the same details as [his] testimony, and included his signature on the second page; 2) why he would be an assistant to an elected official when that type of job more likely would be held by an actual government employee; 3) why [the local elected official] would be killed by Moscow, 4) why only SWAT team members can obtain black military-style uniforms, and 5) why no investigation was conducted into [the local elected official’s] alleged attempted assassination. Admin. R. Vol. 1 at 3–4 (citations omitted). The IJ found Lavrenov not credible and denied his 2018 application. Lavrenov appealed to the BIA. He claimed, among other things, that the IJ erred by proceeding given that detention officials denied him access to a laptop containing unspecified documents that would corroborate his claims 1 and that his detained status otherwise 1 According to Lavrenov, nobody else can access the laptop’s contents because he secured it with facial-recognition technology. 3 prevented him from marshaling evidence. He also filed a motion to remand for the IJ to re-consider her adverse credibility finding in light of new evidence he submitted for the first time on appeal to the BIA. The BIA denied his motion to remand, rejected his due process claims, and adopted the IJ’s adverse credibility finding. II. Discussion A. Motion to Remand Lavrenov first argues that the BIA erred by failing to grant his motion to remand so the IJ could consider new evidence he submitted on appeal and unspecified documents from his laptop. “A motion styled as a request for remand remains, in substance, a motion to reopen.” Alzainati v. Holder, 568 F.3d 844, 847 n.2 (10th Cir. 2009). “A motion to reopen proceedings shall not be granted unless it appears to the [BIA] that evidence sought to be offered is material and was not available and could not have been discovered or presented at the former hearing . . . .” 8 C.F.R. § 1003.2(c)(1). The BIA concluded that Lavrenov did “not establish[] that the proffered new evidence could not have been obtained prior to his merits hearing or would change the result in his case.” Admin. R. Vol. 1 at 6. “We review the BIA’s decision on a motion to reopen only for an abuse of discretion.” Maatougui v. Holder, 738 F.3d 1230, 1239 (10th Cir. 2013) (alterations and internal quotation marks omitted). “The BIA does not abuse its discretion when its rationale is clear, there is no departure from established policies, and its statements are a correct interpretation of the law, even when the BIA’s decision is 4 succinct.” Id. (internal quotation marks omitted). “[M]otions to reopen immigration cases are plainly disfavored,” and the moving party “bears a heavy burden to show the BIA abused its discretion.” Id. (alterations and internal quotation marks omitted). With respect to the prior availability of the new evidence Lavrenov submitted for the first time on appeal to the BIA, he argued to the BIA only that it “was beyond [his] capabilities to obtain while he was detained and unrepresented.” Admin. R. Vol. 1 at 20. On appeal to this court he adds generalized remarks about the challenges of marshaling evidence from a detention center. 2 But other than his argument with respect to the documents allegedly trapped inside his laptop, Lavrenov does not state with any specificity why any piece of evidence could not be obtained prior to the evidentiary hearing. 3 With respect to the documents on his laptop, his argument fails because he did not tell the BIA and does not tell us with any specificity what information those documents contain or how that information relates to his case. He therefore did not 2 To the extent Lavrenov’s argument relies on evidence that he did not submit to the IJ or the BIA, we do not consider that evidence. We must decide his petition “only on the administrative record on which the order of removal is based.” 8 U.S.C. § 1252(b)(4)(A). 3 He does observe that an expert report was unavailable at the time of the hearing because he delayed in hiring the expert until after the hearing. See Aplt. Reply Br. at 6–7. But this self-imposed delay says nothing about whether he could have engaged the expert sooner and thereby obtained the report prior to the hearing. Cf. 8 C.F.R. § 1003.2(c)(1) (“A motion to reopen proceedings shall not be granted unless . . . that evidence sought to be offered . . . could not have been discovered or presented at the former hearing.”). 5 show that the documents “would likely change the result in the case.” Matter of Coelho, 20 I. & N. Dec. 464, 473 (B.I.A. 1992). The BIA did not abuse its discretion in denying the motion to remand. 4 B. Adverse Credibility Finding Lavrenov also challenges the BIA’s adverse credibility finding. We review the BIA’s findings of fact under the substantial evidence standard. Elzour v. Ashcroft, 378 F.3d 1143, 1150 (10th Cir. 2004). 5 Under that standard, “our duty is to guarantee that factual determinations are supported by reasonable, substantial and probative evidence considering the record as a whole.” Uanreroro v. Gonzales, 443 F.3d 1197, 1204 (10th Cir. 2006) (alterations and internal quotation marks omitted). The agency’s findings of fact “are conclusive unless the record demonstrates that any reasonable adjudicator would be compelled to conclude to the 4 To the extent Lavrenov’s argument can be construed as challenging the agency’s actions related to the laptop’s contents on due process grounds, we reject it for a similar reason. To prevail on a due process claim, Lavrenov would need to establish “both that he was deprived of due process and that that deprivation prejudiced him.” Lucio-Rayos v. Sessions, 875 F.3d 573, 576 (10th Cir. 2017). The BIA concluded that since Lavrenov never “indicated the specific evidence he wished to submit,” he did “not establish[] that the manner in which the [IJ] conducted the proceeding demonstrates prejudice against him.” Admin R. Vol. 1 at 6. Because Lavrenov continues to elide the laptop’s contents and does not otherwise tell us how their omission from the proceedings prejudiced him, we agree with the BIA. 5 This appeal involves a single BIA member’s brief order under 8 C.F.R. § 1003.1(e)(5). We review that order as the final agency determination, limiting our review to the issues specifically addressed therein. Diallo v. Gonzales, 447 F.3d 1274, 1278–79 (10th Cir. 2006). We may, however, consult the IJ’s decision “to give substance to the BIA’s reasoning.” Razkane v. Holder, 562 F.3d 1283, 1287 (10th Cir. 2009). 6 contrary.” Rivera-Barrientos v. Holder, 666 F.3d 641, 645 (10th Cir. 2012) (internal quotation marks omitted); see also Sidabutar v. Gonzales, 503 F.3d 1116, 1125 (10th Cir. 2007) (explaining that “[i]t is not our prerogative to reweigh the evidence, but only to decide if substantial evidence supports the agency’s decision” (alterations and internal quotation marks omitted)). Our review is limited to the agency record that formed the basis for the IJ’s order of removal. 8 U.S.C. § 1252(b)(4)(A). Lavrenov does not challenge any of the support for the IJ’s adverse credibility finding that the BIA recited. He instead focuses only on additional observations made by the IJ that Lavrenov’s unsubstantiated assumptions about who attacked him were less plausible than other possible theories relating to the identity of the alleged attackers. 6 But he does not confront the fact that the IJ made these observations only after finding Lavrenov’s testimony regarding the predicate facts from which they stem to be untruthful. And he does not explain why questioning this isolated aspect of the IJ’s adverse credibility finding undermines that finding given the numerous and specific other reasons provided by the IJ to support the notion that Lavrenov is not credible. Cf. Htun v. Lynch, 818 F.3d 1111, 1120 (10th Cir. 2016) (“With three separate areas where the evidence supports a finding of inconsistency and 6 Lavrenov’s opening brief vaguely references other aspects of his story the IJ found implausible but does not cite any other portions of the IJ’s decision or the record and does not otherwise provide enough argument or detail for us to review these aspects of the IJ’s findings. See Kelley v. City of Albuquerque, 542 F.3d 802, 819 (10th Cir. 2008) (“[P]erfunctory” allegations of error that “fail[] to frame and develop an issue” are insufficient “to invoke appellate review.” (internal quotation marks omitted)). 7 nondisclosure, a reasonable adjudicator would not be compelled to find [the petitioner] credible.”); Rizk v. Holder, 629 F.3d 1083, 1088 (9th Cir. 2011) (“[W]e must uphold the IJ’s adverse credibility determination so long as even one basis is supported by substantial evidence.”). The IJ’s adverse credibility determination finds substantial support in the record and we will not question it. C. Convention Against Torture Lavrenov posits that the BIA erred by rejecting his CAT claim based on its adverse credibility finding. But we have affirmed the BIA’s rejection of CAT claims in other cases on this basis and believe it is appropriate to do so here. See, e.g., Ismaiel v. Mukasey, 516 F.3d 1198, 1206 (10th Cir. 2008) (“[T]he IJ and BIA could reasonably refuse to believe [the petitioner’s] claims of past torture and, reviewing all the evidence, remain unpersuaded that [he] had satisfied his burden of proving that he would probably be tortured if returned to [his country of origin].”); Niang v. Gonzales, 422 F.3d 1187, 1202 (10th Cir. 2005) (“Here, our review of [the petitioner’s] CAT claim is controlled by the permissible finding that she is untruthful.”). III. Conclusion The petition for review is denied. Entered for the Court Gregory A. Phillips Circuit Judge 8	01-04-2023	03-04-2020
https://www.courtlistener.com/api/rest/v3/opinions/4512585/	FILED United States Court of Appeals UNITED STATES COURT OF APPEALS Tenth Circuit FOR THE TENTH CIRCUIT March 4, 2020 _________________________________ Christopher M. Wolpert Clerk of Court EARL E. BRAMHALL, Plaintiff - Appellant, v. No. 19-4032 (D.C. No. 2:18-CV-00438-DB-EJF) SALT LAKE DISTRICT ATTORNEY’S (D. Utah) OFFICE; SIMARJIT S. GILL, Salt Lake District Attorney; MELANIE M. SERASSIO, Deputy District Attorney; STEVEN C. GIBBONS, Deputy District Attorney; NATHANIEL J. SANDERS, Deputy District Attorney; ROBERT N. PARRISH, Deputy District Attorney; NATHAN J. EVERSHED, Deputy District Attorney; CHOU CHOU COLLINS, Deputy District Attorney; THOMAS V. LOPRESTO, Deputy District Attorney; CRAIG STANGER, Deputy District Attorney; JARED W. RASBAND, Deputy District Attorney; CHRISTINA P. ORTEGA, Deputy District Attorney; GREGORY N. FERBRACHE, Deputy District Attorney; JARED N. PARRISH, Deputy District Attorney; CYPRUS CREDIT UNION, West Valley, Utah; BROOK BENNION, Previous Branch Manager, Cyprus Credit Union, Defendants - Appellees. _________________________________ ORDER AND JUDGMENT * * After examining the briefs and appellate record, this panel has determined unanimously to honor the parties’ request for a decision on the briefs without oral argument. See Fed. R. App. P. 34(f); 10th Cir. R. 34.1(G). The case is therefore submitted without oral argument. This order and judgment is not binding precedent, _________________________________ Before LUCERO, BALDOCK, and MORITZ, Circuit Judges. _________________________________ Earl Bramhall appeals from the district court’s order dismissing without prejudice his complaint against various members of the Salt Lake District Attorney’s Office (the “County Defendants”) as well as Cyprus Credit Union and Brook Bennion (the “Bank Defendants”). We dismiss this appeal for lack of appellate jurisdiction. I Bramhall was arrested on July 23, 2008, for aggravated robbery and making threats against life or property. Officers from the West Valley City Police Department believed Bramhall had called a branch of the Cyprus Credit Union earlier that morning from a pay phone and told the branch manager, Bennion, that he wanted $100,000 in cash, that he was a sharp shooter and watching her from a building across the street, and that he had surrounded the bank with explosives. After spending over fifty-three months in pretrial detention and undergoing multiple competency evaluations, Bramhall was found not guilty by a jury in July 2017. In June 2018, Bramhall filed an action against more than thirty defendants. He alleged the County Defendants (1) committed prosecutorial misconduct, (2) subjected him to cruel and unusual punishment, (3) violated his Fifth Amendment rights by except under the doctrines of law of the case, res judicata, and collateral estoppel. It may be cited, however, for its persuasive value consistent with Fed. R. App. P. 32.1 and 10th Cir. R. 32.1. 2 failing to indict him before a grand jury, (4) conspired to prosecute him despite a lack of evidence, (5) attempted to coerce him into pleading guilty, (6) denied his right to a speedy trial, (7) improperly subjected him to numerous competency evaluations, and (8) improperly allowed a witness to remain in the courtroom during a preliminary hearing. With respect to the Bank Defendants, he alleged that (1) Bennion made false accusations against him and committed perjury at his trial and that (2) Cyprus Credit Union was negligent in hiring, supervising, and retaining Bennion. Bramhall voluntarily dismissed his claims against the Police Defendants. After the County Defendants and Bank Defendants filed motions to dismiss, a magistrate judge recommended granting the motions. The district court adopted the magistrate judge’s recommendations and dismissed Bramhall’s claims against the County Defendants and Bank Defendants. Bramhall then filed (1) a motion for leave to file an amended complaint, (2) a motion under Fed. R. Civ. P. 60(b)(6) for modification of the district court’s order, and (3) a notice of appeal. We abated the appeal until the post-judgment motions were resolved. The district court denied the motion for leave to amend, concluding it was procedurally improper. It also denied in part and granted in part the Rule 60(b) motion, discerning no factual or legal basis for altering the substance of its prior ruling but modifying that ruling “to clarify that [Bramhall’s] claims are dismissed without prejudice” and that he “may still pursue his claims in an appropriate manner if he is able to allege sufficient facts to state a plausible claim for relief.” Bramhall 3 filed an amended notice of appeal to include the district court’s post-judgment rulings, and we lifted the abatement. II Bramhall contends the district court erred in dismissing his claims against the County Defendants and Bank Defendants and in denying his motion for leave to amend his complaint. Before addressing these claims, we must determine whether we have jurisdiction over this appeal. Ordinarily, only “final decisions” of the district court are appealable. 28 U.S.C. § 1291. “To be final under 28 U.S.C. § 1291, an order must end the litigation on the merits and leave nothing for the court to do but execute the judgment.” Alexander v. U.S. Parole Comm’n, 514 F.3d 1083, 1087 (10th Cir. 2008) (quotation and alterations omitted). “[A] dismissal without prejudice is usually not a final decision,” Amazon, Inc. v. Dirt Camp, Inc., 273 F.3d 1271, 1275 (10th Cir. 2001), but may be final “depending upon the circumstances,” Moya v. Schollenbarger, 465 F.3d 444, 448 (10th Cir. 2006) (quotation omitted). If the dismissal of Bramhall’s claims without prejudice was not a final order, “then we lack jurisdiction to hear the appeal.” Id. At the outset, we note that Bramhall contends “this Court already ruled” it has jurisdiction because the court’s order lifting the abatement of his appeal indicated the district court’s order was final. Nevertheless, “we have an independent duty to examine our own jurisdiction,” Amazon, 273 F.3d at 1274, even if it requires us to 4 reconsider prior determinations on appellate jurisdiction, see Kennedy v. Lubar, 273 F.3d 1293, 1299-1300 (10th Cir. 2001). When assessing whether a dismissal is final and appealable, “we look to the substance and objective intent of the district court’s order, not just its terminology.” Moya, 465 F.3d at 449 (emphases omitted). When reviewing an ambiguous order, we must “determine as best we can whether the district court’s order evidences an intent to extinguish the plaintiff’s cause of action, and whether the plaintiff has been effectively excluded from federal court under the present circumstances. If so, then our appellate jurisdiction is proper.” Id. (quotations, citations, and alterations omitted). We employ a “practical approach” guided by “the following principles”: (1) “if a district court order expressly and unambiguously dismisses a plaintiff’s entire action, that order is final”; (2) if “a district court dismissal expressly denies the plaintiff leave to amend, or the district court’s grounds for dismissal are such that the defect cannot be cured through an amendment to the complaint, that dismissal (even if it is ambiguous or nominally of the complaint) is for practical purposes of the entire action and therefore final”; and (3) if “the dismissal order expressly grants the plaintiff leave to amend, that conclusively shows that the district court intended only to dismiss the complaint” and that the dismissal is not final. Id. at 450-51 (quotations and emphases omitted). The first and third principles do not apply in this case. The district court did not grant leave to amend or “expressly and unambiguously dismiss[] [Bramhall’s] entire action.” Id. at 450. Instead, the court’s order expressly states that 5 Mr. Bramhall’s “claims are dismissed without prejudice” and that the court’s original ruling “dismissed the operative Complaint in its entirety.” See id. at 449 (“[W]hether an order of dismissal is appealable generally depends on whether the district court dismissed the complaint or the action. A dismissal of the complaint is ordinarily a non-final, nonappealable order (since amendment would generally be available), while a dismissal of the entire action is ordinarily final.” (quotation omitted)). Finality in this case thus hinges on the second principle in Moya. Although the district court denied Bramhall’s motion to amend, it explained that allowing him “to file his proposed Amended Complaint would be futile” because the proposed amended complaint did nothing to cure the original complaint’s defects. Moreover, the court suggested the defects could be cured, stating Bramhall “may still pursue his claims in an appropriate manner if he is able to allege sufficient facts to state a plausible claim for relief.” By inviting Bramhall to continue to “pursue his claims,” 1 the district court plainly did not exclude him from federal court. See id. at 450, 454. 1 Bramhall interpreted this statement as “direct[ing] the filing of a new Complaint with a new case number and new date-time-stamp.” He has done just that, filing a new complaint in district court against the County Defendants and the Bank Defendants in Case Number 2:19-cv-00477-RJS-CMR. As of the filing of this order and judgment, a dispositive ruling has not been entered in that action. 6 III Accordingly, the district court’s order dismissing Bramhall’s claims without prejudice was not a final order. We therefore DISMISS the appeal for lack of appellate jurisdiction. Entered for the Court Carlos F. Lucero Circuit Judge 7	01-04-2023	03-04-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624509/	John P. Scripps Newspapers, Petitioner, v. Commissioner of Internal Revenue, RespondentJohn P. Scripps Newspapers v. CommissionerDocket No. 4672-62United States Tax Court44 T.C. 453; 1965 U.S. Tax Ct. LEXIS 66; June 25, 1965, Filed 66 Decision will be entered for the petitioner. Held, the accumulation of petitioner's surplus during the years in issue was not beyond the reasonable needs of its business. Held, further, in view of the above holding and the operation of section 535(c)(1), I.R.C. 1954, it is not necessary to determine whether petitioner was availed of for the proscribed purpose contained in section 532(a), I.R.C. 1954. Jack M. Harrison, for the petitioner.Paul G. Wilson, for the respondent. Fay, Judge. FAY453 The respondent determined deficiencies in petitioner's income tax as follows:Taxable yearDeficiency1957$ 21,458.54195823,226.85195932,964.51The only issue for decision is whether petitioner is subject to tax under section 5311 with respect to all or any part of the earnings retained by it in any of the years involved herein.FINDINGS OF FACTSome of the facts have been stipulated, and the stipulation of facts, together with the exhibits attached thereto, is incorporated herein by this reference.Petitioner is a corporation with principal place of business and office located at 306 Scripps Building, 67 San Diego, Calif. Petitioner filed its Federal income tax returns for the years 1957, 1958, and 1959 454 with the district director of internal revenue, Los Angeles, Calif. Petitioner maintains its books of account and files its Federal income tax returns on an accrual basis of accounting. Petitioner came into existence under the laws of the State of California in March 1935 for the purpose of publishing a daily newspaper in Santa Ana, Calif., which it operated at a loss for 3 1/2 years. The Santa Ana newspaper (Santa Ana Journal) was sold in December 1938, and its printing plant was disposed of.In subsequent years petitioner acquired other California newspapers as follows: Ventura County Star-Free Press in 1936; Watsonville Register-Pajaronian in 1937 (sold December 31, 1945); and Santa Paula Chronicle in 1938 (sold January 1942). Beginning with 1946, petitioner's business activity has consisted of publishing the Ventura County Star-Free Press in Ventura, Calif., hereinafter referred to as Star-Free Press.Star-Free Press was started as a daily newspaper by Roy Pinkerton on June 15, 1925. Pinkerton still serves as editor of the paper and is also president of petitioner.By 1930 Star-Free 68 Press' daily circulation had increased to 5,042; by 1940 to 7,416; by 1950 to 15,276; and by 1960 to 23,804. The growth of the area served by the newspaper is reflected by the following U.S. Census population figures:YearVentura CityVentura County193011,60343,753194013,26469,685195016,534114,647196031,603197,522Star-Free Press is circulated throughout Ventura County, Calif. Petitioner is the only publisher of a daily paper in the city of Ventura but not the only publisher of a daily paper in the county of Ventura. In 1940 the newspaper moved into a building containing approximately 8,500 square feet of floor space, built especially for it under a long-term lease. A used printing press with a capacity of 32 pages was purchased and installed at the same time.Increases in activity from 1940 to 1950 of Star-Free Press are indicated from the following comparisons of data:TotalTotalTotal pagesTotalYearrevenuecirculationprintedadvertisinginches1940$ 140,9947,4163,838217,3761945239,00010,5873,160284,6951950626,00015,2765,866567,947455 In 1954 petitioner constructed a building addition (containing 3,500 square feet) to the leased premises and added a 16-page unit to the press. In late 1957 69 petitioner purchased five units of a used Goss press from Detroit Free Press. The total cost of the press was approximately $ 160,000. In 1957 there was an equipment breakdown and for 10 days in that year Star-Free Press was published in Santa Barbara, Calif., some 30 miles away.The following schedule discloses for each of the years 1950 through 1959 the total revenue of Star-Free Press, its average paid daily circulation, its total pages printed, and its total advertising inches:Average paidTotal pagesTotal advertisingYearTotal revenuedailyprintedinchescirculation1950$ 625,630.6115,2765,866567,9471951662,986.0415,3485,806584,3461952722,223.6816,3186,070697,9451953802,446.9017,2186,316642,5571954853,013.9518,1716,436655,6511955958,029.5219,0106,984715,40419561,067,060.9319,9617,220737,81219571,126,581.5520,3427,464749,85719581,201,684.4521,4497,418720,27819591,369,725.7223,1827,936796,813For the year 1945 the net income of petitioner after Federal income taxes was $ 28,234.30.The following schedule discloses for each of the years 1950 through 1959 petitioner's net income before Federal income taxes, its Federal income taxes, net income after taxes, dividend payments to shareholders, 70 and the percentage of net earnings paid to shareholders:Net incomePercent ofYearbefore FederalFederalNet incomeDividendnet earningsincome taxesincome taxesafter taxespaymentspaid toshareholders1950$ 115,242.90$ 49,652.94$ 65,589.96$ 70,400107.31951148,934.0992,017.5456,916.5538,40067.41952163,562.08104,672.9658,889.1238,40065.21953152,180.3692,971.6559,208.7138,40064.91954167,132.1480,923.3686,208.7838,40044.51955210,528.66103,974.90106,553.7638,40036.01956235,507.23115,594.86119,912.3738,40032.01957231,239.30114,708.56116,530.7438,40033.01958244,318.83121,250.12123,068.7138,40031.21959304,759.30151,948.55152,810.7538,40025.1Petitioner has paid dividends to its shareholders each year since 1943. One factor considered by the board of directors of petitioner in arriving at the amount of dividends to be paid is the need for expansion and improvement, and petitioner has not reached the stage where further expansion is unnecessary.The impact the declaration of dividends may have on the major stockholder of petitioner, John P. Scripps, hereinafter referred to as 456 Scripps, was not considered by petitioner in determining dividend amounts. Petitioner's vice president and treasurer worked 71 together to determine the amount of the dividends. Sixty percent of the capital stock of petitioner during the years in issue was owned by Scripps.Irve C. Boldman, vice president of petitioner, is Scripps' financial adviser, having acted in such capacity for 31 years. Scripps' income, including dividends he had received from petitioner, was not sufficient to provide for his current living expenses during the years in issue. It was necessary for Scripps, during the years in issue, to sell some of his investments in order to pay his income taxes.Scripps has been in the newspaper business for a long time. During this time his activities in the newspaper field reflect constant growth and expansion. During the years in issue, Scripps owned the following percentages of capital stock in the corporations listed below:PercentPetitioner60Bremerton Sun Publishing Co100Telegram Tribune Co81Tulare Newspapers, Inc80Redding Record, Inc60Watsonville Newspapers, Inc60 For the years 1950 through 1959 petitioner invested the following amounts in additions to its property account:YearAmount1950$ 20,748.5019514,733.48195210,569.851953109,958.271954124,672.35195528,731.33195638,828.49195756,485.501958133,349.98195942,597.14During 72 the year 1962 approximately $ 170,000 was expended by petitioner for the purchase of building addition, typesetting machines, and additions to its printing presses; $ 40,000 of this sum involved the purchase of the property petitioner had leased in 1940 and upon which it held an option for which it had paid $ 5,000.Petitioner's management consists of an executive committee composed of Scripps, chairman of the board; Irve C. Boldman, vice president and general counsel; and J. L. McNally, treasurer. The executive committee, occupying the same suite of offices, meets every day to discuss and conduct petitioner's business affairs. The executive committee457 has not recorded in the minutes or transcribed its business decisions except where required by corporate law. The executive committee acts in an informal manner. When necessary it is in a position to act fast. Although petitioner's plans for expansion after 1958 were only of an informal nature, the history of petitioner shows a constant growth by means of retained earnings.Oxnard, another city in Ventura County, grew very rapidly during the last 20 years. Because petitioner did not have available funds to expand its service in that 73 city, another newspaper established itself in Oxnard as a daily paper. Being in the same county and in a similar geographical location, the Oxnard competitor had an adverse effect on Star-Free Press' circulation, as Star-Free Press had a very large percentage of its subscribers located in the county, including the Oxnard area. Circulation of the paper in the county is important because advertisers want their messages communicated throughout the county.A comparable situation presented itself in the Thousand Oaks area, as a newspaper, the Conejo News, had started there in 1958 on a weekly basis. To protect itself and obtain a foothold, petitioner began studying the situation in Ventura County, especially the area of Thousand Oaks. In 1959 plans relative to future competition were discussed. The Janss Corp. was developing an industrial park in this area, and population increases up to 70,000 by the year 1980 were anticipated. No formal written plans were developed by petitioner until the year 1960, even though petitioner was aware that it had this area to protect.To maintain its competitive position in the industry and in carrying out its prior plan, in 1961 petitioner purchased 74 the Conejo News, in Thousand Oaks, for $ 35,000. However, the publishing facilities of this newspaper were wholly inadequate, and they were disposed of for half their cost. Petitioner found it necessary to acquire property in Thousand Oaks for the location of a new plant to operate the paper it had purchased. The cost of such new plant was $ 455,000. Petitioner anticipated spending approximately $ 500,000 as part of its plan to acquire a newspaper in Thousand Oaks. Through 1963 petitioner was able to finance its operation in Thousand Oaks out of retained earnings. However, in 1964 to continue the operation there it was necessary for petitioner to borrow $ 300,000.As of December 31, 1959, there were in effect four profit-sharing and increment agreements which petitioner had entered into with its following employees:Harry Green, general business manager, born Jan. 14, 1904. Irve C. Boldman, legal counsel and member of executive committee, born Feb. 11, 1896.458 J. L. McNally, treasurer and member of executive committee, born Apr. 14, 1905.Harry O. Bostwick, business manager, born June 22, 1908.An epitome of the terms of the agreements between petitioner and McNally is as follows:Profit-Sharing 75 Agreement.(1) Petitioner obligates itself to pay a "bonus" to McNally equal to 5 percent of the net profits of Star-Free Press in excess of $ 21,000, plus 6 percent per annum on any new capital investment made by petitioner over and above the depreciation reserve accumulated since July 1, 1945.(2) Net profits of Star-Free Press in substance are determined by subtracting from gross profits all expenses, such as rent, depreciation, taxes, wages, losses, etc., and all amounts disbursed for replacements of equipment and liquidation of petitioner's debts.(3) Upon ascertaining the amount of the bonus, and after withholding tax has been deducted, 75 percent of the remainder is paid to the employee on request; the other 25 percent is retained by petitioner for the employee until $ 25,000 has been accumulated. Thereafter, all of the bonus is paid to the employee on request.(4) The retained amounts draw interest at the rate of 6 percent per annum and interest is paid to the employee annually.(5) The agreement is terminable at the will of either party.(6) Any amounts retained by petitioner for an employee may be paid in a lump sum or in five equal annual installments, with interest at 6 percent 76 per annum on any unpaid balance.Increment Agreement.(1) If at the date of termination of employment or of the agreement Star-Free Press has increased in value over its value as of January 1, 1950, the employee shall receive credit for 5 percent of the increase; conversely, if the value during the same interval has decreased, 5 percent of the decrease shall be deducted from the balance due the employee under the profit-sharing agreement.(2) The fixed assets used in the publication of the said newspaper, including additional capital investment in excess of the accumulated depreciation reserve since January 1, 1950, and goodwill value shall be the only items considered in determining increase or decrease in value.(3) The same factors existing as of January 1, 1950, shall be considered with the factors existing at the date of termination of the agreement (except in the case of Harry Green, the beginning base value is agreed to be $ 350,000), so that actual difference in value of the newspaper property is determined for settlement purposes.(4) Disputes arising under the "increment" section are to be settled by arbitration.459 The following data summarize variations in the agreements referred 77 to above with respect to covered employees:Employee and agePercent ofPercentBase amountBeginningPercent oat Dec. 31, 1959net profitsretainedaccumulatedincrementincreasevalueGreen (55)10 percent1 75$ 35,000$ 350,00010Boldman (63)5 percent2525,000To be5over $ 21,000determinedMcNally (54)5 percent2525,000To be5over $ 21,000determinedBostwick (51)10 percent2550,000To beover $ 21,300determined10The avowed purpose of each of these agreements is to reward the employee for his services to petitioner.In November 1956 petitioner's executive committee passed the following resolution:Resolved that the Treasurer of this Corporation be, and he is hereby, authorized and directed to set up on the books of this Corporation a reserve account in the amount of $ 200,000 from the Corporation's earned surplus to provide for the Corporation's liability under said profit-sharing agreements.On December 7, 1959, after giving additional consideration to the continued growth of petitioner and its increased liability under the profit-sharing plans, the executive committee passed the following resolution:Resolved that the Treasurer of this Corporation78 be, and he is hereby, authorized and directed to increase the reserve account from $ 200,000.00 to $ 350,000.00 from the Corporation's earned surplus to provide for the Corporation's liability under its profit-sharing agreements.The amount of the reserve set up on the books of account in anticipation of future liabilities arising under the increment agreements was determined by the executive committee, in part, as follows: Current profits were reviewed; historical growth of Star-Free Press, including the increase in circulation, was considered; and the fact that the newspaper had consistently produced substantial net earnings after taxes was a major factor.From this data, and with an awareness that certain employees might be considering retirement in the next few years, amounts (the total of which equaled $ 350,000) were on two occasions set up on the books of account as reservations of earned surplus. The executive committee was of the opinion that the reserve was on the low side, but nevertheless reasonable.Petitioner's books and records show the following liabilities under the aforementioned profit-sharing and increment agreements:As of Dec. 31 --195719581959Liability under profit-sharing agreements$ 72,471.50$ 80,536.50$ 87,934.79Liability under increment agreements200,000.00200,000.00350,000.00Total272,471.50280,536.50437,934.79460 79 Petitioner's liability under the profit-sharing agreements is subject to exact calculation as of any date, and the amounts shown above are exact with respect to such liability. However, the determination of the exact liability under the increment agreements cannot be made prior to the termination of employment of all of the covered employees.Telegram Tribune Co., referred to earlier as a corporation in which Scripps has a controlling interest, retired an employee in 1962. Under a profit-sharing and increment agreement similar to those discussed above, this employee is being paid approximately $ 40,000 over a 5-year period.Petitioner's balance sheets for the taxable years 1957 through 1959 disclose the following:Dec. 31 --195719581959ASSETSCash on hand and in bank$ 191,375.16$ 149,999.84$ 254,261.67Accounts receivable (net)115,784.97120,457.31141,203.00Notes receivable50,000.0074,000.00U.S. Treasury bonds69,723.4430,000.0030,000.00Inventories44,352.1641,215.1351,232.64Depreciable assets (net)234,199.18329,554.31316,963.16Land71,407.7678,347.7678,347.76Investments40,024.0045,824.00Prepaid expenses4,545.515,537.185,201.70Suspense account10,000.005,000.005,368.75Organization expense598.79598.79598.79Goodwill (purchased)34,827.1734,827.1734,827.17Total Assets776,814.14885,561.491,037,828.64LIABILITIES AND NET WORTHAccounts payable (current)14,097.6323,288.6128,170.50Notes payable56,000.0056,000.0056,000.00Accrued taxes124,436.27127,045.79148,575.11Accrued payroll2,790.544,823.247,181.40Employee trust funds9,367.4711,900.0613,600.51Notes payable (employees'72,471.5080,536.5087,934.79profit-sharing)Reserve for liability under employees'profit-sharing agreements200,000.00200,000.00350,000.00Deferred income3,465.103,112.953,101.24Capital stock1,600.001,600.001,600.00Paid-in surplus98,630.8098,630.8098,630.80Earned surplus193,954.83278,623.54243,034.29Total liabilities and net worth776,814.14885,561.491,037,828.6480 Accounts receivable of petitioner, consisting primarily of advertising accounts, turned over approximately 10 times per year.An analysis of the account "Notes receivable" appearing on petitioner's balance sheets as of December 31, 1958, and December 31, 1959, is as follows:Dec. 31,Dec. 31,19581959Telegram Tribune Co.:Note dated July 10, 1958, in the principal sum of $ 50,000,payable on or before 60 days from date, with interest atrate of 6 percent per annum on unpaid principal balance$ 50,000$ 50,000Tulare Newspapers, Inc.:5 notes, 4 in the principal sum of $ 5,000 each, and 1 inthe principal sum of $ 4,000; each dated June 15, 1959,payable on or before 10 years from date and bearinginterest at 6 percent per annum on the unpaid principalbalance24,000Totals50,00074,000461 As stated earlier, during the years in issue Scripps owned 81 percent of the outstanding capital stock of Telegram Tribune Co., and 80 percent of the outstanding capital stock of Tulare Newspapers, Inc. When funds are available in any of the corporations "owned" wholly or in part by Scripps and there exists a need for funds in another of the "owned" corporations, the funds are loaned to the other "owned" corporation 81 at 6-percent-per-annum interest, normally on a short-term basis. This arrangement is reciprocal among the corporations, and avoids where possible the use of bank loans. These types of loans are never used on a permanent basis. For long-term loans, resort is had to banks. Petitioner did not during the years in issue make any loans to Scripps. On the contrary, Scripps has loaned petitioner money as discussed infra.An analysis of the account "U.S. Treasury bonds," appearing on petitioner's balance sheets as of December 31, 1957, 1958, and 1959, is as follows:Dec. 31 --1957195819592 1/2-percent bonds of 1964/69, acquired$ 10,000.00$ 10,000$ 10,000April 26, 19432 1/4-percent bonds of 1956/59, acquiredJanuary 29, 1944n1 10,000.002 1/4-percent bonds of 1956/59, acquiredDecember 27, 19521 29,723.442 1/2-percent bonds of November 1961, acquiredFebruary 15, 195420,000.0020,00020,000Totals69,723.4430,00030,000An analysis of the account "Investments," appearing on petitioner's balance sheets as of December 31, 1958 and 1959, is as follows:Dec. 31, 1958Dec. 31, 1959400 shares of 5-percent preferred stock of E. W.Scripps Co$ 40,024.00458 shares of 5-percent preferred stock of E. W.Scripps Co$ 45,824.00Under 82 the profit-sharing plans between petitioner and its key employees discussed supra, and with their consent, petitioner has retained each year a portion of profits due the employees, paying each employee interest at the rate of 6 percent per annum on the amount retained. Each employee reported his share of the profits as additional compensation for that year, even though retained by petitioner. The purpose of the retention was to provide the employees with security upon retirement.To compensate for the 6-percent interest petitioner was paying these employees, it invested a portion of the retained funds in E. W. Scripps Co. preferred stock. This stock was known to have a ready market 462 and provided a fair return on the investment. Petitioner did not have any investments in unrelated businesses.An analysis of the account "Suspense account," appearing on petitioner's balance sheets as of December 31, 1957, 1958, and 1959, is as follows: Dec. 31 --195719581959Adella M. Dunning -- 10-year option to purchasereal property -- exercised June 30, 1962$ 5,000$ 5,000$ 5,000.00William H. Glover -- option to purchase realproperty -- exercised 19585,000Sta-Hi Corp. -- deposit on equipment for future368.75deliveryTotals10,0005,0005,368.75An 83 analysis of the account "Notes payable," appearing on petitioner's balance sheets as of December 31, 1957, 1958, and 1959, is as follows:FaceUnpaidDate of notePayeeamountprincipalamountDec. 31, 1943Scripps$ 44,000$ 40,000Dec. 31, 1943Scripps3,0003,000Jan. 1, 1944Scripps3,0003,000Jan. 1, 1944Scripps2,0002,000Jan. 1, 1945Scripps3,0003,000Dec. 31, 1957L. D. Coons5,0005,00060,00056,000Each of the foregoing notes bears interest at the rate of 6 percent per annum on the unpaid principal balance. The $ 44,000 note payable to Scripps is payable on or before 35 years from its date. Each of the other notes payable to Scripps is payable on or before 34 years from its date. The L. D. Coons note is payable on or before 60 days after written demand. The purpose of the loan from Coons, an employee of petitioner, was to give him a fair return and retirement security similar to the situation with the other key employees. Coons was given the opportunity to leave money with petitioner which would earn 6-percent interest and be paid back at his retirement. For this reason the loan is considered a long-term liability.The account "Accrued taxes" appearing on petitioner's balance sheets for the years 84 in issue consists of Federal income taxes accrued on prior years' profits, accrued payroll taxes, and Federal taxes withheld from employees' wages but not paid over at the end of the year. All amounts in the account were payable within 12 months and are classified as current liabilities.463 Based on the foregoing classifications, the net working capital for the years in issue is as follows:Dec. 31 --195719581959Current assets:Cash on hand and in bank$ 191,375.16$ 149,999.84$ 254,261.67Accounts receivable (net)115,784.97120,457.31141,203.00Notes receivable50,000.0050,000.00U.S. Treasury bonds69,723.4430,000.0030,000.00Inventories44,352.1641,215.1351,232.64Prepaid expenses4,545.515,537.185,201.70Total current assets425,781.24397,209.46531,899.01Less: Current liabilities:Accounts payable (current)14,097.6323,288.6128,170.50Accrued taxes124,436.27127,045.79148,575.11Accrued payroll2,790.544,823.247,181.40Employee trust funds9,367.4711,900.0613,600.51Total current liabilities150,691.91167,057.70197,527.52Net working capital275,090.33230,151.76334,371.49 The ratio of current assets to current liabilities as of the three balance sheet dates is as follows:Dec. 31, 19572.83 to 1Dec. 31, 19582.38 to 1Dec. 31, 19592.69 to 1Petitioner's 85 operating expenses (excluding depreciation) required an outlay of funds in the years at issue as follows:1957$ 882,316.601958942,532.6419591,049,341.77The accumulated earnings of petitioner were as follows for the stated years:TYEAccumulatedDec. 31 --earnings 11955$ 234,311.721956315,824.091957393,954.831958478,623.541959593,034.29Petitioner paid the following salary to Scripps during the years in issue:YearAmount 11957$ 40,950.12195841,655.80195942,613.15464 Had petitioner distributed all of its accumulated taxable income for the taxable years 1957, 1958, and 1959, and had Bremerton Sun Publishing Co., a corporation owned 100 percent by Scripps, distributed all of its accumulated taxable income for the taxable years 1957, 1958, and 1959, Scripps would have been required to pay the following additional Federal income taxes:YearAmount1957$ 102,393.601958108,631.261959118,443.27Scripps is a grandson of the late E. 86 W. Scripps, and the E. W. Scripps Co. newspapers are operated in the East by cousins of Scripps. Except as stated, there is no other connection or relation between petitioner and E. W. Scripps Co.Respondent, in accordance with section 534(b), sent petitioner notice that he intended to issue a deficiency notice for the years 1957, 1958, and 1959 based on section 531. Petitioner, in accordance with section 534(c), sent respondent a statement setting forth its grounds upon which it relies to establish that its retained earnings for the years in issue were not permitted to accumulate beyond the reasonable needs of its business.The grounds relied upon by petitioner in its statement were as follows: The accumulations of earnings and profits by petitioner during the calendar years 1957, 1958, and 1959 were necessary --(1) To provide for expansion of its plant and facilities; (2) To provide for reserves to meet competition;(3) To meet the deferred liabilities arising out of profit-sharing and increment agreements covering its key employees; and(4) To provide needed working capital.(5) No 87 portion of the petitioner's earnings and profits has been loaned to or for the benefit of its shareholders.(6) No portion of petitioner's earnings and profits has been invested in a business unrelated to that of petitioner.(7) Petitioner paid substantial dividends during the calendar years 1957, 1958, and 1959.The statement sets forth facts sufficient (except as to the second ground) to show the basis of the grounds relied upon.OPINIONRespondent determined deficiencies in petitioner's income tax for the taxable years 1957, 1958, and 1959 under section 531289 in that petitioner 465 was availed of for the purpose of avoiding the income tax with respect to its shareholders by permitting its earnings and profits to be accumulated instead of being distributed as a dividend. 3 Under the present statutory provisions dealing with the accumulated earnings tax, unless petitioner can prove to the contrary by a preponderance of the evidence, the very fact that its earnings and profits were permitted to accumulate beyond the reasonable needs of its business is determinative of the proscribed purpose. 4 However, to the extent petitioner can establish that it retained all or any part of its earnings 88 and profits to meet the reasonable needs of its business, such amount will be allowed as a credit against its accumulated taxable income, subject to the accumulated earnings tax. 590 It thus becomes necessary to consider whether petitioner's earnings and profits were, during the years in issue, accumulated beyond the reasonable needs of its business. Included within this question is the necessity of determining to what extent the earnings and profits were accumulated for the reasonable needs of the business so as to give proper consideration to the credit. Motor Fuel Carriers, Inc. v. United States, 322 F. 2d 576, 580 (C.A. 5, 1963). Pursuant to section 537, the term "reasonable needs of the business" includes the reasonably anticipated needs of the business. In connection with his determination, respondent sent to petitioner a notice of his intention to issue a notice of deficiency imposing the 466 accumulated earning tax. 691 92 In response to such notification, petitioner sent to respondent a statement setting forth the grounds upon which it relies to show that the accumulations of its earnings and profits were for the reasonable needs of its business. 7Respondent takes the position that the statement submitted by petitioner was too vague and too broad to place the burden of proof as to the reasonable needs of the business on respondent. Petitioner, on the other hand, argues that the facts contained in the statement are sufficient to support the grounds stated. We partially agree with petitioner.We have carefully read the statement submitted by petitioner and after giving full consideration to the argument of respondent we are of the opinion that the statement (except as to the second ground) "does suffice to meet the general purpose and intent of the statute, and thereby to shift the 93 burden of proof to the respondent with respect to the grounds alleged therein." Electric Regulator Corporation, 40 T.C. 757">40 T.C. 757, 764 (1963), reversed on other grounds 336 F. 2d 339 (C.A. 2, 1964); Factories Investment Corporation, 39 T.C. 908">39 T.C. 908, 915 (1963), affd. 328 F. 2d 781 (C.A. 2, 1964). The allegations contained in the statement state grounds which, if true, would support a finding that the accumulation of petitioner's earnings and profits was for the reasonable needs of its business. See sec. 1.537-2 (b) and (c), Income Tax Regs.8467 Whether a corporation has permitted its earnings and profits to accumulate beyond its reasonable needs and whether it was 94 availed of for the purpose of avoiding the income tax with respect to its shareholders are both questions of fact. Helvering v. Nat. Grocery Co., 304 U.S. 282">304 U.S. 282 (1938); James M. Pierce Corporation, 38 T.C. 643">38 T.C. 643 (1962), reversed on another issue 326 F. 2d 67 (C.A. 8, 1964). In determining whether petitioner's accumulations of earnings and profits during the years in issue were for the reasonable needs of its business, it becomes necessary to determine whether prior accumulations were, in fact, sufficient to meet petitioner's needs during the current years. Sec. 1.535-3(b)(1)(ii), Income Tax Regs. However, in making the comparison of prior accumulations and current retained earnings and profits with the reasonable needs of the business, it becomes necessary to determine the nature of the surplus. The mere size of the previously accumulated earnings and profits is not in and of itself indicative that they were sufficient to cover the future needs of the business. As was stated by the Court of Appeals for the Fourth Circuit in Smoot Sand & Gravel Corporation v. Commissioner, 274 F.2d 495">274 F. 2d 495, 500-501 (1960), affirming a Memorandum Opinion of this Court, certiorari denied 362 U.S. 976">362 U.S. 976 (1960):the 95 size of the accumulated earnings and profits or surplus is not the crucial factor; rather, it is the reasonableness and nature of the surplus. Part of the surplus may be justifiably earmarked in the form of reserves, for specific, necessary business needs. n3 Again to the extent the surplus has been translated into plant expansion, increased receivables, enlarged inventories, or other assets related to it business, the corporation may accumulate surplus with impunity. * * [Footnote omitted.]It therefore follows that the utilization of working capital by a business for the purchase of fixed assets, although not an occasion for a charge against earned surplus in an accounting sense, does in fact decrease the amount of funds available for operating purposes. On the other hand, if the accumulation of surplus is reflected in liquid assets which are sufficient to meet the business needs for plant expansion, working capital, and other reasonable contingencies, this is a strong indication that the accumulations of surplus were beyond the reasonable needs of the business. Smoot Sand & Gravel Corporation v. Commissioner, supra at 501.We therefore approach the examination of petitioner's 96 prior accumulated surplus (Dec. 31, 1956) as well as its current retained earnings and profits with the foregoing principles in mind. In determining the reasonableness of petitioner's retained earnings during the years in issue, we must keep in mind also that the burden of proof with regard to the various grounds set forth in petitioner's statement (except as to the second ground) is on respondent. Petitioner's statement can be broken into two parts. The first part contains four 468 grounds to show that the accumulations of earnings and profits were for the reasonable needs of the business. The second part contains three grounds showing why the accumulations were not beyond the reasonable needs of its business.We have stated before that what the reasonable needs of a business are is, at first instance, a question for the officers and directors of the corporation. Crawford County Printing & Publishing Co., 17 T.C. 1404">17 T.C. 1404, 1414 (1952). A corporation can finance its growth by various means. One such method is the retention of its earnings and profits until such time as it is ready to expand. Crawford County Printing & Publishing Co., supra.Courts should be hesitant to substitute their 97 judgment and attribute a tax-avoidance motive unless the facts and circumstances clearly warrant the conclusion that the accumulation of earnings and profits was unreasonable and for the proscribed purpose. Breitfeller Sales, Inc., 28 T.C. 1164">28 T.C. 1164, 1168 (1957).Petitioner maintains, and we agree, that its officers and directors, after considering the needs of the business for expansion, meeting competition and reserves for contingent liabilities, and working capital, decided to distribute a portion of its current earnings while retaining the rest. This decision by the directors of petitioner, in our opinion, reflects appropriate exercise of the managerial function when measured by the standards of a prudent businessman. J. L. Goodman Furniture Co., 11 T.C. 530">11 T.C. 530, 536 (1948). We have set forth the facts in this case with great detail. An examination of those facts reveals that petitioner has not remained static, but, on the contrary, has grown from a newspaper with a circulation of 5,042 in 1940 to a circulation of 23,804 in 1960. Its total revenues have grown from $ 140,994 in 1940 to $ 1,369,725.72 in 1959, while its net income has increased from $ 28,234.30 in 1945 to $ 304,759.30 98 in 1959. Petitioner has not allowed its earnings to lie idle but, instead, has plowed back its earnings for the expansion of its business as well as for the acquiring of larger facilities. From 1950 through and including 1959, petitioner has invested $ 570,674.89 in additions to its property account, of which $ 232,432.62 was invested during the years in issue. The fact that this petitioner has financed its growth from retained earnings rather than from the sale of additional stock or commercial borrowing should not place it in a position of being subjected to a penalty tax under section 531. This record is replete with evidence indicating that petitioner's policy of continued growth and expansion has been followed without giving any thought whatsoever to the tax consideration of its shareholders. Crawford County Printing & Publishing Co., supra.In 1962, a year subsequent to the years in issue, petitioner, continuing its policy of expansion, spent approximately $ 170,000 for the purchase of building addition, typesetting machines, 469 and additions to its printing presses. Included within this amount is the sum of $ 40,000 representing the purchase of the premises petitioner had 99 rented since 1940. Evidence of what petitioner did in later years does affect the weight to be given to the evidence of petitioner's intentions during the years in issue. Dixie, Inc., 31 T.C. 415">31 T.C. 415, 430 (1958), affd. 277 F. 2d 526 (C.A. 2, 1960), certiorari denied 364 U.S. 827">364 U.S. 827 (1960); sec. 1.537-1(b) (2), Income Tax Regs.We realize that petitioner's directors act in a rather informal manner and that their plans for expansion might not be as specific as desired nor are all their plans reduced to writing and contained in formal minutes. However, the history of petitioner has been to act in an informal manner. The executive committee, which is the core of petitioner's management, meets daily and when necessary can act with deliberate speed. A closely held corporation cannot be held to the same strict formalities of large public corporations. Times Publishing Co. v.United States, an unreported case ( W.D. Pa. 1963, 11 A.F.T.R.2d (RIA) 1228">11 A.F.T.R. 2d 1228, 63-1, U.S.T.C. par. 9325); Duke Laboratories, Inc. v. United States, 222 F. Supp. 400">222 F. Supp. 400, 412 (D. Conn. 1963), affd. 337 F. 2d 280 (C.A. 2, 1964). We have found as a fact that petitioner did not have any formal plans for expansion after 1958. However, 100 by this finding we do mean that petitioner would not be justified in retaining part of its earnings for future expansion. Nor do we mean by this finding that petitioner did not have any plans for expansion subsequent to 1958. As stated earlier, petitioner's entire history reflects a policy of constant growth. It is not always possible for a company in advance to set aside a specific sum to achieve a specific goal. We are of the opinion that petitioner was justified upon the facts of this case and in keeping with its policy of constant and continuous expansion in retaining some of its earnings during the years in issue for future expansion. Gazette Pub. Co. v. Self, 103 F. Supp. 779">103 F. Supp. 779 (E.D. Ark. 1952); Crawford County Printing & Publishing Co., supra;F. E. Watkins Motor Co., 31 T.C. 288">31 T.C. 288 (1958).Although petitioner published the only daily newspaper in Ventura City, it was not the only daily paper published within the county. It is important to petitioner to keep its circulation up throughout the county as its advertisers want to reach as large a public as possible. Petitioner did have competition from at least two other papers publishing within Ventura County. During 1959, the 101 last year here in issue, petitioner began discussing plans for the acquiring of a newspaper in Thousand Oaks, another city in Ventura County. Formal plans were not adopted until 1960; however, the evidence of record is clear that petitioner during 1959 was aware of the situation and decided to retain some of its earnings to meet this competition. In 1961 petitioner did, in fact, pursuant to its plan, purchase a paper in 470 Thousand Oaks at an initial cost of $ 35,000. However, this was only a small portion of what was yet to come. Petitioner had anticipated that its cost in establishing the Thousand Oaks paper would run in the neighborhood of $ 500,000. A new plant addition for this newly acquired paper cost $ 455,000. Respondent recognizes that setting aside a portion of earnings to meet competition is a reasonable need of a business, but nevertheless argues that petitioner's plans during the years in issue were vague and indefinite. We disagree. Two of petitioner's directors testified that the question of how to properly meet the threat of competition was always a concern of petitioner and that throughout the years in issue petitioner was aware of the need of funds to properly 102 protect itself in other parts of the county. What we said in L. R. Teeple Co., 47 B.T.A. 270">47 B.T.A. 270, 279 (1942), is equally pertinent here:While it is true that petitioner has continuously and profitably operated * * * and there is no indication that it intends voluntarily to make any change in its business, it is also true that the contingencies in question are real, they are and have been continuously present, and the exercise of sound business judgment would not permit their being ignored. * * We are satisfied that sound business judgment required the consideration of ways to meet competition, that petitioner did have competition, and that the retention of part of petitioner's earnings for this purpose was not unreasonable. James M. Pierce Corporation, supra at 654. Although the facts contained in petitioner's statement regarding this ground were not sufficient to place the burden of proof on respondent, the affirmative evidence of record does convince us that petitioner has met its burden as to this ground.Continuing with petitioner's statement, it is asserted that earnings were retained to meet the increasing contingent liability petitioner had under its profit-sharing and retirement 103 plans. The details of said plans are set forth in our Findings of Fact. Suffice to say here that respondent's contention that because the liability was too remote and not capable of being calculated it could not justify the accumulation of surplus, is rejected. The retirement portion of the plan provided for the covered employees to receive, upon their retirement, a certain percentage of the increased value of petitioner's assets (fixed assets and goodwill) from their value as of 1950 to the date of retirement. We have set forth in our Findings of Fact the financial growth of petitioner. Not only have its annual earnings grown but its total assets have greatly increased. It is true, as respondent states, that if the future of petitioner turns sour, its liability under the retirement plans may be diminished. However, in light of the history of petitioner we are in complete agreement with the directors' action of setting up a reserve to meet this contingent liability. Sound business 471 judgment requires such action. The original reserve was $ 200,000 set up in 1956. However, in 1959, after examining the financial prospects of petitioner, it was decided by the directors that a 104 reserve of $ 350,000 was more reasonable.We agree that "a contingency is a reasonable need for which a business may provide, if the likelihood, not merely the remote possibility, of its occurrence reasonably appears to a prudent business firm." Smoot Sand & Gravel Corp. v. Commissioner, 241 F.2d 197">241 F. 2d 197, 206 (C.A. 4, 1957), reversing and remanding a Memorandum Opinion of this Court, certiorari denied 354 U.S. 922">354 U.S. 922 (1957). The liability under the facts in this case was contingent only as to the amount, not as to the actual liability. No management group would ignore the existence of such a liability, and the setting aside of a reserve out of accumulated surplus for such purpose was entirely proper. The growth of petitioner over the years clearly indicates the presence of goodwill, one of the measuring rods in determining the value of petitioner for purposes of the retirement plan. The goodwill, plus the increased investment in fixed assets, in our opinion, clearly justifies the reserve in the amount set aside. See Lion Clothing Co., 8 T.C. 1181">8 T.C. 1181, 1189 (1947); William C. Atwater & Co., 10 T.C. 218">10 T.C. 218, 251 (1948).Petitioner's last ground for the accumulation of its surplus was to provide 105 funds for working capital. The retention of earnings to provide for working capital requirements has been held to be for the reasonable needs of a business. Sec. 1.537-2(b)(4), Income Tax Regs.; J. L. Goodman Furniture Co., supra.As an aid in determining whether a corporation's working capital requirements are sufficient to meet its needs, resort has been had to certain general rules of thumb. It has been held that a ratio of current assets to current liabilities which is in the neighborhood of 2 1/2 to 1 is an indication of a reasonable accumulation of surplus. Cf. R. C. Tway Coal Sales Co. v. United States, 3 F. Supp. 668">3 F. Supp. 668 (W.D. Ky. 1933), affd. 75 F. 2d 336 (C.A. 6, 1935); Sandy Estate Co., 43 T.C. 361 (1964); Sterling Distributors, Inc. v. United States, 313 F. 2d 803 (C.A. 5, 1963); Breitfeller Sales, Inc., supra;James M. Pierce Corporation, supra.The other rule of thumb sometimes resorted to states that an accumulation of earnings to meet operating expenses for at least 1 year is reasonable. F. E. Watkins Motor Co., supra;J. L. Goodman Furniture Co., supra;James M. Pierce Corporation, supra.However, it has been said that working capital requirements of one business 106 are not necessarily the same as another business and that therefore the rule of thumb should not be given any greater weight than a rule of administrative convenience. Dixie, Inc. v. Commissioner, 277 F. 2d 526 (C.A. 2, 1960), affirming 31 T.C. 415">31 T.C. 415 (1958), certiorari denied 364 U.S. 827">364 U.S. 827 (1960); Barrow Manufacturing Co. v. Commissioner, 294 F. 2d 79 (C.A. 5, 1961), 472 affirming a Memorandum Opinion of this Court, certiorari denied 369 U.S. 817">369 U.S. 817 (1962). With the above general principles in mind, we will analyze petitioner's working capital requirements for the years in issue.We have set forth in our Findings of Fact petitioner's balance sheets for the years in issue, as well as its operating expenses (excluding depreciation) and its accumulated surplus. Respondent argues that petitioner's investments in preferred stock of E. W. Scripps Co. should be considered a current asset. While we agree that the preferred stock was readily convertible into cash, we do not agree that it should be considered a current asset in this case. Petitioner purchased the stock in order to provide a return equal to the return it was required to pay the employees covered by its profit-sharing plan. At the same 107 time, petitioner intended to partially "fund" its fixed liability under the profit-sharing plan. An asset used to fund a fixed liability can no longer be considered as a current asset. 9 For this reason we have not classified the investment in the preferred stock as a current asset. An analysis of petitioner's balance sheets reveals that the ratio of current assets to current liabilities for the years in issue, as set forth in our findings, averaged 2.63 to 1. This is some indication that the accumulation of petitioner's surplus was not unreasonable. Sandy Estate Co., supra;Sterling Distributors, Inc. v. United States, supra;Breitfeller Sales, Inc., supra;James M. Pierce Corporation, supra. Petitioner's operating expenses during the years in issue ranged from $ 882,316.60 in 1957 to $ 1,049,341.77 in 1959. If we were to apply the rule of thumb in this case, clearly petitioner's accumulated surplus would not be unreasonable. Respondent contends, 108 however, that resort to the rule of thumb in this case is unwarranted because petitioner's accounts receivable turned over approximately 10 times a year. Nevertheless, we believe that the rule of thumb does carry some weight in this case where the surplus is less than two-thirds of the annual operating costs. Sterling Distributors, Inc. v. United States, supra at 808; James M. Pierce Corporation, supra.The second part of petitioner's statement lists three grounds which are claimed to give additional support to the position that the accumulations of earnings and profits during the years in issue were not unreasonable. They are, stated briefly, (1) a history of substantial dividend payments, (2) no loans to stockholders, and (3) no investments in unrelated businesses.While these factors are strong indications that the accumulations were not for the proscribed purpose, sec. 1.533-1(a)(2), Income Tax Regs., they are also of some aid in determining whether or not the 473 accumulations were for the reasonable needs of the business. There is no doubt that a good history of dividends, the absence of loans to the controlling stockholders, the absence of investments in unrelated businesses, 109 and the paying of large salaries to the controlling stockholders indicate that the accumulations of earnings and profits were for legitimate business needs. James M. Pierce Corporation, supra;Gazette Pub. Co. v. Self, supra.A close examination and comparison of petitioner's contentions with regard to these grounds with the evidence of record reveal that they are readily present here. Petitioner has a history of dividends being paid starting in 1943 and continuing up to and including the years in issue. The record reveals that the amount of petitioner's dividends, expressed in terms of a percentage of net earnings after Federal taxes, was as high as 107 percent but never below 25 percent. Respondent points to the fact that although petitioner's earnings have increased over the years, its dividends since 1950 have remained constant at $ 38,400 per year. While this may be true, petitioner itself has not remained constant but has used its increased earnings to expand its operations. It was through the retention of these very earnings that petitioner was able to expand and thereby consistently increase its annual earnings. Petitioner, in our opinion, acted like a prudent businessman 110 in that it distributed a substantial part of its earnings as a dividend and elected to retain the remainder. James M. Pierce Corporation, supra.Petitioner did not make any loans to Scripps. On the contrary, Scripps on different occasions loaned the petitioner money. This is in petitioner's favor. Cf. Dill Manufacturing Co., 39 B.T.A. 1023">39 B.T.A. 1023, 1033 (1939). Furthermore, petitioner did not have any investments in unrelated businesses. The purchase of E. W. Scripps Co. stock, which was readily convertible into cash, was not an investment in an unrelated business but the investing of money retained under its profit-sharing plan which was intended as a partial "funding" of its liability thereunder. In addition, the purchasing and carrying of U.S. Government bonds by petitioner which are readily convertible into cash do not represent an investment in an unrelated business. Crawford County Printing & Publishing Co., supra at 1414; Sandy Estate Co., supra at 378.Respondent argues that the loan by petitioner to Telegram Tribune Co. and Tulare Newspapers, Inc., two corporations controlled by Scripps, indicates that petitioner had excess cash which could have been distributed instead, as 111 a dividend. While the business of these two corporations cannot be said to be the business of petitioner, they are all in the same field (newspapers). The loans made by petitioner are for relatively short terms only and are never used for long-term financing. The loans carry 6-percent interest. Under the facts and 474 circumstances of this case, we are not convinced that these loans require a holding that the accumulations during the years in issue were beyond the reasonable needs of the business. 10 We have already held that petitioner's statement was sufficient to place the burden of proof as to the reasonableness of the accumulations during the years in issue on respondent with respect to the grounds stated therein (except as to the second ground). Based upon the evidence as a whole, we are not convinced that petitioner's accumulations during the 112 years at issue were unreasonable. Although respondent has been able to show that as to at least one of petitioner's grounds, plant expansion, there were no definite plans in existence subsequent to 1958, we are not persuaded that the total accumulations are unreasonable. We are satisfied that petitioner's directors, acting for the best interest of petitioner, decided after full discussion that the retention of a certain part of each year's earnings was necessary to meet competition, meet contingent liabilities, and for working capital. The remainder of the earnings was available and was actually paid out as dividends. Accordingly, we hold that all of the retained earnings during the years in issue were for the reasonable needs of petitioner's business.In view of the credit provided for in section 535(c)(1), it is unnecessary for us to consider whether or not petitioner was availed of for the proscribed purpose. We realize that the burden of proof as to this issue remains with petitioner. Sandy Estate Co., supra.However, even if petitioner were availed of for the proscribed purpose, it would still be entitled to a credit equal to the amount of earnings and profits for the taxable 113 years which has been retained for the reasonable needs of the business. In this case the credit would be equal to the full amount of the retained earnings. Therefore, under section 535(a) the accumulated taxable income, on which the section 531 tax is imposed, would be zero.Decision will be entered for the petitioner. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended.↩1. Changed by oral agreement to 25 percent during the years in issue.↩1. Called for redemption September 15, 1958.↩1. Included is the reserve for liability under profit-sharing agreements.↩1. A part of this salary was charged by petitioner to various other corporations in which Scripps held a controlling interest. The record does not set forth the exact amount which petitioner is charged with.↩2. SEC. 531. IMPOSITION OF ACCUMULATED EARNINGS TAX.In addition to other taxes imposed by this chapter, there is hereby imposed for each taxable year on the accumulated taxable income (as defined in section 535) of every corporation described in section 532, an accumulated earnings tax equal to the sum of -- (1) 27 1/2 percent of the accumulated taxable income not in excess of $ 100,000, plus(2) 38 1/2 percent of the accumulated taxable income in excess of $ 100,000.3. SEC. 532. CORPORATIONS SUBJECT TO ACCUMULATED EARNINGS TAX.(a) General Rule. -- The accumulated earnings tax imposed by section 531↩ shall apply to every corporation (other than those described in subsection (b)) formed or availed of for the purpose of avoiding the income tax with respect to its shareholders or the shareholders of any other corporation, by permitting earnings and profits to accumulate instead of being divided or distributed.4. SEC. 533. EVIDENCE OF PURPOSE TO AVOID INCOME TAX.(a) Unreasonable Accumulation Determinative of Purpose. -- For purposes of section 532↩, the fact that the earnings and profits of a corporation are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid the income tax with respect to shareholders, unless the corporation by the preponderance of the evidence shall prove to the contrary.5. SEC. 535. ACCUMULATED TAXABLE INCOME.(a) Definition. -- For purposes of this subtitle, the term "accumulated taxable income" means the taxable income, adjusted in the manner provided in subsection (b), minus the sum of the dividends paid deduction (as defined in section 561) and the accumulated earnings credit (as defined in subsection (c)).* * * (c) Accumulated Earnings Credit. -- (1) General rule. -- For purposes of subsection (a), in the case of a corporation other than a mere holding or investment company the accumulated earnings credit is (A) an amount equal to such part of the earnings and profits for the taxable year as are retained for the reasonable needs of the business, minus (B) the deduction allowed by subsection (b) (6). For purposes of this paragraph, the amount of the earnings and profits for the taxable year which are retained is the amount by which the earnings and profits for the taxable year exceed the dividends paid deduction (as defined in section 561↩) for such year.6. SEC. 534. BURDEN OF PROOF.(a) General Rule. -- In any proceeding before the Tax Court involving a notice of deficiency based in whole or in part on the allegation that all or any part of the earnings and profits have been permitted to accumulate beyond the reasonable needs of the business, the burden of proof with respect to such allegation shall -- (1) if notification has not been sent in accordance with subsection (b), be on the Secretary or his delegate, or(2) if the taxpayer has submitted the statement described in subsection (c), be on the Secretary or his delegate with respect to the grounds set forth in such statement in accordance with the provisions of such subsection.(b) Notification by Secretary. -- Before mailing the notice of deficiency referred to in subsection (a), the Secretary or his delegate may send by certified mail or registered mail a notification informing the taxpayer that the proposed notice of deficiency includes an amount with respect to the accumulated earnings tax imposed by section 531. In the case of a notice of deficiency to which subsection (e) (2) applies and which is mailed on or before the 30th day after the date of the enactment of this sentence, the notification referred to in the preceding sentence may be mailed at any time on or before such 30th day.7. SEC. 534. BURDEN OF PROOF.(c) Statement by Taxpayer. -- Within such time (but not less than 30 days) after the mailing of the notification described in subsection (b) as the Secretary or his delegate may prescribe by regulations, the taxpayer may submit a statement of the grounds (together with facts sufficient to show the basis thereof) on which the taxpayer relies to establish that all or any part of the earnings and profits have not been permitted to accumulate beyond the reasonable needs of the business.↩8. We think the following quote from Raymond I. Smith, Inc. v. Commissioner, 292 F.2d 470">292 F. 2d 470, 475, 476 (C.A. 9, 1961), affirming 33 T.C. 141">33 T.C. 141 (1959), certiorari denied 368 U.S. 948">368 U.S. 948 (1961), is appropriate here:"Congress did not want the taxing authorities to be second-guessing the responsible managers of corporations as to whether and to what extent profits should be distributed or retained, unless they [taxing authorities] were in a position to prove that their position was correct. Casey v. C.I.R., 2 Cir., 267 F. 2d 26, 30↩. * *"9. Respondent is in agreement with this rule for he states in his reply brief at pp. 12 and 12a: "The respondent agrees that where a noncurrent liability is funded that the assets used to fund the liability do not constitute current assets."↩10. We are also mindful of the fact that if petitioner paid out all its earnings during the years in issue as dividends, Scripps would have had a heavier personal Federal tax burden. However, we are convinced and have found as a fact that this element did not enter into the decision of the directors regarding the retention of earnings.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624512/	LISBETH STELZIG, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentStelzig v. CommissionerDocket No. 14344-78.United States Tax CourtT.C. Memo 1980-20; 1980 Tax Ct. Memo LEXIS 565; 39 T.C.M. (CCH) 926; T.C.M. (RIA) 80020; January 23, 1980, Filed Lisbeth Stelzig, pro se. Nancy J. Bateman, for the respondent. TIETJENSMEMORANDUM OPINION TIETJENS, Judge: Respondent determined a deficiency of $340.90 in petitioner's Federal income tax for 1976. The issues for our determination are: (1) whether petitioner's parents, citizens and residents of Denmark, qualify as her dependents under section 152, 1 entitling her to deduct them as exemptions under section 151, and (2) whether petitioner qualifies as a head of household under section 2(b)(1)(B), enabling her to use head of household rates under section 1(b). This case was fully stipulated pursuant to Rule 122, Tax Court Rules of Practice and Procedure. The stipulation of facts and attached exhibits are incorporated herein by reference. At the time she filed her petition, petitioner Lisbeth Stelzig (hereinafter Lisbeth or petitioner) resided in New York, New York. Petitioner567 timely filed an individual Federal income tax return for 1976. Lisbeth furnished over one-half of the total cost of maintaining her parents' household for 1976. Petitioner's parents, Willy and Ebba Stelzig, however, were citizens are residents of Denmark throughout that year. They were present in the United States for only three months in 1976, during which time they stayed with their daughter. On her 1976 return, petitioner filed as head of household and claimed two dependency exemptions for her parents. In her petition, Lisbeth states that she is the sole support of her parents and that this responsibility is her major expense. She contends that she, somehow, must be entitled to take this cost as a deduction. Respondent argues that since petitioner's parents were citizens and residents of Denmark during 1976, despite petitioner's providing in excess of one-half of their support, pursuant to section 152(b)(3), they are barred from ualifying as her dependents. Since petitioner's parents are not her dependents, respondent further contends, petitioner does not qualify for head of household status and cannot, therefore, use head of household rates. Although we sympathize568 with petitioner and admire her for serving as her parents' sole support, we nevertheless agree with respondent. Section 152(b)(3) plainly excludes individuals like petitioner's parents from the definition of dependent. 2 In Barr v. Commissioner,51 T.C. 693">51 T.C. 693 (1969), we upheld the constitutionality of this section. We found that the restriction in the statute was not arbitrary or unreasonable since it was impractical for the Internal Revenue Service to investigate the validity of claims for dependents in foreign countries. 3*569 Section 1(b) provides a special tax rate for those individuals who qualify as heads of household. Section 2(b)(1)(B) defines a head of household as a taxpayer who maintains his father's or mother's principal abode if the taxpayer is entitled to a deduction for his (parents) under section 151. Because petitioner's parents do not qualify under section 151 as her dependents, she is not entitled to claim head of household status.See Snyde v. United States,321 F. Supp. 661">321 F. Supp. 661 (D. Colo. 1970), affd. per curiam 445 F.2d 319">445 F.2d 319 (10th Ci. 1971). Decision will be entered for the respondent.Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended and in effect for the year in issue, unless otherwise stated.↩2. Section 152(b)(3) provides in part: The term "dependent" does not include any individual who is not a citizen or national of the United States unless such individual is a resident of the United States or of a country contiguous to the United States. ↩3. See also Habeeb v. Commissioner,559 F.2d 435">559 F.2d 435 (5th Cir. 1977), affg. a Memorandum Opinion of this Court; Wexler v. Commissioner,507 F.2d 843">507 F.2d 843 (6th Cir. 1974), affg. a Memorandum Opinion of this Court; Du De Voire v. Commissioner,T.C. Memo. 1978-11; Bakler v. Commissioner,T.C. Memo. 1974-134; Josan v. Commissioner,T.C. Memo. 1974-144; Hoyle v. Commissioner,T.C. Memo. 1970-172↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624513/	Edward Dzierzawski v. Commissioner.Dzierzawski v. CommissionerDocket Nos. 75009, 79436.United States Tax CourtT.C. Memo 1960-16; 1960 Tax Ct. Memo LEXIS 274; 19 T.C.M. (CCH) 97; T.C.M. (RIA) 60016; February 12, 1960Edward Dzierzawski, pro se, 9449 McDougall, Hamtramck, Mich. Robert W. Siegel, Esq., for the respondent. MULRONEY Memorandum Findings of Fact and Opinion MULRONEY, Judge: The respondent determined deficiencies in petitioner's income tax for each of the years 1956 and 1957 in the amount of $126. The only issue is whether petitioner furnished more than one-half the support of the claimed dependent, Robert Dzierzawski, during the years in queston so as to entitle him to a deduction therefor under the provisions of sections 151 and 152, Internal Revenue Code of 1954. Findings of Fact Facts which have been stipulated are so found. Petitioner resides in Hamtramck, Michigan, and he filed his income tax returns for the years 1956 and 1957 with the district director275 of internal revenue for the district of Michigan at Detroit, Michigan. In these returns petitioner claimed as a dependent his minor son, Robert. During said years Robert resided with his mother, who was petitioner's divorced wife, Mary Dzierzawski. Respondent's notice of deficiency disallowed the deductions for Robert as a dependent in said years. Giving petitioner credit for all payments made by him pursuant to the child support provisions of the divorce decree, and all other payments or gifts about which he testified which might be construed as support, he expended not more than $715.55 and $740.34 in the years 1956 and 1957, respectively, for the support of his son. Petitioner did not contribute more than 50 per cent of the total amount spent for the support of his son in each of the years 1956 and 1957. Opinion Petitioner appeared without counsel and tried his own case. Some of the stipulated facts and petitioner's testimony tend to establish his expenditures during the years in question for the support of his son. He had the burden of showing these expenditures amounted to more than 50 per cent of the total cost of the child's support for each of said years. Petitioner276 offered no evidence of the total amount paid in each year for the support of his son. Respondent had the child's mother testify. She had custody of the boy during the years in question. She and the boy lived alone in a four-room home owned by the mother and she earned approximately $2,000 a year as a full-time employee of a sausage company. She testified in much detail as to her expenditures to keep up the home and for the ultilities in the home. She also testified as to her expenditures for Robert's schooling; her rather heavy expense for baby sitters, because of her employment; Robert's expenses for clothing, food and haircuts; and his medical expenses. She also testified she received some financial help from her sister and her parents during said years. We need not review her evidence here. It is enough to state it gives rise to a strong inference that petitioner paid less than one-half of the support for Robert during the years in question. Petitioner failed to sustain his burden of establishing that he contributed over half of the amount expended for the support of his son during the years 1956 and 1957. Decisions will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624515/	Estate of James E. Curry, Deceased, Aileen Curry-Cloonan and Beulah Bullard, Coexecutrices, Petitioner v. Commissioner of Internal Revenue, RespondentEstate of Curry v. CommissionerDocket No. 9502-76United States Tax Court74 T.C. 540; 1980 U.S. Tax Ct. LEXIS 118; June 9, 1980, Filed 118 Decision will be entered under Rule 155. 119 Pursuant to an agreement entered into prior to decedent's death, P, an estate, had the right to participate in a percentage of any contingent fees subsequently awarded in 13 pending Indian claims cases. Past experience and an analysis of the cases involved (both as to their nature and the stage of the proceedings reached at the date of death), as well as other factors, indicated that the claims had significant value, although estimates of this value were subject to substantial imprecision. Held: Under secs. 2031 and 2033, I.R.C. 1954, the term "property" encompasses choses in action, including claims for services performed. There is no rule of law that contingent legal fees, merely by virtue of their contingency, are automatically excluded from the gross estate. Rather, the contingent nature of the contract right under the circumstances herein bears on the factual question of valuation. Finally, valuation of the claims determined. Landon Gerald Dowdey and Peter A. Noterman, for the petitioners. Marguerite F. Gramza, for the respondent. Wilbur, Judge. WILBUR540 Respondent determined a deficiency in estate tax of $ 163,526.54 against petitioner, the Estate of James E. Curry. Concessions having been made by both parties, the remaining issue for our decision is whether the value of the decedent's interest in certain contingent legal fees pertaining to litigation still in progress as of the date of death should be included in his estate under section 2033. 1 If we find that the interest is includable in the estate, we must then120 ascertain the value of the interest.FINDINGS OF FACTSome of the facts have been stipulated by the parties. The stipulation of facts and the attached exhibits are incorporated 541 herein by this reference. A summary of the pertinent facts in this case is set forth below.At the time of the filing of this petition, executrix Aileen Curry-Cloonan (hereinafter referred to as Ms. Curry-Cloonan) resided in Washington, D.C. Executrix Beulah Bullard (hereinafter referred to as Ms. Bullard) also resided in Washington, D.C. Ms. Curry-Cloonan and Ms. Bullard are the coexecutrices of the Estate of James E. Curry.James E. Curry (hereinafter referred to as Mr. Curry, or, the deceased) died on August 23, 1972. An estate tax return was filed with the District Director, Internal Revenue Service, Philadelphia, Pa., in July 1973. Mr. Curry executed a will on August 4, 1972 (hereinafter referred to as the will), 121 which was admitted to probate on November 1, 1972, in the United States District Court for the District of Columbia. The attorney representing the estate at the time of probate and at all relevant times was Landon G. Dowdey (hereinafter referred to as Mr. Dowdey), a longtime acquaintance of the deceased.During his lifetime, Mr. Curry was an attorney who at one time had been active in prosecuting the claims of American Indian tribes before the Indian Claims Commission (hereinafter referred to as the Commission). Throughout the 1940's and early 1950's, Mr. Curry entered into many contracts with different groups of Indians in which he agreed to represent them before the Commission. Most of the contracts provided for payment on a contingent fee basis, the fee to be calculated as a percentage of any eventual recovery made by the tribes. In the 1950's, Mr. Curry suffered an attack of polio which rendered him unable to engage in the active practice of law. Consequently, the original contracts between Mr. Curry and various Indian tribes were replaced by new contracts between the tribes and other attorneys during the 1950's and early 1960's. One of these attorneys was I. S. Weissbrodt122 (hereinafter referred to as Mr. Weissbrodt).In 1966, Mr. Curry entered into a written agreement with Mr. Weissbrodt with respect to Mr. Curry's right to share in fees in a group of docketed Indian claims cases which were still before the Indian Claims Commission. The agreement provided that Mr. Curry would receive a stated percentage, ranging from 18 percent to 24 percent, of any attorney's fees that might be awarded in the listed cases. When Mr. Curry died, 13 of the cases 542 listed in the agreement were in various uncompleted stages of litigation.In the will executed shortly before his death, Mr. Curry specifically revoked a prior will and named his daughter (Ms. Curry-Cloonan) and a friend (Ms. Bullard) as residuary beneficiaries, to share equally in the residue of his estate. In addition, Mr. Curry stated in the will that certain survivorship provisions in various joint bank accounts, savings accounts, and Government bonds were revoked, thereby attempting to put the proceeds of these accounts in his estate.Conflict occurred between the two beneficiaries. Ms. Curry-Cloonan considered attacking the second will executed by her father. In addition, there was a problem123 concerning the rights of the Estate of James E. Curry (hereinafter referred to as the estate) in coowned Government bonds and joint accounts. Originally, Mr. Dowdey considered the coowned bonds as part of the estate and wrote letters to the owners requesting transfer of the bonds to the estate. Subsequently, he discovered that the bonds in fact belonged to the surviving coowners, but that there might be a possibility of offsetting some of the legacies with the proceeds of the bonds. In order to resolve the various disputes between Ms. Curry-Cloonan and Ms. Bullard and to accomplish what he felt was a strong personal desire on the part of Ms. Curry-Cloonan to terminate a continuing relationship with Ms. Bullard, Mr. Dowdey presented a proposal to the two women in the spring of 1973, under which their respective interests in the residue of Mr. Curry's estate were settled. Pursuant to the agreement, executed on June 1, 1973, Ms. Bullard assigned her right to one-half of any future recoveries in the remaining 11 Indian claims cases to Ms. Curry-Cloonan in exchange for Ms. Curry-Cloonan's agreement to have certain assets owned in joint ownership brought into the estate.The Indian 124 Claims Commission was created in 1946 under the Indian Claims Commission Act, Pub. L. 79-726, 60 Stat. 1049, 25 U.S.C. sec. 70 (hereinafter referred to as the act), in order to reduce the large residue of Indian claims which had occurred prior to August 13, 1946. Under the act, all claims had to be filed before the Commission prior to August 31, 1951. Most cases filed before the Commission sought compensation for the taking of lands. The land cases normally are tried in three phases: title, value, and offsets. In the title phase, the Indian plaintiffs must 543 show that they had a compensable interest in the land which is the subject matter of the suit. This means that the tribe must show that it held aboriginal title based on continuous occupancy and use for a long time prior to the date it was taken. In the second phase, the fair market value of the land, as of the date of taking, is established, and the value of any consideration, which was often in the form of goods and services, is also established. If the Commission finds that the United States is liable in the second phase of the suit, an interlocutory order is entered awarding125 the Indian tribe a fixed amount, subject to any allowable offsets. Allowable offsets normally consisted of gifts of property or money for the benefit of the Indian tribe which were made voluntarily by the United States. Either party may appeal to the U.S. Court of Claims from an interlocutory determination establishing the liability of the United States, as well as from any final determination.The act provided that during the period when claims could be filed, identifiable groups of Indians could contract with attorneys to represent them in their claims before the Commission. These contracts could stipulate the amounts to be paid in the event of recovery. Absent such contract, the Commission would set the contingent fees in these cases. However, in no event could the amount of fees exceed 10 percent of the amount recovered.Often, cases are disposed of by way of compromise settlement after the first or second phase of the litigation. Any proposed settlement of an Indian claim must be approved by the Bureau of Indian Affairs, the Department of the Interior, and the Department of Justice, as well as by the tribal leaders and tribal membership. After the settlement is approved126 by all the parties, the Commission holds a formal hearing on the matter in which it accepts or rejects the settlement. Thereafter, the attorneys petition the Commission for their fee award. After comment by the Justice Department, the Bureau of Indian Affairs, and the Department of the Interior, the Indian Claims Commission must approve the award of attorney's fees, or if the amount is not fixed by contract, must determine the final award.Four months after the date of death, in December of 1972, the estate received its share of attorney's fees in 2 of the 13 pending cases, docketed as 22-D and 22-J, in the amount of $ 100,544.40. As of the date of death, these two cases had reached the point of 544 an agreement between the parties for a compromise settlement, but the settlement had not been approved by the Commission, nor had an award of attorney's fees been applied for. The estate's share of the fees for these two cases was reported as income by the estate on its income tax return. Three years after the date of death, in May and June of 1975, an award of attorney's fees was made in two more cases, docketed as 278-B and 186. The estate's share of the fees, which were 127 $ 1,296 and $ 15,241, respectively, was placed in escrow with Mr. Weissbrodt subject to certain unresolved claims. The unresolved claims involved an indemnity claim arising out of a lawsuit filed against Mr. Weissbrodt in Alaska for $ 67,000 due on account of an alleged fee-sharing agreement with Mr. Curry and claims for nonreimbursed expenses and costs incurred by Mr. Weissbrodt in cases in which Mr. Curry had an interest. In February of 1976, an award of attorney's fees was made in another case docketed as 87-B, and the estate's share of the fees, $ 144,000, was placed in escrow subject to the same unresolved claims. Five years after the date of death, in the latter half of 1977, the estate received the sum of $ 150,000 as its share of attorney's fees in another case docketed as 22-C. This amount was received after the payment of certain third-party claims. On April 10, 1978, a compromise agreement was reached concerning the sums held in escrow. Under the agreement, Mr. Weissbrodt paid $ 133,500, including accumulated interest to Ms. Curry-Cloonan, and released his indemnity claim against her in the three matters of concern. In the remaining 7 of the 13 claims which were pending128 at the date of death, no recovery had been made by the Indian tribes at the time this case was tried, and consequently, there had been no award of attorney's fees.OPINIONIn 1966, the decedent executed an agreement with another attorney which provided that the decedent would receive a stated percentage of any attorney's fees which might be awarded in a list of docketed cases pending before the Indian Claims Commission. Any award of attorney's fees in the cases was contingent upon an ultimate recovery on behalf of the plaintiff tribal members and would be measured by the extent of the recovery. When Mr. Curry died in 1972, 13 of the cases were still in various unresolved stages of litigation before the 545 Commission. The issue for our decision is whether the contractual right to share in contingent attorney's fees with regard to these 13 pending cases is property which must be valued and included in the decedent's gross estate. Petitioners argue that because the decedent's right to share in the attorney's fees was not compensable as of the date of death, i.e., that because by their very nature, contingent fees do not accrue until a final judgment is rendered, the decedent's129 interest in the fees had no market value when he died. Respondent contends that the contractual right to share in future attorney's fees is an interest in property includable in the decedent's gross estate, and that notwithstanding the contingent nature of the fees, the decedent's interest had substantial value on the date of death. We agree with respondent that the contractual right is includable in the gross estate, although we disagree somewhat with his methodology in valuing the interest.Issue 1. Includability of Contingent Legal Fees in the Gross EstateFirst, we deal with the contention that as a matter of law, contingent legal fees are not includable in the gross estate because there is no compensable interest as of the date of death. We find nothing in the statute to sustain such a proposition. Section 2031 2131 provides that the value of the gross estate shall be determined by including the value of all property, real or personal, tangible or intangible. Section 2033 3 provides that the value of the gross estate shall include the value of all property to the extent of the interest therein of the decedent. As used in the statute, the term "property" encompasses all130 choses in action, including claims for services performed. Estate of McGlue v. Commissioner, 41 B.T.A. 1199">41 B.T.A. 1199 (1940). A right of a deceased partner to share in future profits of the partnership is an 546 interest in property, includable in the gross estate. Estate of Hull v. Commissioner, 38 T.C. 512 (1962), revd. on another issue 325 F.2d 367">325 F.2d 367 (3d Cir. 1963); Estate of Riegelman v. Commissioner, 27 T.C. 833">27 T.C. 833 (1957), affd. 253 F.2d 315">253 F.2d 315 (2d Cir. 1958). The date-of-death values of existing claims of the decedent which pass to his estate are includable in the gross estate. Bank of California v. Commissioner, 133 F.2d 428 (9th Cir. 1943), affg. in part and revg. and remanding in part a Memorandum Opinion of this Court; United States v. Simmons, 346 F.2d 213">346 F.2d 213 (5th Cir. 1965).In Duffield v. United States, 136 F. Supp. 944">136 F. Supp. 944 (E.D. Pa. 1955), the deceased was an attorney who represented three persons who were among thousands claiming to be the heirs of a large estate. By contract, it was provided that the attorney would receive a percentage of any recovery made on behalf of his clients upon completion of the litigation. The attorney died before the court gave judgment for his clients as the heirs of the estate, and the executor placed a value of zero on the attorney's contingent fee arrangement. In denying the plaintiff's motion for summary judgment in a suit for an estate tax refund, the court held that the evidence did not establish that the contracts were valueless as a matter of law. Rather, a factual issue was raised as to their values on the date of death. 4132 The fact that the legal fees we are concerned with were contingent upon future recovery by the Indian tribes is a critical consideration in trying to determine what the contract right was worth as of the date of death. However, the contingent nature of the contract right must bear on the factual question of valuation. It cannot, as a matter of law, preclude the inclusion of the interest in the decedent's gross estate or command that the value be fixed at zero. Although uncertainty as to the value of a 547 contract right may postpone the inclusion of the income until it is actually realized for income tax purposes, for estate tax purposes, the value of an asset must be determined in order to close the estate. See Burnet v. Logan, 283 U.S. 404">283 U.S. 404, 412 (1931). Compare Estate of McGlue v. Commissioner, 41 B.T.A. 1186 (1940), revd. 119 F.2d 167">119 F.2d 167 (4th Cir. 1941), with Estate of McGlue v. Commissioner, 41 B.T.A. 1199">41 B.T.A. 1199 (1940). We therefore hold that, under the circumstances before us, the contractual right herein to share in future attorney's fees which are 133 contingent in nature, is property to be included in the decedent's gross estate under section 2033.Issue 2. Valuation of the Contract RightWe must next address the factual issue of the value at the date of death of the contractual right to share in contingent attorney's fees for the 13 cases then pending before the Indian Claims Commission. The regulations under section 2031 provide:(b) Valuation of property in general. The value of every item of property includible in a decedent's gross estate under sections 2031 through 2044 is its fair market value at the time of the decedent's death * * . The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. The fair market value of a particular item of property includible in the decedent's gross estate is not to be determined by a forced sale price. Nor is the fair market value of an item of property to be determined by the sale price of the item in a market other than that in which such item is most commonly sold to the public, taking into account the134 location of the item wherever appropriate. * * [Sec. 20.2031-1(b), Estate Tax Regs.]First of all, we must reject petitioner's contention that because the claims here involved had not been reduced to judgment, they were too remote and speculative to be valued. Valuation for estate tax purposes frequently involves difficult and somewhat imprecise calculations. See Estate of Smith v. Commissioner, 57 T.C. 650 (1972), affd. 510 F.2d 479">510 F.2d 479 (2d Cir. 1975). However, uncertainties and difficulties encountered in determining value have never been considered justifications for obviating this necessary task. See Ithaca Trust Co. v. United States, 279 U.S. 151 (1929), and Estate of Smith v. Commissioner, supra.Approximately half of the cases listed in the agreement executed between Mr. Weissbrodt and Mr. Curry in 1966 were reduced to judgment by 1972, the year in which Mr. Curry died. 548 These cases resulted in substantial awards of attorney's fees. Although there are distinctions between the cases decided prior to 1972 and some of the cases still pending as of135 the date of death, it is clear that the contractual right to share in any future award of attorney's fees for this kind of litigation had substantial value when the decedent died. 5Respondent asserts that the value of the contract right as of the date of death is $ 260,444. He arrives at this figure by adding two distinct sums. First, he valued the right to fees in two of the docketed cases (22-D and 22-J) as the amount of income, $ 100,544, which actually was paid to the estate for these two cases 4 months after the date of death. In order to value the 11 other cases, he took the compromise agreement executed between the two residuary beneficiaries in which Ms. Bullard assigned her right to one-half of any future recoveries in the 11 cases136 to Ms. Curry-Cloonan in exchange for Ms. Curry-Cloonan's agreement to arrange to have certain joint ownership bonds and bank accounts brought into the estate. Respondent reasons that since the result of this arrangement was to benefit Ms. Bullard in the amount of $ 79,950, 6 one can double that figure to arrive at the value of an undivided right to share in the 11 pending cases. By adding the income for the 2 cases which were completed shortly after Mr. Curry's death with the computation of the value of the 11 other cases, respondent concludes that the date-of-death value of the entire contract right is $ 260,444.137 Although appealing because of the simplicity, we must reject respondent's methodology in valuing the contract right of the decedent. With regard to the first two docketed cases (22-D and 22-J), respondent has erred in failing to distinguish between a contractual right to receive future income and the actual receipt of the income subsequent to the date of death. Bull v. United States, 295 U.S. 247">295 U.S. 247 (1935); Estate of Hull v. Commissioner, 38 T.C. 512">38 T.C. 512 (1962), revd. on another issue 325 F.2d 367">325 F.2d 367 (3d Cir. 1963). 549 In addition, we do not share respondent's view that the "sale" of Ms. Bullard's right to receive half of any future attorney's fees in the remaining 11 cases fits neatly into the "willing seller, willing buyer" criteria of the regulations. It seems clear from the record that the agreement was drawn up by Mr. Dowdey and accepted by the residuary beneficiaries primarily for reasons apart from economic considerations. Mr. Dowdey realized he had made a serious mistake in advising the residuary beneficiaries that the joint ownership bonds and accounts were to be part of Mr. Curry's 138 estate and in his initial attempt to collect the bonds from the surviving owners. In addition, it is clear that he was guided by a strong desire on the part of one of the beneficiaries, Ms. Curry-Cloonan, to avoid being locked into a continuing relationship with Ms. Bullard at any cost, 7 and by many other personal considerations of both women. The agreement appears to us to be a carefully orchestrated solution to most of the problems confronting those involved with the estate -- not a disinterested sale between a willing buyer and a willing seller, both having knowledge of the relevant facts. Therefore, we do not consider the compromise agreement as indicative of the economic value of the contract right as of the date of death, and we disregard it in valuing the right.Clearly, there is no way to139 value with exactness a contractual right to share in attorney's fees for 13 Indian claims cases, all of which were in various stages of litigation when Mr. Curry died. However, respondent produced an expert witness (Mr. Webb) who elucidated the procedures of the Indian Claims Commission and gave helpful testimony as to the three broad characteristics of cases covered by the agreement (land, accounting, and damages) and the general potential for recovery in each classification. In addition, the parties submitted voluminous exhibits relating to each of the separate claims, which we have examined with great care.It must be remembered, however, that we are not estimating the potential amount of recovery of the underlying claims in general, but rather the contractual right to share in a percentage (18 percent to 24 percent) of a percentage (usually 10 550 percent) of any recovery on behalf of specific clients. The two most critical factors in valuing the contract right are the classifications of the cases still pending and the stage to which each had progressed. For instance, Mr. Webb testified that the land cases had by far the best potential for recovery on behalf of the tribes. 140 Of the 13 cases, 4 were land cases. However, Mr. Webb also testified that accounting and damage cases, of which the other nine cases were comprised, were much more problematic. It was not at all clear how the Indian Claims Commission would react to these claims, and Mr. Webb was hesitant to try to set any value on them because of the uncertainty and the substantial delay in their resolution. 8Among the land cases, the stage to which each had proceeded is important in setting a value as of August 23, 1972, the date of death. For example, the two cases for which the estate recovered $ 100,544.40 4 months after the date of death were substantially complete, at least as far as the real issues were concerned. Title had been determined, liability had been set, and a compromise settlement had been approved by the parties. The remaining steps -- approval by the Commission of the settlement, 141 and application to and approval by the Commission of attorney's fees -- are basically pro forma steps.However, the other land cases were in some aspects less promising, at least in terms of the estate's receiving a share of the attorney's fees. While we recognize that the estate ultimately received substantial attorney's fees in one land case ($ 150,000), the potential for recovery in even this case was clouded by several factors at the date of death. For, while it was clear that some tribe or a group of tribes was going to make a substantial recovery in this case, it was not clear which tribes these were going to be in 1972. Many tribes had intervened in the suit, and title to and the boundaries of the land were not determined until 1975. Therefore, although the potential for some recovery was good, it was not at all clear how much of the recovery might eventually accrue to Mr. Curry's estate.Additionally, as noted earlier, recovery of attorney's fees in the damage and accounting cases was subject to several contingencies at the date of death, the date critical to our 551 inquiry. And even though the estate ultimately recovered substantial legal fees in one of the damage142 cases, we note that seven of the damage and accounting cases were still pending at the date of trial, and all of these cases must be viewed in the light of the circumstances existing on August 23, 1972, the date of death.Additional relevant considerations in valuing, on August 23, 1972, the contractual right to share in a percentage of future attorney's fees are: Mr. Weissbrodt's past successes as a prosecuting attorney for the tribes; the delays involved in this kind of litigation; and the fact that there were claims by other attorneys on Mr. Curry's share of the fees except for the first two awards, which were made shortly after his death.After a careful consideration of the entire record before us, we find that the date-of-death value of the contractual right to share in the attorney's fees for the two land cases (22-D and 22-J) which were substantially completed and not subject to competing claims was $ 95,000.The date-of-death value of the right to share in the attorney's fees for the remaining 11 cases presents a more difficult problem. We have carefully evaluated the nature and the type of cases involved in the light of the expert testimony received, the stage of the litigation143 at the date of death, Mr. Weissbrodt's experience and past successes in this relatively esoteric area, the impact of delay so characteristic of IndianClaims litigation, and the possibility of competing claims for some of the fees. We recognize that, while there were ultimately substantial awards in some instances, in estimating the date-of-death value of these claims, we must be satisfied with some imprecision. But inexactitude is often a byproduct in estimating claims or assets without an established market and provides no excuse for failing to value the claims before us in the light of the vicissitudes attending their recovery. In the light of all the factors we have enumerated as of the date of death, August 23, 1972, and considering that critical issues were still unresolved, we conclude that the date-of-death value of the remaining 11 cases was $ 70,000. Therefore, the amount includable in the decedent's estate under section 2033 is $ 165,000.Decision will be entered under Rule 155. Footnotes. John L. Tully, Jr., was counsel of record for the petitioners at the time of trial. Mr. Tully died on May 28, 1978, shortly after the trial.↩1. All section references are to the Internal Revenue Code of 1954 as in effect during the tax years in issue.↩2. Sec. 2031(a) reads as follows:SEC. 2031. DEFINITION OF GROSS ESTATE.(a) General. -- The value of the gross estate of the decedent shall be determined by including to the extent provided for in this part, the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated.↩3. Sec. 2033 reads as follows:SEC. 2033. PROPERTY IN WHICH THE DECEDENT HAD AN INTEREST.The value of the gross estate shall include the value of all property to the extent of the interest therein of the decedent at the time of his death.↩4. Petitioners rely on two Memorandum Opinions of this Court, Estate of Nemerov v. Commissioner, T.C. Memo. 1956-164, and Estate of Crail v. Commissioner, a Memorandum Opinion dated June 30, 1942, to support their position that contingent legal fees not compensable at the time of death have no market value. However, Memorandum Opinions of this Court relate to the specific facts and circumstances surrounding the parties who are then before the Court. Nemerov, having been issued as a Memorandum Opinion, turns on its facts and certainly does not establish a rule of law that contingent legal fees are, simply by virtue of their contingency, automatically excluded from the gross estate. And unlike Nemerov, the decedent herein had a contractual right with the attorneys doing the work to a specified portion of the legal fees ultimately recoverable. Neither is Estate of Crail authority for any such rule of law. Nothing in either of these Memorandum Opinions or in any precedents that we have found convinces us that such a bald proposition has been or should be adopted. See Duffield v. United States, 136 F. Supp. 944↩ (E.D. Pa. 1955).5. Indeed, Mr. Dowdey, the attorney for the estate, testified at trial that he never considered this right to share in future fees not to be a valuable asset of the estate. He simply felt that the fees were too speculative to place a definitive value on the contract right.↩6. Petitioners object, under rule 408 of the Federal Rules of Evidence, to respondent's use of the compromise agreement and of Mr. Dowdey's correspondence during negotiations to prove the value of the contract right. However, in light of our determination that the compromise agreement is not indicative of the economic value of the contract right, we decline to rule on the issue of its exclusion under rule 408↩.7. Mr. Dowdey testified at trial that the only item which would require a continuing relationship between the two women as residuary beneficiaries of the estate was the right to future fees from the Indian claims cases.↩8. Of the nine accounting and damage cases, seven were still pending before the Commission or the Court of Claims as of this trial.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624516/	Appeal of HENRY P. KRANSZ and HENRY A. ZENDER, executors and trustees of the estate of PETER REINBERG, deceased.Kransz v. CommissionerDocket No. 789.United States Board of Tax Appeals1 B.T.A. 953; 1925 BTA LEXIS 2748; April 6, 1925, decided Submitted March 9, 1925. 2748 The Board has jurisdiction to consider an appeal from a denial by the Commissioner, subsequent to June 2, 1924, of a claim for abatement of estate taxes assessed on May 11, 1923. J. F. Greaney, Esq., for the Commissioner. LITTLETON953 Before GRAUPNER, LITTLETON, and SMITH. LITTLETON: This is an appeal from the determination of the Commissioner made on September 26, 1924, denying in part a claim for abatement of a portion of estate taxes assessed prior to June 2, 1924. On February 17, 1922, the executors of the estate of Peter Reinberg, deceased, filed an estate-tax return showing a tax of $6,602.04, which was paid. On May 11, 1923, after an investigation of the estate the Commissioner assessed an additional tax of $11,138.27. Upon receipt of notice of the additional tax the executors, pursuant to the regulations promulgated by the Commissioner, executed and filed a claim for abatement of $2,796 of the amount assessed, on thr ground that the value of the net estate as determined by the Commissioner was excessive. After consideration of the abatement claim the Commissioner allowed the same in the amount of $150 and denied it as to the amount2749 of $2,646. The executors were advised of this determination by the Commissioner in a letter dated September 26, 1924, from which this appeal was taken. The Commissioner has moved to dismiss the appeal on the foling grounds: (1) The appeal does not show that there has been since the enactment of the Revenue Act of 1924 a determination by the Commissioner of a deficiency in tax, and (2) No appeal lies to this Board from denial in part by the Commissioner on September 26, 1924, of a claim for abatement of an estate tax assessed prior to June 2, 1924, the date of the passage of the Revenue Act. The motion to dismiss is predicated upon section 316 of the Revenue Act of 1924 relating to estate taxes imposed by prior Revenue Acts, which provides: If after the enactment of this Act the Commissioner determines that any assessment should be made in respect of any estate tax imposed by the Revenue Act of 1917, the Revenue Act of 1918, or the Revenue Act of 1921, or by any such Act as amended, the amount which should be assessed (whether as deficiency or additional tax or as interest, penalty, or other addition to the tax) shall be computed as if this Act had not been enacted, but2750 the amount so computed shall be assessed, collected, and paid in the same manner and subject to the same provisions and limitations (including the provisions in case of delinquency in payment after notice and demand) as in the case of the taxes imposed by Part I of this title, except that the period of limitation prescribed in section 1009 shall be applied in lieu of the period prescribed in subdivision (a) of section 310. The Board has held that final determination by the Commissioner after June 2, 1924, on a claim for abatement of income and profits tax assessed prior to June 2, 1924, gives rise to the right of 954 appeal to this Board. . . These decisions, however, are not directly applicable to this appeal since the provisions of the Revenue Acts prior to the Act of June 2, 1924, governing the determination and assessment of estate taxes were not the same as those relating to income and profits taxes. Section 250 (d) of the Revenue Act of 1921, as has heretofore been pointed out by the Board, provided in respect to income and profits taxes that2751 the taxpayer should be notified of the tax proposed to be assessed by registered letter, and given an opportunity to be heard, and in the event of assessment without compliance with that section a claim for abatement may be filed. In respect to estate taxes for years prior to 1924, the Revenue Act of 1921 contained no provisions giving the executor a right of appeal before assessment of an additional tax, but provided in section 404: That the executor, within two months after the decedent's death, or within a like period after qualifying as such, shall give written notice thereof to the collector. The executor shall also, at such times and in such manner as may be required by regulations made pursuant to law, file with the collector a return under oath in duplicate, * * . The Commissioner shall make all assessments of the tax under the authority of existing administrative special and general provisions of law relating to the assessment and collection of taxes. Section 407 provided: That where the amount of tax shown upon a return made in good faith has been fully paid, or time for payment has been extended, as provided in section 406, beyond one year and six months after2752 the decedent's death, and an additional amount of tax is, after the expiration of such period of one year and months, found to be due, then such additional amount shall be paid upon notice and demand by the collector, * * . If the executor files a complete return and makes written application to the Commissioner for determination of the amount of the tax and discharge from personal liability therefor, the Commissioner, as soon as possible and in any event within one year after receipt of such application, shall notify the executor of the amount of the tax, and upon payment thereof the executor shall be discharged from personal liability for any additional tax thereafter found to be due, and shall be entitled to receive a receipt or writing showing such discharge: Provided, however, That such discharge shall not operate to release the gross estate from the lien of any additional tax that may thereafter be found to be due while the title to such gross estate remains in the heirs, devisees, or distributees thereof; but no part of such gross estate shall be subject to such lien or to any claim or demand for any such tax if the title thereto has passed to a bona fide purchaser for2753 value. The procedure adopted by the Commissioner under the Revenue Acts prior to the Act of June 2, 1924, for the determination and assessment of estate taxes was to assess any additional tax which might appear after an investigation to be due and to notify the executor of the additional amount assessed, at the same time advising him of his right to file a claim for abatement of the tax and to be heard thereon and obtain a final determination before being called upon to pay the additional tax. Regulations 63 relating to estate taxes, promulgated July 22, 1922, under the Revenue Act of 1921, provided as follows: ART. 79. Payment of tax; general. - * * * Following an investigation of the estate the tax liability will be finally determined by the Commissioner upon the basis of such investigation. If at the time the Commissioner's determination is made the tax has been paid upon the basis of the return, an adjustment will be made of the amount of 955 tax. If the amount of tax already paid exceeds the amount of tax as finally determined, the Commissioner will refund such excess. If the amount of tax as finally determined exceeds the amount of tax already paid, the2754 collector will notify the executor of the amount of the unpaid balance of the tax and demand payment thereof. Payment should be made by the executor immediately upon the receipt of such notification. Where the investigation of the return shows that no further tax is due, the executor will be notified to that effect. Until the receipt of such notification, he should reserve a sufficient portion of the estate to satisfy any additional tax. ART. 92. Kinds of relief. - Two forms of relief are afforded the executor in cases where he believes that an excessive amount of tax or an illegal penalty has been assessed or paid either upon the basis of the return or of the investigation conducted by the Bureau. The two forms of relief are: (1) Claim for abatement, where the alleged excessive tax or illegal penalty has been assessed but not paid. (2) Claim for refund, where such tax or penalty has been paid. ART. 95. Limitation of time to file claim for abatement of additional tax. - If it is desired to file claim for abatement of the additional amount of tax disclosed upon an investigation, such claim must be filed with the collector within one month after receipt by the executor2755 of the Commissioner's letter of notification. After that period the claim will not be considered, but the tax must be paid, and adjustment sought by claim for refund. It is clear from the foregoing that the assessment of the additional estate tax in May, 1923, did not constitute a determination of the amount due but was a step in the procedure toward final determination, and gave rise for the first time to a controversy which could be terminated by a decision on the merits upon a claim for abatement which, in the case of estate taxes, filled the same office as an appeal in the case of income and profits taxes under section 250 (d). Accordingly, in this appeal, the executor first received information of additional tax by notice of assessment and immediately, in compliance with article 95, Regulations 63, filed a claim for abatement contesting the valuation of the estate and asking the abatement of a portion of the additional tax. This claim was duly considered by the Commissioner pursuant to the regulations quoted and on September 26, 1924, he notified the taxpayer by letter of his final determination of the deficiency, which was followed by demand for payment by the collector. 2756 We are of the opinion that it was intended by the Revenue Act of 1924 that this Board should consider appeals from determinations made by the Commissioner subsequent to June 2, 1924, that a deficiency is due, and upon the facts in this appeal the Board is of the opinion that it has jurisdiction to consider the appeal from the final determination of the Commissioner made on September 26, 1924; otherwise, as was pointed out in the Terminal Wine Company's Appeal, the entertainment of a claim for abatement would be entirely superfluous and meaningless and would result in denying the executors the right to appeal from a determination after June 2, 1924, which fixes the amount of deficiency in tax. The motion of the Commissioner is therefore denied.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624517/	WARREN L. BAKER, JR. AND DORRIS J. BAKER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentBaker v. Comm'rNo. 599-00United States Tax Court118 T.C. 452; 2002 U.S. Tax Ct. LEXIS 28; 118 T.C. No. 28; May 29, 2002, Filed 28 Decision will be entered for respondent. P (husband) entered into "agents agreements" (agreement) with State Farm Insurance Cos. (State Farm) wherein P agreed to write insurance policies exclusively for State Farm. The agreement provided that all property including information about policy holders belonged to State Farm. P's compensation was based on a percentage of net premiums. The agreement also contained detailed provisions for termination. P was entitled to a termination payment based on the percentage of policies that either (1) remained in force after termination or (2) were in force for the 12 months preceding termination. P and State Farm did not negotiate the terms of the agreement. P retired after approximately 34 years of operating as an independent agent for State Farm. Pursuant to the termination agreement P returned account information, computers and the like to State Farm and the successor agent. P received a payment of $ 38,622 in 1997 from State Farm pursuant to the termination agreement. Ps reported the29 payment on their 1997 Federal income tax return as a long-term capital gain. In a notice of deficiency issued to Ps, R disallowed capital gain treatment and determined that the payment was ordinary income. R did not impose self- employment tax on the income. Held: P did not own a capital asset or sell a capital asset to State Farm, nor did the termination payment P received from State Farm represent payment for transfer of a capital asset to State Farm or the successor agent. Held, further, that Ps are not entitled to capital gain treatment for the termination payment received from State Farm in 1997. Held, further, Ps must treat the payment received in 1997 as ordinary income. Thomas J. O'Rourke, for petitioners.Roger W. Bracken, for respondent. Dawson, Howard A., Jr.;Pajak, John J.DAWSON; PANUTHOS453 OPINIONDAWSON, Judge: 1 This case was assigned to Chief Special Trial Judge Peter J. Panuthos pursuant to the provisions of section 7443A(b)(5) and Rules 180, 181, and 183. 2 The Court agrees with and adopts the opinion of the Special Trial Judge, which30 is set forth below. OPINION OF THE SPECIAL TRIAL JUDGEPANUTHOS, Chief Special Trial Judge: Respondent determined a deficiency in petitioners' Federal income31 tax of $ 2,519 for 1997. All references to petitioner are to Warren L. Baker, Jr.After a concession by petitioners, 3 the issue for decision is whether the termination payment received by petitioner upon retirement as an insurance agent of State Farm Insurance Cos. is taxable as capital gain or ordinary income. BackgroundSome of the facts have been stipulated and are so found. The stipulated facts and the related exhibits are incorporated herein by this reference. At the time of filing the petition, petitioners resided in Fairview Heights, Illinois.454 I. Petitioner's Agreement With State Farma. GeneralPetitioner began his relationship with State Farm Insurance Cos. (State Farm) on January 19, 1963. State Farm consisted of State Farm Mutual Automobile Insurance Co., State Farm Life Insurance Co., State Farm Fire & Casualty Co., and State Farm General Insurance Co.32 Petitioner conducted his business as the Warren L. Baker Insurance Agency (the agency). He sold policies exclusively for State Farm. When he began his relationship with State Farm, he was not assigned customers. Instead, he developed a customer base. He selected the location of his office with State Farm's approval. He also hired and paid employees. He was responsible for paying the expenses of an office such as rent, utilities, telephones, and other equipment. He was obligated to establish a trust fund into which he deposited premiums collected on behalf of State Farm.Petitioner entered into a series of contracts with State Farm known as agent's agreements. The agent's agreement at issue was executed on March 1, 1977. While the agreement contains approximately 6 pages, there are numerous attachments including schedules of payments, amendments, addenda, and memoranda that total 61 pages. The agreement was prepared by State Farm. Petitioner did not have the ability to change the terms of the agreement, but he had the option to refuse a new or revised agreement.The preamble to the agreement reads, in part, as follows: "The Companies believe that agents operating as independent contractors33 are best able to provide the creative selling, professional counseling, and prompt and skillful service essential to the creation and maintenance of successful multiple-line companies and agencies."Section I of the agreement, Mutual Conditions and Duties, provides that petitioner was an independent contractor of State Farm. As a State Farm agent, petitioner agreed to write policies exclusively for State Farm, its affiliates, and government and industry groups. Paragraph C, section I of the agreement states that State Farm "will furnish you, without charge, manuals, forms, records, and such other materials and supplies as we may deem advisable to provide. 455 All such property furnished by us shall remain the property of the Companies [State Farm]." Further, State Farm considered any and all information regarding policyholders to be its property, as follows: D. Information regarding names, addresses, and ages of policyholders of the Companies; the description and location of insured property; and expiration or renewal dates of State Farm policies acquired or coming into your possession during the effective period of this Agreement, or any34 prior Agreement, except information and records of policyholders insured by the Companies pursuant to any governmental or insurance industry plan or facility, are trade secrets wholly owned by the Companies. All forms and other materials, whether furnished by State Farm or purchased by you, upon which this information is recorded shall be the sole and exclusive property of the Companies.Essentially, any data relating to a policyholder recorded by an agent on any paper was the property of State Farm.Petitioner's compensation was based on a percentage of the net premiums. The compensation varied by the type of insurance, such as automobile and homeowner's. Petitioner was also assigned policies for which he received a smaller commission than those policies he personally produced. State Farm assigned existing policies to petitioner because the policyholders moved to the geographic location covered by his agency. Similarly, when policyholders covered by petitioner moved to a different geographic location, the policies were assigned to another agent in that geographic area. Petitioner did not compensate other agents for policies35 he assumed, and he did not receive payments for policies assigned to other agents.The commissions payable for assigned policies are provided for in the schedule of payments attached to the agreement in relevant part as follows: an amount equal to 66-456 b. TerminationSection III of the agreement addresses termination. Either party could terminate the agreement by written notice. The agreement also provided for termination upon the death of petitioner. Within 10 days after termination of the agreement, "all property belonging to the Companies shall be returned or made available for return to the Companies or their authorized representative."Petitioner was required to abide by a covenant not to compete for a period of 12 months following termination. The covenant not to compete provides as follows: E. For a period of one year following termination of this Agreement, you will not either personally or through any other person, agency, or organization (1) induce or advise any State Farm policyholder credited to your account at the date of termination to lapse, surrender, or cancel any State Farm insurance coverage or (2) 36 solicit any such policyholder to purchase any insurance coverage competitive with the insurance coverages sold by the Companies.Pursuant to section IV of the agreement, petitioner qualified for a termination payment if he met certain requirements. First, he must work for 2 or more continuous years as an agent. Second, within 10 days of termination, he must return or make available for return all property belonging to State Farm.The amount of the termination payment payable is different for each of the State Farm companies. With two of the State Farm companies, the amount of the termination payment is based on a percentage of policies that either remained in force after termination of the agreement or those that had been in force for the 12 months preceding termination. 4 The formulas for the amount of termination payment are as follows:37 State Farm Mutual Automobile Insurance Company * * * the lesser of (1) or (2) -- (1) twenty percent (20%) of the service compensation on "personally produced" policies, you earned under the Schedule of Payments for Other than Health Insurance Policies in the twelve (12) preceding months, or twenty percent (20%) of the service compensation on "personally produced" policies 457 credited to your account, as of the date of termination, which remain in force in the same state, during the first twelve (12) months following the date of termination; whichever is greater, or (2) thirty percent (30%) of the service compensation on "personally produced" policies credited to your account as of the date of termination, which remain in force in the same state during the first twelve (12) months following the date of termination. State Farm Fire and Casualty Company and State Farm General Insurance Company * * the lesser of (1) or (2) -- (1) twenty percent (20%) of the commissions you were paid on "personally produced" policies38 for those lines of insurance * * of the applicable Schedule of Payments, in the twelve (12) preceding months, or twenty percent (20%) of the commissions on "personally produced" renewal premiums you would have been paid under the applicable Schedule of Payments, if this Agreement had not been terminated, in the twelve (12) months following the date of termination on "personally produced" policies which remain in the same state, for those lines of insurance designated above and credited to your account as of the date of termination; whichever is greater, or (2) thirty percent (30%) of the commissions on "personally produced" renewal premiums you would have been paid under the applicable Schedule of Payments, if this Agreement had not been terminated, in the twelve (12) months following the date of termination on those "personally produced" policies designated in (1) and credited to your account as of the date of termination. State Farm Life Insurance Company -- An amount equal to the same compensation for the second and39 subsequent policy years as would have been due and payable to you for the first five years following the date of termination on all State Farm life policies personally written by you or assigned to you by the Company for compensation, under the terms of the applicable Schedule of Payments attached hereto, if this Agreement had not been terminated.State Farm and petitioner did not negotiate the amount or conditions of the termination payment. State Farm agreed to pay petitioner a termination payment over either a 2- or 5-year period.Section V of the agreement provides for an extended termination payment if petitioner worked for State Farm for at least 20 years, of which 10 years were consecutive. The extended termination payment would begin 61 months after termination and continue until petitioner's death. The extended termination payment is also based on policies personally produced by petitioner during his last 12 months as an agent for State Farm.458 State Farm paid commissions for new business personally written by the agent as a percentage of the first policy year premium due according to the percentage established in table I of the40 "Schedule of Payments Referred to in State Farm Agent's Agreement" (schedule of payments) attached to the agreement. For many of the policies, commissions would be paid during the first, second, third, fourth, and fifth policy year, depending upon the type of policy and its length. Section VI of the schedule of payments provides as follows: Upon termination of this Agreement by death or otherwise any unpaid compensation provided for under this Schedule of Payments then due and payable shall be paid as soon as ascertainable, and there shall be no further liability on the part of the Company under the terms of this Schedule of Payments.During the operation of the agency and pursuant to the agreement, petitioner operated a trust fund. When petitioner terminated his relationship with State Farm, the trust account was closed and audited by State Farm.II. Petitioner's RetirementPetitioner retired and terminated his relationship with State Farm on February 28, 1997. At that time, he held approximately 4,000 existing policies generated from 1,800 households. Approximately 90 percent of the policies were assigned to one successor agent. The41 successor agent received reduced compensation (that is, a lower percentage) for the assigned policies.Petitioner returned State Farm's property, such as policy and policyholder descriptions, which he gathered in master folders that he purchased, claim draft books, rate books, agent's service texts, and a computer. He maintained much of the information regarding the policies and policyholders on the computer. He fully complied with the provision in the agreement for return of property to State Farm.The successor agent hired the two employees previously employed by petitioner and assumed petitioner's telephone number. The successor agent also worked with petitioner on occasion prior to petitioner's retirement to meet policyholders and to ask questions. The successor agent opened an office in the vicinity of petitioner's office. When the termination 459 was completed, petitioner had returned all of the assets used in the agency to State Farm and the successor agent.III. Tax Return and Notice of DeficiencyPetitioners timely filed their 1997 Federal income tax return. They reported the income of $ 38,622 from the termination payment which petitioner received in 1997 as long-term capital42 gain on Schedule D, Capital Gains and Losses. Petitioners attached a two- page statement to Schedule D on which the termination payment was described as an annuity payable over 5 years. 5 The annuity was described as a sale of assets to State Farm that included "personally produced policies and other intangible assets".Petitioners attached Form 8594, Asset Acquisition Statement Under Section 1060, to their tax return. On Form 8594, petitioners indicated the fair market value for the Class IV asset as $ 164,140. 6 Petitioners answered "yes" to the following question on line 6 of Form 8594: "did the buyer also purchase * * * a covenant not to compete?" Petitioners did not assign a value for the covenant not to compete.43 In a notice of deficiency, respondent determined that the termination payment from State Farm was ordinary income and did not qualify for capital gain treatment. DiscussionI. Positions of the PartiesRespondent argues that petitioner did not sell any property to State Farm because all of the property was owned by State Farm and reverted to State Farm when petitioner terminated his relationship with State Farm. Respondent contends that the agreement does not evidence a sale because the contract does not list a seller or purchaser. Respondent also argues that petitioners failed to establish that the termination payment represents proceeds from the sale of a business, business assets, or goodwill. Respondent also suggests that the termination payment is in the nature of income from self-employment, but hedges that position in 460 arguing that the payment is "similar to an annuity" and a "retirement benefit". We note that respondent did not determine that petitioners were liable for self-employment tax with respect to the termination payment.Petitioners argue that the termination payment was for the sale or buyout of a business resulting in44 capital gain. They assert that petitioner developed a customer base and the termination payment was designed to protect the existing customer base for the successor agent as well as compensate petitioner for the goodwill and going business concern he developed. Petitioners rely on the concurring opinion in Jackson v. Commissioner, 108 T.C. 130">108 T.C. 130, 141 (1997), which characterizes a termination payment similar to the one at issue as a buyout of the taxpayer's business.The Coalition of Exclusive Agent Associations, Inc. (CEAA), filed with leave of the Court an amicus brief pursuant to conditions specified in the Court's order. The CEAA's argument is similar to the arguments made by petitioners: State Farm purchased the goodwill generated by petitioner; therefore, petitioner is entitled to capital gain treatment.II. Evidentiary IssueWe first deal with an evidentiary issue presented at trial. Petitioners proffered a list of questions and answers dated February 14, 1991, which was marked for identification as Exhibit 12- P. The questions were prepared by a representative of respondent, and the answers were provided by a representative of State Farm. Respondent objected to45 the admission of the document and asked for an opportunity to authenticate the document. The Court admitted the document, although it was not admitted for the truth of the assertions contained therein. In a supplemental stipulation of facts the parties agreed that the State Farm representative who provided the answers to Exhibit 12-P, if called as a witness, would testify as set forth in a declaration attached to the supplemental stipulation as Exhibit 13-R. In the declaration the representative states that he provided the answers contained in Exhibit 12-P and further explains the answers set forth in Exhibit 12-P. Petitioners, however, object to the admission of Exhibit 13-R on the ground that State Farm's "view" of certain matters is not relevant. In this regard, the 461 objection appears inconsistent with petitioners' proffer of Exhibit 12-P, which expresses the "view" or opinion of the same individual.Considering Exhibits 12-P and 13-R together, we are satisfied that our initial ruling was correct and that Exhibit 12-P should not be admitted for the truth of the contents because it contains hearsay. To be consistent with our treatment of Exhibit 12- P, we admit Exhibit 13-R for the46 limited purpose of supplementing Exhibit 12-P but not for the truth of the assertions made therein. Fed. R. Evid. 401, 701, 801.III. Burden of ProofGenerally the taxpayer bears the burden of proof. Rule 142(a)(1). Section 7491, which is effective with respect to court proceedings arising in connection with examinations by the Commissioner commencing after July 22, 1998, the date of its enactment by section 3001(a) of the Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. 105-206, 112 Stat. 726, does not apply to place the burden of proof on respondent. Petitioners have neither alleged that section 7491 is applicable nor established that they complied with the requirements of section 7491(a)(2)(A) and (B) to substantiate items, maintain required records, and fully cooperate with respondent's reasonable requests.IV. Sale or Exchange of a Capital AssetWe must decide the proper characterization of the termination payment made by State Farm to petitioner. We first consider whether petitioner owned a capital asset and whether petitioner sold or exchanged a capital asset for Federal income tax purposes. We also consider whether petitioner sold a business to which47 goodwill attached. If petitioner did not sell or exchange a capital asset, then the termination payment is taxable as ordinary income.Long-term capital gain is defined as gain from the sale or exchange of a capital asset held for more than 1 year. Sec. 1222(3). A "capital asset" means property held by the taxpayer (whether or not connected with his trade or business) that is not covered by one of five specifically enumerated exclusions. Sec. 1221.462 In Schelble v. Commissioner, T.C. Memo. 1996-269, affd. 130 F.3d 1388">130 F.3d 1388 (10th Cir. 1997), we considered whether the taxpayer received gain from the sale or exchange of a capital asset. Pursuant to the terms of the agreement with the insurance company for which he was an agent, the taxpayer was required to return all records, manuals, materials, advertising, and supplies or other property of the company. Id. We concluded that there was no evidence of "vendible business assets", and the record did not support a finding of a sale of assets of a business.The Court of Appeals in Schelble v. Commissioner, 130 F.3d at 1394, held that there was "no evidence in the record of vendible assets to support the48 sale of Mr. Schelble's insurance business". It observed the following: By transferring policy records to * * [the insurance company] pursuant to the Agreement, * * * [the taxpayer] maintains he transferred insurance business goodwill developed by him. * * * [The taxpayer] has failed, however, to show a sale of assets occurred.Id.In Foxe v. Commissioner, 53 T.C. 21">53 T.C. 21, 26 (1969), we considered whether payments made to an insurance agent were made pursuant to the sale or exchange of a capital asset to his former insurance company upon the cancellation of his employment contract. The taxpayer claimed that in the course of his business he built up "something of value, an organization" that the insurance company acquired. Id. Moreover, his personal contacts with customers, which were important to the insurance company, were "something of real value". Id.We concluded that even if the taxpayer had "built up an organization of value, it was not his to sell since * * * [the insurance company] under the contract owned all the property comprising such organization. As to the customer contacts * * . They were not his to sell. 49 " Id. It was held that the taxpayer did not sell or exchange a capital asset, and the payments were taxable as ordinary income.Section 1001(c) provides that gain is recognized upon the sale or exchange of property. "The word 'sale' means 'a transfer of property for a fixed price in money or its equivalent'". Schelble v. Commissioner, supra at 1394 (quoting Five Per Cent. Cases, 110 U.S. 471">110 U.S. 471, 478, 28 L. Ed. 198">28 L. Ed. 198, 4 S. Ct. 210">4 S. Ct. 210 (1885)); see also Commissioner v. Brown, 380 U.S. 563">380 U.S. 563, 570, 14 L. Ed. 2d 75">14 L. Ed. 2d 75, 85 S. Ct. 1162">85 S. Ct. 1162 (1965). "Exchange" means an 463 exchange of property for another property that is materially different either in kind or in extent. Sec. 1.1001-1, Income Tax Regs.The key to deciding whether there has been a sale for Federal income tax purposes is whether the benefits and burdens of ownership have passed. Highland Farms, Inc. v. Commissioner, 106 T.C. 237">106 T.C. 237 (1996); Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221">77 T.C. 1221, 1237 (1981). Among the many factors we may consider in deciding whether there has been a sale are the following: Whether legal title passes; how the parties treat the transaction; whether an equity was acquired in the property; whether50 the contract creates a present obligation on the seller to execute and deliver a deed and a present obligation on the purchaser to make payments; whether the right of possession is vested in the purchaser; which party pays the property taxes; which party bears the risk of loss or damage to the property; and which party receives the profits from the operation and sale of the property. Levy v. Commissioner, 91 T.C. 838">91 T.C. 838, 860 (1988); Grodt & McKay v. Commissioner, supra at 1237-1238.Cases addressing whether there has been a sale or exchange of a capital asset often combine the issue of whether the taxpayer owned a capital asset with the issue of whether the taxpayer sold the asset. For example, in Erickson v. Commissioner, T.C. Memo 1992-585">T.C. Memo. 1992-585, affd. 1 F.3d 1231">1 F.3d 1231 (1st Cir. 1993), we concluded that there was no sale of the taxpayer's assets to his former insurance company because there was nothing in the facts showing that there was a sale of "vendible tangible assets" of a business. In Erickson, the Court stated: [The taxpayers] maintain that * * * certain indicia of a sale exist. They assert that employees who formerly51 worked for * * [the taxpayer] went over to Union Mutual and that all records, supplies, and equipment were turned over to Union Mutual. * * * however, the individuals who had worked with * * * [the taxpayer] had always been salaried employees of Union Mutual. * * * And by his own admission, * * * [the taxpayer] had owned very little in the way of supplies and equipment * * Id.Respondent cites Jackson v. Commissioner, 108 T.C. 130">108 T.C. 130 (1997), Milligan v. Commissioner, T.C. Memo. 1992-655, revd. 38 F.3d 1094">38 F.3d 1094 (9th Cir. 1994), and similar cases for the proposition that the taxpayer did not sell or exchange the 464 assets in his business. These cases bear a factual resemblance to the case at hand in that the taxpayer, a former insurance agent, received a termination payment after the termination of his agreement with the insurance company. But these cases focus on whether the taxpayer was subject to self-employment tax under sections 1401 and 1402.The holdings by the Court of Appeals in Milligan and by this Court in Jackson do not require a conclusion that the termination payment paid to petitioner52 represents proceeds from the sale or exchange of a capital asset. Both Jackson and Milligan left open the question of whether termination payments constitute the sale or exchange of capital assets subject to capital gain treatment or whether they should be treated as ordinary income (other than income subject to self-employment tax).V. The Controlling Facts of This CaseWe now apply the above discussion to the facts before us in this case. Upon his retirement, petitioner returned all assets used in the daily course of business, including a computer, books and records, and customer lists to State Farm pursuant to the agreement. Thus, much like the taxpayers in Foxe v. Commissioner, supra, and Schelble v. Commissioner, 130 F.3d 1388">130 F.3d 1388 (10th Cir. 1997), petitioner did not own these assets and, therefore, could not have sold them to State Farm.Petitioner argues that the successor agent assumed his telephone number and hired the two employees of the agency, and that petitioner taught the successor agent about the agency and introduced him to policyholders, all of which support the argument that he sold the agency to State Farm.The successor agent obtained53 the right to use the telephone number utilized by petitioner's agency. Petitioner did not argue, and we do not conclude, that the telephone number was a capital asset in the hands of petitioner. Additionally, there are no facts in the record that indicate that petitioner received any portion of the termination payment as payment for the successor agent's use of the telephone number.There are no facts in the record that indicate that there was an employment contract between petitioner and the 465 employees who worked for the agency or that the successor agent was required to hire the employees. Petitioner did not argue, and we do not conclude, that the employees constitute capital assets in the hands of petitioner. There is nothing in the record that indicates that petitioner received any portion of the termination payment as payment for the successor agent's hiring of the employees. The fact that the successor agent hired petitioner's former employees does not support petitioner's argument that he sold his agency.Petitioner may have taught the successor agent about the agency and introduced him to policyholders when the successor agent visited petitioner's office, but there are no54 facts in the record that indicate that petitioner received the termination payment as payment for teaching the successor agent about the agency and introducing him to policyholders.We conclude that petitioner did not own a capital asset that he could sell to State Farm. He did not receive the termination payment as payment for any asset. Accordingly, the termination payment does not represent gain from the sale or exchange of a capital asset.Petitioner also argues that State Farm purchased goodwill. To qualify as the sale of goodwill, the taxpayer must demonstrate that he sold "' the business or a part of it, to which the goodwill attaches'". Schelble v. Commissioner, 130 F.3d at 1394 (quoting Elliott v. United States, 431 F.2d 1149">431 F.2d 1149, 1154 (10th Cir. 1970)). Goodwill is "the expectancy of continued patronage, for whatever reason." Boe v. Commissioner, 307 F.2d 339">307 F.2d 339, 343 (9th Cir. 1962), affg. 35 T.C. 720">35 T.C. 720 (1961); see also VGS Corp. v. Commissioner, 68 T.C. 563">68 T.C. 563, 590 (1977).Nevertheless, because petitioner, for the reasons already explained, did not own and sell capital assets in his agency to State Farm, we conclude55 that petitioner did not sell goodwill.VI. Nature of Ordinary IncomeRespondent does not clearly explain his position as to the nature of the termination payment other than to argue that it is not taxable as capital gain. In the notice of deficiency, respondent determined 466 that the termination payment was ordinary income. In his brief, respondent primarily argues that petitioners did not satisfy their burden of proof to establish that the termination payment was proceeds of a sale and thus subject to capital gain treatment.Having concluded above that the termination payment was not received for the sale or exchange of a capital asset and is not entitled to treatment as a capital gain, we conclude that the termination payment is taxable as ordinary income. Ordinary income treatment is accorded to a variety of payments. See, e. g., Hort v. Commissioner, 313 U.S. 28">313 U.S. 28, 85 L. Ed. 1168">85 L. Ed. 1168, 61 S. Ct. 757">61 S. Ct. 757 (1941) (income received upon cancellation of lease derived from relinquishment of right to future rental payments in return for a present substitute payment and possession of premises); Elliott v. United States, supra (payment for termination of insurance agency contract was ordinary income); 56 Foxe v. Commissioner, 53 T.C. at 25 (payment to insurance agent upon cancellation of employment contract was ordinary income); General Ins. Agency, Inc. v. Commissioner, T.C. Memo. 1967-143 (payment for agreement not to compete was ordinary income), affd. 401 F.2d 324">401 F.2d 324 (4th Cir. 1968).VII. Covenant Not To CompeteAn amount received for an agreement not to compete is generally taxable as ordinary income. Banc One Corp. v. Commissioner, 84 T.C. 476">84 T.C. 476, 490 (1985), affd. without published opinion 815 F.2d 75">815 F.2d 75 (6th Cir. 1987); Warsaw Photographic Associates, Inc. v. Commissioner, 84 T.C. 21">84 T.C. 21 (1985); Ullman v. Commissioner, 29 T.C. 129">29 T.C. 129 (1957), affd. 264 F.2d 305">264 F.2d 305 (2d Cir. 1959); General Ins. Agency, Inc. v. Commissioner, supra.Petitioners reported the sale of a covenant not to compete on Form 8594 attached to the return. The agreement provides that, after retiring, petitioner would not solicit State Farm's policyholders for 1 year, or petitioner would forfeit the termination payment. If petitioner had competed against State Farm after retiring, he would not have received a termination payment.57 We find that petitioner entered into a covenant not to compete with State Farm and that a portion of the termination payment was paid for the covenant not to compete.Proceeds allocable to a covenant not to compete are properly classified as ordinary income. See General Ins. Agency, Inc. v. Commissioner, 401 F.2d at 329. Petitioner did not allocate *467 any portion of the termination payment to the covenant not to compete, and it is unnecessary for us to make such an allocation because the termination payment is classified as ordinary income.We have considered all arguments by the parties and amicus, and, to the extent not discussed above, conclude they are irrelevant or without merit.To reflect the foregoing,Decision will be entered for respondent. Footnotes1. I wrote the Court's majority opinion in Jackson v. Commissioner, 108 T.C. 130">108 T.C. 130 (1997), holding that termination payments received by the insurance agent from State Farm were not subject to self-employment tax under secs. 1401 and 1402, I.R.C. I also joined Judge Parr's concurring opinion indicating that such payments could be treated as being in the nature of a buyout of the agent's business. After further consideration, I am now persuaded by the opinion of Chief Special Trial Judge Panuthos↩ that this petitioner (agent) is not entitled to capital gain treatment for the termination payment he received.2. Section references are to the Internal Revenue Code in effect for the year in issue. All Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated.↩3. Petitioners concede that they failed to report dividend income of $ 919 from Magna Group, Inc.↩4. It is not clear from the record whether the termination payment that petitioner received was calculated based upon policies that remained in force after termination or instead had been in force for the 12 months preceding termination. These facts have no bearing on our decision.↩5. Timing of the recognition of income is not at issue. The record does not indicate how State Farm treated the termination payment on its return.↩6. n6A taxpayer may treat goodwill acquired before Feb. 14, 1997, as a Class IV asset. Sec. 1.1060-1T(a)(2)(ii), Temporary Income Tax Regs., 62 Fed. Reg. 2272↩ (Jan. 16, 1997).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624519/	Fort Howard Paper Company, Petitioner v. Commissioner of Internal Revenue, RespondentFt. Howard Paper Co. v. CommissionerDocket No. 3127-65United States Tax Court49 T.C. 275; 1967 U.S. Tax Ct. LEXIS 3; December 27, 1967, Filed 3 Decision will be entered under Rule 50. Petitioner for 35 years capitalized only the direct costs of labor and materials connected with self-constructed items. Overhead expenditures were in part allocated to inventory and in part deducted currently. Respondent was fully aware of petitioner's practice and had frequently adopted the same method in requiring petitioner to capitalize repair items which petitioner had deducted on its returns. On a second audit of petitioner's 1961 return, respondent determined that a portion of overhead expenses should be attributed to self-constructed assets and capitalized. Held, petitioner, under all the circumstances involved, utilized an acceptable method of accounting for such overhead and its treatment thereof will not be disturbed. Held, further, that certain fringe items and the cost of this petitioner's drafting department were properly treated as overhead. William A. Cromartie and Douglas L. Barnes, for the petitioner.Robert M. Burns and John L. Pedrick, for the respondent. Tannenwald, Judge. TANNENWALD276 Respondent determined a deficiency in the amount of $ 212,354.52 in the Federal income tax of petitioner for the taxable year ended December 31, 1961. After concessions and agreements with5 respect to various adjustments raised by the deficiency notice, the issues remaining are: (1) Whether the additional examination of petitioner's records and the issuance of a deficiency notice thereunder were improper under section 7605; 1 (2) whether respondent's determination was arbitrary and unreasonable and therefore should be disregarded, or alternatively not be accorded the usual presumption of correctness; and (3) if such determination is not to be disregarded, whether petitioner utilized the proper method of accounting for the cost of "self-constructed assets."FINDINGS OF FACTSome of the facts are stipulated and are found accordingly.Petitioner Fort Howard Paper Co. (sometimes hereafter referred to as Fort Howard) is a Wisconsin corporation with its principal offices in Green Bay, Wis., at the time of the filing of the petition herein. Petitioner timely filed its Federal income tax return for the calendar year 1961 on the accrual basis6 with the district director of internal revenue in Milwaukee, Wis.Fort Howard is a manufacturer of paper and paper products. During the period 1953 through 1961, petitioner's gross sales ranged from approximately $ 15 million to $ 30 million. In 1961, the Fort Howard product line consisted exclusively of manufactured sanitary papers, such as paper towels, napkins, and tissues. Nearly 975 different items, including various grades and sizes of paper products, were manufactured. Six large paper-making machines were in operation at the plant. Petitioner also operated pulpers and equipment for the processing of dried pulp into a usable state for the paper machines. In addition, petitioner used certain machinery to convert logs into groundwood pulp and to process scrap paper and similar products into pulp ingredients when they could be appropriately used in the final product.Petitioner operated its own fleet of motor vehicles and over 80 forklift trucks and towmotors. In addition, the company produced its own 277 electric power from coal-operated steam generators, having in 1961 a maximum capacity of approximately 20,000 kilowatts. In 1961, petitioner purchased no electric7 power from sources outside the plant, with the exception of small amounts used in warehouses not directly connected with the main plant.For many years prior to and including 1961, petitioner's plant was operated on a full 24-hour basis, usually for 13 days in each 2 weeks. Occasionally, the plant would be shut down because of repairs, or during a special "shut down" period of 2 weeks (once a year) when many employees were on vacation and only "skeleton" crews were on duty. To operate at this level, three full production crews were maintained in 1961 for each paper-making machine.In 1961, approximately 1,100 persons were employed by petitioner, 190 to 200 of whom were repair and maintenance personnel in nonsupervisory capacities. Included in the repair and maintenance personnel were skilled mechanics and repairmen, carpenters, electricians, machinists, millwrights, and pipefitters. Petitioner also maintained and operated in its plant "repair shops," which were capable of handling most machine and plant repairs. Most of the employees on the repair and maintenance crews worked on the day shift (7 a.m.-3:30 p.m.) with smaller crews available on the evening (3 p.m.-11 p.m.) and 8 midnight shifts (11 p.m.-7 a.m.). In order to keep the plant in continuous operation, all repair and maintenance personnel were subject to call at any time for emergency work.At least as far back as 1939 and up to and including 1961, the Fort Howard management followed a policy of using its maintenance and repair personnel from time to time in the renovation of its buildings and the construction and installation of assets having useful lives of more than 1 year (hereinafter referred to as self-construction projects or self-constructed assets). To avoid having any "slack," "idle," or "loss" time, repair and maintenance personnel were used only during their spare time, when they could be so employed without disturbing normal operations. Such personnel were not diverted from regular repair or maintenance projects to work on self-construction projects. No special tools or machinery were acquired for use by such personnel in connection with such activities. Projects were often planned a year or more in advance of actual construction, but completion was sometimes delayed several years because work was done only on a "fill-in" basis.Since the time of its inception (1919), Fort Howard9 management followed a policy of determining the size of its repair and maintenance staff on the basis of the need for continuous operation of the regular producing equipment. During peak periods of maintenance, it was often necessary to supplement the repair and maintenance force with 278 anywhere from 25 to 75 employees borrowed from the manufacturing (producing) departments.Self-construction work performed by repair and maintenance personnel was the subject of a written description and was designated a "project." Examples of such "projects" included the following (as recorded from petitioner's record of Jobs in Progress -- 1961):Date openedJob No.May 11, 1953618Make two 4-roll wrappers.Aug. 6, 1956892Install paper converting plyfold machine.Oct. 3, 195610Make and install Yankee hood. No. 3 papermachine.Oct. 3, 195611Heater, fan, and ductwork for Yankee hood, No. 3paper machine.Jan. 14, 1958118Build four wide singlefold towel log bundlers.Oct. 29, 1958198Make and install automatic reel for No. 3 papermachine.Nov. 25, 1958202Fort Howard work on water treatment part ofNo. 51 building.Nov. 25, 1958204Fort Howard work on ledger processing part ofNo. 51 building.Nov. 25, 1958207Lighting for No. 51 building.Nov. 25, 1958208Power wiring for No. 51 building.Nov. 25, 1958209Heating and ventilation for No. 51 building.Feb. 11, 1959236Install air-conditioning unit and ventilation foroffices, first and second floors, No. 49 building.Feb. 11, 1959237Heating for offices, second floor, No. 49 building.Feb. 11, 1959238General construction of office rooms, first floor,No. 49 building.Feb. 11, 1959241Heating for office rooms, first floor, No. 49building.Feb. 11, 1959245Install air conditioning and ventilation forcafeteria, first floor, No. 49 building.Feb. 11, 1959246Heating for cafeteria rooms, first floor, No. 49building.Feb. 23, 1959249Build two high-speed 54-in. winders.May 13, 1959264Sprinkler fire protection system for Quonsets Nos.36, 37, 38, 39, and 41.May 21, 1959268Rebuild and install nine speed reducers formixing agitators, No. 51 building.10 Many of the self-construction projects were covered in whole or in part by plans developed by petitioner's drafting department, and work was performed pursuant to those plans. This department, in terms of number and utilization of personnel, was geared to petitioner's requirements in connection with its production facilities.Petitioner maintained on its books and records an account identified as Construction in Progress. A separate record sheet was prepared for each self-construction project. All direct labor and direct materials employed on each project were accumulated in the "Construction in Progress" account prior to the time that the particular project was completed and placed into service. No indirect costs (i.e., overhead) 279 were so accumulated. No part of the costs of the drafting department was capitalized as a cost of self-construction. Not until a project was completed was it determined whether the applicable labor and materials were to be charged to expense or to be capitalized. Petitioner consistently followed the foregoing method for a least 35 years.For at least the period from 1939 through 1961, Fort Howard followed the practice of allocating a portion11 of its overhead in determining the cost of goods which it produced and sold. For this purpose, the company's cost accounting procedures included a "grade-costing" system which was used to arrive at an average cost per ton for each grade of paper produced. All direct charges for labor and material used in each of the 29 producing departments were charged directly to such departments. Indirect expenses were also distributed to the producing departments, or to three basic service classifications identified as "mill services," "building services," and "steam and power." The company did not consider certain "fringe benefit" items (including bonuses, profit-sharing distributions to employees, group insurance, and personnel, cafeteria, and first aid expense) to represent proper elements of the cost of goods. Instead of being allocated to inventory, these items were always currently expensed.Fort Howard tax returns were audited by agents of the respondent for each of the years 1928 to 1961. For almost all of these years, including 1961, the agents who made the examinations were aware that petitioner, in determining the costs applicable to its self-construction projects, capitalized 12 the direct labor and direct materials involved, but did not allocate any overhead thereto. During the period 1928 to 1961, the accounting for costs in the determination of overhead, and the allocation thereof to cost of goods produced and sold, was also subject to review by these agents. Both Agent Evans (examiner from 1928 to 1938) and Agent Baeb (examiner from 1942 to 1961) reviewed the petitioner's practices in determining the costs to be attributed to self-constructed assets and decided that the method employed was proper under the circumstances because of the consistent use of such method by petitioner over a period of many years. During the course of the foregoing audits (including the year involved herein), respondent's agents themselves frequently adopted this method by utilizing petitioner's computation of costs, i.e., only direct labor and materials, as the measure of the amount of deducted repairs which they required to be capitalized; they included no overhead in the capitalized amount.Petitioner's return for the year 1961 was initially audited by Agent Baeb. He was assigned to the office of the district director of internal revenue, Milwaukee, Wis. Some time after13 Baeb had completed his initial audit, the Internal Revenue Service received a complaint that certain irregularities involving the official conduct of respondent's agent had occurred in the prior examination of the tax returns of 280 petitioner. Pursuant to this complaint, Agent Slotnick of the Chicago district office was assigned to investigate these purported irregularities and to examine petitioner's 1963 income tax return. Slotnick's examination established that none of the purported irregularities had occurred and that the complaint was without substance, but he nevertheless felt that certain adjustments should probably be made, not only in the 1963 return but in the returns for prior years.Upon returning to the Chicago office, Slotnick prepared a memorandum requesting authorization to reopen the taxpayer's returns for the years 1961 and 1962. This request was approved by John W. Hungeling, Acting Assistant Regional Commissioner -- Audit, on February 1, 1965, and a notice of reexamination, dated February 1, 1965, and signed by the Regional Commissioner for the Midwest Region, was sent to petitioner. Thereafter, Agent Slotnick commenced his examination of petitioner's14 1961 return. Engineer Revenue Agent Lawrence M. Kenney was assigned to work with Slotnick and spent 6 days at petitioner's plant between February 18, 1965, and February 26, 1965. Having been advised that he was confronted with a problem of determining "overhead," Kenney familiarized himself with the list of "Jobs in Progress -- 1961" and personally observed the physical facilities in the plant. Kenney had made no visit to the plant in 1961. No official written report was prepared by Kenney with respect to the year 1961 until April 12, 1965. Agent Slotnick's report upon reexamination was dated March 5, 1965. The principal proposed adjustment to petitioner's 1961 income was the allocation of $ 408,374.08 of "overhead expenses" to the capitalized cost of self-constructed assets.The basic approach followed by Agent Slotnick in making his determination of how much overhead to capitalize was (1) to determine the particular departments and persons connected with self-construction projects in 1961; (2) to determine the total costs connected with each of these departments and persons; (3) to determine what percentage of these costs were allocable to self-construction projects; and (4) 15 to determine the amount of supervision costs allocable to each department involved in such projects.In determining which departments and persons were involved in the self-construction projects and the extent of such involvement, Slotnick relied on the following: (1) A single inspection of petitioner's plant; (2) discussions with petitioner's assistant treasurer which were not reduced to writing; (3) his own general experience as a certified public accountant and an Internal Revenue agent; (4) the reading of a cost accounting text in the Green Bay Public Library, which text specifically dealt with the method of allocating mill service departments to the producing departments of a factory; and (5) consultations with Agent Kenney and information furnished by him which formed the basis of his report dated April 12, 1965.281 Petitioner was generally cooperative during the reexamination of its 1961 return, furnishing such records and information as were available, upon request by Slotnick. At the time he conducted his examination, Slotnick was aware that self-construction activities had taken place and that petitioner's records contained detailed information with respect to each16 such project. He did not, however, avail himself of such information. Nor did he attempt to ascertain from petitioner's records the extent to which personnel of any one of the specific departments actually participated in self-construction work.In capitalizing "overhead" in the amount of $ 408,374.08 for the year 1961, respondent did not reduce petitioner's inventory at December 31, 1961, by that portion of said "overhead" which had been allocated to inventory valuation by petitioner in determining its cost of goods sold. The parties have stipulated that, whatever the decision of the Court with regard to other issues in this case, petitioner's inventories at December 31, 1961 (and on Jan. 1, 1962), will be as shown on the 1961 return (namely, $ 1,359,698.17).On its corporate income tax return for the calendar year 1961, petitioner showed taxable income of $ 5,102,651.76, cost of goods sold of $ 16,887,948.60, fixed assets of $ 24,736,046.84, and depreciation of $ 1,516,573.28. Petitioner's total computed income tax for 1961 was $ 2,644,698.10.ULTIMATE FINDING OF FACTPetitioner's method of accounting for self-constructed assets clearly reflected its income.OPINIONThe core17 issue herein involves the question of how petitioner should treat overhead expenses in determining the cost of self-constructed assets for tax purposes. Respondent contends that portions of such expenses should be capitalized and added to the cost basis of the assets. Petitioner asserts that it should be entitled to continue its past practice of capitalizing only direct labor and materials costs without allocation of overhead.Petitioner is a large manufacturer of a great variety of paper and paper products. To a marked degree, its operations are self-sufficient, e.g., it produces the bulk of its own power. For many years prior to and including the taxable year involved herein, petitioner operated on a 24-hour basis, usually for 13 days in each of 2 weeks. During 1961, it employed 1,100 persons at its plant, of whom 190 to 200 persons were repair and maintenance personnel, including mechanics, carpenters, electricians, millwrights, and pipefitters. Such personnel worked throughout the 24-hour daily cycle, the majority of them on the day shift. All were subject to call at any time for emergency work.282 At least as far back as 1939, petitioner followed a policy of using18 repair and maintenance personnel during their spare time in the construction, renovation, and repair of fixed assets used by petitioner in its manufacturing operations. At no time were such personnel diverted from regular repair and maintenance activities to work on such self-constructed assets.At all times the size of petitioner's repair and maintenance staff was determined exclusively by its need for the continuous operation of its regular producing equipment. No special tools or machinery were acquired for use by such personnel in their activities on self-constructed assets. Respondent does not contend that petitioner maintained a larger than necessary repair and maintenance staff as a cover for its self-construction activities, and, indeed, there is no evidence in the record before us to support any such conclusion.For 35 years or more, petitioner capitalized only the direct labor and materials charges directly attributable to self-constructed assets. No portion of expenditures in overhead categories (such as fuel, supplies, oil, grease and waste, insurance, bonuses and vacation pay, profit-sharing, cafeteria, and first aid) was capitalized. Some of such overhead was allocated19 to inventory; the balance was expensed on petitioner's books and deducted as ordinary and necessary business expenses on its Federal income tax returns. Throughout the years, respondent was well aware of petitioner's practice in this regard. Not only did respondent not object, but, in several instances where respondent's agents determined that certain expenditures for repairs should be capitalized, they also included in the capitalized amount only direct labor and material costs.In January 1965, an investigation and an audit of petitioner's 1963 return was commenced by an agent specially designated by respondent's Chicago office for reasons wholly unrelated to the issue involved herein. During the course of that audit, it was determined that a portion of overhead expenses should be capitalized. As a consequence, respondent decided to invoke the provisions of section 7605 and reopened petitioner's 1961 return, which had previously been closed on audit. On March 12, 1965, just prior to the expiration of the 3-year period of limitations, the deficiency notice involved herein was issued.It is against the foregoing background that we consider the core issue confronting us. In so20 doing, we note that we are not faced with questions involving: The proper annual period in which an item of income or expense should be accounted for taxwise; the propriety of the cash versus accrual basis of accounting; the validity of a change of a method of accounting at the instance of the taxpayer; a dichotomy between the basis on which a taxpayer's books and records are kept and that on which his tax returns are filed; or the standards, for tax 283 and regulatory purposes, imposed upon a public utility. In the instant case, the items involved concededly accrued in 1961, and the question before us is how they should be treated in that year.Respondent's thrust herein is predicated on two sections of the Internal Revenue Code. He first urges that overhead is a capital expenditure within the contemplation of section 263. 2 Secondly, he asserts that the accounting method utilized and characterized by petitioner as the "incremental cost" method is in fact the "prime cost" method and does not conform to generally accepted accounting principles. Respondent then claims that the requirement of "clearly reflect income" in section 446322 and the regulations thereunder demands21 the use of the "full absorption cost" method. 4 Petitioner counterattacks with the proposition that its method has been consistently used over a period of many years with the knowledge, and indeed the approval, of respondent and that the method is in accordance with generally accepted accounting principles. For the reasons hereinafter stated, we agree with petitioner.We reject as without merit respondent's contention that section 263 of the Code is in and of itself dispositive of the issue before us. By requiring the capitalization of amounts "paid out for new buildings or for permanent improvements or betterments made to increase the value of any property," such section begs the very question we are asked to answer. We are satisfied that, under the circumstances involved herein, sections 263 and 446 are inextricably23 intertwined. A contrary view would encase the general provisions of section 263 with an inflexibility and sterility neither mandated to carry out the intent of 284 Congress nor required for the effective discharge of respondent's revenue-collecting responsibilities. Accordingly, we turn to a determination as to whether petitioner's method of accounting "clearly reflects income" pursuant to the provisions of section 446.Several broad theses are applicable in such a determination. Income must be reflected with as much accuracy as recognized methods of accounting permit. Caldwell v. Commissioner, 202 F. 2d 112 (C.A. 2, 1953), affirming on this issue a Memorandum Opinion of this Court. Respondent is given broad discretion in determining whether a particular method of accounting clearly reflects income and a heavy burden is imposed upon the taxpayer to overcome a determination by respondent in this area. Commissioner v. Hansen, 360 U.S. 446 (1959); Photo-Sonics, Inc., 42 T.C. 926">42 T.C. 926, 933 (1964), affd. 357 F. 2d 656 (C.A. 9, 1966); Michael Drazen, 34 T.C. 1070">34 T.C. 1070 (1960).24 Even though a particular method may be in accordance with generally accepted accounting principles, it may not so clearly reflect income as to be binding upon the Commissioner. Schlude v. Commissioner, 367 U.S. 911">367 U.S. 911 (1961); American Automobile Assn. v. United States, 367 U.S. 687 (1961). Moreover, mere failure of the Commissioner previously to object to the taxpayer's accounting method will not stop him from later challenging it. Niles Bement Pond Co. v. United States, 281 U.S. 357">281 U.S. 357, 362 (1930); Hotel Kingkade, 12 T.C. 561">12 T.C. 561 (1949), affd. 180 F. 2d 310 (C.A. 10, 1950). Finally it has been recognized that consistency of application is an important consideration and may be entitled to considerable weight. Photo-Sonics, Inc., supra at 935; cf. Advertisers Exchange, Inc., 25 T.C. 1086 (1956), affirmed per curiam 240 F. 2d 958 (C.A. 2, 1957). But consistency standing alone is not sufficient to satisfy the taxpayer's burden. Photo-Sonics, Inc., supra at 935;25 Ezo Products Co., 37 T.C. 385">37 T.C. 385, 391 (1961); V. T. H. Bien, 20 T.C. 49">20 T.C. 49 (1953). Indeed, it will be disregarded where an erroneous method of accounting has been used. Photo-Sonics, Inc., supra;D. Loveman & Son Export Corporation, 34 T.C. 776">34 T.C. 776 (1960), affd. 296 F. 2d 732 (C.A. 6, 1961), certiorari denied 369 U.S. 860">369 U.S. 860 (1962).In the final analysis, we must apply the foregoing theses in light of the particular facts and circumstances of each case with reference to the particular business involved, the particular method employed, and the specific item at issue. Sam. W. Emerson Co., 37 T.C. 1063 (1962). We move to this task mindful of the desirability of avoiding judgments dependent upon "(subtle) accounting nuances" (see Boyton v. Pedrick, 136 F. Supp. 888">136 F. Supp. 888, 891 (S.D.N.Y. 1954), affirmed per curiam 228 F. 2d 745 (C.A. 2, 1955)) and aware that in many situations in this area exact calculations may be neither practical nor necessary26 (cf. E. W. Bliss Co. v. United States, 224 F. Supp. 374">224 F. Supp. 374 (N.D. Ohio 1963), affd. 351 F. 2d 449 (C.A. 6, 1965)).285 At this point, it is useful to recall the salient facts regarding petitioner's policy with respect to self-constructed assets. Petitioner did not in any way augment its personnel to construct these assets. It relied entirely on its repair and maintenance staff to do this work and then only during "slack" or "idle" time, so that the normal flow of production activities was in no way affected. Thus, petitioner's policy achieved a "double duty" objective. In a very real sense, petitioner killed two birds with one stone. There is nothing in the record before us which indicates that there was any increase in overhead costs which could be directly identified with the self-constructed assets. 527 We were favored with considerable expert testimony on the propriety of the method of accounting used by this petitioner with respect to self-constructed assets. The testimony was clear and convincing and is supported by our extensive review of accounting authorities. Finney & Miller, Principles of Accounting -- Intermediate 292-294 (1965); Hendirksen, Accounting Theory 302-304 (1965); Karrenbrock and Simons, Intermediate Accounting 413 (4th ed. 1964); Kohler, A Dictionary for Accountants 85, 217-218 (3d ed. 1963); Meigs, Johnson, Keller, Intermediate Accounting 509-511 (1963); Holmes, Maynard, Edwards, Meier, Intermediate Accounting 365 (1958).These authorities and the testimony of the experts herein clearly indicate that both the "incremental cost" method as applied by this petitioner and the "full absorption cost" method urged by respondent are acceptable. This is in marked contrast to the attitude with respect to allocating a portion of overhead to inventory, where failure to do so is specifically designated an erroneous method of accounting. American Institute of Certified Public Accountants, Bull. No. 43, Restatement and Revision of Accounting Research Bulletins 29 (1961). 28 This factor, namely, the utilization of an erroneous method of accounting, is what deprives Dearborn Gage Co., 48 T.C. 190">48 T.C. 190 (1967), and Photo-Sonics, Inc., supra, heavily relied upon by respondent, of any precedential value herein. We recognize that superficially it would seem to follow that, if a portion of overhead costs is properly allocable to inventory, the same procedure should be followed with respect to self-constructed assets. But the distinctions between the two situations are real. In the first place, they are, as we have noted, treated differently by the accounting authorities. Secondly, since 1918 the respondent has required by regulation that overhead costs be included in inventory. See Photo-Sonics, Inc., supra at 934. No such requirement has 286 been imposed with respect to self-constructed assets, nor did any of respondent's representatives, who testified at the trial, know of any other general policy or rule which contained any such guidance for revenue agents. Indeed, respondent's own acceptance from time to time of direct labor and material costs without 29 overhead as the measure of the amount of repairs, which this petitioner deducted and respondent required to be capitalized, indicates that no such policy or rule, exists. Thirdly, meaningful standards for measuring inventory overhead costs are usually available. On the other hand, it is often impracticable or even impossible to develop the detailed documentation necessary to support a rational allocation of overhead to self-constructed assets, particularly in a case such as this, where literally dozens of miscellaneous projects were involved.Respondent also relies heavily on Ben Perlmutter, 44 T.C. 382">44 T.C. 382 (1965), affirmed on other issues 373 F. 2d 45 (C.A. 10, 1967), and Variety Construction Co., T.C. Memo 1962-257">T.C. Memo. 1962-257. We think these cases are inapposite. The "overhead" costs involved were directly identified with the constructed buildings and therefore properly should have been taken into account. Moreover, in Perlmutter, it appears that the taxpayer conceded that some allocation of overhead was proper and that the sole dispute was as to the measure of the allocation. See 44 T.C. at 404.30 In any event, in both of these cases, the taxpayer's very business was the construction of fixed assets, i.e., buildings, and its personnel was employed for that very purpose. This is a far cry from the situation involved herein, where a large manufacturing concern engages in self-construction activities not at the expense of normal operating time but as a fill-in for slack periods.Under all the circumstances herein, we hold that petitioner has satisfied its heavy burden and has convinced us that it employed a generally accepted method of accounting which "clearly reflects its income." Sam W. Emerson Co., 37 T.C. 1063">37 T.C. 1063 (1962); Klein Chocolate Co., 36 T.C. 142 (1961); Geometric Stamping Co., 26 T.C. 301">26 T.C. 301 (1956). In so doing, we neither hold nor imply that, under all circumstances, a taxpayer has a right to choose between alternative generally accepted methods of accounting or that respondent may not, under some circumstances, require a taxpayer to accept his determination as to a preferred selection among such alternatives. We hold merely that where a taxpayer, in a complicated area such as31 is involved herein, has over a long period of time consistently applied a generally accepted accounting method (which is considered "clearly to reflect" income by competent professional authority and is not specifically in derogation of any provision of the Internal Revenue Code) and where this method has been frequently applied by respondent in making adjustments to the taxable income of the same taxpayer (as distinguished from respondent's mere failure to object to its use by such taxpayer), the taxpayer's choice of 287 method will not be disturbed. Photo-Sonics, Inc. v. Commissioner, 357 F. 2d 656, 658 fn. 1 (C.A. 9, 1966). See also Report of Commissioner of U.S. Court of Claims in McNeil Machine & Engineering Co. v.United States (Mar. 29, 1967), 1967-7 C.C.H. Fed. Tax Rep. par. 8173, 1967-6 P.-H. Fed. Taxes par. 58,036.We now turn to petitioner's treatment of two particular items in the calculation of the cost of its self-construction projects. Petitioner did not capitalize an allocable portion of certain fringe benefit items -- i.e., vacation, profit-sharing, group insurance, bonus, cafeteria, and32 first aid. Neither did petitioner capitalize any of the costs of its drafting department, although such department admittedly prepared plans for some of the self-construction projects.Since the primary question before us is the propriety of petitioner's accounting method, we deem it entirely within our province to determine whether petitioner has correctly applied such method as to particular items. In so doing, we may raise and dispose of contested issues related to the application of petitioner's method even though such issues were not specifically pleaded, particularly where, as here, the parties are not unduly surprised and are given ample opportunity to argue such issues on brief. Certainly there should be no question as to the propriety of such a course of action where, as here, the issues were clearly raised during the course of the trial and there was specific testimony directed to such issues. Cf. J. T. Slocomb Co. v. Commissioner, 334 F. 2d 269, 273 (C.A. 2, 1964), affirming 38 T.C. 752">38 T.C. 752 (1962); Friednash v. Commissioner, 209 F. 2d 601 (C.A. 9, 1954); Hilbert S. Bair, 16 T.C. 90">16 T.C. 90, 98 (1951),33 affd. 199 F. 2d 589 (C.A. 2, 1952); see 9 Mertens, Law of Federal Income Taxation (Zimet rev. 1961), sec. 50.46.On the basis of the expert testimony given at trial and our review of relevant accounting authorities, we are satisfied that this petitioner should not be required to capitalize either the fringe items or the costs of its drafting department.With respect to the fringe items, some of these expenditures, such as profit-sharing, bonus, and group insurance, were essentially discretionary in nature and, in any event, were not planned, fixed charges. Others, such as vacation time, cafeteria, and first aid, were not directly identified with the self-constructed assets. Thus, this petitioner's treatment of such expenditures fits the normal accounting categorization of these items as period costs of an administrative character.A more difficult problem is raised with regard to the drafting department. At first glance, it would seem that the labor cost of the personnel of this department should be charged to the self-constructed assets. In theory, at least, the person who draws the plans for a machine would seem to be making as direct a contribution34 as the person 288 who actually builds the machine, and the cost of his labor would therefore appear to be directly traceable to the machine itself."Direct" labor, however, refers to that labor which is obviously related to and conveniently traceable to specific assets. "Indirect" labor refers to labor which may be attributable to particular assets, but which is not considered feasible to measure and charge thereto. These labor costs are generally considered part of the general pool of factory "overhead." See Horngren, Cost Accounting -- A Managerial Emphasis 22 (2d ed. 1967); Gillespie, Cost Accounting and Control 160 (1957). We think that the drafting department of a manufacturing concern, such as petitioner, reasonably falls within the category of "indirect labor." We are satisfied that not all of the self-constructed assets required blueprints, drawings, or the like. We also note that there is often a significant time lag between the planning of the construction of such assets and the actual consummation of construction. Moreover, some of these projects may very well be "scrapped" in the interim. In essence, the activities of petitioner's drafting personnel were conglomerate35 in nature, as distinguished from those of the repair and maintenance personnel, where there was a clear dichotomy between the "slack" or "idle" time which they devoted to self-constructed assets and the time which they devoted to their normal functions.Nor do we think a portion of the labor costs of the drafting department should be considered as a variable overhead cost and therefore required to be capitalized under the "incremental cost" method utilized by this petitioner. We have found that the operations of this department were geared to petitioner's production requirements. Here again, respondent does not contend that the size of the drafting department was larger than necessary for this purpose and was therefore a cover for its self-construction activities. Nor is there any evidence in the record herein indicating that such was the case. The drafting department, like the repair and maintenance staff, performed a "double duty" function.Finally, we are constrained again to note that, on the frequent occasions when respondent required repair items to be capitalized rather than deducted, his agents themselves adopted petitioner's computation of the cost thereof, although they36 were fully aware that no portion of the expenditures for fringe items or the labor costs of the drafting department were included and although it seems clear that such elements must have been involved in some of the repairs.Without enunciating any general rule applicable in all cases, we hold that this petitioner has satisfied its burden and that its treatment of fringe items and the labor costs of its drafting department as overhead not allocable to self-constructed assets was entirely proper.289 As a consequence of the foregoing holdings, we do not reach the additional issues involved herein, namely: (1) The alleged irregularity of a second examination of petitioner's books and records under section 7605(b) and the issuance thereunder of the within notice of deficiency; (2) the claim that the deficiency notice itself was arbitrary and unreasonable and therefore invalid, or at the very least not entitled to the presumption of correctness; 6 (3) the correct computations of overhead expenses of various of petitioner's departments; and (4) the application of section 481 to certain proposed adjustments.37 To reflect other concessions of the parties,Decision will be entered under Rule 50. Footnotes1. All references are to the Internal Revenue Code of 1954, as amended.↩2. SEC. 263. CAPITAL EXPENDITURES.(a) General Rule. -- No deduction shall be allowed for -- (1) Any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate. * * *↩3. SEC. 446. GENERAL RULE FOR METHODS OF ACCOUNTING.(a) General Rule. -- Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books.(b) Exceptions. -- If no method of accounting has been regularly used by the taxpayer, or if the method used does not clearly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the Secretary or his delegate, does clearly reflect income.(c) Permissible Methods. -- Subject to the provisions of subsections (a) and (b), a taxpayer may compute taxable income under any of the following methods of accounting -- (1) the cash receipts and disbursements method;(2) an accrual method;(3) any other method permitted by this chapter; or(4) any combination of the foregoing methods permitted under regulations prescribed by the Secretary or his delegate.↩4. The "full absorption" cost method involves capitalizing direct costs of materials and labor plus an allocable portion of all overhead. The "prime cost" method involves capitalizing only direct materials and labor costs. The "incremental cost" method involves capitalizing direct labor and material costs plus that portion of overhead which can be directly identified with the self-construction project. Where construction ordinarily takes place only where regular facilities and personnel are not being fully utilized (i.e., during "slack" or "idle" time), there may be no overhead which can be directly identified↩ with the project.5. We are aware that there may well have been some overhead costs generally attributable to the self-constructed assets. But, under the "incremental costs" method, as we understand it, the overhead costs must be directly identified with those assets; general attribution is not enough. See fn. 4, supra↩. A good example of such unidentifiable overhead exists in the very case before us, where this petitioner generated its own electric power.6. We are constrained to note, however, that, while the respondent's determination may not have been arbitrary and unreasonable as a matter of law, the revenue agent's calculations were for the most part made with little, if any, attempt to ascertain with even a modicum of accuracy the relevant underlying circumstances. We make this comment with a full realization of the time limitation under which the agent was operating. We also note that nothing in our references to petitioner's burden in our decision on the accounting issues should be construed as holding that such burden was in fact placed upon it in this case. We merely assumed, for purposes of decision, that respondent's determination was presumptively correct and that petitioner had the burden, indeed a heavy one, of overcoming it.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624520/	CAMERON D. HALL, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentHall v. CommissionerDocket No. 33888-87United States Tax CourtT.C. Memo 1989-502; 1989 Tax Ct. Memo LEXIS 505; 58 T.C.M. (CCH) 140; T.C.M. (RIA) 89502; September 13, 1989Cameron D. Hall, pro se. Sara J. Barkley, for the respondent. COLVINMEMORANDUM FINDINGS OF FACT AND OPINION COLVIN, Judge: By notice of deficiency dated June 26, 1987, respondent determined deficiencies in income tax and additions to tax pursuant to sections 6653(b)1 and 6654 as follows: YearIncome TaxSec. 6653(b)Sec. 665412/31/72$ 2,191.59$ 1,095.80--12/31/733,465.941,732.97$ 110.9012/31/743,485.131,742.57111.5312/31/753,689.901,844.95159.1612/31/764,697.702,348.85175.3712/31/776,983.813,491.90248.25507 The primary issues for decision are: (1) Whether the statute of limitations bars assessment of tax for these years. We hold it does not because petitioner has not filed returns for those years. (2) Whether petitioner committed fraud in connection with the tax years now before the Court. Petitioner filed no Forms 1040 for 1973 through 1977 and a purported Form 1040 disclosing defiance of the tax system for 1972. Petitioner submitted false withholding exemption forms to his employer each year from 1972 through 1977. We hold that petitioner committed fraud in all years now before the Court. Zell v. Commissioner, 763 F.2d 1139 (10th Cir. 1985), affg. a Memorandum Opinion of this Court. FINDINGS OF FACT Some of the facts have been stipulated and are so found. During the tax years at issue (1972-1977) petitioner lived in Denver, Colorado and vicinity. When the petition was filed on September 21, 1987, he lived in Riverton, Wyoming. Petitioner filed Federal income tax returns for tax year 1970 on February 17, 1971, and for tax year 1971 on February 29, 1972. 2508 Petitioner submitted to his employer a Form W-4E, Exemption From Withholding, dated November 15, 1972. That form allows an employee to certify that he anticipates incurring no liability for Federal income tax for that tax year. Section 3402(f)(2)(A). The following words were typed on the Form W-4E to support petitioner's certification of no tax liability: under the Laws of the Land and the United States Constitution, Art. 1, Section 8 and 10, and amend's V, IX, & X; impliedly, this form conforms and is under the U.S. Constitution. Petitioner also filed a Form 843, Claim for Tax Refund, for 1972. Petitioner checked a box indicating that the claim was for "refund of tax illegally, erroneously or excessively collected." Petitioner typed eight reasons on the form for why a refund was due to him. Following are some of the reasons given: 1 -- The taxes paid have been collected illegally. The Internal Revenue Code (Title 26, United States Code) is in its entirety, in violation of the U.S. Constitution, specifically Articles IV, V, XIII, Ad Infinitum, and is therefore Ultra Vires unlawful509 and of no legal effect * . * 4 -- Income tax monies are used by the federal government to pay for the following illegal acts because We, the People, did not delegate these powers to the federal government: a) Pay expenses of undeclared 'war'. b) Give away our tax monies to foreign persons and/or govt. c) Give away our tax monies to domestic persons, firms and/or corporations. 5 -- Using our tax monies to pay for abortions, the killing of fellow human beings, on military grounds. * * The Internal Revenue Service returned the Form 843 to petitioner, indicating that the IRS had no record of a 1972 tax return filed by petitioner. Petitioner sent a Form 1040 for tax year 1972 to the IRS. It gave petitioner's name and address, but contained no dollar amounts or other information to determine liability. Petitioner wrote the following in bold letters across page 1 of the Form 1040: UNDER PROTEST I PLEAD THE FOURTH AND FIFTH AMENDMENTS TO THE UNITED STATES CONSTITUTION. SIGNED: CAMERON D. HALL. Petitioner signed above his name. Petitioner submitted Forms W-4E, Exemption From Withholding, to his employer for tax years 1973-1977 dated April 30 of each510 year. As with the 1972 Form W-4E, the following words were typed on each form: under the Laws of the Land and the United States Constitution, Art. 1, Section 8 and 10, and amend's V, IX, & X; impliedly, this form conforms and is under the U.S. Constitution. Petitioner has never filed tax returns for taxable years 1973-1977. On March 13, 1981, petitioner was convicted of willful failure to file income tax returns in violation of section 7203 for the years 1973, 1974, and 1975. He was sentenced to imprisonment for a term of 1 year. Petitioner had gross income from wages ranging from $ 16,100 to $ 24,000 per year for tax years 1973 through 1977. OPINION The Statute of LimitationsThe first issue for decision is whether the statute of limitations bars assessment of tax for 1972-1977. Petitioner has never filed income tax returns for taxable years 1973, 1974, 1975, 1976, and 1977. Section 6501(c)(3) provides that "in the case of failure to file a return, the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time. 511 " Accordingly, we find that the statute of limitations does not bar assessment of tax for years 1973 through 1977. Petitioner filed a purported Form 1040 for taxable year 1972. The form included petitioner's name and address and tax protester-type language written boldly across the form. Petitioner did not include dollar amounts or any other information needed to determine tax liability. A purported return that contains no information as to gross income and deductions or credits sufficient to allow respondent to calculate petitioner's Federal income tax liability is not a return within the meaning of the Internal Revenue Code. United States v. Silkman, 543 F.2d 1218">543 F.2d 1218, 1219 (8th Cir. 1976), cert. denied 431 U.S. 919">431 U.S. 919 (1977); United States v. Porth, 426 F.2d 519">426 F.2d 519 (10th Cir. 1977). In Beard v. Commissioner, 82 T.C. 766">82 T.C. 766 (1984), affd. per curiam 793 F.2d 139">793 F.2d 139 (6th Cir. 1986), this Court adopted a four-prong test for determining whether a document is sufficient to constitute a return. We stated -- First, there must512 be sufficient data to calculate tax liability; second, the document must purport to be a return; third, there must be an honest and reasonable attempt to satisfy the requirements of the tax law; and fourth, the taxpayer must execute the return under penalties of perjury. 82 T.C. at 777. In the instant case, petitioner failed to satisfy at least the first and third of these requirements. Therefore, we conclude that petitioner did not file a return for 1972 for purposes of section 6501(c)(3), and that tax may be assessed for that year. FraudThe second issue for decision is whether petitioner committed fraud in the years before the Court. The existence of fraud is a question of fact to be determined from the entire record. Grosshandler v. Commissioner, 75 T.C. 1">75 T.C. 1 (1980); Stratton v. Commissioner, 54 T.C. 255">54 T.C. 255 (1970). The burden of proof for determining fraud is on respondent, and it must be met by clear and convincing evidence. Sec. 7454(a); Rule 142(b). Fraud is never presumed; rather, it must be established by affirmative513 evidence. Beaver v. Commissioner, 55 T.C. 85 (1970). Fraud, however, may be inferred by any conduct, the effect of which would be to mislead or conceal, Spies v. United States, 317 U.S. 492">317 U.S. 492, 499 (1943); or where an entire course of conduct establishes the necessary intent. Rowlee v. Commissioner, 80 T.C. 1111">80 T.C. 1111 (1983); Stone v. Commissioner, 56 T.C. 213">56 T.C. 213 (1971). For purposes of section 6653(b), fraud means "actual, intentional wrongdoing," Mitchell v. Commissioner, 118 F.2d 308">118 F.2d 308 (5th Cir. 1941), 3 or the intentional commission of an act or acts for the specific purpose of evading a tax believed to be owing. Webb v. Commissioner, 394 F.2d 366">394 F.2d 366 (5th Cir. 1968), affg. a Memorandum Opinion of this Court; 4McGee v. Commissioner, 61 T.C. 249">61 T.C. 249 (1973), affd. 519 F.2d 1121">519 F.2d 1121 (5th Cir. 1975), cert. denied 424 U.S. 967">424 U.S. 967 (1976). In this case, 514 we must determine whether respondent has met his burden of proof and established, by clear and convincing evidence, that petitioner committed fraud in connection with his willful failure to file tax returns for the years before the Court. Petitioner's Submission of Frivolous Forms W-4E to His EmployerIn Zell v. Commissioner, supra, the taxpayer filed purported Forms 1040 for 1976 and 1977 which contained frivolous constitutional objections in place of the information necessary to a determination of his tax liability. He filed no Forms 1040 for 1978 and 1979. He also submitted Forms W-4 for 1976-1979 that falsely claimed 13 withholding exemptions. Citing Raley v. Commissioner, 676 F.2d 980">676 F.2d 980 (3d Cir. 1982), revg. a Memorandum Opinion of this Court, the Tenth Circuit indicated that since fraud entails some element of deception, and since such disclosure negates an intent to deceive, "under traditional definitions of fraud, disclosed defiance of the tax laws is not fraudulent." 763 F.2d at 1144. It concluded that the addition to515 tax for fraud requires more than -- a disclosed willful refusal to file or the filing of protest returns. Indeed, * * * willful failure to file in conjunction with disclosure to the IRS of that failure to file clearly falls outside the fraud penalty, as does the filing of a protest return which makes clear that the taxpayer is not complying with the law. [763 F.2d at 1144-1145.] 5However, the court in Zell found that Zell "did not merely openly defy the tax laws." He also submitted Forms W-4 for 1976-1979 on which he falsely claimed that he was entitled to 13 exemptions. Applying the "affirmative action" test of Spies v. United States, 317 U.S. 492">317 U.S. 492 (1943), the Tenth Circuit said that the filing of false Forms W-4 is an "affirmative act" of misrepresentation sufficient to justify the addition to tax for fraud. Zell v. Commissioner, supra at 1146.516 The Tenth Circuit found Zell liable for the addition to tax for fraud for all four years before it. The facts in Zell are on point with this case in three key respects. In both this case and Zell -- 1. The taxpayer initially filed purported returns which disclosed defiance of Federal income tax laws (Zell for 1976-77, Hall for 1972). 2. The taxpayer later did not file even purported returns in certain years (Zell for 1978-79; Hall for 1973-77). 3. The taxpayer filed false withholding forms for all years before the Court (1976-79 for Zell, 1972-77 for Hall). 6Since the Tenth Circuit found fraud present in all years in the case before it, we believe it is consistent with that holding to reach the same result in the instant case. See Golsen v. Commissioner, 54 T.C. 742">54 T.C. 742 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971), cert. denied 404 U.S. 940">404 U.S. 940 (1971).517 This holding is consistent with that of Kotmair v. Commissioner, 86 T.C. 1253">86 T.C. 1253 (1986). In Kotmair, the taxpayer, a self-employed tax protester, failed to file returns for the years 1974-1976, and was convicted of willful failure to file for 1975-1976 under section 7203.7 The taxpayer filed protester-type documents purporting to be, but not constituting, returns. There was no evidence of falsification of books or records, or concealment or misleading that would indicate fraudulent intent on the taxpayer's part. The Court concluded that the taxpayer's "open and declared intention not to comply with respondent's filing requirements, and his failure to do so" did not constitute fraud. Kotmair v. Commissioner, supra at 1261-1262. This Court noted that it has -- not been hesitant to impose the addition to tax for fraud, where there has been an intentional failure or refusal to file a return, * * * but in each case, there was also present some other and independent evidence of fraudulent intent, such as by concealing information from the examining518 agents, filing false W-4 Forms, and the like, apart from the single fact of nonfiling, itself. [Fn. ref. and citations omitted.] 86 T.C. at 1260. Thus, while the taxpayer's tax protester arguments may have been "meritless, frivolous,519 wrongheaded, and even stupid," they do not amount to fraud, without something more. Kotmair v. Commissioner, supra at 1262. In contrast, petitioner in the instant case established a pattern of nonfiling and submitted to his employer false Forms W-4 claiming to be exempt from withholding. As this Court stated in Kotmair, petitioner's nonfiling of returns, when accompanied by some other indicia of fraud, such as the filing of false Forms W-4, is sufficient to constitute fraud. Thus, fraud has been found where there was independent evidence of the taxpayer's fraudulent intent. In Rowlee v. Commissioner, 80 T.C. 1111">80 T.C. 1111 (1983), the taxpayer did not file returns for 1977-1979 and filed false Forms W-4 claiming exemption from withholding or entitlement to 10 exemptions. The Seventh Circuit has held that "a taxpayer cannot avoid the fraud penalties by notifying the Commissioner that he has been evading taxes and will continue to do so." Granado v. Commissioner, 792 F.2d 91">792 F.2d 91, 94 (7th Cir. 1986).520 In Granado, the taxpayer filed false Forms W-4 for 1980 and 1981, and did not file income tax returns. He notified the IRS "through various communications" that he was filing the false forms because, based on several frivolous arguments, he believed he was exempt from taxation. The Seventh Circuit found the taxpayer liable for the addition to tax for fraud, noting that informing the IRS that he was not complying with the tax laws "does not make it any less fraudulent." Granado v. Commissioner, supra at 93. Finally, a different result is not called for by Raley v. Commissioner, 676 F.2d 980 (3d Cir. 1982), revg. a Memorandum Opinion of this Court. In Raley, the taxpayer did not file returns for 4 years and falsely claimed exemption on Forms W-4E. However, he called attention to his failure to file returns by writing numerous letters to various tax collection officials pointing out his objections and failure to pay tax. The Third Circuit found that the Commissioner had not proven fraud because the taxpayer "went out of his way to inform every person involved in the collection process that he was not going to pay any federal income521 taxes." 676 F.2d at 983. Petitioner's actions in the present case fall far short of the standard established in Raley and do not constitute a Raley-like pattern of notification. In any event, we note that this case is appealable to the Tenth Circuit and in the situation where false Forms W-4 have been filed along with protest returns such Circuit, as noted, has held that this is sufficient evidence of fraud. Allowance of Deductions and CreditsA final issue concerns allowance of deductions and credits. Petitioner operated a Christmas tree stand during some of the years involved. Mr. Wright testified that he supplied petitioner with Christmas trees for resale. He testified that Christmas tree lot operators, such as petitioner, incur unreimbursed expenses in connection with lot operations. Petitioner testified that he spent $ 540 per year to operate the stand. This included, for example, hired help and fuel for vehicles. The Court will allow a $ 540 deduction for each year petitioner operated a Christmas tree lot. Mr. Griess, an accountant, testified that he was familiar with petitioner's tax situation in the years in question. He testified*522 that he had told petitioner at the time that he thought petitioner would owe "negligible" amounts of tax for the years in question. However, even with this general statement, the record lacks specifics required to bear petitioner's burden of proof to establish entitlement to deductions and credits beyond that just discussed. To reflect the foregoing and concession, Decision will be entered under Rule 155. Footnotes1. All section references are to the Internal Revenue Code, as amended and in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. Petitioner's income tax returns for 1970 and 1971 are considered filed on April 15, 1971 and April 15, 1972, respectively. See sec. 6501(b)(1)↩.3. See Pavlic v. Commissioner, T.C. Memo. 1984-182↩. 4. T.C. Memo. 1966-81↩.5. We note that Circuit Judges McKay and Seth↩ were in agreement with the holding that disclosed defiance is not fraud, but that Circuit Judge Barrett disagreed in a concurring opinion.6. We note that we do not distinguish between a taxpayer who falsely claims 13 withholding exemptions (as in Zell↩) and one who falsely claims to be exempt from withholding (as in the instant case), petitioner's frivolous constitutional assertions for exemption notwithstanding.7. We note that this Court held in Castillo v. Commissioner, 84 T.C. 405">84 T.C. 405, 409-410 (1985), that a taxpayer is collaterally estopped by his criminal conviction under sec. 7203 from denying that he willfully failed to file returns for the tax years there involved. In Kotmair v. Commissioner, 86 T.C. 1253">86 T.C. 1253 (1986), however, we did not consider the issue of collateral estoppel in the context of the taxpayer's liability for the addition to tax for fraud. Rather, collateral estoppel was raised solely in our discussion of sec. 6651(a)(1). Perhaps this was due to our holding in Kotmair that mere failure to file does not constitute fraud. Accordingly, we find no inconsistency between Castillo and Kotmair↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624521/	Alfred Eckstein v. Commissioner.Eckstein v. CommissionerDocket No. 5763.United States Tax Court1945 Tax Ct. Memo LEXIS 79; 4 T.C.M. (CCH) 893; T.C.M. (RIA) 45296; September 21, 1945Bernard Wall, Esq., and Irving T. Palmer, C.P.A., for the petitioner. F. S. Gettle, Esq., for the respondent. MURDOCK Memorandum Opinion MURDOCK, Judge: The Commissioner determined a deficiency of $2,315.96 in the petitioner's income tax for the calendar year 1939. The only issue for decision is whether the Commissioner erred in including $17,500 in the petitioner's income representing 1939 gain from a sale in 1929. The facts have been stipulated. [The Facts] The petitioner, an individual, filed his return for the taxable year with the collector of internal revenue for the second district of New York. He used a cash receipts method. The petitioner has been a member of the New York Stock Exchange since 1902. A dividend gave to the petitioner, in February 1929, a "right" to an additional one-fourth membership. 80 He sold this "right" for $110,000 to Edward Schafer, Jr. in March 1929. No money was received by the petitioner at that time on account of the sale. Schafer acquired three additional "rights", two of them by gift, and was elected to membership in the exchange. The New York Stock Exchange, before electing Schafer to membership, investigated him to make sure that he was a suitable person to be a member of the exchange. This investigation included an investigation of his financial condition as well as of his character. The exchange, as a condition precedent to admitting Schafer to membership, required, as is usual in such cases, that the petitioner enter into an agreement with Schafer subordinating his claims against Schafer, for the purchase price of the "right" for the benefit of other persons having claims against Schafer arising out of business related to his membership in the exchange. This agreement was dated May 14, 1929 and was between the petitioner and Schafer. It referred to the petitioner as the lender and recited that Schafer had borrowed money from Eckstein to be used in the purchase of a membership in the exchange and the agreement was executed to enable Schafer to81 comply with the requirements of the exchange to become a member thereof. Schafer acknowledged therein that he had received from Eckstein the sum of $110,000 to be applied towards the purchase of a membership in the exchange and agreed to repay this sum "from time to time" with interest thereon at 6 per cent "and, in any event, thirty days after the applicant ceases to be a member of the said Exchange and all claims entitled to priority in payment, as herein provided, have been paid in full." Petitioner subordinated repayment of the sum loaned to the payment in full of all claims against Schafer arising out of his membership and agreed not to institute any suit for the recovery of the sum loaned as long as Schafer was a member of the exchange. The agreement further provided that Schafer could make payments to the petitioner on account of the sum loaned or the interest thereon provided that the payments left him still solvent. The agreement was to bind and inure to the benefit of the parties, their heirs, executors, administrators and assigns. The Rules of the New York Stock Exchange required that the parties to a sale of a "right" to a seat, payment for which was to be made at some82 time in the future, execute an agreement of the kind above set forth and permitted no other instrument of agreement to be executed by the purchaser. Schafer has continued as a member of the exchange. The petitioner's basis for gain or loss on the "right" sold to Schafer was $16,200. His income tax return for the year 1929 was filed on a cash receipts basis. He reported therein a gain of $93,800 resulting from the sale of the "right" to Schafer. The return showed a net loss and no tax due. The petitioner received the following payments: DateAmountJuly 18, 1929$20,000.00Sept. 24, 193115,000.00May 29, 193220,757.35Oct. 10,193917,500.00 The balance due the petitioner at the time of the last payment was $54,242.65 exclusive of interest. The petitioner accepted the last payment in full settlement of the amount due. A stock exchange membership was sold on May 16, 1929 for $410,000, ex rights. Section 111 of the Revenue Act of 1928, which was in effect at the time of the abovedescribed transaction, provided that the gain from the disposition of property shall be the excess of the amount realized over the basis, and the amount realized shall be the83 sum of any money received, plus the fair market value of the property (other than money) received. The petitioner disposed of his "right" by transferring it to Schafer in March 1929. The price which Schafer agreed to pay was $110,000. The petitioner's basis for gain or loss on this "right" was $16,200. He received in exchange for the "right" Schafer's agreement in writing to pay him the purchase price of $110,000 with interest. If this agreement had a fair market value at that time in excess of the petitioner's basis on his "right", then the petitioner was required by law to report that difference as a gain. The petitioner, in his return for 1929 which was under oath, reported that the agreement had a fair market value of $110,000, and that he had realized a gain of the difference between that amount and his basis on the "right". He was required to do that by the law. The petitioner also received in that same year from Schafer $20,000 in partial fulfillment of the agreement. Schafer at that time was well known to the petitioner, as was Schafer's father, who had dealt for his son in the acquisition of the "right". Schafer was a person of character acceptable to the Exchange and was84 solvent. He became the owner of a seat on the Exchange. He acquired one-half of it by gift. A seat on the Exchange was worth at that time about $410,000. The agreement of Schafer bore interest at 6 per cent. It has been held that the "lender" in such an agreement may sue for the interest due him. , aff'd . The seat itself was some security for Schafer's agreement despite the fact that no definite time was fixed for payment. The record shows that interest was paid for a number of years and also substantial payments were made on the principal in 1931 and 1932. The stock market crash occurred in the fall of 1929 and thereafter a severe depression set in. Schafer was not able to pay the petitioner as rapidly or as fully as the latter had hoped and expected. But Schafer was able to retain his seat on the Exchange and he still owns it. The Commissioner is now attempting to include in the petitioner's income for 1939 the cash payment which the latter received ten years after the sale in final settlement at a discount of his claim against Schafer for the purchase price. The85 Commissioner contends that the agreement had no fair market value whatsoever in 1929 and that no taxable transaction resulted at that time. We conclude that this contention is shown to be unsound by a fair preponderance of the evidence and that the payment received by the petitioner was not, under the circumstances of this case, taxable income in 1939. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624523/	OLYMPIA HARBOR LUMBER COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Olympia Harbor Lumber Co. v. CommissionerDocket No. 64272.United States Board of Tax Appeals30 B.T.A. 114; 1934 BTA LEXIS 1363; March 20, 1934, Promulgated 1363 1. Deduction allowed for amount paid for cancellation of a contract. 2. Petitioner loaned money on open account to a corporation the stock of which was owned by its stockholders. At the close of the year the book value of the debtor corporation's assets exceeded its liabilities. By placing a liquidating value upon the assets, petitioner's officers concluded that the debtor's liabilities exceeded its assets and after the close of the year wrote off a part of the account. Held, the evidence does not establish an ascertainment of worthlessness which will support a claim for a bad debt deduction. Thomas N. Fowler, Esq., and Robert T. Knight, C.P.A., for the petitioner. Willis R. Lansford, Esq., for the respondent. ARUNDELL114 This proceeding was initiated to test the correctness of respondent's determination of a deficiency for the calendar year 1929 in the sum of $4,334.65. Two issues are involved: (1) The claimed loss on the cancellation of a contract, and (2) the deductibility of an alleged bad debt. 115 FINDINGS OF FACT. Petitioner was organized in 1924 by five brothers (hereinafter called the Anderson brothers), 1364 to engage in the operation of a sawmill at Olympia, Washington. The stock of petitioner was owned in equal proportions by the five brothers. The Anderson brothers also owned in equal parts all of the stock of the Tumwater Lumber Mill Co., which was also located at Olympia and which they had operated since 1919. In 1928 petitioner entered into a contract with the Rockway Mill Wood Co. whereby the latter company agreed to build certain equipment to dispose of the waste from petitioner's sawmill. The Rockway Mill Wood Co. installed a portion of the equipment but failed to carry out its agreement to dispose of the slab wood and other waste material, with the result that the operations of the petitioner's mill were being very materially interfered with. Rather than declare the contract at an end by reason of the failure of the Rockway Mill Wood Co. to perform, petitioner started negotiations with the Rockway Mill Wood Co. to the end of terminating the contract amicably. The contract was terminated in March 1929 by the payment to the Rockway Mill Wood Co. by petitioner of $7,900 and as a part of the settlement the Rockway Co. relinquished to petitioner all of its equipment then on1365 petitioner's property, which was of a value at that time not in excess of $2,500. The difference of $5,400 represented consideration paid for the cancellation of the contract and this item (plus $3.92 which is unexplained) was claimed as a deduction by petitioner in its 1929 tax return. In 1928 the Anderson brothers were interested in the installing of a Swedish gang-saw mill, which had for its purpose the utilization of lumber under 12 inches in diameter, which sizes were generally being wasted at the time. The Tumwater Mill at this period was not engaged in sawmill operations but was working on various real estate contracts as well as other related activities in and around Olympia. The Anderson brothers decided to make the experiment and selected the Tumwater Co. for that purpose. At that time the Tumwater Co. had no funds which it could utilize for the purpose and accordingly the Anderson brothers agreed that the petitioner would advance whatever funds were needed, the funds so advanced to be repaid by the Tumwater Co. out of income from operations. The new mill was a pure experiment and difficulties were soon encountered, with the result that the estimated cost of some1366 $55,000 was exceeded and petitioner found it necessary to advance $84,722 in 1928 and 1929 to put the mill in shape and adapt it to conditions in the Puget Sound country. 116 On or about December 27, 1929, the Anderson brothers, as trustees of petitioner, discussed the question of the large amount owing to petitioner by the Tumwater Lumber Mill Co., and reached the conclusion that the latter, due to the high cost of installing the new mill, the drop in prices of lumber, and the curtailed business due to the depression and consequent depreciation in the value of the assets of the Tumwater Co., including certain real estate contracts, building lots, garage, stock in other lumber companies, etc., would not be able to pay the petitioner the sum advanced to it. It was accordingly decided to charge off approximately 40 percent of the advance to the Tumwater Co. as a bad debt. No actual charge-off was made on the books in 1929 and not until some time in February or March, 1930, at which time there was a charge to surplus and a credit to "special reserve for possible loss" of the Tumwater Lumber Mill Co. account. This charge-off was in the amount of $33,594.65. This entry1367 was so made because the books had been closed and the profits theretofore closed into surplus. The loan made to the Tumwater Lumber Mill Co. was with the idea that that company would be able to repay from the earnings of its business. The petitioner had the money available and used it in the other business and expected to get it back. No notes were given for the advances and there was no understanding between the two corporations as to how long the account would run. Some time after the book entries were made the assets of the Tumwater Lumber Mill Co. were valued as of December 31, 1929, based on their liquidation value, and the result of that valuation placed the assets as worth $142,523.30, with liabilities outstanding of $186,894.92, which latter sum included what had been advanced by petitioner to the Tumwater Lumber Mill Co. as well as certain mortgages on some of the properties. The current assets as of December 31, 1929, were $57,316.38 and the current liabilities $126,995,62, including the sums due petitioner. The Anderson brothers did not intend that the outside creditors of the Tumwater Co. should lose any money and intended that they should be paid through petitioner. 1368 OPINION. ARUNDELL: The evidence establishes to our satisfaction that of the sum of $7,900 paid to the Rockway Mill Wood Co. at least $5,400 was in fact paid to get rid of an unsatisfactory contract and not more than $2,500 was paid for the assets taken over. Even assuming that petitioner was warranted in abrogating the contract because of the breach by the Rockway Mill Wood Co., it is not to be denied the loss it actually suffered because it sought the more amicable course and thus avoided almost certain litigation. The fact 117 that petitioner may have hastened matters because of a proposed plan of various mill owners to join in an operation for the handling of their waste material does not change or affect the transaction between petitioner and the Rockway Mill Wood Co. On this issue the respondent is reversed. The evidence does not convince us that the advances made to the Tumwater Lumber Mill Co. should be allowed as a bad debt deduction in 1929. Undoubtedly a large portion of the sum was not advanced until that year and the entire sum was loaned for frankly experimental purposes and could be repaid only through income from the operations of the Tumwater Co. 1369 At the end of 1929 it was in regular operation, although it had experienced the pinch of the depression, as had business generally. Its balance sheet showed it entirely solvent. It is true that its liquid assets were limited, but that was known when the advances were made by petitioner and was the occasion for its action. By placing a liquidating value on its assets, including the new gang-saw mill which had recently been completed, a value was reached of $142,523.30, and as the outstanding liabilities, including the sum due petitioner and various mortgages on the property, equaled $186,894.92, claim is made that the Tumwater Co. was insolvent and that petitioner was warranted in making the charge-off that it did. Petitioner's president testified that in the light of subsequent events the entire account should have been charged off, but the testimony goes no further than this, and no facts are given to support the general statement. In deducting 40 percent of the indebtedness due by the Tumwater Lumber Mill Co. petitioner evidently did not consider it was dealing at arm's length with that company, for, even on its own calculation of the assets and liabilities of the "Tumwater1370 Co., it would have recovered more than 60 percent of the amount due. Petitioner's answer is that the Anderson brothers did not intend that the outside creditors of the Tumwater Co. should lose anything. However commendable such a course may be, it does not follow that petitioner may at one and the same time treat itself as a true creditor and also as ready to relinquish its right to payment and by so doing charge off the item as a bad debt against its income. Except for the close relationship that existed between the two corporations, it is not likely that the Tumwater Co. would have borrowed such a large sum as it did from petitioner, which sum was payable on demand. The two corporations had in earlier years been in the habit of filing consolidated returns, but that was not permitted under the revenue act in force in 1929. If it had been the accounts could not have reflected under any guise the sum now sought to be deducted. The evidence is far from satisfactory that there was a charge-off within 118 the year 1929, but, passing that matter over unanswered, we are of the opinion that the debt due to the petitioner by the Tumwater Lumber Mill Co. was not ascertained to1371 be worthless to the amount of $33,594.65 and that the charge-off should not be allowed as a deduction from petitioner's 1929 income. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624524/	MARGARET B. PAYNE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. E. J. PAYNE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Payne v. CommissionerDocket Nos. 21487, 21488.United States Board of Tax Appeals19 B.T.A. 1305; 1930 BTA LEXIS 2237; May 29, 1930, Promulgated 2237 Under all the facts in this case, held that the dividend declared and paid by the corporation was a cash and not a stock dividend, and was taxable as such to the stockholder. F. M. Livezey, Esq., for the petitioners. John D. Kiley, Esq., for the respondent. LOVE 1305 These proceedings are for a redetermination of deficiencies in income tax for the year 1920 as follows: Margaret B. Payne, Docket No. 21487$2,550.00E. J. Payne, Docket No. 214881,421.79The two cases, by proper order, were consolidated for hearing and decision. The assignments of error are fully explained in our findings of fact. FINDINGS OF FACT. Petitioners are husband and wife and reside in Huntington, W. Va. At the beginning of the year 1920 E. J. Payne owned and held 250 shares (par value $100) of the capital stock of the Lake & Export Coal Corporation, of West Virginia, which constituted one-fourth of the authorized capital stock of that corporation. By resolution of the stockholders, on February 28, 1920, the capital stock was increased to 3,000 shares, par value $100 each, and authority for such increase was granted by certificate2238 of the secretary of state, dated March 26, 1920. 1306 On April 1, 1920, there were issued to E. J. Payne 500 shares of stock, thereby enlarging his holdings to 750 shares. On the same date he gave to his wife, and transferred to her, 350 shares of that stock. They deemed the issue of 2,000 shares of additional stock as a taxable dividend, and being deemed taxable income, in making return for that year it was reported as income and the tax thereon was paid. However, the amount of 350 shares was returned as income by Mrs. Payne and 150 shares by Mr. Payne. After the decision by the Supreme Court in the case of , wherein it was held that a stock dividend did not constitute taxable income, the Commissioner refunded to each of the parties here involved the amount of tax paid in respect to that item, to wit, to Mrs. Payne, $2,550, and to E. J. Payne $1,421.79, on the theory that it was a stock dividend. On September 29, 1926, after a reaudit of those returns, the Commissioner determined that the income claimed as a stock dividend in 1920 was not a stock dividend, but was in fact a cash dividend and, therefore, taxable, 2239 and that the refund heretofore mentioned was made in error, and determined a deficiency against the parties in the amount refunded to each, respectively, and mailed notices of such deficiencies. Those notices of deficiencies are the bases of the proceedings here involved. By amended petitions offered and received at the hearing, setting out in detail the above described state of facts, it was agreed that Mrs. Payne became the owner of her 350 shares of stock as a gift from her husband in 1920, and that she owed no tax; and, further, that the respondent asked for an enlargement of the amount of deficiency asserted against E. J. Payne, and that he, the respondent, would be relieved of the burden of proof on that issue, counsel for the petitioners conceding that in the event it be held, under the proof, that the receipt of the 500 shares of stock was a cash and not a stock dividend, then and in that event, E. J. Payne owed all the tax and his deficiency may be increased to equal the amount of both combined. Therefore, the case resolves itself into the one issue - Was the receipt of the 500 shares of stock on April 1, 1920, a stock dividend, or was it a cash dividend in fact and effect? 2240 The Lake & Export Coal Corporation was practically a close corporation, with only nine stockholders, all of whom were active in the operation of the business. In the beginning of the year 1920 the authorized capital stock was 1,000 shares, par value $100, all outstanding, of which E. J. Payne and S. J. Hyman each owned 250 shares. Payne was the president of the company, and he and Hyman were the dominating spirits of its business policies and activities, and were very efficient executives. 1307 The business had been very profitable in past years and had accumulated a large surplus. In 1919 the company had done a business in excess of sixteen million dollars in volume. However, in the early months of 1920 the coal business throughout the country was in an unsettled condition and demanded great care and business acumen in handling it to prevent losses. It was the judgment of the directing heads of the company that, in order to give the company greater prestige, its capitalization should be enlarged. On October 15, 1919, at a stockholders' meeting at which all stockholders participated it was stipulated, in a resolution duly considered and adopted, that, if certain2241 of the officers would surrender rights then held by them under former action of the board of directors, 80 per cent of the gross earnings of the company (after deducting certain operating expenses) would be set aside as a compensation fund, to be paid to the officers and executives and distributed to said executives and officers as directed by the board of directors as compensation for their services. It was provided, however, that said 80 per cent compensation fund should be subject to a net fund for distribution as a dividend of 30 per cent on all outstanding stock. As hereinbefore recited, the capital stock of the company was enlarged from $100,000 to $300,000. On April 1, 1920, the following resolution was duly considered and adopted by the board of directors. This resolution was offered in evidence by the respondent and was objected to by the petitioner as irrelevant and immaterial, which objection was overruled and exception allowed: SPECIAL MEETING OF THE BOARD OF DIRECTORSApril 1, 1920 A special meeting of the Board of Directors of Lake & Export Coal Corporation was held at the office of the company, Day & Night Bank Building, Huntington, W. Va., at four o'clock2242 P.M. on April 1, 1920, pursuant to the following waiver of notice of the holding thereof: The undersigned members of the Board of Directors of Lake & Export Coal Corporation waive notice thereof and consent and agree that a meeting of said Board of Directors may be held at the office of the company, Day & Night Bank Building, Huntington, W. Va., at four o'clock P.M. on April 1, 1920, for the purpose of transacting all business properly presented to said meeting. GIVEN UNDER OUR HANDS this 1st day of April 1920: S. J. HYMAN E. J. PAYNE C. A. FRENCH T. O. DEITZ H. E. MORAN 1308 The meeting was called to order by Mr. Payne, who presided, and Mr. Hyman recorded. All of the members were present. Thereupon J. R. Marcum presented to the Board the certificate issued by the Secretary of State of West Virginia, authorizing the increase of the capital stock of this company to Three Hundred Thousand Dollars. On motion of Mr. Deitz, the certificate was accepted and approved and was directed to be recorded, as provided by law. Thereupon Mr. Hyman, as treasurer, reported to the Board concerning the present financial status of the company. from the facts stated by2243 Mr. Hyman, it was apparent to the Board that the company's gross earnings for the first nine months of the fiscal year have been large enough to enable the declaration and payment of the thirty percent dividend reserved by the stockholders' resolution of October 15, 1919, and in addition thereto, to pay the current operating expenses and taxes, as also reserved by said stockholders' resolution of October 15, 1919, and in addition thereto, to provide a fund of more than Two Hundred Thousand ($200,000.00) Dollars available to be distributed to the officers and executives of this company, as also provided by the said resolution. The Board then discussed the general financial condition and financial needs of the company, particularly with reference to the present expediency of making a disbursement at this time of the money so available in said compensation fund. After mature deliberation, on motion of Mr. Deitz, duly seconded and carried, the following resolution was unanimously passed and adopted: RESOLVED that the Board of Directors does now declare, from information conveyed to the Board by the treasurer, that the company has earned to this date a sufficient fund to enable the2244 declaration and payment of an annual cash dividend of thirty percent on the issued and outstanding stock of the company, in addition to a sufficient reserve for current expenses and for taxes, and that it has earned in addition thereto a sufficient fund to enable at this time a disbursement from the said compensation fund, as provided by the stockholders' resolution of October 15, 1919, of Two Hundred Thousand ($200,000.00) Dollars. RESOLVED, second, that the Board of Directors authorize, empower and direct the proper officers of this company to make immediate disbursement to the persons entitled thereto, under and by virtue of the stockholders' resolution of October 15, 1919, and of the directors' resolutions of October 15, 1919, and of January 15, 1920, of the sum of Two Hundred Thousand ($200,000.00) Dollars, which said fund and the disbursement thereof shall be charged to the compensation fund so provided by the said stockholders' resolution. RESOLVED, third, that the proper officers of this company be authorized, empowered and directed to ascertain the relative sums of money due to the several officers and executives of this company, under said directors' resolutions, by2245 proper calculations, and to notify the persons entitled thereto that such respective sums are available to them. RESOLVED, fourth, that the said respective sums, when ascertained as aforesaid, shall be paid in cash to the persons entitled thereto, or be left with and loaned to the company at six percent interest, or applied to the purchase of stock of the company at par, as the officers and executives may severally elect. 1309 No further business appearing to require the attention and action of the Board, the meeting was adjourned. S. J. HYMAN, Secretary.E. J. PAYNE, President.Examined, verified and approved as and for a true and accurate minute of the meeting of the Board of Directors held April 1, 1920: S. J. HYMAN E. J. PAYNE C. A. FRENCH T. A. DEITZ H. E. MORAN On April 1, 1920, 500 shares of the new stock were issued to E. J. Payne. Also there were issued to S. J. Hyman 500 shares of said stock, and to the other stockholders proportional amounts, that is, two shares of new stock for each one share of old stock held by him. As a bookkeeping procedure, checks were issued to each stockholder equal in amount to the par value of the stock2246 issued to him, but those checks were not delivered to such stockholder, but were held until a convenient time, when each stockholder endorsed his check and received the stock. Those checks were what are known as "counter checks," and not the regular voucher checks. They were, however, carried through the bank, where appropriate debit and credit entries were made. The checks were dated March 12, 1920. On that date the cash balance in the bank to the credit of the corporation was $143,850.62. On March 31, 1920, the cash balance was $203,800.32. The checks were carried through the books of the corporation as shown by the books as follows: On March 31, 1920, the cash journal shows charges to private ledger, and credits to the bank of certain checks marked "returned," S. J. Hyman, $50,000; E. J. Payne, $50,000; H. E. Moran, $36,000; B. F. Spellman, $22,500; T. A. Deitz, $20,000; L. W. Sydnor, $10,000; W. L. Walton, $6,000; A. D. Williams, $5,000; C. A. French, $4,000. On the same page of the cash journal there is shown a charge to the bank and a credit to the private ledger of $203,500. The bank statement indicates that the checks passed through the bank in August, 1920. 2247 There was never any resolution or other formal order made by the board of directors declaring a stock dividend, but there was a mutual understanding among the stockholders that each would take his proportional share of the new stock. On November 15, 1920, a meeting of the board of directors was held, and the following proceedings were had: A MEETING OF THE BOARD OF DIRECTORS OF LAKE & EXPORT COAL CORPORATION. * * * Thereupon the president reported to the board that, subject to the approval of the board, he had employed Mr. G. J. Weale as comptroller for the company 1310 at the salary of One Thousand Dollars ($1000.00) per month, effective November 1, 1920. On motion duly made, seconded and carried, the employment of Mr. Weale, as reported, was approved and confirmed. The President stated that Mr. Weale had recently discussed with the authorities in Washington the matter of compensation for the officers of this company, as outlined in the minutes of meeting held October 15, 1919, and reported that the authorities stated they would not look favorably on such methods as were at that time proposed. Mr. Weale further advised that the action of the board on October 15, 1919, appeared2248 to conflict with the intent of the meetings held on July 16, 1919, and April 1st, 1920, and felt that under all the circumstances insofar as reference had been made to drawing accounts rather than to fixed and determinate sums representing reasonable compensation to officers and employees for services actually rendered, it was proper for the members of this board to definitely determine what compensation should be paid to each officer and employee for the fiscal year and what compensation should be established for the current year, and that it was imperative that this be done without delay as the company's income and Excess Tax return was due for filing with the collector of internal revenue and could not be finally prepared until the question of actual compensation properly deductible as an item of operation expense had been determined and recorded on the books of the corporation. Thereupon discussion ensued, each interested officer or employee absenting himself as the question of his compensation was discussed and acted upon. In due and proper form it was finally agreed after each discussion by motion duly made, seconded and unanimously carried, that compensation for the fiscal2249 year ending June 30, 1920, should be as follows: E. J. Payne, president$80,000S. J. Hyman, secretary-treasurer80,000T. A. Deitz, vice president20,000H. E. Moran, New York manager60,000B. F. Spellman, legal advisor30,000C. A. French, auditor3,600L. W. Sydnor, purchasing agent12,000W. L. Walton, Chicago representative5,000A. D. Williams, salesman5,000The question of commissions standing to the credit of Messrs. Shenlin, Shifflette and Pugh was then discussed and it was unanimously agreed that in view of the able and attentive manner in which these gentlemen had served the company, the board felt that they were fully entitled to this additional remuneration, regardless of what transpired and ordered that the amounts credited so stand, but directed the Assistant Treasurer to record them as "Bonuses to Employees" and not as "Commissions," as follows: B. W. Shenlin$15,483.71H. F. Shifflette5,161.24N. J. Pugh5,161.24Mr. C. A. French at this time absented himself from the meeting and Mr. Hyman took occasion to draw to the attention of the board the fact that Mr. C. A. French had been working a great amount of2250 overtime during the first year of the company's operations and had most cheerfully given up his spare time including all Sundays and holidays in order to establish an accounting record which would expeditiously furnish the executives with much needed information. Mr. Hyman stated that the members of this board alone could 1311 appreciate how vitally necessary it became for information of an almost momentary nature during the developments of the company's status in the coal business, and in full appreciation of the valuable services rendered to the company, he moved that a bonus of one hundred percent (100%) of his annual salary be granted to Mr. French and that the Assistant Treasurer be, and he is hereby authorized to place the sum of $3600.00 to the credit of Mr. French; that the same be charged as an operating expense chargeable to "Bonuses to Employees" account. The motion was duly seconded and there being no dissenting record it was ordered carried. Mr. S. J. Hyman then brought up the question of compensation for the current year, and upon motion duly made, seconded and accepted unanimously, it was thereupon RESOLVED, That the salaries of the officers and employees2251 for the fiscal year beginning June 30, 1920, be fixed as follows: E. J. Payne, president$25,000 per year.S. J. Hyman, secretary-treasurer$25,000 per year.H. E. Moran, manager, New York office$18,000 per year.B. F. Spellman, N.Y. attorney $650 per month.C. A. French, auditor $250 per month.L. W. Sydnor, assistant to president $500 per month.W. L. Walton, manager, Chicago office $600 per month.A. D. Williams, salesman, Chicago office $250 per month.RESOLVED that should the services rendered by any officer or employee, during the current year, be curtailed in any material degree, a revision downward shall be effected as and when the value of such service may diminish. RESOLVED SECOND: That any additional compensation for the current year should be based upon the values of the services shown to have been rendered in the year by each and be paid in the form of bonuses or commissions. RESOLVED THIRD: That it is the sense of the entire membership of this board that the question of bonuses not only to the officers but to all employees of this corporation should receive early consideration and that the president be, and he is hereby authorized2252 to form such committee or committees as he may deem necessary or proper to determine upon what basis bonuses shall be paid for the current and subsequent years. No further business appearing, the board of directors meeting was adjourned. S. J. HYMAN Secretary. E. J. PAYNE President. Examined, verified and approved. E. J. PAYNE S. J. HYMAN C. A. FRENCH OPINION. LOVE: The only question at issue in this case is whether the acquisition of the 500 shares of stock by E. J. Payne on April 1, 1920, was a stock dividend, and hence not taxable, or was the result of a purchase by him of that stock with the proceeds of a cash dividend, declared and paid by the corporation. It is the contention of petitioner that, notwithstanding the purport of the resolutions adopted by the stockholders and by the board of 1312 directors of the corporation, it was mutually understood and agreed by and among the stockholders that it was a stock dividend of 200 per cent and that each and all of the stockholders did take the full amount to which he was entitled. There seems to be no room for doubt that the whole procedure, as finally consummated, brought about in the end the2253 same ultimate result as though a formal stock dividend had been declared. Each of the stockholders took two shares of the new stock for each old share held by him, and when all had so taken stock, the entire issue was absorbed and each stockholder owned and held exactly the same proportional interest in the corporation which he held prior to that stock issue. Petitioner held before and after that stock issue a one-fourth interest. However, from a legal point of view the resolutions of the stockholders are what determined the legal rights of the parties, as well as the legal result of the operations. That a cash dividend of $200,000 was authorized by the resolutions dated April 1, 1920, is patent on the face of the instrument. In carrying out the provisions and instructions contained in those resolutions, checks were issued to each stockholder. While it may be true that a mutual understanding and agreement existed among the stockholders that each would take additional stock to the amount of his check, he was not legally bound to do so and could have demanded the cash. The procedure carried out was to all intents and purposes a purchase of stock, and payment therefor was by2254 an endorsed check. It was as much a purchase of that stock as though he had cashed his check and paid the money for the stock. Such was not the situation in the case of . In that case the board of directors, by resolution, authorized a stock dividend. No checks were issued and no payment in cash, or its equivalent, was made. No stockholder could have demanded anything other than his proportionate amount of stock. The Supreme Court in that case said: An actual cash dividend, with a real option to the stockholder either to keep the money for his own or to reinvest it in new shares, would be as far removed as possible from a true stock dividend. See also ; ; . The case of Eisner v. Macomber was decided by the Supreme Court on March 8, 1920, prior to the issuance of the stock in question, and a year prior to the making of the return for 1920. Petitioner is presumed to have known of that decision and there is no evidence in the record to indicate that he did not have actual knowledge2255 of it at that time, and yet he and his wife reported the transaction here involved 1313 as taxable income. The idea that it was not taxable evidently was an afterthought. In view of all the evidence in the case, and in view of the stipulations at the hearing, we decide that the dividend in question was a cash dividend and taxable as such, and, further, that there is no deficiency as against Margaret B. Payne, Docket No. 21487, and that on motion of respondent, the deficiency against E. J. Payne is enlarged as requested by counsel for respondent. It may be well to note here that the issue as to whether the $50,000 paid to E. J. Payne on April 1, 1920, was compensation for services, and taxable as such, was not raised by the pleadings. The deficiency notice stamps it as a cash dividend and not a stock dividend, and the sole issue urged was whether it was a stock dividend or a cash dividend. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624525/	Nelson A. Farry, Petitioner, v. Commissioner of Internal Revenue, Respondent. Velma R. Farry, Wife of Nelson A. Farry, Petitioner, v. Commissioner of Internal Revenue, RespondentFarry v. CommissionerDocket Nos. 16105, 16106, 20069, 20070United States Tax Court13 T.C. 8; 1949 U.S. Tax Ct. LEXIS 135; July 6, 1949, Promulgated 135 Decisions will be entered under Rule 50. Petitioner Nelson A. Farry, who for a good many years has been in the insurance and real estate business, developed certain subdivisions in the city of Dallas, Texas, and constructed residences thereon, and in the taxable years he sold some of them at a profit. These profits he returned as ordinary income. Petitioner also during the course of the years acquired other properties, not located in these subdivisions, primarily for investment purposes and collected rentals thereon. During the taxable years he sold some of the rental properties and returned the profits therefrom as long term capital gains. The Commissioner has determined that such gains should be taxed as ordinary income. Held, that petitioner was not holding these rental properties primarily for sale to customers in the ordinary course of his trade or business, but was holding them primarily for investment purposes, and the gains from the sale thereof are taxable as capital gains under the provisions of section 117 (j), Internal Revenue Code. S. L. Mayo, Esq., and J. L. McNees, Esq., for the petitioners.Stanley B. Anderson, Esq., for the respondent. Black, Judge. BLACK 8 These consolidated proceedings involve deficiencies in income tax for the years 1944 and 1945, as follows: 9 PetitionerDocket No.YearDeficiencyNelson A. Farry161051944$ 1,131.622006919452,092.51Velma R. Farry1610619441,131.622007019452,092.51Petitioners filed separate returns for the years involved on the community property basis with the collector of internal revenue for the second district of Texas.For the year 1944 the deficiency of each petitioner is due to one adjustment, "Additional income137 $ 6,466.18," which is explained in the deficiency notices as follows:It is held you are engaged in the business of buying and selling real estate and are not entitled to the benefits afforded by section 117 (j) of the Internal Revenue Code in determination of taxable income for 1944 resulting from sales of real estate.Therefore, the entire profit reported by you is held to be taxable in 1944, both on outright sales and the profit in installment payments received. * * For the year 1945 the deficiency of each petitioner is due to one adjustment, "(a) Gain from real estate sales increased $ 10,038.31." This adjustment is explained in the deficiency notices as follows:(a) It is held that the gains from sales of real estate which you reported on your 1945 return as capital gains represented ordinary income taxable 100% under section 22 (a), Internal Revenue Code. Your income for that year has been increased in accordance with this determination.Petitioners, by appropriate assignments of error, contest the foregoing determinations of the Commissioner as to both years.FINDINGS OF FACT.Petitioners Nelson A. Farry and Velma R. Farry, husband and wife, are residents of Dallas, Texas. 138 Sometimes hereinafter Nelson A. Farry is referred to as the petitioner.During 1944 and 1945 petitioner was engaged in the business of collecting rentals for a commission, insurance, investments, and dealing in real estate. Petitioner entered business in 1921 as a rent collector for a Dallas firm engaged in property management, real estate loans, and insurance. On January 1, 1927, the members of the firm having retired, petitioner succeeded to the business, and since then he has conducted it under his own name, considerably enlarging it as time has gone on.In his investments in rental properties, from actual experience, petitioner considered negro rentals and duplex apartments more desirable as revenue producers than single family rent houses. For his own investment purposes, therefore, he acquired and retained more of the former type than the latter. Other than some stock in a small 10 local company, petitioner had no other investments than those in his rental properties.During the 1920's petitioner bought and built for his own account several negro rental houses, but was forced to sell them early in the depression. In 1934 he purchased 3 negro rental houses under a139 10-year loan. These were bought from a bank which was liquidating its foreclosed properties. From time to time thereafter petitioner either made similar purchases or built for his own account duplexes and negro rental houses until at the end of 1939 he owned 29 such rental properties and at the end of 1940 he owned 38. These produced gross rents in excess of $ 10,000 in 1939 and $ 13,400 in 1940. All of these properties were located elsewhere than in two subdivisions known as Cedar Crest and Clarendon Heights, which petitioner developed and sales from which are not here involved.In 1941 petitioner constructed 5 duplexes for rental purposes. He still owned these in 1949 at the time of the hearing. He also constructed for rental purposes 8 single family negro houses in that year from secondhand materials and scraps from other construction projects. Those houses were rented for $ 12 to $ 15 per month. Petitioner's gross rental income in 1941 was in excess of $ 15,000. At the end of 1941 petitioner owned approximately 45 different parcels of rental properties, comprising about 100 rental units.In 1940 and 1941 there was an abnormal vacancy ratio in the city of Dallas and rents140 were unusually low. These low rents were eventually frozen by rent controls, effective in late 1942. During that period and into 1943, rental properties of the kind petitioner owned could be purchased at a relatively small investment by arranging proper financing. In 1942 petitioner purchased 11 rental properties. In 1943 petitioner acquired 18 rental properties, including 10 duplex apartments. In 1943, in connection with the great expansion of the Municipal Airport, Love Field, for use by plane manufacturers and the Army Air Forces, petitioner purchased 15 buildings from the Government -- 5 single family houses and 10 duplexes. These had to be purchased as one transaction and removed from the area in a hurry. Nine duplexes and 2 single family houses were moved to Danford Street and 1 duplex and 3 single family houses were moved to Bomar Street. The 5 single family houses were sold forthwith without being rented or registered for rent control, since petitioner did not favor that type of rental property. Gains on their sale were reported as fully taxable. The projects at Danford and Bomar Streets were completed in August 1943, and the 10 duplexes were rented immediately under141 2-year written leases.While petitioner paid cash for some of the above rental properties and constructed others from left-over materials, most of his 11 rental properties were acquired under long term loans ( 10 years or longer). Many of these were blanket loans, covering several rent properties. The blanket loans usually contained no "release clauses" and were payable in installments on specified dates, without "on or before" privileges. Petitioner made these long term financing arrangements on his rental properties (as distinguished from short term construction loans) in expectation that the rentals would liquidate the loans so as to increase his estate and ultimate revenue.In additional to acquiring rental properties as aforesaid and managing them and collecting rent from them, petitioner acquired lands in the city of Dallas and developed subdivisions by constructing single family residences for sale. These subdivisions were known as Cedar Crest and Clarendon Heights. Petitioner never rented the residences which he constructed in these two subdivisions, but generally sold them soon after they were completed. The gain from the sales of these houses and lots which petitioner142 made in the taxable years was reported as ordinary income and is not here in controversy.By mid-1943 the housing situation, especially rentals, in Dallas had changed materially. The removal of the Eighth Service Army Command from San Antonio to Dallas, which began in late 1942, was accomplished, bringing in thousands of service personnel. Other war agencies and plants were in operation. The heavy influx of new Dallas residents had absorbed rental vacancies and people were seeking almost any place to live; if not to rent, then to buy. The scramble to rent or to buy housing, not investment property, was well under way in late 1943. It was yet to become acute in 1944 and 1945, when housing demands forced prices to new peaks. Under these conditions and in view of rent control, when petitioner counseled with his banker the advisability of liquidating some of his rental properties was suggested. It was pointed out to petitioner by his banker that interest on the notes which he could take in the sale of these rental properties would yield more than rents from the property. Petitioner concurred in this view.In 1944 petitioner sold 19 of his rental properties and reported the gains143 as capital gains. Of the 19 rental parcels sold in 1944, 2 were held and rented between 6 months and 1 year; 11 from 1 to 2 years; and others up to 8 years.In 1945 petitioner sold 27 of these rental properties and reported the gains therefrom as capital gains. Of the 27 rental or investment parcels sold in 1945, 12 were held from 1 year 4 months to 5 years, and 15 were held from 5 years or longer, up to 11 1/2 years.Petitioner accounted for rental income, both his own and that of clients, in a manner quite distinct from his gains on sales of houses constructed for sale. A separate ledger was maintained for rents and a separate one kept for houses built for sale. A separate account was set 12 up for each rental property petitioner owned and rents were collected or credited thereto just as for property managed for clients. Separate ledger sheets for rental properties carried all expenses, including depreciation. Separate ledger sheets were maintained in a separate ledger on each house constructed for sale, reflecting all costs, selling prices, and profits.The gains reported by petitioner for 1944 and 1945 as long term capital gains (both installment and cash basis) were144 gains from properties acquired and held by him for more than six months, primarily for investment and the production of income.Petitioner is the holder of a real estate dealer's license. In petitioner's income tax return for 1944 the business of petitioner is stated to be "Rentals, Insurance, Investments, Real Estate." In petitioner's income tax return for 1945 the business of petitioner is stated to be "Rentals, Insurance, Investments, Real Estate Developer."OPINION.In these proceedings we have no issue as to the amounts of petitioners' income, which, as shown in our findings of fact, was from several sources. The only question is whether petitioners are entitled to report the profits from the sales of certain rental properties as long term capital gains and taxable on only 50 per cent thereof, as petitioners contend, or whether they are taxable on 100 per cent thereof as the Commissioner has determined. In addition to the income which petitioners reported from the sale of these rental properties, they also reported gross income on the community property basis from rentals received, commissions on insurance written, commissions on the sale of real estate, and profits from the145 sale of houses and lots in subdivisions which petitioner had developed. All of these latter were reported as ordinary income and taxable on 100 per cent thereof. The only income which petitioners reported as long term capital gains was the profits from the sale of the rental properties described in our findings of fact. Petitioners claim the right to do this under the provisions of section 117 (j), added to the Internal Revenue Code by section 151 of the Revenue Act of 1942. Respondent concedes that is the applicable section, but denies that petitioner is entitled to the benefit thereof under the facts. It is printed in the margin. 1 For a discussion 13 of the 1942 amendments containing section 117 (j) as applied to losses on the sale of such assets, see Leland Hazard, 7 T. C. 372; William H. Jamison, 8 T. C. 173; and Solomon Wright, Jr., 9 T. C. 173. In the Leland Hazard case, we said: * * Section 151 (b) of the 1942 Act added the new subsection (j), covering, as its title indicates, "Gains and Losses From Involuntary Conversions and From the Sale or Exchange of Certain146 Property Used in the Trade or Business." This section provides for special treatment where gains exceed losses from involuntary conversions and from the sale of certain property used in a trade or business. Such gains are treated as capital gains. This is a relief provision for the benefit of such taxpayers as come within its provisions. Losses in excess of gains in respect to such property are still treated as ordinary losses allowable in full. * In the above cited cases we held that under the provisions of section 117 (j) of the code the losses incurred from the sale of rental property should be allowed as ordinary losses and deductible in full. However, as pointed out in the Hazard case, supra, the situation is different when the sale of such property results in a gain. In such a case the gain, under the provisions of section 117 (j), is taxable as capital gain and not as ordinary income. In other words, under the provisions of section 117 (j) the taxpayer is given the benefit of full deduction of any loss on a sale of rental property used in his trade or business, but the Government does not receive a corresponding advantage in the case of gain.147 We do not understand from respondent's brief that he disputes the foregoing interpretation of the meaning of section 117 (j). However, he does contend that in the instant case the petitioner was holding the rental properties "primarily for sale to customers in the ordinary course of his trade or business." Of course, if that were true, petitioner could not prevail even under the provisions of section 117 (j). Section 117 (j) does not change the rule of law that property held by a taxpayer "primarily for sale to customers in the ordinary course of his trade or business" is not a capital asset. However, it seems to us that petitioner has proved by overwhelming evidence that he purchased and held these rental properties primarily for investment purposes. The fact that in the taxable years he received satisfactory offers for some of them and sold them does not establish that he was holding them "primarily for sale to customers in the ordinary course 14 of his trade or business." The evidence shows that he was holding them for investment purposes and not for sale as a dealer in real estate.It is true, of course, that petitioner was in the business of developing two subdivisions148 in the city of Dallas, namely, Cedar Crest and Clarendon Heights. He constructed houses on these properties and sold them at a profit. To this extent he was a dealer in real estate. That he does not deny and he has returned all of his gains from the sale of these Cedar Crest and Clarendon Heights properties as ordinary income. But a dealer can also be an investor, and, where the facts show clearly that the investment property is owned and held primarily as an investment for revenue and speculation, it is classed as a capital asset and not property held "primarily for sale to customers in the ordinary course of trade or business." See E. Everett Van Tuyl, 12 T. C. 900, and Carl Marks & Co., 1196">12 T. C. 1196. On the facts, we sustain the petitioner on the issue presented for our decision.Decisions will be entered under Rule 50. Footnotes1. SEC. 117. CAPITAL GAINS AND LOSSES.* * * (j) Gains and Losses From Involuntary Conversion and From the Sale or Exchange of Certain Property Used in the Trade or Business. --(1) Definition of property used in the trade or business. -- For the purposes of this subsection, the term "property used in the trade or business" means property used in the trade or business, of a character which is subject to the allowance for depreciation provided in section 23 (l), held for more than 6 months, and real property used in the trade or business, held for more than 6 months, which is not (A) property of a kind which would properly be includible in the inventory of the taxpayer if on hand at the close of the taxable year, or (B) property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business. * (2) General rule. -- If, during the taxable year, the recognized gains upon sales or exchanges of property used in the trade or business * * exceed the recognized losses from such sales, exchanges, and conversions, such gains and losses shall be considered as gains and losses from sales or exchanges of capital assets held for more than 6 months. If such gains do not exceed such losses, such gains and losses shall not be considered as gains and losses from sales or exchanges of capital assets. * * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624526/	The Princess Garment Company v. Commissioner.Princess Garment Co. v. CommissionerDocket No. 109874.United States Tax Court1942 Tax Ct. Memo LEXIS 75; 1 T.C.M. (CCH) 186; T.C.M. (RIA) 42639; November 25, 194275 In 1939 petitioner created a pension plan under which it established a trust to which it paid $25,000 for the purpose of paying premiums on annuity and insurance policies on certain of its employees and officers whose services were vitally important to its continuing prosperity. Held, that under the facts, petitioner is entitled to deduct the amount so paid under the provisions of section 23 (p), Internal Revenue Code. Lester A. Jaffe, Esq., 1616 Union Central Bldg., Cincinnati, O., and Harry Stickney, Esq., 1616 Union Central Bldg., Cincinnati, O., for the petitioner. Melvin S. Huffaker, Esq., for the respondent. VAN FOSSAN Memorandum Findings of Fact and Opinion The respondent determined deficiencies of $4,554.48 and $1,029.04 in the petitioner's income and excess profits taxes respectively for the year 1939. The single issue is whether or not the petitioner is entitled to the deduction of a $25,000 payment made to an employees' pension trust. In the alternative, the petitioner claims the deduction as an ordinary and necessary business expense. Findings of Fact Certain facts were stipulated and as so stipulated we adopt them as a part of our findings of fact. In so far as they76 are material to the issue they are substantially as follows: The petitioner is an Ohio corporation with its principal place of business in Cincinnati, Ohio. The return for the period herein involved was filed with the Collector of Internal Revenue for the first district of Ohio. The petitioner is engaged in the manufacture of ladies' and children's garments and in the sale of such garments and related items made directly to consumers through sales representatives who solicit orders therefor from such consumers. Delivery is made by the petitioner directly to the purchasing consumers by mail. On December 22, 1939, the Board of Directors of the petitioner adopted a plan establishing a pension trust and named Philip Meyers, Sidney Meyers and Melville Meyers as the Board of Managers of the Trust. They also authorized the payment of at least $25,000 to create the pension trust fund and to operate it for the year 1939. They further authorized the payment of such sums as might be found necessary to maintain the successful operation of the pension trust during each succeeding year of the life of the trust. They designated The First National Bank of Cincinnati, Ohio, as trustee. The purpose77 of the pension plan was to reward the faithful service of certain officers and employees, to foster a feeling of greater loyalty to the company and to provide appropriate protection for such officers and employees when confronted with infirmity or old age. The pension plan, hereinafter called the Plan, provided that a trust should be established for the benefit of officers and employees earning $2,500 per year and over; that the petitioner would make an initial payment of not less than $25,000 and that from time to time the petitioner would pay to the trust, amounts necessary to operate the Plan successfully. The Plan outlines the conditions and terms as later reflected in the trust agreement. The beneficiaries of the Plan were only those who earned annually $2,500 and over, who were between the ages of 21 and 35 and who had been employed by the petitioner at least twelve months. The Board of Managers was empowered to determine the amount of the pension of each applicant on the basis of all relevant factors, such as length of service, ability, value of service and salary. Pensions were payable at age 65. If the participant should become incapacitated, the contract purchased by 78 the trustee on his life would be assigned to him. If he were discharged or should leave petitioner's employ during the first ten years of his participation in the Plan, he would have no claim on the funds deposited for his benefit, nor on the contracts purchased therefrom, but the accumulations to his credit would revert to the corpus of the trust. If, however, he should resign or voluntarily leave the employ of the petitioner after such ten-year period, the annuity or life income contract purchased by the trustee on his life would be assigned to him. If the pensioner should die before the pension would become payable, the entire proceeds of the life income or annuity contract would be paid to the decedent's designee or, if no designation had been made, to his administrators or executors. The Plan further provided that the petitioner "hereby waives, surrenders and relinquishes all right, title and interest in and to any of the funds or property of the Pension Trust, whether contributed thereto by it or otherwise received by the Trustee". The petitioner also reserved the right to amend or revise the Plan provided such amendment or revision should not "as determined by the Board of79 Managers, detrimentally affect or impair the rights of any officer or employee already a participant in said Pension Trust, nor revest in the Company any claim, interest or right in and to any of the funds or property of the Pension Trust". The petitioner had no right to modify or amend the trust agreement so as to take or obtain for itself any interest in the insurance contracts. On December 28, 1939, by authority of the petitioner's Board of Directors, the petitioner executed a trust instrument with The First National Bank of Cincinnati, Ohio, as trustee, in which the trustee agreed to carry out the instructions of the Board of Managers relating to the purchase of insurance contracts or policies for the benefit of the petitioner's officers and employees who were included in the Plan and to take all appropriate action in connection therewith. Provisions were made for the disposition of the policies in case the beneficiaries left the employ of the petitioner and for other routine procedure. On December 29, 1939, the petitioner paid to the trustee the sum of $25,000. The trustee made disbursements therefrom aggregating $24,817.20 for the first year's premiums due on each of the policies80 purchased for the Plan. No money was paid or contributed by any beneficiary thereunder. All of the policies are now in full force and effect and have been, since their inception, in the possession of the First National Bank of Cincinnati, Ohio, as trustee, with the exception of Policy No. 10951895 for the benefit of Melville Meyers, which was discontinued by the Board of Managers as of the first anniversary date. The amounts paid as first year premiums on the policies issued to the trustee for the benefit of the various beneficiaries and the annual amounts payable to them at retirement age pursuant to the terms and conditions of the Plan, were as follows: First Yr.Ann. Inc.Ann. Inc.NameInsurance Co.Pol. No.Premiumage 55age 65Philip MeyersState MutualR-4675$2,500.00$13,830.00$30,000.00Prudential109412082,000.00Conn. General595841,500.00Provident Mut9074802,000.00New England MutA-343211,800.00John Hancock0607454,831.00Sidney MeyersNorthwestern30056035,784.506,556.5015,000.00* Melville MeyersPrudential10951896821.002,400.00Clarence IsraelNorthwestern3005699255.70600.00Ferdinand SchottNorthwestern3005602233.00600.00Chas. JenningsNorthwestern3005600169.95600.00Martin RotterNorthwestern3005501162.95600.00Albert PollockJohn Hancock060747173.95600.0081 During the year 1939 the issued and outstanding capital stock of petitioner was 100 shares of preferred stock, 100 shares of no par Class A stock and 150 shares of no par Class B stock. The Class B stock carries all the voting rights unless there is default in the payment of dividends on the preferred or Class A stock. The stockholders of the petitioner as of December 31, 1939, were as follows: SHARESPre-NameferredClass AClass BMitchell Meyers10100Philip Meyers565Sidney Meyers1030Melville Meyers1018Albert Meyers1012Leona Rosenthal1012Philip Meyers, Trusteefor Philip Meyers,Jr203Philip Meyers, Trusteefor Lynne Meyers203Lucille Meyers57100100150The names of all employees originally selected for participation in the pension plan, the official position of each, the number of years service with petitioner and the annual salary of each at the time of the inception of the pension plan, were as follows: Years ofAnnualNamePositionServiceSalaryPhilip MeyersVice President19$30,000.00Sidney MeyersProduction Manager715,000.00Clarence IsraelMgr. of Hartford Dept76,500.00Ferdinand SchottSales Manager13,900.00Chas. JenningsEfficiency Engineer43,075.00Martin RotterPurchasing Agent62,615.80Albert PollockPurchasing Agent62,880.00Melville MeyersPrinting Purchaser142,600.0082 The number of persons employed by petitioner by months during the year 1939 in both its office and factory was as follows: No. of Em-No. of Em-ployees onployees onFactoryOfficeMonthPayrollPayrollJanuary 13297358February 17365270March 17366227April 14356267May 12342206June 16335207July 14324269August 18308362September 15343213October 13353201November 17350201December 15373202The net income of the petitioner for the year 1939 as disclosed by its 1939 income tax return was in excess of $283,000. Dividends declared by the petitioner on its issued and outstanding stock for the calendar year 1939, as stated in its income tax return, aggregated $162,000. In December, 1939 Melville Meyers' aggregate compensation received from the petitioner and from B. J. Melville Company (a corporation whose preferred stock is owned by the petitioner) was $9,000 per year. In the fall of 1940, Policy No. 10951895, issued by the Prudential Insurance Company for the benefit of Melville Meyers, was withdrawn from the Pension Trust and Melville Meyers personally reimbursed the trustee for the cash value thereof. 83 In December 1940, the petitioner paid to the trustee $20,620.64 to cover the net second annual premium on the trust policies and in December, 1941, it paid $22,231.05 to cover the net third annual premium thereon. The record disclosed the following additional facts: The petitioner is not engaged in the mail order business. Orders for garments are obtained through sales representatives, generally women, located in all parts of the country. In 1939, the petitioner had about 60,000 sales representatives, of whom from 20,000 to 25,000 were usually quite active. The petitioner occupied an outstanding position in its industrial field. In 1939 Philip Meyers was the president of the "National Association of Direct Selling Companies of America" and held such office for three terms. The petitioner first considered the pension plan in 1936 but largely on account of the flood of January, 1937, it sustained a heavy loss and hence was not interested in such a plan. In 1938, the petitioner was concerned with restoring its business position and, with that accomplished during that year, consideration of the pension plan was resumed in 1939. Philip Meyers, Sidney Meyers, Albert Meyers and Leona84 Rosenthal are all children of Mitchell Meyers. Lucille Meyers is the wife of Philip Meyers and Philip Meyers, Jr. and Lynne Meyers are his minor children. The trusts for the said minor children are irrevocable. In 1939 the average age of petitioner's office employees was about 25 years and the average of its factory employees was about 33 years. Only three out of over 300 employees in the petitioner's office during that year were over 40 years of age, and out of an average of 343 factory employees, only between 20 and 25 were 40 years of age. The percentage of annual turnover for office and factory employees is 49 per cent and 50 per cent, respectively. The small number of employees over 40 years of age employed by the petitioner and the large percentage of turnover are not due to the discharge of employees by petitioner after short periods of employment. Most of the employees are young women. During the year 1939, of 701 who were employed in the office at some time during the year, 664 were women and seven were men. In the factory, 98 per cent are women and of these, 85 per cent to 90 per cent are married women. Since most of the women employees are young, a large number get married85 and voluntarily leave the employ of the petitioner. Others who are married leave as soon as they have children and do not return. Other married women employees leave "when their husbands are doing well." In addition the seasonal character of the business contributes to the large turnover. Out of all the employees of petitioner, in both factory and office, only eleven earned more than $2,500 per year during the calendar year 1939. One of these, Mitchell Meyers, then president of petitioner, was over 65 years of age when the Plan was put into effect and was, therefore, not included. Another, J. D. Park, then earning $3,000, was not included because he had been with the company for a very short time and his department was experimental. George Rutmann was employed less than a year. The remaining eight were included in the Plan. If $2,000 or $1,500 had been used as a minimum basis for inclusion in the plan, four and eight additional employees, respectively, would have shared therein. The success of petitioner's business peculiarly depends first, on a primary group of employees, viz., Mitchell Meyers, Philip Meyers and Sidney Meyers. Mitchell Meyers was 66 years of age at the inception86 of the Plan. Philip Meyers and Sidney Meyers "carry the load of the whole business." The secondary group of employees consists of those not so important but whom it requires a few years to train. All of the members of the primary and secondary groups are beneficiaries under the Plan excepting only Mitchell Meyers and J. D. Park, whose department was experimental. All of the included employees are "key employees" in the business. Those employees who are easily replaceable, have no appreciable effect on the business, and occupy no responsible position, do not participate in the Plan. Philip Meyers was president of petitioner at the time of the hearing but was vice-president during the year 1939. He has been associated continuously with petitioner's business since 1922 and was responsible for petitioner's inaugurating the policy of direct selling in the fall of 1925. He was in charge of the general policy of the company, its financial problems and policies, all merchandising, which includes the preparation of the catalogue and the determination of how much merchandise to purchase. He is also in charge of advertising and all sales. Sidney Meyers was vice-president and secretary of 87 petitioner at the time of the hearing, but was secretary of petitioner in 1939. He was in charge of production, personnel, labor relations and the various purchasing departments that have to do with the manufacturers who make goods for petitioner. The petitioner's gross sales and net profits at intervals during 1922 to 1941, were as follows: Gross SalesNet Profits1922$ 161,000.001934$177,246.111925223,000.00193583,475.381928502,000.00193628,130.851930915,000.00193712,385.49(Loss due to flood)1934$3,275,000.001938$ 87,260.3019394,913,000.001939274,433.9619405,330,000.001940167,642.401941224,620.61The petitioner carried $368,000 and $225,000 of life insurance on the lives of Philip Meyers and Sidney Meyers, respectively. It paid respective annual premiums of $11,003 and $4,762 thereon. The business of the company is peculiarly dependent on Philip Meyers and Sidney Meyers. The death or incapacity of either would impose a loss on the petitioner while trying to replace him. The salaries of Philip Meyers and Sidney Meyers were as follows: YearPhilip MeyersSidney Meyers1935$25,000$15,0001936 25,00015,0001937 None (flood)6,5001938 25,60011,2251939 30,00015,4001940 30,00015,0001941 30,00015,00088 Opinion VAN FOSSAN, J.: The sole question presented is whether or not the sum of $25,000 paid by the petitioner to an employees' pension trust is deductible from its gross income. The deduction is asked under the provisions of section 23 (p), Internal Revenue Code. If that section is found inapplicable, the petitioner seeks the deduction as an ordinary and necessary business expense as provided in section 23 (a) (1), Internal Revenue Code. Both the petitioner and the respondent agree that the answer to the first question lies in the proper interpretation and application of section 165 (a) (1) 1, Internal Revenue Code. The respondent contends that the benefits received from the Plan by the principal stockholders of the petitioner bore a definite and direct relation to the proportions of stock held by them. Therefore, he charges, the Plan was merely a device for distributing corporate earnings in lieu of dividends and thus enabled the Meyers brothers to escape their individual income taxes. He concludes that consequently the Plan was not exempt from taxation under section 165 and that the sums so paid by the petitioner are not deductible under section 23 (p). 89 In his opening statement at the hearing, counsel for the respondent stated: "There is no question of bona fides involved in this trust". On brief he concedes that the trust was a "bona fide juristic trust" but denies that the Plan was established in good faith. His position is hard to understand. The trust was an inseparable part of the Plan. If the Plan was surcharged with mala fides, as the respondent asserts, it seems impossible that the trust could escape its taint. The essence of the case at bar is the good faith of the petitioner and its board of directors in establishing the Pension Plan. We find nothing in the stipulated facts, in the evidence adduced at the hearing, or in the demeanor of the witnesses to cast any suspicion on their actions or to impute to them any improper and sinister motives. By an arithmetical grouping of figures the respondent attempts to show that the first year premiums paid on behalf of certain active stockholders were approximately proportionate to their common voting stock interests. In so doing he includes stock in an irrevocable trust established for the benefit of Philip Meyers' children and stock owned outright by his wife. 90 He also disregards stock owned by others than the three Meyers brothers. He likewise includes in his calculations Policy No. 10951895, issued to Melville Meyers, on which the petitioner paid a premium of $2,586.15 but which was withdrawn in 1940, reimbursement being made to the trustee for the cash value thereof. The policy is not included in the stipulated table of first year (1939) premiums. The correct amounts and percentages of salaries, pension trust payments and stockholdings of the Meyers brothers are as follows: PensionPercent-Stock-Percent-SalaryPercentagePaymentsageholdingsagePhilip Meyers$30,000.0062.5$14,631.0058.56543.3Sidney Meyers15,400.0032.15,764.5023 3020 Melville Meyers2,600.005.4821.003.31812 At a glance we see the mathematical inaccuracy of the respondent's position. As we view the situation, the services of Philip Meyers and Sidney Meyers were of great value to the petitioner. Its outstanding success in its peculiar industrial and commercial field was due almost wholly to their efforts. The petitioner's business required only a few top-ranking persons whose continued association91 with the company would be beneficial to it. Those were all included as beneficiaries of the Plan. The Plan was adopted in order to give proper recognition to the worth of its beneficiaries to the petitioner and to induce them to remain with it. We note that Mitchell Meyers, a large owner in the company, was omitted from the benefits of the Plan because he was over the age fixed. The creation and continuance of the Plan were based on the relationship of employer and employee. The Plan appears to be precisely the kind of a pension institution contemplated by the statute. It was created for the exclusive benefit of some of the employees, thereby satisfying the statutory requirement. The trust is exempt under the provisions of section 165. The pension plan in the case of Raymond J. Moore, et al., 45 B.T.A. 1073">45 B.T.A. 1073, cited and relied on by the petitioner, is particularly in point. In no important features does it differ from the Plan before us. The Board there held that the pension trust was within the provisions of section 165, and stated: * * These employees are chosen because of their value to the business of the company. To provide for the custody and92 maintenance of the funds which, under the plan, it pays in each year, a trustee has been formally appointed under a deed of trust. Under the plan and deed of trust the amounts paid by the company to the trustee pass from its possession and control, and are administered wholly for the benefit of the employees participating in the benefits awarded. Upon the payment of these moneys to the trustee the company loses all its rights thereto. It is evident that the creation of this plan and the trust is not a subterfuge by which earnings of the company are distributed to stockholders as such. Although the participant petitioners are stockholders, as well as employees, the monetary benefits were awarded to them as employees. These benefits bear no relation to their respective stock interests in the company. The above might well have been written of the present case. Cf. W. F. Parker, et al., 38 B.T.A. 989">38 B.T.A. 989, where the Board held that the trust was created primarily for the benefit of the principal stockholder, was under his domination and hence was not within section 165 of the Revenue Act of 1934. We hold that the $25,000 paid by the petitioner to the pension93 trust is a proper deduction under the provisions of section 23 (p). In view of our decision on the primary issue, the alternative question need not be considered. Decision will be entered under Rule 50. Footnotes. Pol. No. 10951895 (Ex. 0-9) is omitted as set forth hereafter).↩1. SEC. 165. EMPLOYEES' TRUST A trust forming part of a stock bonus, pension, or profit-sharing plan of an employer for the exclusive benefit of some or all of his employees - (1) If contributions are made to the trust by such employer, or employees, or both, for the purpose of distributing to such employees the earnings and principal of the fund accumulated by the trust in accordance with such plan, and * * * *shall not be taxable under section 161, but the amount actually distributed or made available to any distributee shall be taxable to him in the year in which so distributed or made available to the extent that it exceeds the amounts paid in by him. Such distributees shall for the purpose of the normal tax be allowed as credits against net income such part of the amount so distributed or made available as represents the items of interest specified in section 25 (a).↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624527/	Alphonsus C. Fox and Agnes W. Fox v. Commissioner.Fox v. CommissionerDocket No. 6614-66.United States Tax CourtT.C. Memo 1968-28; 1968 Tax Ct. Memo LEXIS 270; 27 T.C.M. (CCH) 125; T.C.M. (RIA) 68028; February 16, 1968. Filed David L. Ketter and C. J. Queenan, Jr., 1100 Oliver Bldg., Pittsburgh, Pa., for the petitioners. John W. Tissue, for the respondent. MORDOCK Memorandum Findings of Fact and Opinion The Commissioner determined additions to tax against the petitioners for fraud under section 6653(b) of $1,999.21 for 1959, $3,042.10 for 1960 and $3,673.89 for 1961. Findings of Fact The petitioners, Alphonsus C. and Agnes N. Fox, husband and wife, resided in Pittsburgh, Pennsylvania when the petition was filed in this case. They filed joint individual income tax returns for the years 1959, 1960 and 1961 with271 the director of internal revenue for the district of Pittsburgh, Pennsylvania. The returns for 1960 and 1961 were delinquently filed on April 9, 1963 and the return for 1959 was delinquently filed on August 30, 1963. Alphonsus received an A.B. degree from Miami University in 1920. His net worth during the tax years was about $250,000. He was a branch manager for the Fuller Brush Company in Pittsburgh during the years 1959, 1960 and 1961 and maintained an office at 3 Parkway Center, Pittsburgh, Pennsylvania. He had no partners or associates but the name on the door of that office was "A.C. Fox Associates." He felt that applicants were more likely to enter the office with that name on the door than had the Fuller Brush name been on the door. Alphonsus had seven field supervisors and approximately 100 to 115 dealer salesmen under his general supervision. The primary responsibilities of his position were to recruit dealers content to work from house to house on a straight commission basis of compensation and to promote the productivity of such dealers. He attempted to promote dealer productivity by publishing a weekly promotional bulletin and by attending evening sales meetings an272 average of two or three evenings a week. 126 Alphonsus was compensated on a commission basis and was reimbursed for office expenses by the Fuller Brush Company, based upon a four-week periodic compilation. He retained his cancelled checks, receipts and brokers' slips for each year but maintained no formal books of account. The petitioners used a cash receipts and disbursements method of accounting. Alphonsus knew how to make the returns, knew he should file returns, knew he owed taxes for each year, and knew the penalties for not filing the returns. The petitioners reported in their delinquent returns for the taxable years in controversy the following amounts and sources of gross income, deductions, taxable income and tax liabilities: Taxable year195919601961Gross income from Fuller Brush Co$37,170.53$41,363.42$48,722.34Business expenses 19,047.9917,470.3121,508.60Net earnings$18,122.54$23,893.11$27,213.74Dividends (after exclusions)1,101.641,089.981,521.29Interest123.8148.48Speaking Fee100.00Annuity (taxable portion)1,443.90680.40Rental (after depreciation)40.0040.0040.00Capital gains (taxable net) 120.10120.16279.15Adjusted gross income$19,284.28$26,810.96$29,783.06Itemized deductions1,735.822,779.932,567.67Personal exemptions 1,200.001,800.001,800.00Taxable income$16,348.46$22,231.03$25,415.39Tax withheld and credit2,925.783,975.834,591.36Balance paid1,112.702,151.962,817.26273 Alphonsus borrowed the money in 1963 to pay the tax and interest shown by the 1959, 1960 and 1961 returns filed. Alphonsus on April 17, 1961 requested a sixty-day extension to file his 1960 return and on April 16, 1962 requested a thirty-day extension to file his 1961 return. He was granted a thirty-day extension for each year. The internal revenue service made repeated unsuccessful efforts to have Alphonsus file returns for 1959, 1960 and 1961 or explain why such returns were not filed. Alphonsus gave some excuses for not filing and made promises to file but did no work on and did not file 1960 or 1961 returns as he promised. An internal revenue special agent went to Alphonsus' office in March 1963 with respect to 1959, 1960 and 1961 returns of the petitioners. Alphonsus told him that their return for 1959 had been filed. No return for 1959 had been filed. Alphonsus called a certified public accountant late in March 1963 and asked him to prepare tax returns for him for the years 1960, 1961 and 1962. The C.P.A. did not know Alphonsus at that time. The year 1959 was not mentioned during that call. The C.P.A. then prepared the 1960 and 1961 returns and filed them in April 1963. 274 The internal revenue service inquired at that time about a 1959 return. The C.P.A. then talked to Alphonsus who told him that the 1959 return had been filed. Alphonsus, in an interview in July 1963 with two agents of the internal revenue service, admitted that he had never filed a return for 1959. Alphonsus in August 1963 employed the C.P.A. who had prepared the 1960 and 1961 returns to prepare the return for 1959 which was filed on August 30, 1963. Alphonsus pleaded guilty and was convicted in the United States District Court for the Western District of Pennsylvania, under section 7203 of the Internal Revenue Code of 1954, of willful failure to file income tax returns for each of the taxable years 1960 and 1961. All stipulated facts and exhibits are incorporated herein by this reference. Opinion MURDOCK, Judge: Section 6653(c)(1) provides that an underpayment of income tax is a deficiency as defined in section 6211 but the tax shown on a return shall not be taken into account if the return in question was not filed on or before the last day prescribed for the filing of such return including any extension of time granted for 127 the filing. Section275 6653(b) provides that, if any part of any underpayment of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 50 percent of the underpayment. None of the three returns here involved was filed "on or before the last day prescribed for the filing of such return" and the entire tax due for each year was an underpayment within the meaning of section 6653(b). The only question for decision here is whether any part of any one or each of those underpayments was due to fraud. The Commissioner has the burden of proving by clear and convincing evidence that some part of one or of each was due to fraud. Alphonsus had adequate knowledge of the Federal tax laws and their requirements. He was quite capable of filing the required tax years returns for himself and his wife. Her income did not exceed $630 for any of the tax years. He knew that tax was owed for each year. Cf. Cirillo v. Commissioner, 314 F.2d 478">314 F. 2d 478, 483. His stated reason for not filing the returns as required by law was that he could not take sufficient time from his business to prepare and file the returns. Not only is this contention not supported by convincing evidence276 but, in any event, he should have taken sufficient time from whatever else he was doing to file the returns required by law. Incidentally, he had sufficient time to take a short vacation each year. Certainly he could have employed a capable person to file the joint return for each tax year had he so desired. He deliberately ignored the known requirements of the law in regard to the filing of tax returns, even though the I.R.S. had endeavored to have him file returns or explain why the required returns were not filed. He made no effort to prepare or file returns until after a special agent had visited him. His false statement that he filed a return for 1959 does not help his case. His continued avoidance of his known duty and behavior under all of the circumstances here present are outrageous and convincing indications that his intent was to evade some part of the tax which he knew he owed for each of the years 1959, 1960 and 1961. A part of the deficiency for each year was due to fraud with intent to evade tax. Charles F. Bennett, 30 T.C. 114">30 T.C. 114, 122, et seq. and cases there cited. Decisions will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624528/	HENRY J. GORDON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Gordon v. CommissionerDocket No. 13838.United States Board of Tax Appeals12 B.T.A. 1191; 1928 BTA LEXIS 3388; July 6, 1928, Promulgated 3388 Petitioner is entitled to deduct any loss sustained in 1923 in the sale of residential property constructed by him in 1906-1907 to sell at a profit. J. Philip Dippel, Esq., for the petitioner. J. L. Backstrom, Esq., for the respondent. MORRIS1191 This proceeding is for the redetermination of a deficiency in income tax of $1,030.42 asserted by the respondent for the year 1923. The sole question for determination is whether the respondent erred in disallowing a loss sustained by the petitioner in the sale of residential property in 1923. FINDINGS OF FACT. The petitioner is an individual residing at 40 King Street, Weehawken, N. J. Prior to engaging in his present occupation as a banker he was a druggist by profession. He has at all times since 1890 engaged in the purchase and sale of real estate either on his own account or with others. From 1891 until about 1910 he and Frederick Walker maintained real estate offices in various parts of the county and during the period when he was engaged in the drug business he also devoted about 90 per cent of his time to the real estate business. In addition to the erection and sale of the Bellevue3389 Avenue house, hereafter discussed, the petitioner and one Carpenter also constructed and sold nine two-family houses on Eighth Street in West New York. In 1893 the petitioner formed a syndicate of four men and they purchased 41 acres of land in the Palisades on the Hudson River, which were subdivided into lots, some of which were sold, and the profits therefrom divided among the syndicate members, the petitioner receiving some cash and four and one-half lots, in lieu of cash, the fair market value of which at that time was $4,500. The lots received by him front on the south side of Bellevue Avenue, and on their east face the Hudson River and overlook New York City. The petitioner endeavored to sell the lots himself and he also enlisted the aid of other individuals and real estate brokers. A man by the name of McDonald, to whom the petitioner had spoken about the sale of the lots, interested someone in the purchase of two of them in or about 1903, but because of their peculiar location and the adverse effect the sale of only a portion of the plot would have upon the value of the lots remaining unsold, the petitioner refused to sell only two. 1192 In 1906 he started3390 construction of a two-story residence on these lots, which, compared with other homes in the immediate vicinity, was very elaborate; it was 50 by 72 feet, contained 20 rooms, was of brick construction with a tile roof, and was of Spanish patio architecture. It had a probable life after it was built in 1907 of 50 years. The house was completed in February or March of 1907, and in August, 1907, the petitioner and his family moved into it, where they made their home continuously until the property was sold in 1923. Prior to 1907, when he moved upon the premises aforesaid, the petitioner and his family made their home in a modest flat of five rooms on the second floor of a two-story frame house in Guttenberg, the first floor of which was a drug store. At the time of the construction of this residence in 1906-1907 petitioner employed an architect and he sought his wife's advice as to the plans and the details of arrangement of the house. While the construction was in progress he was residing about three miles from the Bellevue Avenue property and at that time had no intention of moving into the house, but was building it in order to dispose of it at a profit. The petitioner had3391 the property listed for sale in his own real estate office while it was under construction. He spoke to a number of other real estate brokers about it, advertised it for sale for about ten years, and it was officially listed with the firm of Koch Brothers, real estate brokers, in 1910 to be sold at $60,000. A fair value of the four and one-half lots received by the petitioner as a portion of his profits from the sydicate hereinbefore mentioned, at the time he concluded to build thereon, was $12,000, and the construction cost of the residence was $35,000. An additional lot was acquired and added to this property in 1909 at a cost of $1,750. A retaining wall and a garage were erected on the premises in 1915 at a cost of $5,200. The petitioner also expended $1,215 in advertising the property. The fair market value of the property at March 1, 1913, was $53,500. This property was sold by the petitioner in 1923 for $50,000, out of which he paid a commission of $2,600, and he claimed a loss in the computation of his net income for that year of $8,565.87, which the respondent disallowed on the ground that the loss was not one sustained in a transaction entered into for profit3392 within the meaning of the taxing statute. OPINION. MORRIS: Section 214 of the Revenue Act of 1921 provides, among other things, that an individual shall be allowed deductions in the 1193 computation of net income for "losses sustained during the taxable year and not compensated for by insurance or otherwise, if incurred in trade or business"; and also "losses sustained during the taxable year and not compensated for by insurance or otherwise, if incurred in any transaction entered into for profit, though not connected with the trade or business." As to the deductibility of the amount of the loss sustained in the computation of his net income for 1923, the petitioner urges , and . While the question raised in that case is with respect to the deductibility of a loss sustained in the sale of alleged residential property, the facts there are so utterly different from those in the instant case that we do not regard it as dispositive of the issue here in determining whether this petitioner is entitled to the deduction claimed. There the dwelling house was erected at some3393 time prior to 1892 and it was occupied as a residence until 1901, in which year it was leased by the taxpayer at a stipulated rental until 1920, when it was sold at a loss and a deduction claimed in the computation of net taxable income. The Commissioner disallowed the deduction, and assessed an additional tax against the taxpayer, which was paid under protest, and suit was brought in the district court for recovery of the amount so paid. That court rendered a judgment for the collector of internal revenue which was reversed by the Circuit Court of Appeals for the Third Circuit. On certiorari the Supreme Court of the United States sustained that court in the allowance of the deduction but reversed the decision and remanded the case so that the value of the property as of 1901 could be found. The basis for the decision rendered there was that when the property was abandoned for residential purposes in 1901 and leased at a stipulated rental "all sentimental connection in the use of the house as a home ended, and thereafter the use of the property was by others under lease * ." The instant case is distinguishable from 3394 , in one very vital particular in the petitioner's favor, namely, that the residence and the land upon which it was situated were at the outset intended to be sold at a profit, and by another vitally distinguishing factor which in our opinion mitigates against the petitioner's cause, namely, that he moved into the house shortly after its completion and continued to reside there for over 16 years. While the use of a residential property as a home for such a lengthy period of time raises a strong presumption that it was constructed, not with a view to selling it at a profit, but for a permanent place of abode, and without more, would completely defeat the petitioner's cause, it is not, by any means, a conclusive presumption, and therefore may be rebutted by showing that the motivating influence which 1194 impelled the construction was the hope and expectation of an immediate sale at a profit. The statute permits an individual to deduct such losses as are sustained during a taxable year which are not compensated for by insurance, even though they are not connected with his trade or business, "if incurred in any transaction entered3395 into for profit." Therefore, the test of deductibility is whether a taxpayer entered into the transaction for profit and the question of occupying the premises as a residence is only one of the evidential factors to be considered in satisfying that test. A review of the cases bearing upon this question reveals to us that where a taxpayer acquires property with the intention of selling it at a profit, even though he may have resided thereon, if the predominating factor in its selection was the prospect of future profits, he is entitled to any loss sustained upon the sale thereof. See ; ; ; ; and . The factors which convince us that the petitioner's occupancy of this residence for over 16 years was merely by force of circumstances rather than choice are that he was himself a real estate agent and engaged in the purchase, sale and development of residential property in that vicinity; that his personal wealth was not sufficient3396 to justify the maintenance of such an expensive home; that prior to erection of this residence on Bellevue Avenue he lived in a modest five room flat above his drug store; that the lots themselves upon which the house was built were originally acquired for resale and were at all times offered to the public for sale; that at the time of the construction of the building, the petitioner had no intention of moving thereto upon its completion; that all during the period of construction and for the many years thereafter during his occupancy every effort was made to sell at a profit; that due possibly to the fact that the building was elaborately erected in a settlement of much less desirable homes it was made more difficult to sell than had it been erected among more costly homes. From these factors, together with the undisputed testimony of the petitioner that the building was constructed for the purpose of resale at a profit and that he never intended it as a home, and the testimony of men who were aiding in the attempt to dispose of the property for the petitioner, we are forced to the conclusion that this was a transaction entered into for profit within the meaning of section 214, 3397 supra, and that the respondent erred in holding that any loss sustained from the sale in 1923 was not deductible. Judgment will be entered for the petitioner under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624529/	Joseph Weidenhoff, Incorporated, et al., 1 Petitioners, v. Commissioner of Internal Revenue, RespondentJoseph Weidenhoff, Inc. v. CommissionerDocket Nos. 60793, 60794, 60795, 60796United States Tax Court32 T.C. 1222; 1959 U.S. Tax Ct. LEXIS 81; September 23, 1959, Filed 81 Decisions will be entered under Rule 50. 1. In computing the amount of net operating loss for the year 1947 absorbed by carryback to the year 1945 under section 122(b) (1) and (2), I.R.C. 1939, the net income for the year 1945 against which the carryback is applied is to be reduced under section 122(d)(6) by the excess profits tax accrued for the year 1945, which is the excess profits tax computed to be due less the deferral in payment provided under section 710(a)(5) and less the 10 per cent credit provided under section 784.2. That portion of the consolidated net operating losses of the affiliated group for the years 1948 and 1949 attributable to the Fostoria Screw Company, a member of the affiliated group which sold its operating assets and ceased operations in 1949 but was not dissolved until 1952, is includible in the consolidated net operating loss deduction available to the affiliated group in computing its consolidated income and excess profits taxes for the years 1950, 1951, and 1952.(a) Fostoria, which joined in the consolidated returns for the years 1950, 1951, and 1952, was not de facto dissolved, for the purpose of computing the consolidated net operating loss deduction 82 of the affiliated group, prior to July 31, 1952, when it filed a certificate of dissolution with the secretary of state of Ohio.3. Regulations 129, section 24.31(b)(24), limiting the consolidated excess profits credit for the taxable year of an affiliated group formed subsequent to March 14, 1941, held, not to be applicable. Bernard Hoban, Esq., for the petitioners.Robert E. Johnson, Esq., for the respondent. Drennen, Judge. DRENNEN1223 OPINION.This consolidated proceeding involves deficiencies in income and excess profits taxes determined against petitioners as follows:DocketPetitionerYearDeficiencyNo.60793Joseph Weidenhoff, Incorporated1946$ 16,788.4660794Johnson Fare Box Company, Alleged Transferee194611,890.5860795Bowser International, Inc1947344.8160796Bowser, Inc. and its Subsidiaries, et al19511 711,316.80195292,492.36These cases were submitted on a stipulation of all facts under Rule 30. The facts are found as stipulated and the stipulation, together with the exhibits attached thereto, is incorporated herein by reference.Petitioners are corporations, all members of an affiliated 83 group of which Bowser, Inc., is common parent. For the years 1943 through 1945, and 1948 through 1952, consolidated income and excess profits tax returns were filed for the group by Bowser, Inc.; for 1946 and 1947, the individual affiliates filed separate returns. Petitioners all maintained their books and records and filed their tax returns on an accrual basis of accounting.A number of issues were raised by the pleadings, but after concessions by both parties there are three basic issues remaining for decision, which are:(1) Whether in computing operating loss carrybacks and carryovers under section 122(b) (1) and (2), I.R.C. 1939, 2 the deduction for accrued excess profits tax, allowed under section 122(d)(6), is the excess profits tax for the year without reduction for the 10 per cent credit allowed under section 784, and for the deferral in payment allowed under section 710(a)(5), or whether it is the net amount after such reductions; (2) whether the consolidated returns for Bowser, Inc., and its affiliated group may include and carry forward past 1949 the 1948 and 1949 operating losses of the Fostoria Screw Company, an affiliate, which had in 1949 ceased production and sold its 84 operating assets; 3 and (3) whether Regulations 129, section 24.31 (b)(24), is applicable to limit the amount of the affiliated group's consolidated excess profits credit for the years 1951 and 1952. The first issue is common to three dockets, Nos. 60793, 60794, and 60796; the other two issues involve only Docket No. 60796. Docket No. 60795 will not require separate consideration as the issue raised therein 1224 is a matter of computation which may be settled under Rule 50 on the basis of our resolution of the primary issues.Respondent has, on brief, conceded the "tax benefit" issue raised by the pleadings in Docket Nos. 60793, 60794, and 60796. Petitioners have on reply brief conceded two other issues joined in the pleadings in Docket Nos. 60794 and 60796 involving (1) the carryover of a 1948 net operating loss of Briggs Filtration Company in determining the 1950 consolidated income of the Bowser, Inc., affiliated group; and (2) the liability of Johnson Fare Box Company 85 as transferee for the 1946 income tax liability of Johnson Consumer Industries, Inc., if any. Petitioners did not argue on brief the issue of whether Bowser, Inc., is entitled to a loss in the year 1949 or 1952 on its investment in the stock of the Fostoria Screw Company, but take the position in their reply brief that respondent's disallowance of the investment loss can result only through allowance of the operating loss of Fostoria for the years 1948 and 1949 to the affiliated group for subsequent years. Under the provisions of the consolidated Regulations 129, section 34.34, it would reduce the investment cost to zero if the operating losses are allowed.Inasmuch as the parties are agreed on all essential facts, the details of which are complex, we will recite herein only the facts we deem essential to a conclusion of the remaining legal issues involved. The amounts to be entered as our decision can be computed by the parties from the stipulated facts under Rule 50.Issue 1.The first issue is whether an accrual basis taxpayer in computing the amount of 1947 net operating loss available for carryback to 1946 or carryover to subsequent years may deduct from 1945 net income the gross 86 amount of the excess profits tax computed for the year 1945, or may deduct only the gross amount of tax less (a) the 10 per cent credit provided in section 784, 4 and less (b) the deferral in payment provided in section 710(a)(5) 587 of the Code. In other words, is 1225 the deduction allowed by section 122(d)(6) 688 the excess profits tax for the year before allowance of the credit and the deferral in payment provided where section 722 relief is claimed, or is it the excess profits tax actually shown to be due and payable on the return as of the end of the year 1945, after reduction thereof by the credit and the deferral above mentioned?Joseph Weidenhoff, Incorporated, an Illinois corporation with principal office at Algona, Iowa, filed its separate income tax return for the calendar year 1946 with the former collector of internal revenue for the first district of Illinois.In 1946, the corporation had net income of $ 318,795.57 before net operating loss deduction, and in 1947 a net operating loss of $ 187,564.74 before net operating loss deduction.For the purpose of applying the net operating loss carryback and carryover provisions of section 122, the amount of excess profits tax accrued on December 31, 1945, before credit under section 784, was $ 79,300.27. The 10 per cent credit provided by section 784 was $ 7,930.03.Johnson Fare Box Company, a Delaware corporation with principal office in Chicago, Illinois, is the transferee of the 1946 income tax liability of its subsidiary Johnson Consumer Industries, 89 Inc., which in 1948 was merged into its parent. (Petitioner no longer contests its liability as transferee.) Johnson Consumer Industries, Inc., was a Delaware corporation with principal office in Maspeth, Long Island, New York, and filed its 1946 income tax return with the former collector of internal revenue for the first district of New York.Johnson Consumer Industries, Inc., had net income for 1946 of $ 101,934.65 before net operating loss deduction, and for 1947 had a net operating loss of $ 65,541.65 before net operating loss deduction.For the purpose of applying the provisions of section 122, the excess profits tax of Johnson Consumer Industries, Inc., accrued on December 31, 1945, before credit under section 784, was $ 5,832.98; the credit was $ 583.30.1226 The Fostoria Screw Company, an Ohio corporation with principal office at Fostoria, Ohio, filed its separate income tax return for the calendar year 1946 with the former collector of internal revenue at Toledo, Ohio.The corporation sustained a net operating loss of $ 296,907.71 in 1946, and in 1947 had a net income of $ 165,989.70.For the purpose of applying the provisions of section 122, the excess profits tax of the Fostoria 90 Screw Company accrued on December 31, 1945, before credit under section 784, was $ 193,957.22; the credit was $ 19,395.72.Bowser, Inc., an Indiana corporation with principal office at Fort Wayne, Indiana, filed as common parent of an affiliated group consolidated income and excess profits tax returns for the calendar years 1943-1945 and 1948-1952 with the former collector of internal revenue for the district of Indiana. In 1946 and 1947, the 2 years in which each member of the affiliated group filed separate returns, Bowser, Inc., itself had, before net operating loss deduction, a loss of $ 1,522,017.77 and an income of $ 568,218.75, respectively. The following year, 1948, with the resumption of consolidated reporting, the group sustained a consolidated net operating loss of $ 1,316,733.92 before net operating loss deduction.For the purpose of determining the net operating loss carryover from 1946 to years 1947 and 1948, which in turn is determined by the loss carryback from 1947 through 1945 to 1946, the amount of excess profits tax accrued as of December 31, 1945, for the affiliated group, with the deferral in payment and credits as noted, is as follows:1945 excessprofits taxaccruals beforeDeferral incredit underpaymentCreditsec. 784 andunder sec.underbefore deferral710(a)(5),sec. 784,in paymentI.R.C. 1939I.R.C. 1939under sec.710(a)(5),I.R.C. 1939Bowser, Inc$ 2,676,412.10$ 92,864.27$ 258,354.78The Fostoria Screw Company193,957.22(1) 19,395.72The Eagle Lock Company(1) (1) (1) Johnson Fare Box Company(1) (1) (1) Joseph Weidenhoff, Incorporated79,300.27(1) 7,930.03Johnson Consumer Industries, Inc5,832.98(1) 583.30Consolidated excess profits taxaccrued for the affiliated group 2,955,502.5792,864.27286,263.83The 91 parties settled by agreement the tax liabilities of the corporations involved for the year 1945, and we are not here concerned with the tax liabilities for that year. However, in determining how much of the 1947 operating losses of the corporations is available for carryback 1227 to the year 1946 and carryover to subsequent years, we must reduce the 1947 operating loss carryback by the amount thereof that would be applied to the year 1945, the second taxable year preceding the year of loss. This record does not show whether the 10 per cent credit and the deferral in payment were taken into consideration in the settlement of the 1945 tax, and as we understand the law as interpreted by various courts, this would make no difference in any event. The parties have stipulated the amount of excess profits tax accrued at December 31, 1945, determined in accord with the normal accounting concepts relevant to the accrual basis, prior to the deferral in payment under section 710(a)(5) and the credit under section 784, and they have also stipulated the amounts of the deferrals and credits.The parties agree that the amount of the 1947 net operating loss carryback that would be absorbed in 1945 is 92 decreased by the excess profits tax properly accrued as of December 31, 1945. Petitioners claim that the gross amount of the 1945 tax is the figure to be used, thereby leaving a larger amount of the 1947 loss to be carried back to 1946 or carried forward to subsequent years; whereas respondent claims the tax properly accruable as of December 31, 1945, is the tax computed on the 1945 net income reduced by the deferrals and credits, thereby absorbing a greater amount of the 1947 loss against the year 1945, which year has been closed by settlement.This issue is a further refinement of the questions decided by the Supreme Court in United States v. Olympic Radio & Television, 349 U.S. 232">349 U.S. 232, and Lewyt Corp. v. Commissioner, 349 U.S. 237">349 U.S. 237, and by this Court in California Vegetable Concentrates, Inc., 10 T.C. 1158">10 T.C. 1158, and F. L. Jacobs Co., 30 T.C. 1194">30 T.C. 1194. While those cases do not decide the points here in issue, we believe the reasoning employed in those opinions logically directs the conclusion we reach here.So far as here pertinent, section 23(s) provides that there may be deducted from gross income a net operating loss deduction computed under section 122. Section 122(a) defines the term "net 93 operating loss" as the excess of the deductions allowed by this chapter over the gross income, with the exceptions, additions, and limitations provided in subsection (d). Section 122(b)(1) provides that if a taxpayer has a net operating loss for a taxable year, such net operating loss shall be a net operating loss carryback for each of the 2 preceding taxable years, except that the carryback in the case of the first preceding taxable year shall be the excess, if any, of the amount of such net operating loss over the net income of the second preceding taxable year computed with the exceptions, additions, and limitations provided in subsection (d)(6). Section 122(d)(6) provides that there shall be allowed as a deduction "the amount of tax imposed by Subchapter 1228 E of Chapter 2 paid or accrued within the taxable year," subject to certain rules not here important. Subchapter E of chapter 2 imposed the World War II excess profits tax effective for the years 1940 through 1945. Part I of subchapter E, section 710(a), imposed the tax, and section 710(a)(5) provided that if the adjusted excess profits net income for the taxable year of a taxpayer which claims on its return the benefits of 94 section 722 is in excess of 50 per cent of its normal tax income for the year, the amount of tax payable at the time prescribed for payment may be reduced by an amount equal to 33 per cent of the amount of the reduction in the tax so claimed. It also provided that any unpaid tax remaining after the section 722 issue is finally determined may be assessed within 1 year after such final determination. The excess profits tax return for 1945 of Bowser, Inc., and its affiliates claimed a deferral of $ 92,864.27 under section 710(a)(5).Part III of subchapter E, as originally enacted, provided for a postwar refund of 10 per cent of the tax imposed by this subchapter for the years 1942 and 1943. This was accomplished under section 780 by means of establishing a credit to the account of the taxpayer and the issuance of bonds to the taxpayer in the amount of the credit after the tax was paid, which bonds were to mature after the cessation of hostilities. However, for years beginning after 1943, section 784, enacted in 1945, provided for the allowance of a credit directly against the tax, equal to 10 per cent of the amount of the tax, and the excess profits tax return for the year 1945 provided 95 for deduction of the credit in computing the excess profits tax due. A taxpayer claiming the credit for 1945 was not required to pay the amount of the credit at the time the return was filed.In United States v. Olympic Radio & Television, supra, the Supreme Court held that for an accrual basis taxpayer, the deduction of excess profits tax allowed under section 122(d)(6) is the tax that accrues for that particular year rather than the excess profits tax for a preceding year that might have been paid during the particular year.In a companion case, Lewyt Corp. v. Commissioner, supra, an additional issue was raised, being whether the amount of the 1946 operating loss absorbed by carryback to 1944 was the net income for 1944 less the excess profits tax originally shown to be due on the 1944 return (properly adjusted for errors), or was the net income for 1944 less only the excess profits tax for that year ultimately found to be due after adjustments for renegotiation and carrybacks or for other events occurring subsequent to the close of the taxable year. The Court held that the deduction allowed by section 122(d)(6) was the excess profits tax originally shown to be due, unreduced by events 96 occurring after the year 1944. The Court reasoned that the language 1229 "the amount of tax imposed by Subchapter E of Chapter 2" simply identified the tax for which the deduction is allowed, and that the words "accrued within the taxable year" were the critical words in determining the amount of the deduction; and since the tax accrued by an accrual basis taxpayer is determined in accord with the normal accounting concepts relevant to the accrual basis from known events as of the end of the year, the tax properly computed on the accrual basis is the tax which may be deducted under section 122(d)(6). (Emphasis added.) "Events and transactions of later years, irrelevant to a determination of income on the accrual basis do not warrant alteration of the figure computed under § 122(d)(6) for the year in question." Lewyt Corp. v. Commissioner, supra, at 243.Based on the decision in the Lewyt case, this Court held in F. L. Jacobs Co., supra, that in carrying back a 1946 net operating loss to the year 1945, the computation required by section 122(b)(1) involves the use of the 1944 net income figure after renegotiation and accelerated amortization adjustments but the excess profits tax figure 97 for 1944 computed before such adjustments are given effect.Applying the rule of the above cases to this case, the amount of excess profits tax for the year 1945, which may be deducted from the 1945 net income in computing the amount of carryback of 1947 net operating losses to the year 1946, is the amount of excess profits tax properly accruable as of the end of the year 1945. But we must also determine whether the excess profits tax properly accrued as of the end of 1945 was the tax as computed before the credit allowed under section 784 and the deferral allowed under section 710(a)(5).This Court held in California Vegetable Concentrates, Inc., supra, that the 33 per cent deferral allowed under section 710(a)(5) is not a part of the tax imposed within the language of section 271, defining a deficiency, because the 33 per cent deferral is not imposed, if ever, until final determination under section 722 that the taxpayer is liable therefor. We found that Congress did not intend that a taxpayer should be liable for the 33 per cent deferral until completion of the section 722 procedure. While it is true that the Supreme Court in the Lewyt case emphasized the word "accrued" in section 98 122(d)(6) rather than the word "imposed," whereas the opinion of this Court in California Vegetable Concentrates, Inc., supra, relied primarily on the word "imposed," we think it is clear that if the amount of the deferral is not a part of the tax imposed under subchapter E of chapter 2, it could not be a tax accrued under that subchapter as of the end of the taxable year. Furthermore, we do not think the gross amount of the excess profits tax computed before the deferral is a proper accrual within the normal accounting concepts relevant to an accrual basis, because liability for the deferred amount, by virtue of 1230 the claim on the return itself, was contested by the taxpayer and could not become fixed until settlement of the section 722 claim, or events occurring subsequent to the end of the taxable year. Security Mills Co. v. Commissioner, 321 U.S. 281">321 U.S. 281. Petitioners' argument that the tax imposed by subchapter E is the gross amount of the tax and that the question we must decide is whether the deferral allowed under section 710(a)(5), since it simply allows a deferral in payment of the tax, is a properly accruable deduction in the year 1945, loses its weight in the light of our decision 99 in California Vegetable Concentrates, Inc., supra, that the deferred amount is not a part of the tax imposed, and the Supreme Court opinion in the Lewyt case holding that the basic question is the amount of the tax properly accrued as of the end of the year.This Court also had before it in California Vegetable Concentrates, Inc., supra, the question whether the credit for postwar refunds of excess profits tax, provided by sections 780 and 781, should be deducted in computing the amount of a deficiency in excess profits tax. This same question was indirectly involved in United States v. Arthur G. McKee & Company, 139 F. Supp. 263">139 F. Supp. 263 (N.D. Ohio). Both courts held in effect that the credit allowed under section 780 did not reduce the excess profits tax liability of the taxpayer for the taxable year with the result that the proper amount of excess profits tax accrued as of the end of the year would be the gross amount of the tax without reduction by the credit. However, both courts based their decisions on the mechanics employed by Congress in allowing this credit under sections 780 and 781 for the years 1942 and 1943.But we are here concerned with the 10 per cent credit allowed for the 100 year 1945 under section 784. Unlike sections 780 and 781, which required the taxpayer to pay 100 per cent of the excess profits tax but provided a credit to his account which was to be refunded after cessation of hostilities, section 784, applicable to the year 1945, allows a direct credit against the tax imposed by the subchapter in an amount equal to 10 per cent of such tax. The taxpayer is not required to pay the tax at that time or at any future date. He never has any liability for the amount of the credit because the credit is always available in the amount of 10 per cent of the tax imposed, whatever that may be. If any part of the 10 per cent credit deducted on the excess profits tax return for the year ever has to be paid, it would in most cases result only from events occurring after the close of the taxable year. The reasoning used by this Court and by the District Court in determining that the postwar refund credit provided by section 780 was not deductible from tax liability accrued as of the end of the year, as well as the reasoning of the Supreme Court in the Lewyt case, we feel requires the conclusion here that the 10 per cent credit allowed under section 784 should 101 be deducted first 1231 in determining the amount of excess profits tax accrued as of the end of 1945.We hold that in determining the amount of the deduction against 1945 net income allowed under section 122(d)(6), the excess profits tax accrued for the year 1945 is the amount stipulated by the parties as set out above, less the deferral in payment under section 710(a)(5) and less the credits under section 784.Issue 2.The second issue is whether Bowser, Inc., and its affiliates are entitled to carry forward in their consolidated income tax returns for the years 1950 and 1951 the operating losses of the Fostoria Screw Company for the years 1948 and 1949.Bowser, Inc., acquired all of Fostoria's capital stock in 1941, at a cost of $ 400,000, which it has continuously owned through the years involved.According to its articles of incorporation, as amended, Fostoria's business purpose was "manufacturing and dealing in steel, iron, brass, bronze, copper, aluminum, and kindred metal, nuts, screws, bolts and specialties." It maintained its separate records and corporate minute books throughout the years of its existence and at least to July 16, 1952.At a special meeting of its stockholders and directors 102 held on September 12, 1949, an agreement to sell the assets of Fostoria was accepted and the officers and directors of the corporation were authorized and directed to sell the assets of the corporation for cash to the other parties to the agreement. Pursuant to such authorization, all of the operating assets of Fostoria were sold for cash to interests unconnected with the Bowser group, and Fostoria terminated its business operations as of that date.At a special meeting of the stockholders of Fostoria held on July 16, 1952, a resolution to dissolve the corporation was adopted and pursuant thereto, on July 31, 1952, a certificate of dissolution of the corporation was filed with the secretary of state of Ohio. Franchise taxes were paid to the State of Ohio for Fostoria in the years 1950 and 1951.Shortly after the sale of its operating assets, the books of the company were transferred from Fostoria, Ohio, to Fort Wayne, Indiana, the principal office of Bowser, Inc., and the collector of internal revenue at Toledo, Ohio, was advised that tax returns for Fostoria would henceforth be filed at Indianapolis. Neither the stockholders nor directors of Fostoria held any meetings between November 103 7, 1949, and July 16, 1952. Fostoria's remaining assets as of December 31, 1949, consisted of cash, accounts receivable, 1232 and an income tax refund receivable; as of December 31, 1950, accounts receivable and the carryover tax refund receivable; and as of December 31, 1951, only the tax refund receivable. The company, during the course of these years, also had several claims pending against the Federal Government for renegotiation rebates and income and excess profits tax refunds.During the period following the sale of its operating assets in 1949 and until its dissolution in 1952, the principal activities of Fostoria consisted of the receipt of 13 invoices issued by Bowser, Inc., primarily for collection services; the maintenance by a Bowser, Inc., auditor of two bookkeeping documents for Fostoria designated "Home Office Account" and "Journal Entries 1951," and preparation by him of a handwritten trial balance sheet for 1949, 1950, and 1951; the execution of consent agreements with the collector of internal revenue for extensions of periods of limitations for assessment of tax; and participation in various court proceedings in this Court and the Court of Claims. In 1955, a refund 104 of taxes in the amount of $ 21,640.40, less a previous allowance of $ 13,859.73, and interest in the amount of $ 5,208.82 was allowed Fostoria by the collector of internal revenue.Starting in 1944 and continuously thereafter until at least September 8, 1949, Bowser, Inc., loaned money to Fostoria on notes and open account. During 1948 and 1949, Bowser, Inc., loaned Fostoria a total of $ 374,500 on demand interest-bearing notes, all of which were paid off in full on October 19, 1949.In 1946, Bowser, Inc., sold $ 5 million of its preferred stock, and the registration statement filed with the Securities and Exchange Commission listed the assets of Fostoria as a part of the plant and properties of the company and its subsidiaries.During the years 1947 to 1953, inclusive, stock of Bowser, Inc., was held by more than 4,000 stockholders and was traded "over the counter" by brokers in most of the major cities of the United States.In 1948 and 1949, Fostoria had operating losses, before net operating loss deductions, of $ 315,540.45 and $ 584,961.96, respectively, which were included in the consolidated income tax returns filed by Bowser, Inc., for the affiliated group for those years, which 105 consolidated returns reported consolidated losses, before net operating loss deductions, of $ 1,438,400.06 in 1948 and $ 2,248,754.22 in 1949. These consolidated losses, including the losses of Fostoria, were carried over and claimed as deductions in the consolidated returns for the affiliated group for subsequent years, including the years here involved.The consolidated income tax returns filed for the affiliated group by Bowser, Inc., showed income, before net operating loss deduction, of $ 1,024,048.40 for the year 1950; of $ 1,886,845.12 for the year 1951; and of $ 964,230.20 for the year 1952. These returns did not show any operating income for Fostoria.1233 The operating losses of Fostoria for 1948 and 1949 were included in the decrease of consolidated earned surplus of the affiliated group.In his notice of deficiency respondent did not eliminate Fostoria's operating losses for the years 1948 and 1949 from the consolidated operating loss carryovers of the affiliated group to the years 1950 and 1951, but allowed them as claimed in the consolidated return filed for the group.This issue was raised by respondent by an amendment to his amended answer wherein he alleged that the affiliated 106 group was not entitled under any section of the 1939 Code or regulations thereunder to carry forward past the year 1949 any net operating loss of the liquidated subsidiary, Fostoria, for the years 1948 and 1949, because (a) Fostoria was not a member of the affiliated group after 1949, (b) it ceased to do business in 1949, (c) the affiliated group did not carry on the former business of Fostoria after 1949, and (d) there was no continuity of business thereafter which would permit the affiliated group to carry over the net operating loss of Fostoria.Petitioners claim that by statutory definition Fostoria was a member of the affiliated group in all years from 1948 to 1952, inclusive, and that respondent's regulations, issued pursuant to statute, require that Fostoria's losses be included in the consolidated net operating loss for years in which it was included in the consolidated return. Petitioners also claim that the affirmative allegations in the amendment to the amended answer are immaterial to the adjudication of this issue and, furthermore, that respondent has not proved these allegations.On brief respondent does not mention his consolidated return regulations and to all intents 107 and purposes ignores the fact that consolidated returns were filed for the affiliated group, with Fostoria included, for each of the years 1948 to 1952, inclusive. Instead, respondent argues primarily that the carryover privilege is not available to the affiliated group unless there is a continuity of the business enterprise which incurred the loss, and secondarily, that Fostoria was not a member of the affiliated group after 1949 because it was de facto dissolved in 1949.Unquestionably, Fostoria, at least until it was formally dissolved in August 1952, came within the statutory definition of an includible corporation within an affiliated group. The sole test of what is a member of an affiliated group is statutory; and the only requirement is the requisite stock ownership. Sec. 141 (d) and (e), I.R.C.; Regs. 129, sec. 24.2(b); Burnet v. Aluminum Goods Co., 287 U.S. 544">287 U.S. 544; Autosales Corporation v. Commissioner, 43 F. 2d 931 (C.A. 2); Utica Knitting Co. v. United States, 68 Ct. Cl. 77">68 Ct. Cl. 77; Hancock Construction Co., et al., 11 B.T.A. 800">11 B.T.A. 800.Unless the sale of its operating assets in 1949 and its cessation of operations, or its lack of income, relieved it of doing so, Fostoria was 1234 required to 108 file a return for the years 1950, 1951, and 1952. Sec. 52, I.R.C.; Regs. 111, sec. 29.52-1. Having joined in the consolidated returns of the affiliated group for the years 1948 and 1949, Fostoria, if it was required to file a return at all, was required to join in the consolidated returns filed for the affiliated group in 1950, 1951, and 1952 as long as it remained a member of the group, and it did so. Sec. 141(a), I.R.C.; Regs. 129, sec. 24.11. And under Regulations 129, section 24.31(a), the consolidated net operating loss deduction for the affiliated group must be computed by combining the net operating losses of the several affiliated corporations having net operating losses, including carryovers and carrybacks.So under the consolidated return regulations, Fostoria's operating losses for 1948 and 1949 were includible in the net operating loss deduction of the affiliated group for the years 1950 and 1951 unless respondent can show that Fostoria was not a member of the affiliated group, within the meaning of the regulations, after 1949. And if Fostoria's losses were includible in the losses of the affiliated group under the regulations, they are deductible under the law unless 109 to do so would not clearly reflect the income and excess profits tax liability of the group and each corporation in the group. Sec. 141(a), I.R.C.We turn first to respondent's contention that Fostoria was not in existence as a member of the affiliated group after 1949 because it was de facto dissolved in 1949. For support of this contention, respondent relies on Winter & Co. ( Indiana), 13 T.C. 108">13 T.C. 108, and A B C Brewing Corp., 20 T.C. 515">20 T.C. 515, affd. 224 F. 2d 483 (C.A. 9), each of which cases dealt with the carryback of an unused excess profits credit accruing after the corporation had ceased operations. On the other hand, petitioners cite United States v. Kingman, 170 F. 2d 408 (C.A. 5), Allegheny Broadcasting Corporation, 12 T.C. 552">12 T.C. 552, affd. 179 F. 2d 844 (C.A. 3), and Union Bus Terminal, Inc., 12 T.C. 197">12 T.C. 197, affirmed per curiam 179 F. 2d 399 (C.A. 5), in support of its claim that there was no de facto dissolution of Fostoria in 1949. Each of these cases involves the question of whether the corporate taxpayer had a short taxable year ending at the time it ceased operations, within the meaning of the statutory provision requiring annualization of income and proration of credits where 110 a corporation has a taxable year less than 12 months. A comparison of cases cited by each party makes it apparent that in considering whether a corporation is de facto dissolved before it is legally dissolved, the courts have looked not only to the facts of each individual case but also to the different provisions of the tax law under consideration and the underlying purpose of Congress in enacting the various provisions. Therefore, inasmuch as none of the above cases is concerned with operating loss 1235 carryovers and carrybacks and consolidated returns, we do not consider any of them conclusive of the issue before us.The case most directly in point cited to us appears to be Hancock Construction Co., et al., supra, wherein this Court held that where a corporation, a member of an affiliated group, filed a consolidated return for the year 1919, transferred all of its assets to its mortgagee in 1919, and was completely inactive and without income in 1920, nevertheless, its share of the consolidated net operating loss of the affiliated group for the year 1919 could be carried over and used as a deduction against the consolidated net income of the other members of the affiliated group for 111 the year 1920.In a later decision of this Court, not involving, however, consolidated returns, Acampo Winery & Distilleries, Inc., 7 T.C. 629">7 T.C. 629, we held that a corporation which filed a voluntary consent to dissolve in February 1943 and transferred substantially all of its assets to trustees for its stockholders, retaining a few assets to pay some commitments, taxes, and expenses of winding up, and then ceased doing business but proceeded to wind up its affairs in complete liquidation and dissolution, was entitled to an operating loss carryback from the years 1944 and 1945 to the year 1943. The Court based its conclusion on the absence of anything in the statute or regulations to show that the corporation was not entitled to the deduction, stating that the words of the statute are general in their application and something would have to be read into them which is not there to limit them so they would not apply in that case.A distinction between the application of the de facto dissolution theory to excess profits credit carryback cases and operating loss carryover and carryback cases was also pointed out in Wier Long Leaf Lumber Co., 9 T.C. 990">9 T.C. 990, affirmed in part and reversed in part 173 F. 2d 549112 (C.A. 5), and in Gorman Lumber Sales Co., 12 T.C. 1184">12 T.C. 1184. In the Wier case, this Court distinguished the intent and purpose of Congress in allowing operating loss carrybacks and excess profits credit carrybacks, holding that the former are allowable during the period of liquidation of a corporation incurring the loss, while the latter are not allowable during such period. On appeal, the Court of Appeals disagreed with the theory of this Court that in the case of excess profits credit carrybacks a credit could never be obtained after a corporation ceased operations, and held that the credit was available during that period of corporate liquidation in which the continued existence of the corporation was necessary. However, the Court of Appeals said nothing about operating loss deductions.In the case before us, the evidence indicates only that Fostoria sold its operating assets in 1949 and ceased operations. No resolution to dissolve was adopted prior to 1952, and there is no evidence 1236 regarding the intent of the officers, directors, and stockholders of the corporation with respect to the future of the corporation until its ultimate dissolution in 1952. See Hancock Construction Co., et al., supra.113 The evidence does indicate that there was very little activity on the part of the corporation, subsequent to the year 1949, other than in collecting debts and engaging in court proceedings with respect to its income taxes, but the evidence also shows that the corporation had assets in the form of bank accounts, accounts receivable, and income tax receivable, and claims against the United States for renegotiation rebates, income, and excess profits tax refunds. Fostoria was also indebted to its parent, Bowser, Inc., which indebtedness was curtailed during this period by applying thereon amounts collected on accounts receivable and tax refunds. All of the evidence before us indicates at best that the corporation was in the process of an orderly liquidation of its affairs during 1950 and 1951, although it would have been entirely possible at any time prior to adoption of the resolution of dissolution in 1952 for the corporation to have again become active.On the record before us, we cannot find that Fostoria ceased to exist as a member of the affiliated group prior to its dissolution in 1952. Respondent's reliance on the Ohio Code, sec. 8623-80 (Throck-morton), which provides in part 114 that on filing a certificate of voluntary dissolution, a corporation shall cease to carry on its business and shall be without authority to do so but shall continue for the sole purpose of settling its affairs, is misplaced because as we read that section of the Ohio Code, it applies only after a certificate of dissolution has been filed, which was not done in this case until 1952. We hold that Fostoria was not de facto dissolved in 1949 or at any time prior to July 31, 1952, when it filed a certificate of dissolution with the secretary of state of Ohio, for the purpose of applying the consolidated net operating loss deduction provisions of the Internal Revenue Code and the regulations.In 115 the absence of a de facto dissolution of Fostoria, it seems clear that under the statutory provisions and respondent's own regulations, as pointed out above, Fostoria's portion of the 1948 and 1949 consolidated net operating losses not only may be, but probably must be included in the computation of the consolidated net operating loss deduction of the affiliated group for the years 1950 and 1951, unless to do so would avoid the tax liability intended to be imposed on an affiliated group by Congress.Respondent does not suggest that Fostoria was not required to file income tax returns for the years 1950, 1951, and 1952, nor does he suggest how Fostoria could have done other than join in the consolidated return filed by the affiliated group, it having joined in consolidated returns filed for the previous years. Rather, respondent 1237 claims that Libson Shops, Inc. v. Koehler, 353 U.S. 382">353 U.S. 382, and Mill Ridge Coal Co. v. Patterson, an unreported case (N.D. Ala., 1958; 1 A.F.T.R. 2d 1627, 58-1U.S.T.C. par. 9489), affd. 264 F. 2d 713 (C.A. 5), require the conclusion that Fostoria's portion of the consolidated net operating losses for 1948 and 1949 cannot be carried over beyond the year 1949, 116 after which the former business of Fostoria was no longer continued by any member of the affiliated group.We do not agree with respondent that the Libson Shops case requires the denial of the deduction here under consideration. On the contrary, we believe the opinion implies at least that a net operating loss incurred by a member of an affiliated group during a consolidated return period will be allowed as a carryover against the operating income of other members of the affiliated group in a succeeding consolidated return year. In Libson Shops, the Supreme Court specifically points out that in that case the 16 sales corporations, prior to the merger, chose to file separate income tax returns rather than to pool their income and losses by filing a consolidated return, thus implying that had the corporations filed consolidated returns prior to the merger, the premerger losses of the three loss companies could have been included in a net operating loss carryover to the continuing corporation after the merger. We also believe that the intent and purpose of Congress in enacting the loss carryover provisions, as discussed by the Supreme Court in Libson Shops, are carried out by allowing 117 the deduction claimed here. The businesses which suffered the 1948 and 1949 losses were the businesses of the affiliated group, and Bowser, Inc., which owned all of the stock of Fostoria, was the taxpayer which suffered the actual economic loss. Furthermore, there is no claim or evidence of any tax avoidance scheme here, and there can be no claim that the affiliated group has acquired a deduction which it would not have been entitled to had Fostoria not sold its operating assets, as was the basis of the Supreme Court decision in the Libson Shops case and was also the basis of the decision of the Fifth Circuit Court of Appeals in denying the operating loss deduction in Mill Ridge Coal Co. v. Patterson, supra.We conclude that Fostoria's pro rata share of the consolidated net operating losses of the affiliated group for the years 1948 and 1949 should be included in the computation of the consolidated net operating loss deduction of the affiliated group for the years 1950 and 1951.Issue 3.The third issue remaining for decision is whether respondent erred in computing the consolidated excess profits credit of the affiliated group for the years 1950, 1951, and 1952. The affiliated group, 118 which became such after March 14, 1941, computed its excess profits credit based on invested capital.1238 This issue involves two points:(1) In computing net assets for consolidated equity capital purposes, respondent subtracted the investment of some of the members of the affiliated group in stock of other members of the affiliated group from the balance sheet of the corporation whose stock was owned by another. Petitioners assert that under consolidated Regulations 129, section 24.31(b)(2)(xiii), 7119 the investment in stock of another member of the affiliated group should be subtracted from the balance sheet of the corporation that made the investment and which owns the stock. Respondent does not argue this point on brief. In computing net assets for consolidated equity capital purposes, adjustments are necessary so that investments and assets are not duplicated in the consolidated total. 120 In Regulations 129, section 24.31(b)(2)(xiii), respondent directs the method of adjusting separate balance sheets for the computation of total assets. We think it is clear that subparagraph (a) of this section provides for the adjustment that is to be made to the balance sheet of the stockholding corporation, which is that the corporation owning stock of another member of the affiliated group must eliminate from its assets for purposes of computing equity invested capital its adjusted basis in the stock of the other corporation. It is equally clear that subparagraph (b) of this section directs the method of adjusting the balance sheet of the corporation whose stock is owned by another member of the affiliated group and that this section makes no provision for deducting the cost of its stock to another corporation from its balance sheet. We also think it is clear that the method directed by these two subparagraphs of this section of the regulations is consonant with the objective of eliminating duplication of assets in the affiliated group.1239 We find no authority in the regulations or elsewhere to support respondent's method of eliminating the investment in stock of other members 121 of the affiliated group, and we hold for petitioner on this point.(2) The second and more difficult point under this issue is whether consolidated Regulations 129, section 24.31(b)(24), 8122 123 124 is (a) applicable 1240 to petitioners in this case, and (b) if applicable, whether it has been properly applied by respondent. No decided case wherein the application of this section of the regulations was involved has been called to our attention. Section 24.31(b)(24) of the regulations provides that in the case of an affiliated group formed at any time subsequent to March 14, 1941, or having members which joined the group subsequent to March 14, 1941, the consolidated excess profits credit shall be determined subject to certain qualifications. Subdivision (i) provides that the portion of the consolidated excess profits credit otherwise allowable with respect to the common parent corporation shall not exceed (a) "[the] portion of the consolidated 125 section 433(a) excess profits net income for the taxable year attributable to such common parent corporation, in the case of a group formed subsequent to March 14, 1941." The group here involved was formed subsequent to March 14, 1941.Subdivision (ii) applies the same limitation on the credit of a subsidiary corporation which became a member of the affiliated group after March 14, 1941, and subdivision (iii) provides that the disallowed portion of the credit otherwise allowable shall be considered as an unused excess profits credit with respect to the corporation whose credit is so disallowed in part.Subdivision (iv) provides that the limitations in subdivisions (i) and (ii) shall not apply in certain circumstances. Under (iv) (d), they shall not apply to either the parent or subsidiary to the extent to which the Commissioner determines that a consolidated excess profits credit computed without regard to subdivisions (i) and (ii) will not serve to distort the excess profits tax liability of the group or any member thereof.Subdivision (v) also provides that if, upon consideration of the facts of a particular case, the Commissioner determines that the general purpose of the provisions 126 of (i) and (ii) would be better served by using some date subsequent to March 14, 1941, the subdivisions may be administered by substituting such later date. It further states that ordinarily the provisions of (i) and (ii) shall not apply to groups formed or expanded after December 31, 1946, and before July 1, 1950.Unfortunately, the general purpose of the limitation provisions of subdivisions (i) and (ii) is not set forth in the regulations and respondent has not enlightened us with respect thereto on brief. Neither has he explained anywhere in his notice of deficiency, in the pleadings, or in his brief, why the limitation is being applied in this case or why he has computed it in the manner he did. On brief he simply explains what adjustments and computations were made in applying the limitation.1241 This procedure by the Commissioner has an important bearing on our decision of this issue in this case. Congress provided that those filing consolidated returns thereby consented to the regulations prescribed by the Treasury to require a clear reflection of income and excess profits tax liability and to prevent avoidance of tax where consolidated returns are filed. However, Congress127 did not intend that the Commissioner could arbitrarily interpret or apply his regulations contrary to the provisions of the Internal Revenue Code. This is particularly true in a case like the present one where the regulations would permit the Commissioner to determine in his own discretion what may or may not serve to distort the excess profits tax liability or better serve the general purpose of subdivisions (i) and (ii) of this section of the regulations. Neither the petitioners nor the Tax Court can tell whether the Commissioner's action in this case has been proper, improper, or arbitrary unless they know why he did it. The failure of the Commissioner in this case to explain to either the petitioners or this Court why he has applied this limitation provision of the regulations, how it is justified under the law, and why he has computed the limitation in the manner he has done so, seriously and unnecessarily handicaps both the petitioners and the Court and what is said hereafter must be read in the light of this situation.In the Korean War excess profits tax law, applicable to taxable years ending after June 30, 1950, and beginning before January 1, 1954, and thus applicable to 128 the 3 years here involved (sec. 430, et seq., I.R.C. 1939), Congress imposed an excess profits tax on a taxpayer's adjusted excess profits net income. The adjusted excess profits net income upon which this tax was to be imposed was the excess profits net income less a credit. This credit could be determined either by the base period income method, or the invested capital method, the latter being used by petitioners here. The invested capital credit was specified percentages of invested capital. The effect of the allowance of this credit was that the excess profits tax was not imposed on net income up to the amount of the credit. While the law provided certain adjustments in determining the amount of the credit, it made no provision for limiting the credit after it was once determined.Section 141, I.R.C. 1939, permitted the filing of consolidated returns under certain conditions, one of which was consent to all consolidated return regulations prescribed under subsection (b). Subsection (b) directed the Secretary to prescribe such regulations as he may deem necessary in order that the tax liability of any affiliated group making a consolidated return and of each member of the group 129 may be returned, determined, computed, assessed, collected, and adjusted in such manner as to reflect clearly the income and excess 1242 profits tax liability thereof, and in order to prevent avoidance of such tax liability. This subsection gives the Secretary broad powers in prescribing consolidated return regulations -- but only within the scope of the authority granted, that being to permit a determination of the correct tax liability of the taxpayers and the various factors necessary for such determination, and to prevent tax avoidance. It does not give him authority to prescribe a regulation which will in practical application to a particular taxpayer or group of taxpayers impose a tax on income that would not otherwise be taxed (by limiting the excess profits credit) simply because the taxpayers exercise the privilege of filing consolidated returns, unless it is to prevent tax avoidance.Section 24.31(b)(24) of Regulations 129, on its face purports to place qualifications or limits on the computation of the consolidated excess profits credit otherwise allowable, under a certain circumstance -- that being the formation or expansion of the affiliated group subsequent to March 14, 1941. 130 This circumstance alone would surely not justify limitation of an excess profits credit granted by law, unless its application in a particular case is necessary to determine the correct tax liability or prevent tax avoidance. This section of the regulations may be perfectly valid and warranted under the law if applied for the purposes mentioned -- and presumably that was the "general purpose" for which it was promulgated. But in the absence of possible tax avoidance or some necessity for its use to properly determine the tax liability, we do not think it can be applied, without explanation, in the absolute discretion of the Commissioner.It is true that by electing to file consolidated returns, petitioners consented to the regulations prescribed by the Commissioner under section 141(b). One answer to this is that it does not appear that section 24.31(b)(24), as applied to petitioners here, is authorized under section 141(b) of the Code. Further, petitioners were also entitled to rely on subdivision (iv) (d) of the regulations which provides that the limitation shall not apply if the circumstances of the case indicate that the consolidated excess profits credit computed without 131 the limitation would not serve to distort the excess profits tax liability of the group or its members. Our attention is not directed to anything in this record which would indicate that the excess profits tax liability of this group for the years here involved would be distorted by computing the consolidated excess profits credit without regard to the limitations provided in subdivisions (i) and (ii) or that there was any tax avoidance scheme involved in this affiliation.Even if this section of the regulations was applicable here, we do not think the limitation has been computed by respondent in a manner consistent with the wording of the regulations. This discussion 1243 will also illustrate why we think respondent's application of this section of the regulations in this instance appears to impose an excess profits tax on income not taxed by law.In computing the limitation on the consolidated excess profits credit under this section in this case, respondent starts with the net income of each company before the net operating loss deduction. He then adjusts the net income of the profit corporations by first allocating to each of them a proportionate part (prorated on the basis of income) 132 of the current year's operating losses of the loss corporations. He then reduces the net income figure as so revised by allocating the net operating loss carryovers from 1948 and 1949 (which were consolidated return years) only to those corporations which contributed to the prior years' losses and in the amounts not previously absorbed by carrybacks to their separate return years. The excess profits net income of the individual corporation as so revised is then applied to the excess profits credit of the individual corporation as the limiting factor. In effect, this is an adjustment of the excess profits net income of the individual corporations, which is not provided for in the regulations themselves. The regulations provide that the credit otherwise allowable to the individual corporation shall not exceed "the portion of the consolidated section 433(a) excess profits net income for the taxable year attributable" to such corporation. (Emphasis added.) This appears to contemplate an attribution (in some manner not specified in the regulations) of a portion of the consolidated excess profits net income after it has been computed. This would involve deducting the consolidated net 133 operating loss deduction from the consolidated net income to get consolidated excess profits net income, which is the starting point -- rather than first deducting that portion of the net operating loss carryovers contributed by individual companies in prior years from their separate net incomes for the current year.As a result of respondent's application of section 24.31(b)(24) of the regulations to this group for the year 1951, for example, the consolidated excess profits credit allowed was $ 941,627.04, whereas the consolidated excess profits credit as computed by respondent on the consolidated equity invested capital, adjusted for inadmissibles and new capital additions, according to law, was $ 1,287,515.46. Also the excess profits credit allowed with respect to the parent corporation, Bowser, Inc., was limited by respondent's application of this section to $ 887,862.78, whereas the excess profits credit of that corporation otherwise allowable, as computed by respondent, was $ 1,237,403.95.Thus the application of section 24.31(b)(24) of Regulations 129 to these petitioners deprives them of a credit granted them by law, whether computed on an individual corporation basis or on 134 a consolidated 1244 group basis, for no apparent reason authorized by law. We hold that this section of the regulations is not applicable to petitioners in the years here involved. This conclusion will automatically eliminate an admitted error made by respondent in computing the limitation for the year 1952.Decisions will be entered under Rule 50. Footnotes1. Proceedings of the following petitioners are consolidated herewith: Johnson Fare Box Company, Alleged Transferee, Docket No. 60794; Bowser International, Inc., Docket No. 60795; Bowser, Inc., and its Subsidiaries, Bowser International, Inc., The Briggs Filtration Company, The Eagle Lock Company, The Gudeman Company, Johnson Fare Box Company, Defense Identification Service, Inc., The C. L. Downey Company, The Electrofile Corporation, Visible Cash Controls, Inc., National Scientific Laboratories, Inc., Petinco Systems, Inc., and Joseph Weidenhoff, Incorporated, Docket No. 60796.↩1. By an amendment to the amended answer, this deficiency determination was increased to $ 1,105,936.24.↩2. All section references are to the Internal Revenue Code of 1939, as amended.↩3. This issue was raised by respondent by amendment to answer, and respondent recognizes on brief that he has the burden of proof on this issue.↩4. SEC. 784. TEN PER CENTUM CREDIT AGAINST EXCESS PROFITS TAX.(a) Allowance. -- Against the tax imposed by this subchapter for any taxable year beginning after December 31, 1943, there shall be allowed as a credit an amount equal to 10 per centum of such tax.↩5. SEC. 710. IMPOSITION OF TAX.(a) Imposition. -- * * * (5) Deferment of payment in case of abnormality. -- If the adjusted excess profits net income (computed without reference to section 722) for the taxable year of a taxpayer which claims on its return, in accordance with regulations prescribed by the Commissioner with the approval of the Secretary, the benefits of section 722, is in excess of 50 per centum of its normal tax net income for such year, computed without the credit provided in section 26(e) (relating to adjusted excess profits net income), the amount of tax payable at the time prescribed for payment may be reduced by an amount equal to 33 per centum of the amount of the reduction in the tax so claimed. For the purposes of section 271, if the tax payable is the tax so reduced, the tax so reduced shall be considered the amount shown on the return. Notwithstanding any other provision of law or rule of law, to the extent that any amount of tax remaining unpaid pursuant to this paragraph is in excess of the reduction in tax finally determined under section 722, such excess may be assessed at any time before the expiration of one year after such final determination.6. SEC. 122. NET OPERATING LOSS DEDUCTION.(a) Definition of Net Operating Loss. -- As used in this section, the term "net operating loss" means the excess of the deductions allowed by this chapter over the gross income, with the exceptions, additions, and limitations provided in subsection (d). * * (d) Exceptions, Additions, and Limitations. -- The exceptions, additions, and limitations referred to in subsections (a), (b), and (c) shall be as follows: * * (6) There shall be allowed as a deduction the amount of tax imposed by Subchapter E of Chapter 2 paid or accrued within the taxable year, subject to the following rules --↩1. None.↩7. Regs. 129.SEC. 24.31. BASES OF TAX COMPUTATION.(b) Computations. -- In the case of affiliated corporations which make, or are required to make, a consolidated return, and except as otherwise provided in these regulations -- * * (2) Other computations on separate basis. The various other computations required by these requlations to be made by the several affiliated corporations shall be made in the case of each such corporation in the same manner and under the same conditions as if a separate return were to be filed, but with the following exceptions: * * (xiii) Total assets for equity capital purposes. In the computation of the total assets for consolidated equity capital purposes, the following rules shall apply:(a) In the case of a corporation owning stock of another member of the affiliated group, there shall be subtracted an amount equal to the adjusted basis of such stock for determining gain.(b↩) In the case of a corporation the stock of which is held by other members of the group with a basis for equity capital purposes determined to be a cost basis, the adjusted basis of its assets attributable to the stock so held on the date on which such corporation became a member of the group (whether such date falls before, on, or after July 1, 1950, and whether such date falls within a consolidated or separate return period) shall be determined as if, on such date, the adjusted basis of its assets were equal to the fair market value of such assets as of such date. * 8. Regs. 129.SEC. 24.31. BASES OF TAX COMPUTATION.(b) Computations. -- In the case of affiliated corporations which make, or are required to make, a consolidated return, and except as otherwise provided in these regulations -- * * (24) Qualifications on excess profits credit where group membership changed after March 14, 1941. In the case of an affiliated group formed at any time subsequent to March 14, 1941, or having among its members one or more subsidiaries which became members of the group subsequent to March 14, 1941, the consolidated excess profits credits for the taxable year shall be determined subject to the following qualifications: (i) The portion of the consolidated excess profits credit otherwise allowable with respect to the common parent corporation and with respect to any subsidiaries which were members of the group on March 14, 1941, shall not exceed --(a) The portion of the consolidated section 433(a) excess profits net income for the taxable year attributable to such common parent corporation, in the case of a group formed subsequent to March 14, 1941, or * * (ii) The portion of the consolidated excess profits credit otherwise allowable with respect to a subsidiary corporation which became a member of the group subsequent to March 14, 1941, shall not exceed --(a) The portion of the consolidated section 433(a) excess profits net income for the taxable year attributable to such subsidiary corporation in the case in which such subsidiary corporation was not on March 14, 1941, a member of an affiliated group within the meaning of section 141, or * * (iii) The portion of the consolidated excess profits credit otherwise allowable for the taxable year which is disallowed pursuant to the provisions of (i) and (ii) shall be considered as an unused excess profits credit in respect of those members of the group by reference to which the amount of the credit disallowed under (i) and (ii) was determined, originating, for the purpose of the unused excess profits credit carry-back provisions, in a taxable year subsequent to the last taxable year in respect of which their income was included in a consolidated return, and, for the purpose of the unused excess profits credit carry-over provisions, in a taxable year prior to the first taxable year in respect of which their income was included in a consolidated return.(iv) The provisions of subdivisions (i) and (ii) shall not apply with respect to the common parent corporation of an affiliated group formed subsequent to March 14, 1941, or to the common parent corporation or subsidiaries of a group in existence on March 14, 1941, acquiring new members subsequent to March 14, 1941, or with respect to subsidiaries becoming members of the group subsequent to March 14, 1941 -- * * *(d) To the extent to which, upon consideration of the facts or circumstances presented by the particular case, the Commissioner determines that a consolidated excess profits credit computed with respect to the affiliated group but without regard to subdivisions (i) and (ii) will not serve to distort the excess profits tax liability of the group or of any of its members.(v) If, upon consideration of the facts and circumstances presented by the particular case, the Commissioner determines that the general purpose of the provisions of subdivisions (i) and (ii) would be better served in a particular respect by adherence to a date subsequent to March 14, 1941, such subdivisions shall be administered in that respect as if the appropriate date determined by the Commissioner were substituted in such subdivisions in lieu of the date March 14, 1941. Ordinarily, under the preceding sentence, the provisions of subdivisions (i) and (ii) shall not apply with respect to the formation or expansion of an affiliated group occurring after December 31, 1946, and before July 1, 1950.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624530/	Appeal of STEELE COTTON MILL CO.Steele Cotton Mill Co. v. CommissionerDocket No. 488.United States Board of Tax Appeals1 B.T.A. 299; 1925 BTA LEXIS 2967; January 13, 1925, decided Submitted December 17, 1924. 2967 A debt may not be charged off as worthless until the taxpayer has taken all reasonable steps to determine that there is no probability of payment or collection thereof and has prima facie evidence to prove that the debt has no value. Under section 234(a)(5) of the Revenue Act of 1918 a part of a debt may not be written off as worthless and the other part maintained on the books of the taxpayer as having a value. James C. Peacock, Esq., for the taxpayer. W. Frank Gibbs, Esq. (Nelson T. Hartson, Solicitor of Internal Revenue) for the Commissioner. GRAUPNER 299 Before GRAUPNER, LANSDON, and SMITH. This appeal involves income and profits taxes for the calendar year 1920 and is from a deficiency in the amount of $10,554.23 determined by the Commissioner. Oral and documentary evidence was introduced at the hearing, from which the Board makes the following FINDINGS OF FACT. 1. The taxpayer is a North Carolina corporation engaged in the manufacture of cotton yarn at Lenoir, in that State. 2. In July 14, 1920, the taxpayer sold 30,000 pounds of cotton yarn to the Piedmont Commission Co., of Charlotte, N.C., at an agreed price of $30,875.28, 2968 payment for which became due under the terms of the sale on September 2, 1920. No part of that amount was paid by the due date. Thereafter and on October 9, 1920, after several demands for payment had been made by the taxpayer, the 300 Piedmont Commission Co. paid to the taxpayer, on account, the sum of $4,000. 3. During the period between July 14 and December 31, 1920, the market price of cotton yarn declined from a value of $1.30 to a quoted price of about 30 cents per pound, with a demoralized and stagnant market and little demand for yarn at the latter-named price. 4. After the payment of the $4,000 on October 9 and prior to December 16, 1920, the taxpayer made several demands on the Piedmont Commission Co. for payment of the balance of $26,875.28 which remained due on the sale of the yarn. No payment was made by the company and its officers admitted to the taxpayer that, due to the drop in prices on cotton yarn, it was financially embarrassed and could make no further payments at that time. 5. The Piedmont Commission Co. was incorporated with a capital stock of about $35,000; it was engaged in the manufacture of duck and madras, and its board of directors2969 was composed of men of admitted integrity, financial responsibility, and prominence in business in North Carolina. These directors arranged a meeting between the board and some of the larger creditors of the company, which was held on December 16, 1920, and at which the secretary-treasurer of the taxpayer was present as its representative. The creditors were informed that the liabilities of the company approximated $200,000 and that if it was forced into bankruptcy the assets would be insufficient to permit any payments to the creditors. At this meeting it was orally agreed between the members of the board of directors of the company and creditors' representatives that the creditors would compromise their claims and accept the promissory notes of the corporation for 70 per cent of the amounts due, which notes were to be indorsed by the members of the board of directors as individuals. It was also agreed that the creditors represented would not institute proceedings in bankruptcy against the company. 6. At the above-mentioned conference of December 16, 1920, the taxpayer agreed to accept promissory notes of the company in the aggregate amount of $18,712.68, which notes were2970 to be indorsed by the members of the board of directors and were to be in settlement of the taxpayer's claim against the Piedmont Commission Co. It was understood that the notes would be executed and mailed to the taxpayer on the next day. The promissory notes were not mailed by the company to the taxpayer on the prescribed day. On December 24 and again on December 29, 1920, the taxpayer made written or telegraphic demand upon the company for the delivery of the promissory notes but received no reply. On December 31, 1920, the taxpayer closed its books for the calendar year and at that time charged off the entire amount of $26,875.28, the balance of the sales price of the cotton yarn sold to the Piedmont Commission Co. as a bad debt. 7. The closing of the books of the taxpayer on December 31, 1920, was in accordance with its usual custom and was completed in order that a financial report on the affairs of the corporation might be made to the annual meeting of its stockholders, which was held on January 2, 1921. 8. Subsequent to the closing of the books and the stockholders' meeting and on January 4, 1921, the Piedmont Commission Co. 301 mailed its promissory notes2971 to the total amount of $18,712.68 to the taxpayer. Each of the notes was indorsed by the individuals composing the board of directors of the company and all were paid in the course of two years thereafter. The notes were accepted by the taxpayer and the amount thereof was credited to profit and loss on the books of the taxpayer on January 5, 1921. 9. On March 14, 1921, the taxpayer filed its corporation income and profits tax return for the calendar year 1920 with the collector of internal revenue at Raleigh, N.C. In this return the taxpayer deducted the said sum of $26,875.28 as a debt ascertained to be worthless and charged off in the taxable period. This deduction was disallowed by the Commissioner. DECISION. The deficiency determined by the Commissioner is approved. OPINION. GRAUPNER: The taxpayer contends that, having considered the debt of $26,875.28 worthless and written it off its books of account on December 31, 1920, the Commissioner erred in not allowing that amount to the taxpayer as a deduction in its tax return for the calendar year 1920. As an alternative the taxpayer asserts that the Commissioner, having disallowed the deduction of the entire amount2972 of the debt, should have allowed a deduction of $8,162.60, which is the difference between the sum of $18,712.68, for which it agreed to compromise on December 16, 1920, and the amount of $26,875.28, the balance due on the original indebtedness. The Commissioner contends that under the provisions of 234(a)(5) of the Revenue Act of 1918 his disallowance of the deduction was proper and that the alternative suggested by the taxpayer is not within the contemplation of that subsection. Section 234(a) of the Revenue Act of 1918 provides in part: That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions: * * (5) Debts ascertained to be worthless and charged off within the taxable year. Under the provisions of this section two events must have occurred before the taxpayer was entitled to write off the balance due from the Piedmont Commission Co. as bad debt, viz: (1) The debt must have been ascertained to be worthless, and (2) it must have been charged off within the taxable year. The second of these may be considered as having been performed. Therefore, whether or not the debt was ascertained to2973 be worthless remains to be determined. The word ascertain has a definite and common meaning, both in law and in ordinary usage, i.e., "To make certain to the mind; to make sure of; to determine." See Webster's Unabridged Dictionary, Standard Dictionary, Bouvier's Law Dictionary, 1 Words and Phrases (1st series), 1 Words and Phrases (2d series). With this definition in mind the question naturally arises: What did the taxpayer do to determine that the balance due from the Piedmont Commission Co. was worthless before it was written off the books on December 31, 1920? 302 The evidence shows that the debt was incurred July 14, 1920; that a part payment of $4,000 was made on October 9, 1920; that on December 16, 1920, a conference was had between the directors of the Piedmont Commission Co. and the taxpayer, whereat the taxpayer agreed to accept promissory notes, indorsed by the individual directors, in the amount of $18,712.68 in full settlement of its claim; that the notes were not delivered on the day following the conference; that, between December 16 and December 31, 1920, the taxpayer made two demands for delivery of the notes but received no reply; that2974 on December 31, 1920, it charged off the full amount of the debt as worthless. It also shows that the taxpayer made no endeavor to ascertain the actual assets of the Piedmont Commission Co.; that the men who composed the directorate of the company were men of high integrity, financial responsibility, and prominence in business in North Carolina, and that they did not desire the company forced into bankruptcy; that the taxpayer did not seek out or confer with any of the directors to ascertain whether or not the promised notes would be delivered or what was the cause of the delay in delivery. A summing up of these facts shows that the taxpayer reached its conclusion as to the worthlessness of the debts upon the facts that the notes were not delivered within 14 days after the conference with the directors and that it had received no reply to one letter and one telegram sent sometime after December 17, 1920. Before a taxpayer is entitled to take a deduction for a "debt ascertained to be worthless," he must take reasonable steps to determine that there is no probability of payment or collection and have prima facie evidence to prove that the debt has no value. Under the facts shown2975 in this appeal, the time was too limited and the endeavor too restricted for us to consider that the taxpayer had thoroughly investigated the resources of the Piedmont Commission Co. or that sufficient effort had been made to make sure that the compromise agreement would not be fulfilled or that the company could not or would not pay. This taxpayer has not made a showing which would entitle it to consideration under this test, and its first contention must be denied. This decision leads to the consideration of the alternative contention made by the taxpayer, viz: The Commissioner should have allowed a deduction in the amount of $8,162.60, the difference between the debt of $26,875.28 and the amount of the promised notes, $18,712.68. The Commissioner assumes the position that the word debt, as used in the act of 1918, means a debt in its entirety and does not permit the partition of a debt and the writing off of one part and the retention of the other part. A comparison of the wording of sections 234(a)(5) of the Revenue Acts of 1918 and 1921, respectively, leads us to the conclusion that Congress did not contemplate, in the act of 1918, the deduction of a part of a*2976 debt. The notes given in evidence of the compromise were not delivered until after the end of the calendar year 1920 and the taxpayer could not well write down its debt of 1920 until such time as it knew whether or not the compromise agreement was to be fulfilled. For the foregoing reasons, the determination of the Commissioner is approved.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624531/	BERKS FOUNDRY & MANUFACTURING CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Berks Foundry & Mfg. Co. v. CommissionerDocket No. 6998.United States Board of Tax Appeals5 B.T.A. 756; 1926 BTA LEXIS 2798; December 8, 1926, Promulgated 2798 1. Surplus of a corporation may not be reduced in determining the extent to which a dividend is paid from current earnings of a year by a "tentative tax" theoretically set aside out of such earnings pro rata over such year. Appeal of L. S. Ayers & Co.,1 B.T.A. 1135">1 B.T.A. 1135. 2. In determining invested capital for the calendar year 1919 the Commissioner correctly reduced surplus on account of the tax for the year 1919 prorated, and he also correctly excluded from surplus at the beginning of the year the amount of $6,650.05 representing additional tax for the year 1917. John W. Jacobs, Esq., and John W. Townsend, Esq., for the petitioner. W. F. Gibbs, Esq., for the respondent. LITTLETON756 This proceeding is for the redetermination of a deficiency in income and profits tax of $772.23 for the calendar year 1920. The issues concern invested capital. The stipulation of facts is set forth verbatim. FINDINGS OF FACT. The Berks Foundry & Manufacturing Co. is a corporation organized under the laws of Pennsylvania, with principal office at Berks, Pa., and is engaged in the general foundry business. 757 The Berks2799 Foundry & Manufacturing Co. rendered its corporation income and excess-profits-tax return for the calendar year 1920, which return was audited and certain adjustments of the income And invested capital shown thereon were made by the Commissioner. In determining invested capital the Commissioner reduced surplus as at the beginning of the year by $3,277, on account of account of certain dividends paid on March 19, 1920, in excess of available current earnings. In computing the current earnings available the Commissioner first deducted a tentative tax. Had no tentative tax been deducted, the current earnings available for dividends would have so been increased that only a reduction of $1,591.83 in surplus as at the beginning of the year would have been occasioned by the payment of such dividends. In determining invested capital, the Commissioner reduced surplus as at the beginning of the year in the amount of $61.30, on account of the prorated amount of 1919 Federal income tax. In determining invested capital, the Commissioner reduced the surplus as at the beginning of the year by $6,650.05, on account of additional 1917 income and excess profits taxes determined and assessed2800 by the Commissioner during the year 1923. OPINION. LITTLETON: Petitioner claims that the Commissioner erred (1) in deducting a tentative tax in computing the current earnings available for the payment of dividends on March 19, 1920; (2) in reducing surplus at the beginning of the year 1920 in the amount of the tax upon the income for the preceding year prorated; (3) in reducing the earned surplus at January 1, 1920, in the amount of $6,650.05, representing an additional tax for the calendar year 1917 determined and assessed in the year 1923. The first issue is governed by the Board's decision in the . On the authority of that appeal it is held that the amount by which surplus was reduced on account of the tentative tax should be restored to invested capital. Petitioner's claims set forth in the second and third issues are not well taken and the Commissioner's action in this regard is approved. ; ; 2801 ; ; . Judgment will be entered upon 15 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624532/	Appeal of EDWARD L. SCHEIDENHELM CO.Edward L. Scheidenhelm Co. v. CommissionerDocket No. 1223.United States Board of Tax Appeals1 B.T.A. 864; 1925 BTA LEXIS 2781; March 23, 1925, decided Submitted March 17, 1925. 2781 Where the taxpayer's sole witness admits that a portion of his testimony was false, the Board may regard all of his testimony as having no weight in establishing error on the part of the Commissioner in determining a deficiency in tax. Samuel T. Ansell, Esq., George M. Wilmeth, Esq., and Charles Kersherbaum, C.P.A., for the taxpayer. George K. Bowden, Esq., for the Commissioner. GRAUPNER 864 Before GRAUPNER, LANSDON, LITTLETON, and SMITH. This appeal involves a deficiency in income and profits taxes for the year 1918 in the amount of $12,221.95. It first came on for hearing before this Board on February 24, and was adjourned to March 17, 1925, in order that the taxpayer might produce its books of original entry. Oral and documentary evidence were produced at the hearings on both dates and, from the credible evidence, the Board makes the following FINDINGS OF FACT. 1. The taxpayer is an Illinois corporation with its principal place of business in the city of Chicago. Edward L. Scheidenhelm is its president and has been such since the organization of the corporation in 1916 and is, and has been at all times since its organization, 2782 the owner of substantially all of the stock therein. 2. The Scheidenhelm Construction Co., hereinafter called the Company, was organized under the laws of the State of New York, and had its principal place of business in the city of New York. Scheidenhelm was president of this corporation and owned substantially all of the stock therein. 3. Both the taxpayer and the Company were organized by Scheidenhelm for the purpose of contracting for and performing construction work. During the year 1916 the Company entered into two contracts - one for the construction of a building, on Long Island, N.Y., for the Packard Motor Car Co., and the other for the construction of a pier for the State of Connecticut, at New London in that State. These were the only construction contracts entered into by the Company during its existence. In respect of the Packard Motor Car contract, Scheidenhelm, as president, signed the taxpayer's name as surety on a bond in the sum of $327,284 given by the Company to the Packard Motor Car Co. conditioned on the faithful performance of said contract. In respect of the New London pier contract, Scheidenhelm, individually, signed an undertaking to indemnify2783 the United States Fidelity & Guaranty Co. of Maryland, a corporation engaged in the business of indemnity insurance, in the amount of $97,500 by reason of its having become surety on two bonds aggregating that sum given by the Company to the State of Connecticut for the faithful performance of said contract. 865 4. In the calendar year 1917 the Company became financially involved, and by September 1 of that year it had exhausted its funds and was unable to proceed in the performance of the contracts into which it had entered. On September 1, 1917, the office of the Company in New York was closed and its books and records were removed from the State of New York. The charter of the Company was surrendered and the corporation was formally dissolved in September, 1919. 5. Upon the failure of the Company to complete its work on the two contracts, the taxpayer completed the contracts undertaken by the Company. Work on said contracts was completed and final settlement effected in July, 1918. Upon the final adjustment and settlement it was ascertained and determined by the taxpayer that it and the Company had suffered a loss on account of the completion of said contracts2784 in the amount of $51,321.60, and the taxpayer sought to deduct as a loss for the year 1918 the sum of $24,931.71, which it claimed was chargeable solely against it. 6. The Commissioner held that the taxpayer and the Company were affiliated in 1918; that the completion of the contracts of the Company by the taxpayer constituted an intercompany transaction; that both companies had adopted the method of reporting income from long-term contracts on the basis of estimated receipts and expenditures for each year such contracts ran; and, therefore, that the total loss sustained by both companies, amounting to $51,346.60, should be allocated on the basis of corrected expenses over the entire period covered by the contracts. Under this adjustment the deduction claimed by the taxpayer for 1918 is reduced from $24,931.71 to $7,598.03, which reduction is the basis for the deficiency of $12,221.95 determined by the Commissioner and from which the taxpayer has appealed to this Board. ANCILLARY FINDINGS. (a) In its endeavor to establish its contention that the taxpayer was obligated as a surety to complete the contract of the Company with the State of Connecticut, the taxpayer introduced2785 in evidence purported minutes of a meeting of its board of directors, held at its office in Chicago, Ill., July 13, 1916. These minutes contained a resolution which purports to have been adopted at said meeting whereby the president of the taxpayer was authorized to become surety on any bond or bonds required by the State of Connecticut of the Company, and also authorized him to sign any indemnity agreement required by any surety company in connection with any such bonds, and in the event he signed or was required to sign any such indemnity agreement personally that the same should be deemed to have been ratified by the Company and binding upon it. (b) The aforesaid minutes were identified by Scheidenhelm, who testified that they were written up "immediately after the meeting of the board." The minute book of the taxpayer was submitted by counsel for the Commissioner to the inspection of the members of the Division of this Board who heard the appeal. On inspection, it was very evident that the pages of the minute book containing the purported minutes of July 13, 1916, were new and of a paper entirely 866 different from that on which the other minutes contained in the2786 book were written; also, that the ink with which the signature of the secretary was affixed to such minutes was fresh and had not darkened through age. (c) After the hearing had closed and counsel for the taxpayer had made his opening argument, Samuel T. Ansell, Esq., one of counsel for the taxpayer, requested, as a matter of personal privilege, that Scheidenhelm be recalled to the witness stand. Thereupon, and on examination by counsel and the members of the Board, Scheidenhelm testified that said minutes of July 13, 1916, were not written until sometime subsequent to February 24, 1925, and that no resolution (such as is described in ancillary findings of fact (a)) was presented to the alleged meeting of directors on July 13, 1916. DECISION. The determination of the Commissioner is approved. OPINION. GRAUPNER: The taxpayer, in its petition, asserts error on the part of the Commissioner in the following details: (a) In affiliating the taxpayer and the Company for the taxable year 1918; (b) in holding that the taxpayer was not liable as a surety on the contract of the Company with the State of Connecticut; (c) in holding that the contracts entered into by the Company2787 were intercompany transactions; and (d) in prorating the losses which the taxpayer contends that it suffered in completing the contracts over the period of time covered by said contracts, viz, over the years 1916, 1917, and 1918, instead of allocating the losses to the year 1918. At the conclusion of the taxpayer's offer of proofs on its behalf, the attorney for the Commissioner moved to dismiss the appeal on the ground that the taxpayer had failed to establish its allegations of error. On account of the suspicious conditions developed at the hearing, and not because of lack of merit in the motion, the Board here denies the motion in order that decision may be made on grounds which deserve our serious consideration and comment. As we view this particular appeal, all of the contentions of the taxpayer may be determined without special analysis of each of the assignments of error. We are compelled to deny the appeal of the taxpayer because the conduct of its president and principal stockholder, who was the sole witness at the hearing, has been such as to cause this Board to doubt or disbelieve the major portion of the testimony given by him on the witness stand. Section 9002788 of the Revenue Act of 1924 designates this Board as "an independent agency in the executive branch of the Government." Notwithstanding this description, the requirements of the section vest this Board with the main attributes of a court and make it a tribunal, entitled to respect and charged with great responsibilities. These responsibilities require the Board to mete out justice to the taxpayer and at the same time to protect and expedite the collection of the revenues. The Board can not exercise its functions if it is hampered by suspicion or confronted with deceit or chicanery. We have the right to expect and rely upon taxpayers seeking relief 867 to fully, frankly, and honestly present all the facts relating to their assignments of error on appeal. Suppression of facts, distortion of testimony, falsification or alteration of documents or records, and perjury deter us from performing the duties with which we are charged and lead to injustice. Such acts constitute fraud on the Board and the Government, and we can not too strongly condemn them and the results flowing therefrom. In this appeal the taxpayer first came before this Board without the original books2789 of account of the two corporations involved. Adjournment of the hearing was granted to enable it to produce its books before the division hearing the appeal. The books were present in the hearing room when the appeal was heard after the adjournment. None of the books of account were offered in evidence, the witness for the taxpayer was asked to and did read into the record only a part of the debit entries and none of the credit entries in one ledger account, and counsel for the Commissioner was permitted by the taxpayer to make only a restricted examination of the books brought into the hearing room. The issues presented depended to a great degree upon proving the authority of the taxpayer to become a surety and, having apparently become a surety, its responsibility to complete contracts which could only be performed at a loss. The articles of incorporation of the taxpayer and the Company were not introduced to show their corporate powers, the accounts were not sufficiently disclosed to give the Board an adequate understanding of the transactions involved, and the minutes of the taxpayer were distorted or manufactured to the advantage of the taxpayer. Such a method of presentation2790 does not encourage belief in the merits of the appeal. The president of and sole witness for the taxpayer positively and unequivocally identified, as minutes of a purported meeting of the board of directors of the corporation, supposedly held on July 13, 1916, pages in the minute book of the taxpayer. The distinct difference in appearance between the pages of that book containing the purported minutes and the other pages excited the comment of the attorney for the Commissioner, who called the attention of the Members sitting at the hearing to the fact. The appearance of recent substitution or alteration was so evident to the Members on inspection of the book and their surprise was so manifest that, undoubtedly, Scheidenhelm was aware of the attention which the condition excited. The minute book had not been placed in evidence, and the witness, after making positive identification of it, had read the purported minute into the record. Whether this method was employed to conceal the newness of the pages and the secretary's signature, we can only surmise. But for the reference of Commissioner's counsel to the book for purposes of cross-examination we would have remained in ignorance2791 of the condition existing. It may be said, therefore, that what appears to be an attempted fraud upon the Board and an attempted perversion of justice was accidentally discovered and would not have been revealed to the Board had not Commissioner's counsel called attention to the peculiar appearance of the pages which were read into the minutes. From the circumstances surrounding the disclosure of the fact that the purported minutes were not written until after the adjournment of the first hearing of the appeal, when the taxpayer's president had 868 knowledge that he must produce original records, we are convinced that confession would not have been made of the addition to or alteration of the taxpayer's minutes had he not been aware and convinced that the Members were confident that the record had been manufactured. With this unavoidable conception of the attitude of the taxpayer in testifying before the Board, we feel that the testimony contains sufficient other products of deceit to justify us in disregarding all the testimony of the witness, Scheidenhelm. As there was no other witness produced, we feel that there is no evidence before the Board to warrant us in disturbing*2792 the Commissioner's determination.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624533/	JOHN P. WILSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Wilson v. CommissionerDocket No. 93140.United States Board of Tax Appeals42 B.T.A. 1260; 1940 BTA LEXIS 877; November 22, 1940, Promulgated 877 Held:(1) The ordinary income of two trusts was currently distributable and distributed to named beneficiaries other than grantor. The capital gains of the trust were accumulated and added to corpus for distribution as such at termination of the trusts. The trusts were not revocable. Neither the ordinary income nor the capital gains thereof were taxable to grantor under section 166 of the Revenue Act of 1934. (2) One of the trusts involved was for a two-year period and terminated by its terms in the taxable year. Capital gains were realized in the taxable year, added to corpus, and as such paid to grantor in such year. The capital gains are taxable as income to grantor under section 167 of the Revenue Act of 1934. (3) On the facts of the second trust involved, grantor retained a mere possibility of reverter of corpus. The accumulated capital gains are not taxable to grantor. C. F. Selfridge, Esq., for the petitioner. D. A. Taylor, Esq., and David Altman, Esq., for the respondent. HILL 1260 This proceeding involves deficiencies in income tax of petitioner for the calendar years 1934 and 1935. For 1934 respondent determined878 a deficiency of $1,562.57, based upon the inclusion of additional income of $2,849.72 representing the entire net income of a trust created by petitioner in December 1933 for the benefit of his son. For 1935 respondent determined a deficiency of $11,156.24 based upon the inclusion of additional income of $35,986.20, of which $28,876.10 represented the net ordinary income and capital gain of the 1933 trust and $7,110.10 represented the net ordinary income and capital gain of a trust created by petitioner in June 1935 for the benefit of his daughter. FINDINGS OF FACT. Petitioner, John P. Wilson, an individual, resides at 1516 North State Street, Chicago, Illinois. Prior to December 1930 the petitioner had given to his son, John P. Wilson, Jr., an allowance of $300 per month. On December 29, 1261 1930, petitioner created a trust for a period of three years, under which the son was to receive $300 per month. The corpus of the trust consisted of 150 bonds of $1,000 face value each of the American Tar Products Co. On the same day that the trust expired and the corpus reverted to the petitioner, December 21, 1933, petitioner executed a new trust indenture providing for879 a short term trust to continue for not more than two years. The corpus of this trust consisted of the same bonds that comprised the corpus of the prior trust. The same three trustees were named again. They were to hold the corpus, collect the income, and, after paying expenses, distribute ordinary income to the son. The capital gains were to be accumulated. This trust was to continue for a period of two years, ending December 21, 1935, or on the death of the petitioner in the event petitioner died prior to December 21, 1935. Article second (4) empowered the trustees to receive all proceeds which might be paid upon the sale of the trust assets: * * or which may be otherwise paid out of capital or on account of the principal of any bond, stock or other security * * * provided that any and all moneys, stock dividends or other securities received under this paragraph shall constitute and be a part of the principal of the trust estate. Article fourth of the trust provided as follows: Distribution of the Principal of the Trust EstateThe trust hereby created shall terminate on December 21st, A.D. 1935, or on the death of said grantor, JOHN P. WILSON , if he shall die880 prior to said date, and upon the termination of said trust the entire net income then remaining in the hands of said Trustees shall be paid over to said JOHN P. WILSON, JR., and the entire principal of said trust estate shall then vest in and be transferred and delivered to said Grantor if he shall then be living, absolutely as his own property free from said trust, and in case he shall not then be living said entire trust estate shall vest in and be transferred and delivered to the executors of his estate and shall be administered by them in the same manner as if said Grantor had died owning the same. The trusts for three and two years, respectively, were created for such periods because petitioner did not wish to set up any trust of a permanent character for his son until the latter had demonstrated to his father's satisfaction that the income would not impair his ambition or usefulness in his work. By an indenture dated November 29, 1935, petitioner created a third trust for the benefit of his son, John. The principal of that trust was about the same as in the 1933 trust. The 1935 trust provides that the son shall have the entire net income so long as he and his father both881 live. The trust is to terminate at the expiration of ten years from the death of the last survivor of Alice B. Wilson (wife of petitioner), John P. Wilson, Jr., and Cynthia Compton. No part of this trust is involved in the issues in the present proceeding. 1262 By indenture dated June 25, 1935, the petitioner created a trust for the benefit of his daughter, Cynthia Wilson, and Beverly Compton, whom she married on July 6, 1935. Under this trust the net income was to be paid to the beneficiaries during their lifetimes in such shares as the trustees should determine; provided, however, that the beneficiaries could designate in writing the shares in which the net income was to be paid to them. Shortly after the creation of the trust, Cynthia Wilson issued written instructions to the trustees to pay the entire net income to her husband. The corpus of the trust consisted of $500 cash and 46 bonds of the American Tar Products Co., dated July 1, 1930, having a face value of $1,000 each. Article second (4) of the trust indenture empowered the trustees to receive all proceeds which might be paid upon a sale of the trust assets: * * or which may be otherwise paid out of capital882 or on account of the principal of any bond, stock or other security, * * provided that any and all moneys, stock dividends or other securities received under this paragraph shall constitute and be a part of the principal of the trust estate. (5) The decision of said Trustees as to the source from which any and all cash received by them on account or by reason of their holding any stocks or securities hereunder, that is, as to whether such cash is paid from principal or income, shall be final and binding on all parties for all purposes. Article fourth provided as follows: Distribution of the Principal of the Trust EstateThe trust hereby created shall terminate on the death of said CYNTHIA WILSON, unless she shall die leaving issue surviving her, in which case the trust hereby created shall continue in force and terminate when her youngest child surviving from time to time attains the age of twenty (20) years or dies prior to attaining said age; provided, however, that the trust hereby created shall in any and the latest event terminate upon the death of said Grantor, JOHN P. WILSON, and upon the termination of said trust, under any of the conditions above named, the883 entire principal of said trust estate, together with all accrued and unpaid income thereon, shall then vest in and be transferred and delivered to said Grantor if he shall then be living, absolutely as his own property free from said trust, and in case he shall not then be living said entire trust estate, together with all accrued but unpaid income thereon, shall revert to his estate and be transferred and delivered to the executors of his estate and shall pass under his will and be administered by his executors in the same manner as if said Grantor had died owning the same. Petitioner's daughter was in a financially independent position to marry because petitioner's father in his lifetime had given her stocks which would produce an income of something better than $5,000 a year, which petitioner thought was adequate to take care of a young married couple "just starting out." The reason petitioner created this trust, which was expected to produce about $1,200 to $1,500 a year, was because his daughter's husband was a young doctor who had no established practice yet and petitioner was opposed to having the wife hold all the money in the family. 1263 Cynthia Wilson Compton884 had two children at the time this proceeding was heard - Beverly, Jr., three, and Cynthia, one. During the year 1934 the entire net income of the trust created December 21, 1933, amounted to $2,849.72, which was paid during 1934 to John P. Wilson, Jr. The net income of this trust for 1935 was $28,876.10, consisting of dividend income of $1,000, interest income of $11,937.50, and capital gains of $16,095.31 (after the application of the 40 percent holding period percentage) from the sale of the 150 bonds constituting the trust corpus. The trustees distributed in 1935 to John P. Wilson, Jr., $12,780.79, but retained the capital gains of $16,095.31, which they reported as income of the trust on a Form 1040 income tax return for 1935, and paid a tax thereon. Upon termination of this trust on December 21, 1935, in accordance with the terms of the trust indenture, the corpus thereof was returned to the petitioner, together with the $40,238.27 capital gains representing the capital gains (prior to the application of the 40 percent holding period percentage, which reduced this amount to $16,095.31). The net income of the trust created June 25, 1935, for the calendar year 1935 amounted885 to $7,110.10, including $4,935.89 (after the application of the holding period percentage of 40 percent) from the sale of the 46 bonds constituting the trust corpus. The trustees distributed the ordinary income to Beverly Compton and retained the capital gains of $4,935.89, which they reported as income of the trust on a Form 1040 income tax return. The American Tar Products Co. bonds which constituted the entire principal of both trusts, with the exception of $500 cash to each, were delivered to and received by the trustees of the respective trusts when the trusts were created and were held by the trustees until their sale in October 1935. The trustees kept the bonds in a custodian's account in their names at the First National Bank. Separate bank accounts and complete books of account were kept by the trustees. In 1935 the trustees considered selling the bonds and sought petitioner's advice in the matter. The sale was agreed upon and the proceeds were reinvested in other securities, issued in the names of the trustees and kept in separate safe deposit boxes. In his individual income tax returns for 1934 and 1935 the petitioner did not report or include either the ordinary886 income or capital gains of the two trusts. Upon audit of these returns, the Commissioner determined that the income of these two trusts, both ordinary and capital, was taxable to the petitioner, as grantor thereof. OPINION. HILL: Since this proceeding was submitted to the Board, the Supreme Court has rendered two decisions construing section 166 of the 1264 Revenue Act of 1934, upon which respondent rests, in part, his argument in this case - Helvering v. Clifford,309 U.S. 331">309 U.S. 331, and Helvering v. Wood,309 U.S. 344">309 U.S. 344. The distinction between a reversion, with which we are faced in the instant case, and a power to revest or revoke is clearly set forth in the Wood case, supra:* * * generally speaking, the power to revest or to revoke an existing estate is discretionary with the donor; a reversion is the residue left in the grantor on determination of a particular estate. * * * Congress seems to have drawn Sec. 166 with that distinction in mind, for mere reversions are not specifically mentioned. * * * And where Congress has drawn a distinction, however nice, it is not proper for us to obliterate it. * * * The interest887 of this petitioner in the 1933 trust was clearly a reversion. He reserved no power to revoke the trust set up for his son, and the trust was certain to terminate in two years. In the case of the trust for his daughter and her husband the facts are different; but the ultimate vesting of the trust estate, either in the petitioner or in his estate is no less certain to occur than in the case of the 1933 trust, nor did petitioner have the power either to change the conditions set forth in the instrument or to revoke the trust. Both of the trusts clearly fall within that class of trusts which the Supreme Court in the Wood case, supra, specifically excluded from the scope of section 166. They are not revocable trusts. In the brief of counsel for respondent the income of the two trusts is sought to be attributed to petitioner on the theory that the direction of investments and sales and the accumulation of capital income is tantamount to control over the income. Clearly this view is erroneous. Cf. Christopher L. Ward,40 B.T.A. 225">40 B.T.A. 225, where, as here, the corpus was actually conveyed to the trustees who collected and distributed the income to the beneficiaries888 in accordance with the trust agreements. The advice given by petitioner for sales and investments could not nullify a trust otherwise valid. Respondent, however, has a further alternative contention, i.e., that the capital gains of the two trusts for the year 1935 are taxable to the petitioner as grantor under section 167 of the Revenue Act of 1934.1 That section, unlike section 166, does not apply solely to trusts where the grantor retains a power of revocation. Several cases tend to shed light upon the application of section 167. Everett D. Graff,40 B.T.A. 920">40 B.T.A. 920, and Commissioner v. Morris, 90 Fed.(2d) 962. In the Morris case the court said, at page 964, in upholding a decision of this Board: As to its decision regarding the capital gains which has to be added to the principal, regardless of any exercise of discretion by the trustees, for disposal 1265 when the trusts terminated, we think the Board was right. It held that as to such income from capital gains absolutely distributable as principal at the termination of the trust section 167 of the 1928 Act did not apply. * * There is, indeed, no plausible reason apparent889 why, when income which may be accumulated for eventual distribution to the grantor is taxed to him, he should not also be taxed on income which must be accumulated for that purpose. In the Revenue Act of 1932 (Section 167 (26 U.S.C.A. Sec. 167 and note)), the tax was so extended * * Nor does the fact that in the Revenue Act of 1932 Congress changed the law to cover such instances as this indicate more than that the amendment was for the purpose of filling a gap in the previous law. * * * [Italics ours.] And at page 924 of the Graff case, supra, the Board said: * * * But section 167, in its present form, operates as effectively upon accumulated trust income where it "is * * * held * * * for future distribution to the grantor" as it does where that future distribution may be contingent upon the exercise of a nonadverse discretion. * * * In the instant890 case the income from capital gains of the 1933 trust was paid to petitioner in 1935 as a part of the reverted trust corpus. Furthermore, there is no dispute as to the amount of that income. Clearly, therefore, the petitioner is taxable thereon pursuant to section 167. As to the 1935 trust for the daughter, the situation is materially different. The corpus, including any and all capital gains which the trustees must accumulate, must at some future date vest either in the petitioner or his estate. It will vest in the petitioner himself only if (1) Cynthia Wilson Compton dies without issue during the lifetime of the petitioner, or, (2) her youngest surviving child attains the age of 20 or dies prior thereto during the lifetime of petitioner. And it will vest in petitioner's estate upon (3) the death of petitioner at any time. There is not only no reasonable certainty that the corpus will ever vest in the petitioner, but, on the contrary, it would seem that such vesting is not reasonably probable. The future life expectancy of the daughter is now greater than that of the petitioner. And, even should she predecease him, he would not become entitled to the corpus until her youngest891 surviving child reached the age of 20 or died prior thereto. In view of these contingencies, it can not be said that the petitioner has any more than a mere possibility of reverter in the corpus. This Board and the courts have now definitely established that the grantor of a trust is not subject to tax upon accumulated income if his only interest is a mere possibility of reverter. William E. Boeing,37 B.T.A. 178">37 B.T.A. 178; J. S. Pyeatt,39 B.T.A. 774">39 B.T.A. 774; Genevieve F. Moore,39 B.T.A. 808">39 B.T.A. 808; Christopher L. Ward, supra.It is our conclusion that such interest as petitioner retained in the property of the 1935 trust was not of sufficient substance to justify a reasonable expectation that he will ever benefit by the accumulations of the income thereof. 1266 As already pointed out, however, the corpus must vest in petitioner's estate, if not in petitioner himself. Because of this fact, counsel for respondent concludes that the situation falls within the scope of section 167, a conclusion with which we do not agree. The wording of that section is "for future distribution to the grantor." Nowhere is there any mention of892 "or his estate", the additional scope which counsel for respondent would impute to the section. Accordingly, we hold in favor of the respondent as to the taxability to petitioner of the accumulated capital gains of the 1933 trust, and in favor of the petitioner on all issues concerning the 1935 trust for the daughter. Decision will be entered under Rule 50.Footnotes1. SEC. 167. INCOME FOR BENEFIT OF GRANTOR. (a) Where any part of the income of a trust - (1) is, * * * held or accumulated for future distribution to the grantor, or * * * then such part of the income of the trust shall be included in computing the net income of the grantor. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624534/	Louis H. and Madelene Diamond, Petitioners v. Commissioner of Internal Revenue, RespondentDiamond v. CommissionerDocket No. 39473-86United States Tax Court92 T.C. 423; 1989 U.S. Tax Ct. LEXIS 30; 92 T.C. No. 25; February 23, 1989; As amended March 1, 1989 February 23, 1989, Filed 30 Decision will be entered under Rule 155. Petitioner was a limited partner in Robotics which was a limited partner in the project partnership, an Israeli limited partnership. The project partnership's general partner was Elco, a publicly held Israeli corporation. The project partnership was formed to conduct research and development work with respect to an arc welder with an optical seam follower. The project partnership agreement gave Elco the right to manufacture, produce, and/or market the welder as exclusive and irrevocable licensee. Held, expenditures of the project partnership were not in connection with any trade or business, and petitioner is not entitled to deductions under sec. 174. Spellman v. Commissioner, 845 F.2d 148">845 F.2d 148 (7th Cir. 1988), followed; held, further, deductibility of guaranteed payments, consulting fees, legal fees, accounting fees, and organizational expenses determined; held, further, petitioner is not liable for an addition to tax pursuant to sec. 6659; held, further, petitioner's liability for increased interest under sec. 6621(c) will be determined by the parties' Rule 155 computation. Joseph M. Jones,31 Samuel Paul Kastner, and Robin Kofsky Gold, for the petitioners.Dianne Crosby and David Click, for the respondent. Whitaker, Judge. WHITAKER424 By statutory notice dated July 14, 1986, respondent determined deficiencies in and additions to petitioners' Federal income tax for the years and in the amounts as follows:Addition to taxYearAmount1 sec. 6659 1981$ 19,174$ 5,752.2019827,5232,256.90 Respondent also determined that petitioner was liable for increased interest under section 6621(c). The issues are: (1) Whether Elco R&D Associates (the project partnership), an Israeli limited partnership, was engaged in a trade or business so that expenses incurred by it in 1981 and 1982 for research and development may be deducted pursuant to section 174; (2) whether Robotics Development32 Associates, L.P., (Robotics), a Maryland limited partnership in which petitioner was a limited partner, is entitled to deduct payments to its partners for management fees; (3) whether and to what extent Robotics may amortize its claimed partnership organizational expenses over 60 months pursuant to section 709; (4) whether Robotics is entitled to deductions for legal, accounting, and consulting expenses; (5) whether petitioner is liable for an addition to tax pursuant to section 6659; and (6) whether petitioner is liable for increased interest pursuant to section 6621(c). Should 425 petitioner prevail on the primary issue pertaining to research and development expenditures, the parties have agreed that further briefing will be necessary to enable the Court to reach a decision as to the extent such research and development expenditures may be deducted under the project partnership's method of accounting.FINDINGS OF FACTSome of the facts are stipulated and are so found. The stipulation and attached exhibits are incorporated herein by this reference. At the time the petition was filed, Louis Diamond was a resident of Bethesda, Maryland, and Madelene Diamond 2 was a resident33 of Washington, D.C.This dispute arises from petitioner Louis Diamond's ownership of an interest in Robotics, a Maryland limited partnership, which was a limited partner in the project partnership, an Israeli limited partnership. The project partnership's general partner is Elco Ltd. (Elco), a publicly held Israeli corporation. Robotics was organized in 1981 with three general partners and initially one limited partner holding a 99-percent interest. This limited partner interest was divided into 26 limited partnership interests which were sold to investors including petitioner.Robotics' general partners are Itzhak Yaakov (Yaakov), G-B Energy Systems, Inc. (G-B Energy), and the managing general partner, Capital Corp. of Washington (Capital), each of whom contributed $ 16,100 335 for a 1/3-percent interest in Robotics. Yaakov, who34 resided in New York during the years [ILLEGIBLE WORD] issue, was formerly a general in the Israeli army in charge of research and development. From 1974 through 1977, he was the Chief Scientist in the Israeli Ministry of Industry. G-B Energy is a Connecticut corporation wholly owned by Jacob E. Goldman (Goldman), who was formerly director of Ford Motor Co.'s Scientific Research Laboratory and head of research and development at Xerox Corp. Capital is a District of Columbia corporation wholly owned by Robert E. Slavitt (Slavitt), who is an investment banker 426 and is involved in organizing research and development projects in Israel. 4 Slavitt first became involved in organizing and funding research and development projects in Israel in 1981. From that time until the time of trial, he had been involved in projects with 13 different Israeli companies. Each of the Israeli companies with which he was involved was marketing in the United States through either joint ventures or OEM (other equipment manufacturer) contracts. 5 Slavitt had been involved with three Israeli companies which had tried unsuccessfully to penetrate the U.S. market on their own.Slavitt and Yaakov first met in May 1981. They discussed the general climate for investment in high technology in Israel, and Yaakov introduced Slavitt to several specific projects, including a project proposed by Elco for the development of an arc welder with an optical seam follower (the project or the robot). As a result of that meeting, Slavitt investigated each of the proposed investments. He subscribed to a number of professional magazines dealing with robotics and performed a certain amount of research to familiarize himself with the field. He obtained data from the Department of Commerce, and spoke with several technicians, 36 including Goldman. From his investigation, Slavitt became convinced that robotics was a viable, promising industry. He learned that the United States was behind the Japanese in utilizing this technology, but was trying to catch up, thus creating a potentially large U.S. market for this kind of technology.After identifying robotics as an area in which he might want to invest, Slavitt retained the services of Goldman and asked him to go to Israel to investigate certain aspects of the Project as then proposed. Particularly, Goldman was asked to assess the feasibility of the technology, the ability of Elco to pursue and develop the technology, and the market for any product which might be developed. Goldman returned with the opinion that, while there are no automobile manufacturers in Israel, robotics technology would be 427 well-suited for that use in the United States. As a result of Goldman's investigation, Slavitt became convinced not only of the promise of robotics technology, but of the talent which Goldman possessed in both the technical and marketing areas.On August 20, 1981, Slavitt himself went to Israel to further investigate the project. While there, he consulted37 both American and Israeli counsel concerning tax and other matters. During this trip, he was introduced to representatives of Elco who gave him an overview of the project, and convinced him that they had the ability to develop a marketable product. However, because Elco did not have the funds to pursue the research and development of the technology either alone or in conjunction with the chief scientist's office, it sought outside investors.Elco had been approached by three different investors, but decided to team up with Robotics because of the expertise and connections of Yaakov and Goldman, both of whom were expected to contribute at later stages in the development of the robot. Elco expected to draw upon Yaakov's expertise in research and development and his connections with the chief scientist's office, while Goldman's participation was sought because of his connections with the U.S. automobile industry and his expertise in the technical and marketing areas. Elco desired that these two men be partners in any venture or entity that invested in the robot so as to give them some financial incentive.Through its general partners, Yaakov and Slavitt, Robotics entered into negotiations38 with Elco for the formation of a joint venture for the development and exploitation of the Project. Elco was represented by its vice president for finance, Uri Kviatek. These negotiations culminated in an agreement dated May 1, 1981, 639 which formed the project partnership. Pursuant to this project partnership agreement, Elco was to contribute to the project partnership the 428 lesser of 5.88 percent of the total investment 7 in the project or $ 250,000. Elco was also to contribute "the exclusive right, title, and interest in all the Technology which it presently possesses as well as any Technology conceived, made, gained, acquired or developed in the course of or as a result of the implementation of the Project." For its part, Robotics was to contribute $ 500,000 upon the approval of the project by the chief scientist and execution of a loan agreement with the Industrial Development Bank, and cash in installments during the following months and in the following amounts:MonthAmount February 1982$ 325,000July 198275,000February 1983325,000July 1983275,000February 1984325,000May 1984150,000The project partnership agreement conferred upon Elco the following additional rights and duties:5. Obligations and Undertakings by [Elco](a) Research and Development; Exploitation.(ii) [ELCO] agrees that (1) the actual research and development work on the Project shall be carried out by [Elco], at its premises and using primarily its employees and equipment, (2) it will provide, within the framework of the budget of the Project approved by the Chief Scientist, such personnel and facilities and devote such time to the Project as shall be required for the diligent pursuit of the Project Partnership's objectives, (3) the undertakings of [Elco] under this Agreement shall be performed or otherwise carried out under the general supervision and management of Mr. Gideon Gelman or a suitable successor selected by [Elco]; provided, however, that [Elco] may employ a third party (including, without limitation, an affiliate) as40 sub-contractor to carry out all or part of the research and development work on the Project or may consult with any third party (including, without limitation, an affiliate) in connection with the research and development work on the Project if (y) such employment of a sub-contractor or consultation shall not violate the [Chief Scientist] Agreement and (z) such employment of a sub-contractor or consultation shall not in any manner relieve [Elco] of its obligations under this Agreement in respect of the research and development work on the Project.429 (iii) In the event that [Elco] determines that the manufacturing, production and/or marketing of any product resulting from the research and development work of the Project should be carried out by [Elco] and/or any one or more of its affiliates, (1) such manufacturing, production and/or marketing activity shall be carried out exclusively by it and/or any such affiliate in the capacity of an exclusive and irrevocable licensee (such license to survive the termination of the Project Partnership), * * and not in [Elco's] capacity as a general partner of the Project Partnership, * * . Notwithstanding the foregoing provisions 41 * it is hereby agreed that [Elco] or such affiliate shall have no obligation to carry out any manufacturing, production and/or marketing itself in the event that [Elco] shall determine that such manufacturing, production and/or marketing should be carried out wholly or partly by any third party or parties * * .In the event that Elco exercised the right pursuant to section 5(a)(iii) of the project partnership agreement to make itself or an affiliate exclusive and irrevocable licensee, the project partnership agreement set up a schedule of fees to be paid by Elco to the project partnership, based on Elco's gross receipts. Pursuant to that schedule the project partnership was to receive 5 percent of Elco's gross receipts until Robotics received 65 percent of its investment. The project partnership was to receive 4 percent of the next $ 10 million of gross receipts, 3 percent of the next $ 5 million of gross receipts, and 2 percent of any gross receipts over $ 15 million. Robotics was to receive 99 percent of the fees paid to the project partnership. The project partnership agreement contained provisions for an adjustment of these fees in the event that Elco applied the technology42 to products other than the robot. However, any of the "Fees payable to the Project Partnership with respect to any fiscal year shall not exceed twenty-five percent (25%) of the pre-tax profits for such fiscal year of the manufacturing licensee under Section 5(a)(iii) in manufacturing and selling the products." To the extent that the fees otherwise payable under the project partnership agreement exceeded 25 percent of Elco's pre-tax profits, such excess was carried over to the next year. If, at the end of the partnership's 50-year life, there is an accumulated amount of fees unpaid, that accumulated amount "shall be disregarded and shall no longer be payable." In the event that Elco exercised its rights under section 5(a)(iii), the Project Partnership Agreement gave Elco the right to convert Robotics' right to receive distributions 430 into an equity interest in the manufacturing licensee, either Elco or an affiliate, which would incorporate either in Israel or the United States. 843 Section 6(d) of the project partnership agreement gave Elco the right to transfer all or any of the rights to the project to any third party other than Elco or its affiliate, subject to Elco's obligation to give notice to Robotics of the transaction and the terms thereof. In the event of such transfer, Robotics had the right within 30 days to object to the transfer "on reasonable grounds." In the event of such a transfer, Robotics would "receive in cash an amount equal to 33 1/3% of all gross receipts of the Project Partnership * * * with respect to such * * * transfer after deduction of the direct expenses incurred in such * * * transfer, and the balance of such receipts shall be paid to [Elco]." As of the date of trial, Elco had neither marketed the robot as exclusive licensee, nor had it transferred any rights to any third party.In general, the project partnership's profits and losses were to be allocated 94.45 percent to Robotics and 5.55 percent to Elco, except that if Robotics' share of losses ever equaled its investment in the project partnership, all further losses would be allocated to Elco. The losses that passed through the project partnership to Robotics were allocated44 99 percent to the limited partners and 1 percent to the general partners, to the extent such losses were attributable to the funds contributed by Robotics' limited partners. Further losses, and all gains, were allocated in the same ratio as cash-flow. Cash-flow was to be distributed 100 431 percent to the limited partners to the extent attributable to "Continuing Royalty Payments"; to the extent attributable to "Capital Transactions" and "Stock Transactions," cash-flow was distributed 70 percent to the limited partners and 30 percent to the general partners, or if the limited partners had yet to recover their investment, 85 percent to the limited partners and 15 percent to the general partners. 945 On or before November 23, 1981, Robotics sold, through its agent Sheltered Investments, Inc., 10 26 limited partnership units pursuant to a private placement memorandum of even date. Those persons purchasing units in the partnership joined the existing general partners in entering into the Robotics' amended limited partnership agreement dated December 15, 1981. 11 Petitioner purchased one-half of one partnership unit for $ 91,675, giving him a 1.9038-percent interest in Robotics. Upon entering the partnership, petitioner contributed $ 15,000 in cash, and was required to execute notes in the amounts and due on the dates as follows:AmountDue date$ 7,5002/1/827,5007/1/827,5002/1/837,5007/1/835,0002/1/84432 The remaining $ 41,675 of petitioner's46 capital contribution was the proceeds of a loan, described below, which petitioner received from the Government of Israel, through the Industrial Development Bank of Israel, Ltd. Each limited and general partner of Robotics was the recipient of a similar loan and each limited partner executed a special power of attorney appointing each general partner his agent in connection with such loans.Pursuant to the Robotics partnership agreement, its general partners were to perform "all services necessary or desirable for the proper management and operation of [Robotics'] business" subject to the provisions of that agreement and Israeli law. These duties included supervision of the expenditure of partnership funds and review of all project projections and marketing activities. In return for providing these services, the general partners were to be paid the aggregate amount of $ 271,000 "during the years 1982 through 1983." While these services were to be performed over [the] Robotics' life, there was no provision for the payment of fees after 1983. None of the general partners nor any affiliate thereof was to receive any disbursements from Robotics other than management and project review47 fees and partnership distributions.Yaakov was instrumental not only in negotiating the project partnership agreement, but also in assisting in administrative matters and in defining the project itself. He had regular consultations with the project's manager, Gideon Gelman, and negotiated with the chief scientist's office when the decision was made to narrow the scope of the project to the development of the optic system only. His status as a former chief scientist was influential in this regard, and also in his negotiations with the then-current chief scientist regarding budget increases. Finally, he introduced the project to one potential buyer with access to the U.S. market.Although he was a general partner in the project partnership's limited partner, Goldman assumed the role of supervising the research and development activities of the project, providing feedback on the market available for such a robot, and helping the project partnership to make contacts in the American marketplace. Goldman made four 433 or five trips to Israel from late 1981 through 1982, particularly to meet with Elco's president; he also met with representatives of Elco during their visits to 48 the United States. As he was familiar with the status and existence of the type of research and development in this area in the United States, Goldman could prevent the project from being duplicative.Pursuant to the project partnership agreement, Elco was to secure the approval of, and in its individual capacity enter into an agreement with, the office of the chief scientist for development of the robot (the chief scientist agreement). That agreement provided that, in exchange for financial assistance from the Israeli Government, Elco would adhere to certain reporting requirements and would not exploit the results of any resulting invention or patent outside of Israel without the prior written consent of the Israeli Government. That financial assistance was in the form of a loan to each individual partner of Robotics in an aggregate amount (less certain expenses) equal to the amount of financing supplied by Robotics. Only Elco could obtain a patent for any invention which was the result of the research, unless prior written consent was obtained from the chief scientist and Elco took all legal steps to ensure that the invention would not be exploited outside of Israel without the49 Government's consent. The chief scientist agreement also contained the following provision:If the Applicant [Elco] does not exploit in Israel the inventions, patents, know-how or other results which will be reached during the conduct of the Research or derived therefrom (hereinafter the "Patents"), or does not commercialize them in Israel within seven years from the termination of the Execution Period [which extended from 4/1/81 to 3/31/82] (initial or extended -- if extended) (hereinafter "the Exploitation Period"), the rights therein will pass to the Government. * In the event that the rights to the project passed to the Israeli Government under this clause, any proceeds that it derived would go first to repayment of the loan, then to payment of the expenses incurred by the project partnership in developing the robot. The Government would keep any and all remaining profits. Elco was empowered to transfer to the project partnership any of its rights under 434 the operative portions of the chief scientist agreement, but did not do so.The loans received by each of Robotics' partners and referred to in the chief scientist agreement were memorialized in a separate50 agreement (the loan agreement), which called for the Government of Israel, through the Industrial Development Bank of Israel, Ltd., to loan to Robotics' partners, individually, the aggregate sum of 4,621,039 Israeli shekels, to be disbursed in installments. The first installment was to be disbursed within 2 months from the date of the commencement of research, and was to be one-quarter of the principal amount of the loan. A subsequent installment was to be disbursed within 30 days after the submission of an expense report, which was to be filed by Elco within 120 days after the signing of the research agreement. Each subsequent installment was to be disbursed within 30 days of the submission of subsequent expense reports, which were to be submitted "from time to time." The amounts to be disbursed after submission of these periodic expense reports (which were to be approved by the office of the chief scientist) were equal to one-half of the expenses incurred during the period covered by the report. However, no more than 80 percent of the principal balance of the loan was to be disbursed prior to the submission of a final report.The loans were to bear 6-percent simple interest; 51 however, interest was not to accrue until the chief scientist determined that the project was complete. Accrued interest was not payable until the expiration of 12 years after receipt of the first installment. On the dates on which Robotics was required to make payments on behalf of its partners, such payments were to be no less than 25 percent of Robotics' net profit, as shown by certified financial statements.Robotics was represented in Israel by Worldtech Israel, Ltd. (Worldtech), which was organized by Yaakov after he left his post as chief scientist. 12 Pursuant to its November 20, 1981 agreement with Robotics, Worldtech was to make periodic visits to the site where research was being conducted, 435 monitor Elco's reports to the chief scientist and payments made in return, and otherwise act as Robotics' agent in Israel. For its services, Worldtech was to be paid an amount not to exceed the lesser of $ 50,000 or 1.282 percent of the total research budget. Worldtech was actually paid $ 15,000 in 1981 and $ 35,000 in 1982. The agreement was to terminate upon completion of the contemplated services or on December 25, 1985, whichever was to occur first.52 On November 23, 1983, Robotics entered into a project review contract with Israel Development Corp. (IDC), which was formed by Slavitt in 1981 13 to monitor this and other similar projects. IDC was to report to Robotics' general partners, who would in turn report to its limited partners, concerning all financial transactions taking place with respect to the Project. IDC's undertaking pursuant to its contract with Robotics committed it to:* * * reviewing and reporting to the General Partners of [Robotics] as to the progress of the Project Partnership with respect to the Robot Project through its various stages, including the research and development stage, the manufacturing stage, the marketing stage and the future exploitation stage; the preparation of quarterly reports; reviewing the annual budget of [Robotics]; reviewing the annual and quarterly reports submitted by Elco to [Robotics]; reviewing [Robotics'] tax return and otherwise promoting the business of [Robotics].The term of the contract was to run from the date of its execution "until such time as [Robotics] is terminated," which was to be December 31, 2031. 14 However, IDC's entire fee of $ 150,000 was paid $ 21,00053 in 1981 and $ 129,000 in 1982.On December 24, 1981, Elco, in its capacity as general partner of the project partnership, and pursuant to its authority to do so contained in the project partnership agreement, entered into a subcontract agreement with itself individually "to carry out the Initial Research and Development subject and pursuant to the terms and conditions of the Project Partnership Agreement." Pursuant to that subcontractor agreement, such initial research and development 436 was to be carried out primarily by Elco Robotics, Ltd., a subsidiary of Elco. In consideration of its undertaking to perform such services, Elco as subcontractor was to be paid $ 1,900,000 by the project partnership.During the course of the research and development of the project, it was 54 decided to shift the emphasis of the research from the robot as a whole to the optical seam follower, as there were more than enough robots already on the market capable of performing the required task. A prototype was developed in 1984 or 1985, of which fewer than 12 units were sold or loaned to potential customers. This prototype incorporated technology which Elco management considered to be a breakthrough. Elco had anticipated that at this point secondary financing would be needed for purposes of marketing and production. Elco was hopeful that Robotics would participate in this secondary financing. However, the Robotics limited partners were unwilling to make any further investments, and Elco was ultimately unsuccessful in obtaining any such financing, in large part because of a crisis in the automation industry at about that time. Those industrial customers which Elco had anticipated would be the robot's primary market reduced employment and production in the robotics industry by one-third to one-half.At the time of trial, Robotics was negotiating with a Belgian firm which had exhibited interest in the sensing device. There were also negotiations between Slavitt, as Robotics' 55 general partner, and Elco for amendment of the project partnership agreement which would allow Robotics to share in the profits derived from any sale on a 50-50 basis. During the course of these negotiations between Elco and Robotics, Kviatek wrote a letter to Slavitt in which he stated that Elco:* * * for and on behalf of the Project Partnership, was at all times (and it is at the present time), ready, willing and able, to entertain any economically attractive offer from another party (including the U.S. partnership [Robotics] or a party introduced by the U.S. Partnership), which party is willing to acquire non-exclusive rights in the Technology, * * * (subject, of course, to any applicable requirements of the Chief Scientist in the Israeli Ministry of Commerce and Industry), * * *437 While Elco was willing to consider arrangements other than those contained in the project partnership agreement, it would not, even as late as January 1988, relinquish its option to become exclusive licensee under section 5(a)(iii).OPINIONSection 174 DeductionsSection 174(a)(1) states that "A taxpayer may treat research or experimental expenditures which are paid or incurred by him56 during the taxable year in connection with his trade or business as expenses which are not chargeable to capital account. The expenditures so treated shall be allowed as a deduction." Prior to the Supreme Court's decision in Snow v. Commissioner, 416 U.S. 500 (1974), such expenses incurred before the actual commencement of business were disallowed as nondeductible pre-operating expenses. See Best Universal Lock Co. v. Commissioner, 45 T.C. 1 (1965); Koons v. Commissioner, 35 T.C. 1092">35 T.C. 1092 (1961). Snow gave section 174 broad application vis-a-vis other sections of the Code containing the phrase "trade or business." As an example, the Court compared section 174 with section 162 stating that "Congress wrote into section 174(a)(1) 'in connection with,' and section 162(a) is more narrowly written than is section 174, allowing 'a deduction' of 'ordinary and necessary expenses paid or incurred * * * in carrying on any trade or business.'" Snow v. Commissioner, supra at 503.Following the Supreme Court's mandate, this Court held in Green v. Commissioner, 83 T.C. 667">83 T.C. 667, 686 (1984),57 that "the phrase 'in connection with a trade or business' used in section 174 should not be limited by other restrictive definitions of 'trade or business' which had been suggested for other sections of the Code." However, in order to take advantage of section 174,the taxpayer must still be engaged in a trade or business at some time, and we must still determine, through an examination of the facts of each case, whether the taxpayer's activities in connection with a product are sufficiently substantial and regular to constitute a trade or business * * [Green v. Commissioner, supra at 686-687.]438 We went on to hold that the taxpayer's partnership could not have been engaged in a trade or business as it had disposed of all the incidents of ownership by assigning all its rights in the inventions in that case to a third party. See Green v. Commissioner, supra at 689. Following this assignment, the partnership's activities were purely ministerial; the taxpayers were no more than mere investors. After our decision in Green, we held in Levin v. Commissioner, 87 T.C. 698">87 T.C. 698 (1987),58 affd. 832 F.2d 403">832 F.2d 403 (7th Cir. 1987), that the grant of an exclusive license foreclosed the possibility that the licensor could be engaged in a trade or business in connection with the licensed product, as the licensor was deprived of control over the product. Levin v. Commissioner, supra at 726-727. The precise question here is whether section 5(a)(iii) constitutes a license of the type before us in Levin or, as petitioner argues, an option to acquire a license. That determination is to be made with respect to the project partnership. See Levin v. Commissioner, supra at 725.Respondent argues that this case is controlled by Green and the right granted to Elco by section 5(a)(iii) of the project partnership agreement, whereby Elco may become exclusive licensee with respect to any product of the research, is in reality a sale or exchange of all rights to any such product. Alternatively, respondent contends that section 5(a)(iii) is in substance an immediate grant of an exclusive license to exploit the robot and the result in Levin should apply here. Petitioner distinguishes Green59 by arguing that section 5(a)(iii) does not constitute a sale, but merely an option to acquire a license. Petitioner argues that Levin is distinguishable since there is a possibility that Elco will not exercise its right, and the door will be open for the project partnership or Robotics to exploit the results of the research. Petitioner contends that the project partnership need not have past or current sales in order to be considered to be engaged in a trade or business. Petitioner further argues, citing Green, that the project partnership need only be "capable of engaging in a trade or business at some time." We find petitioner's arguments to be without merit as applied to the facts of this case, and hold for respondent on this issue.439 In Levin, we found it unnecessary to determine whether the transfer of rights by the licensor constituted sales of the inventions to the licensee, since "even if the agreements granted only licenses, they deprived the partnerships of control over the manufacture, use, and sale of the developed machines for virtually the entire lives of the partnerships * * ." Levin v. Commissioner, supra at 726-727.60 Respondent urges us to find such a license here. However, we need not determine whether section 5(a)(iii) is the equivalent of such a license, since even if it does constitute an option, there is no realistic prospect that the robot would ever be exploited in any trade or business carried on by any one other than Elco. In so holding, we adopt the reasoning of the Seventh Circuit in Spellman v. Commissioner, 845 F.2d 148">845 F.2d 148 (7th Cir. 1988), affg. a Memorandum Opinion of this Court.The facts in Spellman are somewhat similar to the facts before us. In Spellman, the taxpayer was a limited partner in Elmer South, which was a limited partner in Sci-Med, whose general partner was an Israeli corporation. The agreement creating Sci-Med provided that Sci-Med would enter into a research and development agreement with Teva, 15 to which it would contribute $ 855,000 for the development of new antibiotics. Teva was to have the exclusive right to market the antibiotics developed as part of the specific project, and Sci-Med was to become the owner of any byproducts developed under the agreement which were not developed as part of that project. Teva was61 given the exclusive right to use those byproducts in connection with the exploitation of the antibiotics developed as part of the project, and was given the further option to purchase the remainder of Sci-Med's rights in these byproducts for $ 20,000. Citing Green, this Court held that the exclusive license agreement "effected a relinquishment * * of Sci-Med's proprietary interest and substantial rights in the results of the research and development venture." Spellman v. Commissioner, T.C. Memo. 1986-403, 52 T.C.M. (CCH) 298">52 T.C.M. 298, 306-307, 55 P-H Memo T.C. par. 86,403 at 1824 (fn. ref. omitted). 1662 440 The Seventh Circuit affirmed, not on the basis of the exclusive license agreement, but rather because of the substance of Teva's option to purchase the byproducts of the research. The court posed a hypothetical situation in which Sci-Med financed Teva's research and development in exchange for a royalty interest, stating that such financing would be a capital contribution and not deductible. The court went on to say that:The only difference between the hypothetical case and our case is that Sci-Med had a prospect of recovering not only royalties but also byproducts, and if that happened and it decided to develop the byproducts rather than sell or license their development to another firm like Teva, it would be in the pharmaceutical business. But this prospect was remote, and not only because Sci-Med presented no evidence that it has, or is likely ever to acquire, a staff, relevant experience, or anything else indicating a likelihood or intention of entering the business. Whatever Sci-Med's desires, Teva's option to acquire for only $ 20,000 all rights in the byproducts will prevent Sci-Med as a practical matter from ever entering the pharmaceutical business as a result63 of the venture with Teva. If the byproducts turn out to be worth more than $ 20,000, Teva will exercise the option and Sci-Med will have no products to make or sell; if the byproducts turn out to be worth less, Sci-Med will have the right to market them but will not exercise the right because the costs would exceed the possible profits. * * [Spellman v. Commissioner, 845 F.2d 148">845 F.2d 148, 150-151 (7th Cir. 1988).]We think this reasoning is sound and equally applicable to this case. Elco was not required to furnish additional consideration to the project partnership or Robotics, and could exercise the option granted by section 5(a)(iii) at any time. In the exercise of sound business judgment, Elco would surely exercise its right under section 5(a)(iii) if the project was anticipated to be profitable enough to justify incurring the costs of manufacturing and marketing the robot. Elco would already have in place part of the infrastructure necessary for it to pursue those activities, since Elco was itself a high technology firm, and it and/or its subsidiary performed the research and development work. However, should the robot appear to be unprofitable, 64 Elco would decline to exercise its rights under section 5(a)(iii), leaving the project partnership or Robotics with the right to develop an asset whose costs would not appear to 441 justify additional investment. Absent Elco's participation, neither of these parties would have the necessary infrastructure to undertake to manufacture the robot, although Robotics' general partners, Yaakov and Goldman, had the expertise and contacts necessary to secure the robot's manufacturing and marketing through other channels if it could be done profitably.We are mindful of the fact that here, unlike Spellman, we are not presented with a situation in which petitioner has presented "no evidence that [the Project Partnership or Robotics] has, or is likely ever to acquire, a staff [or] relevant experience." Spellman v. Commissioner, supra at 150-151. Robotics' general partners had an abundance of relevant experience, which they could presumably employ to assemble a staff. However, the Seventh Circuit found in Spellman that the lack of such resources was not the factor that was fatal to the taxpayer's case, but that "whatever Sci-Med's desires," it would65 have the opportunity to engage in a trade or business with respect to the byproducts only if it was uneconomical to do so. Taxpayer there, as petitioner here, is prevented from engaging in the particular trade or business either by the law of contracts or the laws of economics.Petitioner points to Slavitt's testimony concerning his experience with Israeli enterprises and the difficulty they encountered upon attempting to penetrate the U.S. market. 17 From this, petitioner argues that Robotics was to employ its general partners, Goldman and Yaakov, to alleviate similar problems as they might arise in the course of exploiting the robot in the U.S. However, this does not necessarily place Robotics in any trade or business in connection with the robot. Elco had its own plan with respect to Robotics' participation in the exploitation of the robot in the United States, which was to give Robotics an equity interest in any entity incorporated in the United States or Israel subsequent to Elco's exercise of its rights under section 5(a)(iii). According to the Robotics partnership agreement, that corporation was also to have an exclusive 442 license with respect to the robot. 1866 As Robotics would be no more than a shareholder in any such corporation, any marketing activities undertaken by Goldman or Yaakov would necessarily be in the capacity of independent third parties.Petitioner argues that, notwithstanding the terms of the project partnership agreement, Robotics expected to, and did, take an active role in the management of the Project and promotion of the optic sensing device. Petitioner points out that although they were general partners of the project partnership's limited partner, Goldman and Yaakov were heavily involved in managing and directing the project, and expected to be similarly involved to an even greater extent in the project's later years. Additionally, Slavitt testified that Robotics, through its general 67 partners, was at the time of trial negotiating with a Belgian company for the sale of the robot, and that negotiations were taking place between Robotics and Elco for a sharing of profits apart from the project partnership agreement.We find petitioner's arguments unpersuasive. First of all, while alteration of the contractual relationship 19 between Robotics and Elco may at some point more closely align Robotics with the trade or business of marketing the robot, there remained the restrictions placed by the Israeli Government upon the robot's exploitation. Under the terms of the chief scientist agreement, only Elco in its independent capacity could obtain any patent with respect to the project, or transfer any patent or technology out of Israel without that Government's permission. Finally, in the event that Elco decided not to exploit the technology, the rights to such technology would pass to the Israeli Government at the end of 7 years after the expiration of the chief scientist agreement, including any extensions.68 Any such amendments to the project partnership agreement, even if consummated, cannot alter the position of Robotics in the year before the Court. According to Slavitt's testimony, negotiations for such amendments took place a mere 4 to 5 months prior to trial. Petitioner has not shown that any such alteration in the relationship between 443 Robotics and Elco was contemplated or foreseeable in the years before the Court. 20 Even if such were the case, our decision should be based upon the facts as they existed at the beginning of the transaction, and our analysis should not be based upon hindsight. Taube v. Commissioner, 88 T.C. 464">88 T.C. 464, 480 (1987). In the absence of the consummation of any amendment to the project partnership agreement, even hindsight does not afford a view of the facts that is inconsistent with our holding. See Levin v. Commissioner, supra at 406 n. 3.69 It is a most fundamental principle of tax law that the substance of a transaction controls over its form. While we recognize that "the tax laws affect the shape of every business transaction," James v. Commissioner, 87 T.C. 905">87 T.C. 905, 918 (1986), "the question for determination is whether what was done, apart from the tax motive, was the thing which the statute intended." Gregory v. Helvering, 293 U.S. 465">293 U.S. 465, 469 (1935). As the Supreme Court noted in Snow v. Commissioner, 416 U.S. 500 (1974), the purpose of the statute was "somewhat to equalize the tax benefits of the ongoing companies and those that are upcoming and about to reach the market." Snow v. Commissioner, supra at 504. The purpose of section 174 was not to elevate the status of mere investors in those companies, be they shareholders, limited partners, or otherwise. The substance of the transaction before us is that Elco the independent corporation had complete control over the research and development phase of the project through its subcontracts with the project partnership pursuant to section 5(a)(ii) 70 of the project partnership agreement. Section 5(a)(iii) extended such control to the production and marketing of the robot. Elco left no room for Robotics or any other party to have a say in the affairs of the project. An entity with no control over activities in which it invests is more properly classified as an investor and cannot be engaged in a trade or business in connection with those activities.444 Other DeductionsPetitioner contends that Robotics is entitled to deductions for consulting fees paid to Worldtech and IDC, guaranteed payments to partners for management services, and legal fees. Petitioner also contends that Robotics is entitled to amortize its organizational expenses over a 60-month period pursuant to section 709(b). The burden of proof is on petitioner. Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1930).We find that Robotics is entitled to deduct only a portion of the fees paid to Worldtech and IDC. Robotics made payment in full in 1981 and 1982 for services to be performed by both of these corporations over periods extending past the years in which payment was made. Payment in advance for services to be in the future71 "results in the creation of an asset" which is to be exhausted ratably over the term for which the payment was made. Higginbotham-Bailey-Logan Co. v. Commissioner, 8 B.T.A. 566">8 B.T.A. 566, 577 (1927). In the case of fees paid to Worldtech, those services were to be rendered over a period of not more than 50 months (November 1981 through December 1985). Robotics is therefore entitled to a deduction equal to 2 percent of such fees for each of the 14 months in which it was in business in 1981 and 1982. Similarly, the services for which IDC was paid in 1981 and 1982 were to be rendered over Robotics' lifetime, which was to run from December 1981 through December 2031, a period of some 50 years. Robotics is therefore entitled to a deduction equal to 2 percent of such fees for each year before the Court.On its 1981 and 1982 Form 1065 partnership tax returns, Robotics deducted $ 174,800 and $ 135,800, respectively, as guaranteed payments to partners. In order for such payments to be deductible under section 707(c), they must meet the requirements of section 162(a). Further,In determining whether the payments in the present case are deductible under section 162(a), 72 we look to the nature of the services performed by the general partners rather than to their designation or treatment by the partnership. * * Payments allocable to organizational costs and syndication expenses must be capitalized. Organizational costs, if elected, are amortizable over a 60-month period, but syndication costs are not 445 amortizable. Secs. 263, 709 * * [Durkin v. Commissioner, 87 T.C. 1329">87 T.C. 1329, 1388-1389 (1986).]Respondent argues that such fees are, in whole or in part, organizational or syndication expenses. The burden of proving what portion of the fees is deductible or amortizable is upon petitioner. Durkin v. Commissioner, supra at 1389. However, the record contains little to assist us in determining the purpose for such expenditures. While we believe that some of the management fees paid by Robotics were for ordinary and necessary expenses with respect to its general partners, we are convinced that some of those fees constitute either syndication or organizational expenses or unreasonable compensation. However, we are wholly unable to determine the extent to which the management fees73 fall into either category. Petitioner has provided us with no basis even to estimate under the rule of Cohan v. Commissioner, 39 F.2d 540">39 F.2d 540 (1930), what portion of the guaranteed payments are deductible. See Conforte v. Commissioner, 74 T.C. 1160">74 T.C. 1160, 1188 (1980), affd. in part, revd. in part, and remanded without discussion of this issue 692 F.2d 587">692 F.2d 587 (9th Cir. 1982). To the extent such fees were for expenses incurred or compensation earned before December 15, 1981, they are nondeductible organization or syndication fees. To the extent that such fees are for management services which are already the subject of the Worldtech and IDC contracts, they are duplicative and therefore constitute unreasonable compensation. While respondent argues for the disallowance of such deductions, he also states that such expenses should be capitalized as either organizational or syndication expenses. As petitioner has not shown that any of such expenses should be amortized pursuant to section 709(b), we agree with respondent that such expenses should be capitalized.Petitioner deducted his distributive share of 74 Robotics' organizational expenses which Robotics elected to amortize over a 60-month period pursuant to section 709(b). Robotics claimed deductions for these expenses of $ 1,184 in 1981 and $ 7,102 in 1982. Respondent asserts that because Robotics was not engaged in a trade or business during the years before the Court, it was not yet entitled to begin amortizing these expenses. Respondent's reliance on Aboussie v. 446 , 779 F.2d 424">779 F.2d 424 (8th Cir. 1985), in this regard is misplaced. A partnership is not required to be in a trade or business in order to begin business for purposes of section 709. Section 1.709-2(c), Income Tax Regs., states that a partnership "begins business when it starts the business operation for which it was organized." Robotics' business was investing in the project partnership, which it began in December 1981. As Robotics' election to do so was timely and proper, we find that such organizational expenses were properly amortized.Petitioner also claims as deductions his distributive share of the following expenses of Robotics:19811982Legal fees$ 53,533Accounting expenses285$ 4,00021 Office expenses 1,03975 Respondent disallowed these deductions on the grounds that they were either organization fees which may be amortized over 60 months pursuant to section 709 or nondeductible, nonamortizable syndication fees.Petitioner seeks to allocate the legal expenses between securities advice and tax advice and seeks to introduce into evidence letters from the various counsel who performed those services. Respondent has objected to this correspondence on hearsay grounds. However, it is unnecessary to rule on respondent's objection, since petitioner has not proven that any portion of those fees is allocable to expenses other than for promotion of the sale of partnership interests.While expenses for advice in connection with the determination, collection, or refund of any tax is generally deductible under section 212(3), section 709 and the regulations thereunder76 22 require that all expenses connected with the issuing and marketing of interests in the partnership must be capitalized. Expenses for tax advice fall into that category when the opinion thereby gained is "an integral part of the offering prospectus and was * * included therein to facilitate the sale of partnership interests." 447 Surloff v. Commissioner, 81 T.C. 210">81 T.C. 210, 245 (1983). The tax opinion afforded potential investors in this case was contained in the private placement memorandum itself. Further, the claimed legal expenses were incurred only in 1981, the year Robotics was organized. Finally, petitioner did not produce any time records from those persons or firms rendering legal advice showing with particularity how their time was allocated. 23 Petitioner has therefore not shown that any legal fees were related to matters other than the sale of partnership interests; we therefore find that Robotics' legal fees must be capitalized.77 We find that Robotics is entitled to its claimed expenses for accounting fees. The fees are relatively small in amount, and were incurred in both of the years before the Court. They do not strike us as unreasonable when compared with the services required on a year-to-year basis. We find for petitioner on this issue.Respondent has determined that petitioner is liable for an addition to tax pursuant to section 6659 because of a valuation overstatement. As was the case in Smith v. Commissioner, 91 T.C. 733">91 T.C. 733, 766 (1988), "We have disallowed the * * * deductions in issue because we have concluded that the partnerships were not in a trade or business that would support the deductions claimed." Here, the underpayment was not attributable to a valuation overstatement and we therefore find for petitioner on this issue.Respondent has also determined that petitioner is subject to increased interest pursuant to section 6621(c). That section states that interest shall accrue at the rate of 120 percent of its normal rate with respect to any substantial underpayment attributable to tax-motivated transactions. Such transactions include "any use of an accounting78 method specified in regulations prescribed by the Secretary as a use which may result in a substantial distortion of income for any period." Section 6621(c)(3)(A)(iv); section 448 301.6621-2T, Q&A-3(4), Temporary Proced. and Admin. Regs., 49 Fed. Reg. 50391 (Dec. 28, 1984), include within that category of tax-motivated transactions "Any deduction disallowed for any period under section 709." We have disallowed all of Robotics' claimed management fees/guaranteed payments and legal fees on the grounds that petitioner has not shown that respondent is incorrect in his determination that such expenses should be capitalized pursuant to section 709. We hereby direct the parties to determine in connection with their Rule 155 computation whether the underpayment attributable to those items exceeds $ 1,000, thereby constituting a "substantial underpayment attributable to [a] tax motivated transaction" under section 6621(c). If so, increased interest is applicable to that extent.In accordance with the foregoing,Decision will be entered under Rule 155. Footnotes1. All section references are to the Internal Revenue Code of 1954 as amended and in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. Madelene Diamond is a petitioner herein solely by reason of having signed a joint Federal income tax return with her husband. All further references to petitioner are to Louis Diamond.↩3. Each general partner's capital contribution included $ 7,223.33 which was the proceeds of a loan from the Industrial Development Bank of Israel, Ltd., as described more fully below with reference to petitioners.↩4. The project partnership's general partners were to perform certain services as set forth in the project partnership agreement. As Goldman and Slavitt were the only persons performing such services on behalf of G-B Energy and Capital, all further references to the Project Partnership's general partners are to Yaakov, Goldman, and Slavitt.↩5. Slavitt defined an OEM contract as an arrangement whereby a company would market an Israeli product under its own name and label.↩6. It is unclear on this record why this agreement is dated May 1, 1981, when it appears from Slavitt's testimony that the decision to go forward with the project had not been made even as late as August of that year. Neither is it apparent when Robotics was first organized with the one limited partner who served in that capacity until investors were found. We think the probable scenario is that Slavitt found what he thought to be a good investment, both from a profit and tax standpoint, set up the partnership structure, and found investors after securing Elco's commitment. The sequence of these events, however, has little bearing upon the resolution of this case.↩7. Robotics' investment was defined by the preamble of the project partnership agreement to include amounts loaned by the office of the chief scientist as described below.↩8. In order for this equity conversion option to be exercisable, such licensee was required to (1) make a public offering of its shares in the United States; (2) cause the shares allotted to Robotics to be registered with the Securities and Exchange Commission; and (3) cause such shares to be allotted to Robotics immediately after the public offering. The percentage of Robotics' equity participation was to be fixed by calculating the ratio which the amount of Robotics' investment bore to the total price of the public offering, which was to be reduced to the extent Robotics had received certain distributions from the project partnership prior to the exercise of the equity conversion option. In the event that Elco exercised the equity conversion option, Robotics' right to receive "Fees" from Elco as exclusive licensee of the project would be reduced to 0.3 percent of all gross receipts received during the 10 years following its exercise. Elco could elect to exercise the option to the extent of less than 100 percent of Robotics' interest, in which case Robotics' right to receive "Fees" would be reduced only to the extent that the equity conversion option was exercised. An example given in the project partnership agreement stated that "such reduced fee shall be 0.18%, in lieu of 0.3%, if only 60% of said right is converted * * * 40% of the Fees * * * will continue to apply if 60% of said right is converted."↩9. "Capital Transactions," "Stock Transactions," and "Continuing Royalty Payments" were defined in the Robotics partnership agreement as follows:"Capital Transaction" means a disposition by [Robotics] of any interest in a Project Partnership; a refinancing by [Robotics], insurance award received by it or similar transaction which is attributable to capital in accordance with generally accepted accounting principles; or a distribution received by [Robotics] from a Project Partnership which, in accordance with generally accepted accounting principles, is attributable to a capital transaction of such Project Partnership.* * * "Stock Transaction" means the stock or equity to be distributed to [Robotics] pursuant to the option granted to Elco, * * to convert all or any part of [Robotics'] right to royalty payments from the Project into a stock or equity participation in a publicly held company to be incorporated in the United States or Israel (the "New Company"). Such New Company would receive an exclusive license with respect to the Invention developed by the Project Partnership and such New Company would make a public offering of its shares. In addition to receiving stock in the New Company, the Limited Partners of [Robotics] would receive a continuing royalty payment for ten (10) years in such amount as set forth in the Project Partnership Agreement (the "Continuing Royalty Payment").↩10. Sheltered Investments, Inc., was wholly owned by Slavitt.↩11. Robotics' original limited partner was liquidated upon the admission of the investing limited partners. The original partnership agreement was not offered into evidence.↩12. Yaakov owned only a 10-percent interest in Worldtech when it was first formed, its major shareholders being one American and two Israeli corporations. He later acquired two-thirds of the stock of that company.↩13. Slavitt was IDC's sole shareholder.↩14. Robotics' existence could be extended by unanimous consent of all general and limited partners, or could be shortened as provided in the Robotics partnership agreement or by operation of law.↩15. Teva was the parent corporation of Sci-Med's general partner, Ikapharm.↩16. We were faced with a similar option in Moore v. Commissioner, T.C. Memo 1989-38">T.C. Memo. 1989-38, and found that its exercise "was either predetermined or inevitable." However, we scrutinized the transaction therein as a "generic tax shelter," Rose v. Commissioner, 88 T.C. 386↩ (1987), and held for respondent on the basis that it was primarily tax-motivated.17. While we excluded Slavitt's testimony to the effect that this was a phenomenon common to all Israeli companies, we think that the testimony that was admitted proves essentially the same point, although it is relatively unimportant.↩18. See note 9, supra↩.19. There was no evidence that any such alteration had been consummated.↩20. As stated by the Court of Appeals in Levin v. Commissioner, 832 F.2d 403">832 F.2d 403, 406 (7th Cir. 1987), affg. 87 T.C. 698">87 T.C. 698↩ (1986), "Even a firm that has surrendered by contract all rights to the product * * * may renegotiate the contract; in this sense every investor has the 'potential' to be a manufacturer."21. Respondent has not contested petitioner's entitlement to deductions for a distributive share of Robotics' office expenses and is deemed to have conceded the issue.↩22. See sec. 1.709-2(b), Income Tax Regs.↩23. Petitioner did produce a bill from the law firm which performed the greatest part of the legal work for the transaction. That bill separated the fees into three parts: advice pertaining to tax matters ($ 45,000), advice pertaining to securities matters ($ 10,000), and organizational matters ($ 20,000). This latter category was stated to include services which were clearly syndication costs, such as preparation of the "Offering Memorandum and Investor Subscription Booklet." In the absence of proof to the contrary, we find that any organizational costs included in this category are included in the organizational expenses claimed by Robotics which we have allowed to be amortized over a period of 60 months.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624535/	Holsey Auto Sales, Inc. v. Commissioner.Holsey Auto Sales v. CommissionerDocket No. 12756.United States Tax Court1948 Tax Ct. Memo LEXIS 170; 7 T.C.M. (CCH) 351; T.C.M. (RIA) 48101; June 8, 1948Edward E. Burke, C.P.A., 921 Bergen Ave., Jersey City, N.J., for the petitioner. Jonas M. Smith, Esq., for the respondent. OPPERMemorandum Findings of Fact and Opinion OPPER, Judge: By this proceeding petitioner seeks a redetermination of deficiencies for 1943 as follows: Income Tax$ 94.84Declared Value Excess-Profits Tax388.54Excess-Profits Tax3,732.92The only question before us is petitioner's right to capitalize and use in its 1943 opening inventory costs paid in 1942 on cars held by it subject to Government restrictions on sale, these costs having been deducted in 1942. The parties submitted171 a stipulation of fact and evidence was adduced at the hearing. Findings of Fact The stipulated facts are hereby found ccordingly. Petitioner, a New Jersey corporation, was organized in February, 1927. It filed its Federal tax returns for the period in question with the collector of internal revenue for the fifth district of New Jersey at Newark. Petitioner was a dealer in new Chevrolet automobiles. On December 31, 1941, the Federal Government restricted the sale of new automobiles. On December 31, 1942, petitioner had on hand 49 new Chevrolet automobiles. During 1942 it made the following expenditures in relation to these cars: Storage$2,200.00Preparing cars for storage392.00Monthly check-up1,100.00Materials used72.03Interest on financing1,349.98$5,114.01The closing inventory used in the 1942 income and declared value excess-profits tax return filed by petitioner on March 15, 1943, did not include the $5,114.01 above mentioned. In petitioner's 1942 income and declared value excess-profits tax return (executed March 13, 1943, and receved for filing March 15, 1943) $5,114.01 was claimed as a deduction from gross income as operating172 expense and was allowed by respondent. Petitioner has not filed an amended income and declared value excess-profits tax return for 1942. No agreement has been executed extending the statutory period in which such taxes for 1942 would be assessed. On March 1, 1943, a letter signed by T. Mooney, Deputy Commissioner of Internal Revenue, was addressed to James A. Councilor and Company, Tower Building, Washington, D.C. It stated as follows: "In re: Automobile dealers - Capitalization of carrying charges. "Sirs: "Reference is made to your letter of October 29, 1942, with respect to inquiries received from automobile dealers who are members of the National Automobile Dealers' Association, regarding the capitalization of carrying charges on new automobiles being financed by loans from the Reconstruction Finance Corporation. "In view of the Federal restrictions with respect to the disposition of new automobiles and in order to clearly reflect the income of the dealers affected thereby, it is the opinion of this office that such dealers may, at their option, include in their inventories of new cars warehouse and maintenance expenses applicable thereto which have been incurred subsequent173 to the imposition of the restrictions referred to." Petitioner was not a member of the National Association of Automobile Dealers. During the calendar year 1943 petitioner was a member of the New Jersey Automotive Trade Association. On March 9, 1943, that association prepared a "Bulletin 91," which was mailed to petitioner not later than March 10, 1943. The bulletin stated as follows: "DEALERS MAY CAPITALIZE CARRYING CHARGES ON FROZEN CARS "We have just received the following information from the NADA and hope it will reach you in time to be of benefit to those dealers who wish to take advantage of the ruling made March 1st by the Commissioner of Internal Revenue - "'Under date of March 1st the Commissioner of Internal Revenue made a ruling on the petition which we filed some time ago permitting automobile dealers to capitalize carrying charges in connection with their inventories of new automobiles. "'This gives the automobile dealer the opportunity of determining whether for tax purposes it is more advantageous for him to deduct in 1942 the expenses which he incurred in connection with new automobiles which he had in stock but did not sell in 1942. If he believes that174 his income will be greater in 1943 than in 1942 he is given the privilege of adding the expenses incurred on new automobiles which he still had on hand on December 31, 1942 to their inventory value. "'This, in effect, will carry those expenses into 1943 when they can be deducted upon the sale of those cars, thereby decreasing the net profit in 1943. Although the Office of Price Administration, in Price Schedule 85, permits dealers to add 1% of the list price each month to compensate them for carrying expenses, the Internal Revenue Department will not recognize the 1% as such and the dealer is permitted to capitalize only actual expenses incurred'. "The exact language of the ruling is: 'In view of the Federal restriction with respect to the disposition of new automobiles and in order to clearly reflect the income of the dealers affected thereby, it is the opinion of this office that such dealers may, at their option, include in their inventories of new cars warehouse and maintenance expenses applicable there-to which have been incurred subsequent to the imposition of the restrictions referred to'." Charles V. Holsey, who was the dealer and petitioner's president and manager, received175 all petitioner's mail personally, including the bulletins from the New Jersey Association. Petitioner's secretary and office manager did not receive the mail and did not see any of the bulletins. Prior to filing its returns for 1942 petitioner had knowledge of the above-described ruling by respondent. Petitioner first contacted the revenue agent with respect to its 1942 tax liabilities during August, 1944. The revenue agent began the audit of the 1942 returns during October of 1944. The examination resulted in a report dated January 3, 1945, in which it was stated that petitioner desired to capitalize the $5,114.01 charges "at this time in accordance with a Bureau ruling." The report continued: "These charges may not be capitalized at this time because the taxpayer did not exercise its option at the time of filing the original return." On April 4, 1945, petitioner filed a protest with the Internal Revenue Agent in Charge at Newark to the above-mentioned report, stating: "D. The years involved are 1941 and 1942. The Revenue Agent proposes additional income tax of $520.88 for 1941 and an overassessment of $2,198.53 for that year on Excess Profits Tax. He also proposes an additional176 tax of $98.96 on 1942 income tax. The taxpayer contends that there was no deficiency in the 1941 income tax and no overassessment of 1941 Excess Profits Tax. The taxpayer admits that there is a deficiency for the year 1942 and that such deficiency may have been greater than the amount stated by the Internal Revenue Agent. "E. The taxpayer takes exception to the statement of the Internal Revenue Agent that the right to inventory certain expenses with relation to new cars frozen by Government order, is to be denied the taxpayer because the option was not exercised at the time of filing the original return, and states that the ruling with relation to this matter did not require the exercising of such option at the time the original return was filed." The tax returns for 1942 and 1943 were executed by "Charles V. Holsey Pres." and the petitioner herein was verified by him. Opinion Fundamentally the technical question involved here is one of capitalizing or "expensing" costs of maintenance which petitioner as an automobile dealer was required to pay on cars that it could not sell expeditiously. On March 9, 1943, a ruling by respondent, dated March 1, was circulated, purporting to177 permit such dealers to choose which method they preferred. There is agreement that the methods are mutually exclusive. Petitioner shortly thereafter filed its 1942 return, in which the costs in question were deducted as a current expense. No amended return was filed. No effort was made to pay an additional tax for 1942. But when, by early 1944, petitioner came to file the return for 1943, the year now in controversy, it again deducted, this time as a capital item by adjustment to inventory, the same costs, which was tantamount to a comparable deduction for 1943, since all of the cars were sold in that year. Respondent raised no question as to the expense deduction for 1942, and the statute of limitations for the determining of any deficiency for that year has now expired. Petitioner being a corporation could act only through its authorized officers or employees. See Fletcher, Cyclopedia of the Law of Private Corporations, section 267. Receipt of the disputed notice is shown to have fallen in the province of petitioner's president. The exercise of any election or option resulting from the notice would likewise, at least in the absence of other evidence, more probably reside in its178 president than in any other officer. Asbury Park & Ocean Grove Bank v. Stoneham (Sup. Ct., New Jersey), 157 A. 650">157 A. 650; see Myrtle Avenue Corp. v. Mt. Prospect Bldg. & Loan Assn., 169 A. 707">169 A. 707, 708. But that officer was not called as a witness and we must, therefore, assume that his testimony, if given on these two matters, would have been favorable to respondent. Wichita Terminal Elevator Co., 6 T.C. 1158">6 T.C. 1158, 1165, affirmed (C.C.A., 10th Cir.), 162 Fed. (2d) 513. And that a different employee of petitioner testified is of no significance, and certainly fails to sustain its burden of proof where, as here, the record shows that he was not the one who would have had knowledge of the central issue of fact about which the case revolves. We have accordingly found as a fact, because the burden of proof otherwise has not been sustained by petitioner upon which it rested, that petitioner received due notice of its right to capitalize these deductions at its option; and that it deliberately and affirmatively elected instead to charge the items as current expense and to return its income accordingly. We do not for a moment suggest that any misstatements179 or falsifications of fact are attributable to petitioner's witness. But the testimony that he had no knowledge of the notice admittedly sent to petitioner, and the receipt of which would not normally have fallen in his jurisdiction is of no probative value in arriving at a conclusion on the sole issue of fact. This removes from consideration the legal questions which the controversy would otherwise present. Petitioner's contention that an option may not be exercisable in the absence of knowledge of its existence is deprived of factual support and, accordingly, its consideration becomes unnecessary. But see J. E. Riley Investment Co. v. Commissioner, 311 U.S. 55">311 U.S. 55. The ruling itself, as well as the statute 1 and pertinent regulations, 2 eliminate any doubt, even if one could otherwise exist, that the addition of the carrying charges to a taxpayer's inventory figure - that is, their capitalization - was an alternative to the current charge-off as an expense. The word used in the ruling is "option." Petitioner clearly exercised such an option when it deducted the item as an expense and charged it against current income. We need not consider whether it could subsequently180 have changed its position and elected to restore the item to income and add it to inventory since that was never done. Cf. Haggar Co. v. Helvering, 308 U.S. 389">308 U.S. 389. The statute of limitations having run against the earlier year, the sole relief available would be to permit petitioner a second deduction for an item of which it has already voluntarily taken the benefit. The result would be a double deduction which is not envisaged by statute, regulation, nor ruling. See Keystone Auto Club Casualty Co., 40 B.T.A. 291">40 B.T.A. 291, 308; supplemental opinion, 42 B.T.A. 356">42 B.T.A. 356, affirmed (C.C.A., 3rd Cir.), 122 Fed. (2d) 886; certiorari denied, 315 U.S. 814">315 U.S. 814. Decision will be entered for the respondent. Footnotes1. Internal Revenue Code, section 24(a)(7)↩; and cf. section 113(b)(1)(A). 2. Regulations 111, section 29.24-5.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624536/	ROBERT C. WIEDMAIER AND IRENE O. WIEDMAIER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentWiedmaier v. CommissionerDocket No. 7930-82.United States Tax CourtT.C. Memo 1984-540; 1984 Tax Ct. Memo LEXIS 130; 48 T.C.M. (CCH) 1350; T.C.M. (RIA) 84540; October 9, 1984. Jack M. Schultz and Thomas H. Bergh, for the petitioners. Joseph R. Goeke and Richard E. Trogolo, for the respondent. DAWSON MEMORANDUM OPINION DAWSON, Chief Judge:* Respondent determined the following deficiencies in petitioners' Federal income tax: YearDeficiency1978$2,27219792,00419804,233The only issue presented for decision is whether the retirement allowance received by petitioner Robert C. Wiedmaier in 1978, 1979 and 1980 is excludible from petitioners' gross income. This case 1 was submitted fully stipulated pursuant to Rule 122. 2 The stipulation of facts and joint exhibits are incorporated herein by this reference. The pertinent facts are summarized below. 132 Robert C. and Irene O. Wiedmaier 3 (petitioners), husband and wife, were legal residents of Harrisonville, Michigan at the time they filed their petition in this case. Petitioners filed timely joint Federal income tax returns for 1978, 1979 and 1980 with the Internal Revenue Service Center in Covington, Kentucky. On February 11, 1953, petitioner began working for the City of Detroit as a firefighter, at which time he became a participant in the City of Detroit Policemen and Firemen Retirement Systen (hereinafter Retirement System), which is included within the Charter of the City of Detroit. The Retirement System was adopted by the City of Detroit to provide retirement allowances and death benefits for policemen and firemen of the City of Detroit and their beneficiaries. 4 Pursuant to the provisions of the Retirement System, petitioner's creditable service with the City of Detroit did not begin until March 30, 1953. 133 On February 26, 1976, petitioner was injured in the course of his employment by the explosion of an air tank. His left arm was fractured and did not heal sufficiently to allow him to perform his job. Petitioner submitted an application for duty disability retirement. In support of his application he included material from the medical director of the City of Detroit.Pursuant to the provisions of Article VI, Part B, Section 1 of the Retirement System, this application was approved by the Board of Trustees of the Retirement System, effective June 6, 1977. Petitioner had not yet completed twenty-five years of service and therefore was subject to Article VI, Part B, Section 2(a) of the Retirement System. This section provided that petitioner would receive a disability benefit of sixty-six and two-thirds percent of his final compensation. His monthly benefit payment was $1,162.67. Petitioner did not report these payments as taxable income. Respondent does not contest petitioner's treatment of these payments. On November 21, 1977, in anticipation of petitioner's completion of twenty-five years of creditable service, he was notified that his benefits were to be reduced134 to equal fifty percent of his average final compensation pursuant to Article VI, Part B, Section 1 and Section 2(b), and Article VI, Part A, Section 2(b) of the Retirement System. Petitioner had to complete a new application for this "reduced disability allowance," which was computed in the same mannner as if it were a regular retirementallowance. Petitioner's monthly benefit was reduced to $687.95, effective March 30, 1978. As a result of this recomputation, petitioner received $6,191.55 in 1978, 5 $8,255.40 in 1979, and $14,519.37 in 1980. All monies were issued to petitioner by the Detroit Pension Board. Petitioners excluded these amounts from their gross income in computing their tax liability for those years. The parties agree that the initial payments for duty disability retirement received by petitioner until March 30, 1978 are excludible from gross income pursuant to section 104(a)(1). 6 The parties disagree, however, as to whether the payments received thereafter (during the remainder of 1978, and 1978 and 1980) are also excludible. 135 Petitioner contends that when he was approved for disability retirement under Article VI, Part B, Section 1 of the Retirement System 7 due to his service-connected injury, all resulting payments pursuant to Article VI, Part B, Section 2(a), of the Retirement System were in the nature of worker's compensation payments and hence excludible from his gross income. 136 Respondent contends that once petitioner completion twenty-five years of creditable service, his duty disability retirement terminated. Respondent notes that petitioner had to complete a new application for a "reduced disability allowance" under Article VI, Part B, Section 2(a) 8 and Article VI, Part B, section 2(b), of the Retirement System. 9 Petitioner's payments were then computed under the normal retirement provisions 10 and reduced to equal fifty percent of his average final compensation. 11 Respondent maintains that since petitioner's payments were recomputed as normal retirement benefits based upon his years of service, the recomputed payments are in reality pension benefits and are includible in petitioner's gross income. 137 Section 104(a)(1) 12 excludes from gross income amounts received under workmen's compensation acts as compensation for personal injuries or sickness. Respondent's regulations interpret section 104(a)(1) as applying to amounts received "under a statute in the nature of a workmen's compensation act which provides compensation to employees for personal injuries or sickness incurred in the course of employment." Section 1.104-1(b), Income Tax Regs.Exclusions from gross income are limited by section 1.104-1(b), Income Tax Regs. which provides in part that: [S]ection 104(a)(1) does not apply to a retirement pension or annuity to the extent that it is determined by reference to the employee's age or length of service, or the employee's prior contributions, even though the employee's retirement is occasioned138 by an occupational injury or sickness. * * Whether the applicable provisions of the Retirement System constitute a workmen's compensation statute is a question of fact. See Frye v. United States,72 F. Supp. 405">72 F. Supp. 405 (D.D.C. 1947). Section 1.104-1(b), Income Tax Regs., states clearly that if payments are determined by reference to one's years of service then the payments are not excluded from gross income. This mandate applies even in situations like that in the case before us where the employee's retirement is occasioned by an occupational injury. Sec. 1.104-1(b), Income Tax Regs.Petitioner was injured in the course of his employment and applied for duty disability retirement. He submitted supporting materials from the Retirement System's medical director. He was approved for duty disability payments based upon his disability. These benefits are clearly excludible under section 104(a)(1). 13139 In contrast, when petitionercompleted twenty-five years of service his payments were then computed under the provisions for a normal retirement allowance. His retirement payments would have remained the same regardless of whether he had suffered any disability because they were computed only with reference to his length of service. See Haar v. Commissioner,78 T.C. 864">78 T.C. 864 (1982), affd. 709 F.2d 1206">709 F.2d 1206 (8th Cir. 1983). In addition, petitioner's contention that we characterize as compensation for personal injury or sickness all retirement payments received by Detroit fire fighters who took disability retirement prior to completing twenty-five years of creditable service is contrary to the basic purpose of section 104(a)(1) which, as petitioner himself notes, is to prevent retirement payments from being excluded from income because they were disguised as disability payments. See e.g., McDonald v. Commissioner,33 T.C. 540">33 T.C. 540 (1959); Brown v. Commissioner,25 T.C. 220">25 T.C. 220 (1955). Therefore, we hold that what petitioner's Retirement System has labelled a "reduced disability allowance" that is computed with reference only140 to petitioner's length of service is in reality a pension benefit and is includible in petitioner's gross income. Alternatively petitioner argues that section 1.104-1(b), Income Tax Regs., is invalid. He contends that section 1.104-1(b), Income Tax Regs., is unreasonable and plainly inconsistent with the statute because it precludes an exclusion under section 104(a)(1)for any payment computed under a pension provision that makes reference to age or years of service. We cannot agree. Regulations are issued by the Treasury Department pursuant to the authority delegated by section 7805. While such regulations are not controlling, they must be sustained "unless unreasonable and plainly inconsistent with the revenue statutes." Commissioner v. South Texas Lumber Co.,333 U.S. 496">333 U.S. 496, 501 (1948); Edward L. Stephenson Trust v. Commissioner,81 T.C. 283">81 T.C. 283, 287 (1983). Section 1.104-1(b), Income Tax Regs., is not unreasonable or "plainly inconsistent" with section 104(a)(1). Section 104(a)(1) excludes disability payments, not pension payments from income. Section 1.104-1(b), Income Tax Regs., acts to prevent pension payments that are disguised141 as disability payments from being excluded under section 104(a)(1). If a retirement provision is meant to compensate employees for their disability and not for their creditable service, then payments are computed with regard to the injured employee's disability, not with regard to the number of years that the employee has worked for the organization. See Dyer v. Commissioner,71 T.C. 560">71 T.C. 560 (1979). Otherwise, the payments received serve to retire a veteran employee and to reward him for his years ofservice, instead of compensating him for a service-connected disability. To reflect the foregoing, Decision will be entered for respondent.Footnotes. By order of the Chief Judge, this case was reassigned from Judge Herbert L. Chabot to Chief Judge Howard A. Dawson, Jr.↩ for disposition.1. Petitioners originally filed their petition with this Court requesting that this case be heard as a small tax case. Thereafter, respondent filed a motion to remove the small tax case designation. This motion was granted on May 21, 1982. ↩2. All rule references are to the Tax Court Rules of Practice and Procedure.↩3. With respect to the items at issue herein, Irene O. Wiedmaier is a petitioner only because she filed a joint return with her husband. References to petitioner are intended to refer to Robert C. Wiedmaier.↩4. Under the Michigan Workers' Disability Compensation Act (MWDCA) when city employees elect benefits under the municipal charter, they are excluded from coverage under the MWDCA.↩5. This payment does not include the $1,162.67 monthly benefit payment received by petitioner through March 1978.↩6. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩7. Article VI, Part B, Section 1 provides: B--TOTAL DISABILITY PENSION AND RETIREMENT ALLOWANCES. SEC. 1. DUTY DISABILITY. If a member shall become totally incapacitated for duty by reason of injury, illness or disease resulting from performance of duty and if the Board of Trustees shall find such injury, illness or disease to have resulted from the performance of duty, on written application to the Board of Trustees by or on behalf of such member or by the head of his Department such member shall be retired; provided, the Medical Director, after examination of such member, shall certify to the Board of Trustees his total incapacity. If said member was separated from service after the filing of the written application, and he had attained 25 years or more of service prior to the date of separation, the Board of Trustees shall retire said member, under this Part B.↩8. Article VI, Part B, Section 2(a) provides: SEC. 2. BENEFITS. A member * * * retired under Section 1 above shall receive the following benefits: (a) if such member shall not at the time of his retirement have a total of twenty-five years of creditable service, he shall receive a disability pension of sixty-six and two third per cent of his final compensation at the time of his retirement. ↩9. Article VI, Part B, section 2(b) provides: (b) If such member, at the time of his retirement, shall have a total of twenty-five years or more of creditable service or on the expiration of the period when a member retired and receiving benefits under (a) above would have such total had he continued in active service, he shall receive a reduced disability allowance computed in the same manner as the allowance provided in Part A of this Article with optional benefits as provided in Part H of this Article. ↩10. Petitioner's payments were determined by reference to Article VI, Part A, Section 2 which provides: SEC. 2. AMOUNT OF ALLOWANCE. Upon his retirement from service, a member * * * shall receive a straight life retirement allowance which shall consist of the benefits provided in paragraphs (a) and (b) below * * * (a) An annuity which shall be the actuarial equivalent of his accumulated contributions standing to his credit in the Annuity Savings Fund at the time of his retirement; and (b) A pension, which when added to his annuity, will provide a straight life retirement allowance equal to two per cent of his average final compensation, multiplied by the number of years, and fraction of a year, of his creditable service, not to exceed twenty-five years; * * * ↩11. Average final compensation is defined in Article II, Section 14(a) as follows: Sec. 14. (a) With respect to a member * * * "average final compensation" shall mean the average, earnable compensation of a member for service as a Policeman or Fireman during his last five years of service; or if he has less than five years' service, then his average final earnable compensation during his total years of service; provided further, that the preceding shall be based on the annual rate of earnable compensation of a member on the rank and/or ranks held during the five year period selected as fixed by the budget for said rank or ranks at the time of termination of the member's employment.↩12. Section 104(a)(1) provides: (a) IN GENERAL.--Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable year, gross income does not include-- (1) amounts received under workmen's compensation acts as compensation for personal injuries or sickness;↩13. Due to agreement of the parties, we need not decide the tax treatment of the payments received by petitioner prior to his completing twenty-five years of service. However, we view these payments as presenting an opportunity to show a contrast between benefits that are excludible under section 104(a)(1) and those that are not. See also Rev. Rul. 80-14, 1 C.B. 33">1980-1 C.B. 33↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624538/	Illinois Water Service Company, Petitioner, v. Commissioner of Internal Revenue, RespondentIllinois Water Service Co. v. CommissionerDocket No. 100404United States Tax Court2 T.C. 1200; 1943 U.S. Tax Ct. LEXIS 8; December 24, 1943, Promulgated 8 Decision will be entered under Rule 50. Petitioner, a subsidiary of a holding company, acquired its properties in 1927 from X corporation, a subsidiary of another holding company, which had acquired the same properties in 1926 from Y corporation. Until 1935 and 1936 petitioner took the view that the basis of the property for purposes of depreciation deductions was the same as the original basis to Y corporation under the theory that the basis was not increased as a result of the transfers of the property in 1926 and 1927. In this proceeding, involving 1935 and 1936, petitioner claimed that the property had acquired a new basis in the transfer from X in 1927, or, in the alternative, in the transfer from Y in 1926. Under the facts, held, (1) that the transfer from X was pursuant to a reorganization and the basis to petitioner is the same as that of X; (2) that the transfer from Y was made pursuant to a plan which did not come within any of the provisions of sections 203 (b) or 203 (h) (1) of the Revenue Act of 1926, or within section 113 (a) (7) of the Revenue Act of 1932; (3) that the basis to petitioner is the cost to X, petitioner's transferor (section 204 (a) of the 19269 Act), which is the fair market value of the securities of X which were paid for by causing Y to transfer the property to X in 1926. Francis L. Casey, Esq., Richard H. Appert, Esq., and Russell D. Morrill, Esq., for the petitioner.Z. N. Diamond, Esq., for the respondent. Harron, Judge. Hill and Disney, JJ., concur only in the result. Murdock, J., concurring. Mellott and Kern, JJ., agree with the concurring opinion. HARRON 1201 The respondent determined a deficiency in income tax for the taxable years 1935 and 1936 in the respective amounts of $ 2,312.48 and $ 2,562.63.The main question, involving the determination of annual depreciation allowance, is whether respondent erred in determining that petitioner is not entitled to a stepped-up basis for property known as the Freeport property. He determined that the basis to petitioner was $ 744,797.23 for 1935, and $ 749,008.41 for 1936, representing the cost basis of such property to the original owner of the property, the Freeport Water Co. adjusted for subsequent additions and retirements. Respondent takes the view that petitioner's basis is the same as the basis in the hands of the transferor, 10 Peoples Illinois, which, in turn took the basis of its transferor, Freeport Water Co., because each transfer of the Freeport property was made pursuant to a tax free reorganization.Petitioner claims a stepped-up basis and a corresponding increase in the allowance for depreciation in the taxable years on the ground that the Freeport property was purchased in 1927 and acquired a new basis as a result. At the hearing, petitioner waived its contention that respondent erred in reducing the rate of depreciation from 2 1/2 to 2 percent in both years Petitioner claims that taxes for the years in question have been overpaid. Petitioner has filed claims for refund.Petitioner filed its returns for the taxable years 1935 and 1936 with the collector for the second district of New York.Some of the facts have been stipulated, and such stipulation of facts is adopted as part of the findings of fact and is incorporated by reference. Those facts appearing hereinafter which are not found in the stipulation are facts otherwise found from exhibits attached to the stipulation and from testimony introduced at the hearing.The property involved, referred to as the Freeport property, was originally 11 owned by the Freeport Water Co. In November of 1926 it was transferred to the Peoples Utilities Illinois Corporation, which in turn transferred the property to petitioner in September of 1927. Petitioner contends that in each transfer of the property the transfer was not within the nonrecognition provisions of the statute, so that the basis after each transfer in 1926 and 1927 was the amount paid for the property. Petitioner makes other contentions, in the alternative, in the event its primary contention is rejected.It is necessary first to consider th last transaction. Accordingly, the facts are set forth in inverse order, in point of time. The facts and opinion relating to the acquisition of the Freeport propery by petitioner from Peoples Utilities Illinois Corporation will be set forth first; and the facts and opinion relating to the acquisition of the same property by Peoples Utilities Illinois Corporation from the Freeport Water Co. will be set forth last.1202 I. Acquisition of Freeport Property by Petitioner.Facts. -- 1. Petitioner, an Illinois corporation, has its principal office at Champaign, Illinois. It was organized on November 26, 1926. During the 12 taxable years it engaged in the business of operating water service utilities in the cities of Freeport, Sterling, Streator, and Champaign-Urbana, in the State of Illinois, and it owned certain waterworks properties consisting of buildings, distributing systems, pumping stations, filter houses, reservoirs, wells, materials, tools, and plant equipment. Petitioner was a subsidiary of the Federal Water Service Corporation, a holding company, in 1935 and 1936.2. The W. B. Foshay Co., a Minnesota corporation (sometime referred to as "Foshay" hereinafter), having its principal office in Minneapolis, was engaged in an investment and management business in 1926 and 1927. It specialized in the sale of new issues of securities and in the ownership of common stock of public utility companies. During 1926 the Foshay Co. organized and developed the Peoples Light & Power Corporation, hereinafter called Peoples, which was a holding company which owned the controlling voting stock of subsidiary corporations in several states, including Indiana, Illinois, Wisconsin, Virginia, California, Washington, Oregon, Minnesota, and Arizona. The subsidiary companies owned and operated properties. Peoples13 Utilities Illinois Corporation, hereinafter called "Peoples Illinois," and Peoples Utilities Indiana Corporation, hereinafter called "Peoples Indiana" were subsidiaries of Peoples which owned all of the outstanding common stock (voting stock) of these companies. At the end of 1926 Peoples together with its subsidiaries constituted a holding company system. The Foshay Co. managed the business and operations of Peoples under a broad management contract. The Foshay Co. had developed the Peoples system.The plan of organization of the Peoples system was to organize new domestic corporations within the states where operating properties were acquired, and to vest the ownership of the operating properties in such domestic corporations, which in turn operated the properties and conducted a business of furnishing and selling public utility service to consumers. The securities of the domestic corporations were held entirely by Peoples, and Peoples in turn issued its own securities against the securities of the subsidiary companies. The assets of Peoples consisted solely of senior and junior securities of subsidiary corporations. Some of the securities of Peoples were sold to G. L. Ohrstrom14 & Co., a dealer in securities in New York City, sometimes referred to hereinafter as "the Ohrstrom Co." or as "Ohrstrom," for resale to the public, and some of the securities of Peoples which were received by the Foshay Co. in transactions with Peoples were sold to 1203 the public through Foshay's own selling organization. The Ohrstrom Co. was not connected with the Foshay Co.The Foshay Co. at the end of 1926 controlled Peoples through the ownership of substantially all of its class B common stock; it also owned some of Peoples' class A common stock, preferred stock, debenture notes, and the notes of some of the subsidiaries. During 1926 and 1927 Peoples' class B common stock was the sole voting stock of the corporation.The Foshay Co. managed Peoples and its subsidiaries in the following way: It had a management contract with Peoples which placed the direct management of the business of Peoples under the executive department of Foshay; Foshay could nominate the officers and directors of Peoples; it provided Peoples with an accounting service, purchasing service, advertising service, new business service, power engineering, inspection service, a corporation record service, 15 treasury department service, financial service, and engineering and construction service. It was paid for all of such services at agreed rates. Also, Foshay undertook the initial promotion of the acquisition of new utility properties by entering into contracts with owners to acquire the stock or the properties of outside utility companies with the intent of placing those properties in existing corporations which were subsidiares, or in new corporations which would be subsidiaries of Peoples.As of January 31, 1927, the consolidated balance sheet of Peoples and its subsidiaries showed assets of a total value of a little over $ 32,000,000, the bulk of which consisted of property, plants, equipment, land, and water rights valued at $ 22,568,263.3. The Foshay Co. and the Ohrstrom Co. were both concerned with the marketing of securities of the Peoples system. A disagreement arose between the two companies. In the early part of 1927 both companies recognized that their disagreements were serious. The Foshay Co. was willing to sell all of its control in Peoples to the Ohrstrom Co. Accordingly, the Foshay Co. and the Ohrstrom Co. executed a contract dated March 22, 1927, under which16 Foshay sold to Ohrstrom all of its interest in Peoples Light & Power Co., the holding company, for a stated money consideration. The agreement covered many details so that the Foshay Co. would step out of all relations with Peoples and its subsidiaries. Among other things, Foshay agreed to sell and Ohrstrom agreed to purchase 45,000 shares of Peoples' class B common stock (the total number of outstanding shares) and debenture notes of Peoples in the principal amount of $ 422,500 for $ 1,200,000; a maximum of 16,040 shares of Peoples' preferred stock, or a minimum of 15,840 shares, at $ 90 a share; a maximum of 8,860 shares of Peoples' class A common stock, or a minimum of 8,600 shares, at $ 24 per share. The maximum amount 1204 to be paid by Ohrstrom for stock and debentures of Peoples was $ 2,856,240. Foshay agreed, also, to sell to Ohrstrom all of the outstanding capital stock of Green Mountain Power Co., an outside company, for $ 247,500.There were certain pending contracts to which the Foshay Co. was a party, about 10 of them, under which Foshay was committed to purchase or had options to purchase the capital stock of outside utility companies in several states, or 17 certain properties, or the physical properties of the outside companies. Petitioner refers to these properties as the "May 3rd properties." All of these contracts were between the Foshay Co., as vendee, and the respective vendors, and no mention is made in the contracts of Peoples or of any of its subsidiary corporations. It had been the intent of Foshay to put the new properties into existing subsidiaries of Peoples, or into newly organized subsidiaries, which would issue their securities to Peoples and Peoples would in turn issue new securities of its own against the securities of the subsidiary corporations. It was also intended that Foshay would acquire the new securities of Peoples and would market them through the Ohrstrom Co. On December 31, 1926, Foshay offered to sell said new securities of Peoples to Ohrstrom. The above plan of Foshay to market new securities of Peoples in order to finance Foshay's contracts relating to the purchase of the "May 3rd properties" was not carried out. Rather, under the March 22 agreement, Foshay assigned to Ohrstrom all of its interest in those contracts and Ohrstrom itself was to proceed to purchase properties under the contracts.Under18 the above 10 contracts Foshay had options to purchase or was committed to purchase the following properties and securities: (a) All the physical properties of the Alturas Electric Power Co., an electric power company in California; (b) all the capital stock of the New Jersey Northern Gas Co., $ 75,000 par value, and not less than $ 243,000 principal amount of its bonds, or, all the physical property and assets of that company; (c) all the common capital stock of the Platteville Gas Co., a Wisconsin corporation, aggregating $ 40,704.71 par value, and all of its preferred stock, aggregating $ 15,000 par value; (d) all the common capital stock of the Citizens Gas Co.; (e) all of the properties owned by Consolidated Electric Light Co. at John Day and Canyon City, Oregon, consisting of electric light and power plants and distributing systems; (f) properties of the Prairie Power Co., an Oregon corporation, located at various places in Oregon, consisting of an electric light and power plant, a hydroelectric power generating station, and certain water rights; (g) properties of the Lakeview Water Co., an Oregon corporation, consisting of a waterworks plant at Lakeview, Oregon; (h) certain 19 properties in Oregon and California from N. P. Jensen, consisting of electric light and 1205 power plant and hydroelectric steam power generating station; (i) various pieces of land, water rights, and flowage rights located in Vermont and known as the "Green River Power Development"; and (j) certain property in Vermont owned by the Clyde River Power Co., in receivership.Foshay had paid about $ 567,443.83 under all these contracts in part payment of the respective consideration under each contract, and also had expended $ 57,449.03 out-of-pocket expenses in connection with the contracts and had incurred salary expenses of its own employees of at least $ 1,000. It was provided in the March 22 agreement with the Ohrstrom Co. that Foshay would assign to Ohrstrom both the contracts and the payments which had been made thereunder, and Ohrstrom agreed to reimburse Foshay for all of its cash advances, plus 6 percent interest, plus the above out-of-pocket expenses, salaries expense of $ 1,000, and reasonable costs of acquiring the contracts which Foshay had incurred but which had not yet been billed to Foshay or paid. Ohrstrom agreed to assume all obligations of Foshay under the contracts. 20 The Foshay Co. owned notes, made payable to its order, of subsidiary corporations of Peoples representing advances of money by Foshay to such subsidiaries. The total amount of the notes was $ 398,950.07. Foshay agreed to assign all of the notes to Ohrstrom, or its nominee, and Ohrstrom agreed to purchase the notes from Foshay for the principal amounts of the notes, plus accrued interest. None of these notes were notes of Peoples Illinois. They were notes of Peoples' subsidiaries in Arizona, Iowa, Minnesota, Wisconsin, and on the West Coast.Under the contract with Foshay, Ohrstrom was to pay Foshay a total amount of about $ 4,128,583, for everything.Foshay agreed to deliver to Peoples and its subsidiaries resignations of the officers and directors of the companies in the Peoples system and of other companies in which Ohrstrom acquired Foshay's interests, and to transfer the management of Peoples to Ohrstrom. Foshay and Ohrstrom were to give each other mutual releases.Foshay and Ohrstrom executed the March 22 agreement on March 22, 1927.On the same day as it executed the agreement, the Ohrstrom Co. assigned the March 22 agreement with the Foshay Co. to its subsidiary, the Federal21 Water Service Corporation, i. e., on March 22, 1927, pursuant to a separate agreement with Federal dated March 22, 1927. Ohrstrom assigned to Federal all its rights under the agreement with Foshay, and Federal assumed all of Ohrstrom's obligations and liabilities, except in one or two matters which are not material. Federal had been organized in 1926.1206 Under the terms of the March 22 agreement, the vendee made a down payment of $ 250,000 upon the execution of the agreement, and 45,000 shares of the class B stock of Peoples were deposited by Foshay in escrow as collateral to secure Foshay for the payment of further amounts until the total additional payments of $ 850,000 were made by the vendee, when the stock was to be released from escrow. However, by virtue of the down payment of $ 250,000, the vendee became the owner of the class B stock, subject to the escrow, with full power to vote the stock as stockholder. Accordingly, as assignee of the March 22 agreement, Federal acquired control of Peoples Light & Power Corporation and its subsidiaries through the ownership of all of the voting stock of that company on or about March 22, 1927.The agreement of March 22, 1927, 22 contained no provisions and made no reference whatsoever to the transfer of any physical properties owned by any subsidiary of Peoples to Ohrstrom or to any corporation controlled by Ohrstrom, or to any subsidiary of such corporation. It did not make any reference to the transfer by Ohrstrom, or any corporation it controlled, to Peoples or to any subsidiary of Peoples of any properties owned or to be acquired by Ohrstrom or any subsidiary of Ohrstrom. The March 22 agreement related to the sale by Foshay to Ohrstrom of the controlling interest in Peoples Light & Power Co., to the transfer of the management thereof to Ohrstrom, and to the assignment of several contracts to which Foshay was an original party.On and after the execution of the above agreement and the assignment thereof to Federal, Federal had the right to do whatever it wished to do in connection with the management of Peoples and its subsidiaries, and Foshay had no interest or concern whatsoever in the future of Peoples and its subsidiaries. In short, under the terms of the March 22 agreement, Federal purchased the controlling stock of Peoples and thereafter it was in full control of the whole Peoples utility system. 23 Whatever plans of its own Federal may have had with respect to what it would do with all or any part of the Peoples system, or with any particular properties held by Peoples or its subsidiaries, or with any new properties which Federal was to acquire from outside vendors or corporations after it had obtained control, was wholly within the discretion of Federal and was separate and apart from the terms of the March 22 agreement. The consideration which Federal paid to Foshay under the March 22 agreement was for nothing other than the particular stocks, securities, and interests which are described in detail in the agreement.4. Christopher T. Chenery, a practicing engineer, became interested in 1926 in developing a holding company system for water service companies. Throughout the United States small water service companies were still privately owned, and he believed they could be purchased 1207 and brought under a new holding company system. G. L. Ohrstrom, an investment banker and the owner of G. L. Ohrstrom & Co., was familiar with the financing of water companies. Chenery discussed his plan with Ohrstrom. Chenery and Ohrstrom organized the Federal Water Service Corporation, 24 hereinafter called "Federal," on June 21, 1926, under the laws of the State of Delaware, and they intended it to be a parent company owning the stock of subsidiaries.Originally all of the voting stock of Federal, class B common stock, was owned by G. L. Ohrstrom & Co. In the latter part of 1926 Chenery acquired stock in Federal, and after February 7, 1927, Federal's stock was owned by the Ohrstrom Co., 51,346 shares; Chenery, 13,650 shares; and directors, 4 shares; the total outstanding stock being 65,000 shares. Chenery owned 21 percent of the stock and the Ohrstrom Co. and directors owned 79 percent.Federal was a holding company and a management company. It was never intended that it would be an operating company, but it was the plan that Federal would own the controlling stock of subsidiary corporations which would be operating companies. The general plan was to purchase privately owned water properties in each state and to bring such properties together into a single, newly organized corporation within the state. It was never intended that Federal would own any physical properties. Chenery and his associates preferred to arrange a purchase directly of the physical properties25 from individual or corporate vendors, but if such procedure was not possible, the controlling stock of an outside corporation was purchased first and later the physical properties were transferred to a Federal subsidiary corporation and the outside corporation was dissolved. Pursuant to this plan of procedure, during 1926 and 1927, Federal arranged for the purchase of the controlling stock or the property and assets of several independent water companies and water and electric light companies in Indiana, New Jersey, West Virginia, Michigan, New York, Pennsylvania, Ohio, and other states and put the various physical properties into new subsidiary corporations of its own in those states. In all instances Federal owned the common stock of its subsidiaries. The senior securities of the subsidiaries' preferred stock and bonds were sold. The senior securities of subsidiaries were sold to the Ohrstrom Co. by Federal or by the subsidiary company, itself, and Ohrstrom resold the securities to the public.5. Shortly after its incorporation, Federal acquired for cash all the stock of Champaign and Urbana Water Co. (Champaign), and of Sterling Water Co. (Sterling). Also, Federal acquired26 99.32 percent of the stock of Streator Aqueduct Co. (Streator). All of these companies owned water properties in Illinois. Pursuant to its plan, on February 2, 1927, Federal caused Champaign, Streator, and Sterling to transfer all their properties to petitioner, which had been organized 1208 on November 26, 1926, in exchange for petitioner's stock and bonds, petitioner assuming the liabilities of the transferors. In the contracts covering the transfers of assets of the above companies to petitioner, it was agreed that after such transfer each company would cease to operate as a public utility company. The Illinois Commerce Commission ordered each of the three companies to cease operations as public utility concerns after transferring their properties to petitioner. Petitioner issued its stock as follows:Champaign5,907 sharesStreator 5,687 sharesSterling2,406 sharesTotal 14,000 sharesChampaign, Streator and Sterling immediately distributed part of petitioner's bonds and stock as a dividend to Federal, after which petitioner's stock was27 held as follows:Federal2,863 sharesChampaign3,560 sharesStreator5,556 sharesStreator minority stockholder1 shareSterling2,020 sharesTotal 14,000 sharesIn addition to issuing its stock to the above companies in payment for their respective assets bonds of petitioner were to constitute part of the consideration in the total principal amount of $ 2,100,000, part of which were to be issued direct to each company, in specific amounts, and part of which were to be retained by petitioner to be used to pay assumed liabilities of the companies. Accordingly, petitioner issued to the three companies a total of $ 264,000 of its bonds and sold to the Ohrstrom Co. $ 1,436,000 of its bonds, using the proceeds to pay the indebtedness of the other companies. Petitioner was to retain the balance of $ 400,000 of bonds until its earnings equaled 1 1/4 times the interest requirements of all of the outstanding bonds, and petitioner retained such amount of bonds.In July of 1927 Federal purchased from Streator's one minority stockholder the 1 share of petitioner's stock held by the estate of the individual.On September 22, 1927, Sterling distributed to Federal all of 28 the stock of petitioner which it held, 2,020 shares, as a dividend.On December 31, 1927, Champaign, Sterling, and Streator were dissolved, and as of that date Federal received as a final liquidating dividend from Champaign and Streator all of the stock of petitioner owned by each, namely, 45,580 shares, being new common stock into 1209 which petitioner converted 9,116 old common on September 23, 1927, as stated hereinafter.6. At some time prior to June 2, 1927, Federal purchased the securities or properties covered by some of the Foshay contracts, which petitioner calls the "May 3rd properties," to wit, the securities or properties of Alturas, New Jersey Northern Gas, Platteville Gas, Citizens Gas, Consolidated Electric Light, Prairie Power, N. P. Jensen (referred to in paragraph 3, supra, items a to f, inclusive, and h). Federal expended about $ 1,084,838.67 under the above contracts to acquire the above securities and properties. Federal also expended $ 307,290.19 to purchase the notes of the subsidiaries of Peoples to Foshay, as was required by the March 22 agreement. The total sum thus expended was $ 1,392,128.86, exclusive of some additional expenses which were 29 paid after June 30, 1927. Federal did not intend placing the physical assets of the above companies in any of its own subsidiaries because the properties were gas and electric properties. Federal intended putting these gas and electric properties into the Peoples system, which it controlled.On June 2, 1927, Federal offered to sell to Peoples all of the securities which it had acquired in Citizens Gas, New Jersey Northern Gas, Platteville Gas, and Jersey Shore Gas and demand notes of certain subsidiaries of Peoples issued against the acquisition of the properties of Alturas, Prairie Power, Consolidated Electric Light, and N. P. Jensen, in the total principal amount of $ 403,900, and notes of other subsidiaries of Peoples payable to Foshay in the total principal amount of $ 299,303.10, in consideration of the delivery to Federal, or its nominee, of all of the outstanding common stock and first mortgage 5 1/2 percent bonds of the Peoples Utilities Indiana and Peoples Utilities Illinois corporations. There were $ 205,000 bonds of Peoples Indiana and $ 650,000 bonds of Peoples Illinois. It was provided in the offer of June 2, 1927, also, as follows:It is also understood and agreed30 that, pending delivery to us [Federal] of the securities above mentioned, we may proceed with proper corporate proceedings looking toward the sale of the assets of Peoples Utilities Indiana Corporation and Peoples Utilities Illinois Corporation to Indiana Water Service Company and Illinois Water Service Company, respectively, subsidiaries of this corporation, and that you will cooperate with us in such proceedings provided, however, that no consummation of the sale of the assets of the foregoing companies shall be effective as long as the same shall be subsidiaries of your corporation as defined in the First Lien Indenture with The Equitable Trust Company of New York dated July 1, 1926. [Italics added.]Peoples accepted Federal's offer on June 2, 1927. On June 30, 1927, Federal acquired bonds and stocks of Peoples Illinois, pursuant to the terms of the June 2 agreement. Federal held the stock of Peoples Illinois until that corporation was dissolved on December 31, 19271210 7. On May 23, 1927, petitioner entered into a contract with Peoples Illinois to "purchase" all of its properties, comprising the Freeport property. Under this contract Peoples Illinois was to 31 transfer the Freeport property to petitioner in exchange for petitioner's stock and bonds. Under an amendment to the agreement dated July 29, 1927, it was agreed that petitioner was to give Peoples Illinois 3,500 shares of its common stock and $ 650,000 of its first mortgage 5 percent gold bonds in exchange for its assets. It was also provided that petitioner could withhold $ 400,000 of said bonds until such times as its earnings reached a stated level. It was provided in the agreement that the said stock and bonds of petitioner would be accepted by Peoples Illinois in full payment for all of its properties to be transferred to petitioner. The Illinois Commerce Commisssion approved the sale of the Freeport property by Peoples Illinois to petitioner on September 14, 1927, and on September 16, 1927, petitioner acquired all of the assets of Peoples Illinois, subject to certain liabilities. It was understood that Peoples Illinois would "cease operation as a public utility" upon completion of the transfer of its assets to petitioner. On September 22, 1927, petitioner issued to Peoples Illinois 3,500 shares of its common stock and its note dated September 15, 1927, for $ 650,000 payable32 in its first mortgage 5 percent gold bonds.The order of the Commission approving the transaction stated that bonds bearing 5 percent interest and secured, such as the bonds petitioner proposed to issue, would have a sale value of approximately 88 percent of their face value, and, as the stock might be considered to be worth its par value, the aggregate value of the proposed issue of bonds and stock would be $ 922,000. The Commission refused to accept the appraisal of Stone & Webster of September 1, 1926, as "representing a proper and reasonable valuation for the property involved in this proceeding," but said such property might reasonably be considered as being worth the consideration given by petitioner, namely, 3,500 shares of its capital stock and $ 650,000 of its 5 percent gold bonds.The order of the Commission recited its approval of the conveyance by Peoples Illinois "for the consideration of" the above stated shares of stock and bonds of petitioner, with the $ 400,000 withholding provision as aforesaid. The order also permitted petitioner to elect to assume existing funded indebtedness or other indebtedness constituting liens against the property to be transferred, but33 if petitioner did so elect, it was to reserve a sufficient number of the aforesaid bonds of its own for sale at not less than 88 to produce sufficient funds to retire such assumed indebtedness. The order required Peoples Illinois to cease operations as a public utility thereafter.8. On September 22, 1927, the day of the receipt of petitioner's stock and note, Peoples Illinois transferred to Federal as a partial 1211 liquidating dividend the 3,500 shares of petitioner's stock. Federal recorded on its books the receipt of this stock as part of a liquidating dividend from Peoples Illinois as follows: Debit, $ 446,672.25, "Investment in Illinois Water Service Co. Common stock, 3,500 shares." Credit, $ 446,672.25, "Investment in Peoples Utilities Ill. Corp. (Freeport)."9. Federal held $ 650,000 of bonds of Peoples Illinois which it had acquired from Peoples. Peoples Illinois owned $ 650,000 of bonds of petitioner which it had received along with the 3,500 shares of petitioner's stock, evidenced by a note of petitioner for $ 650,000 payable in its bonds. On September 23, 1927, Peoples Illinois paid its bonded indebtedness in full by giving Federal the note of petitioner for 34 $ 650,000, duly endorsed to Federal, and Federal returned to Peoples Illinois its own bonds. The journal voucher of Peoples Illinois recording the transfer of the note of petitioner to Federal shows a debit "Bonded Debt" in the amount of $ 650,000, against which is a credit for $ 650,000, "Note Receivable." The explanation of the entry is as follows:To record the retirement of our Funded Debt -- by giving to Federal Water Service Corp. the holder of our bonds -- a note of the Illinois Water Service Corporation for the face amount of $ 650,000 payable in bonds of that company in exchange for our bonds.Federal recorded on its books the receipt of the $ 650,000 note as follows: Debit, $ 581,750, "Notes Receivable from Affiliated Co's. (Ill. W. S. Co.)." Credit, $ 581,750, "Investment in Peoples Utilities Ill. Corp. $ 581,750." The explanation for the above entry is as follows:To record receipt as a partial liquidating dividend [sic] from Peoples Utilities Illinois Corp. of a note of Ill. Water Service Co., for amount $ 650,000.00 payable in Bonds of Illinois Water Service Co. having a sale value of $ 89.50 per hundred dollars of bonds.Federal received from petitioner a total 35 number of its bonds in the face amount of $ 650,000 on various dates beginning September 23, 1927, when Federal received bonds in the amount of $ 250,000, and ending January 31, 1930, during which interval Federal received the remaining bonds in the amount of $ 400,000.10. While the application of petitioner and Peoples Illinois for approval of the sale to petitioner of the latter's assets was pending before the Illinois Commerce Commission (said application having been filed jointly on May 24, 1927), petitioner, on July 28, 1927, increased its authorized capital from 16,000 shares of common stock of a par value of $ 100 each (of which 14,000 shares were outstanding) to 17,500 shares of common stock of the same par value. On September 7, 1927, petitioner amended its certificate of incorporation so as to authorize an increase in authorized capital stock from $ 1,750,000 consisting of 17,500 shares of common stock, to $ 2,000,000 consisting 1212 of 20,000 shares of preferred stock, par value $ 100, and 50,000 shares of common stock, no par value. The new preferred stock and common stock had equal voting rights, share for share.On September 15, 1927, the Illinois Commerce Commission36 granted an application of petitioner to convert 7,500 shares of its common stock into 7,500 shares of 6 percent cumulative preferred stock, and to convert 10,000 shares of common stock into 50,000 shares of no par value common stock.11. After September 22, 1927, and before petitioner converted any of its stock into new preferred and new common, petitioner's stock was held as follows:Federal8,384 sharesChampaign3,560 sharesStreator5,556 sharesTotal authorized and outstanding shares 17,500 shares12. On September 23, 1927, acting with reference to the authorization given by the Illinois Commerce Commission and the amendment to its articles of incorporation, petitioner proceeded to convert its old common stock, consisting of 17,500 shares held by Federal, Champaign, and Streator, into new preferred stock and new common stock. After that conversion, petitioner's new preferred and common stocks were held as follows:CompanyNew commonNew preferredSharesSharesFederal4,4207,500Champaign17,800Streator27,780Total 50,0007,50013. Previously, on August 29, 1927, prior to petitioner's acquisition of the assets of Peoples Illinois37 but after Federal had acquired all of the common stock of Peoples Illinois from Peoples, and after petitioner had entered into a contract with Peoples Illinois to purchase all of the latter's assets in exchange for its own stock and bonds, Federal had entered into a contract with the Ohrstrom Co. to sell to Ohrstrom, if, as, and when issued, $ 250,000 of petitioner's 5 percent gold bonds at 89 1/2, and 7,500 shares of petitioner's preferred stock at 88. In accordance with this agreement, Federal sold to Ohrstrom a total of 7,500 shares of petitioner's preferred stock at 88, on September 30, 1927, October 5, 1927, and November 1, 1927.14. On December 1, 1937, petitioner sold the aforesaid Freeport water works property to the city of Freeport for $ 1,253,400 in cash.15. On August 3, 1938, petitioner filed its corporation income and excess profits tax return for the calendar year 1937 in the office of the 1213 collector of internal revenue for the second New York district. In that return petitioner reported a profit of $ 211,298.30 on said sale, using in its computation of profit a basis of $ 1,042,101.70, which is the highest basis now being contended for by petitioner herein, 38 with certain adjustments, and not the old basis to Peoples Illinois and to Freeport.16. For the fiscal year ended May 31, 1927, Federal filed with the collector of internal revenue for the second district of New York a consolidated income tax return for itself and affiliated subsidiaries which included as affiliated companies petitioner, Champaign, Streator, and Sterling. For the fiscal year ended May 31, 1928, Federal filed with said collector a consolidated income tax return which included as affiliated companies Champaign, Streator, Sterling, and Peoples Illinois (the last from July 1, 1927), but petitioner was omitted therefrom. Petitioner filed a separate income tax return with the collector of internal revenue for the second district of New York for the entire taxable period beginning June 1, 1927.For the fiscal year ended July 31, 1927, Peoples Light & Power Corporation filed with said collector a consolidated return for itself and affiliated subsidiaries, including Peoples Illinois, to July 1, 1927.17. The basis for the depreciation deduction on the Freeport properties used by petitioner in its income tax returns for the taxable years 1935 and 1936 and for prior years39 was the same basis used by Peoples Illinois, which was in turn the same basis used by Freeport Water Co., with appropriate adjustments for subsequent additions and retirements.18. On March 3, 1938, petitioner filed claims for refund of income taxes paid for 1935 and 1936 on the ground that it had computed its depreciation on an improper basis.19. After Champaign, Streator, and Sterling distributed all of their assets to petitioner on February 2, 1927, they were in fact nominee corporations of Federal. It was intended by Federal, the sole stockholder of these three corporations, that they would be dissolved after distributing to Federal their only remaining assets, consisting of stock and bonds of petitioner. The three corporations held some of petitioner's stock during 1927 until final distribution thereof was made to Federal on or about December 31, 1927, as mere nominees of Federal. After February 2, 1927, Federal owned all of the outstanding stock of petitioner, to wit, 14,000 shares of common stock of a par value of $ 100 a share, directly and through its nominees, Champaign, Streator, and Sterling.20. The agreement of March 22, 1927, between the Foshay Co., the vendor, 40 and the Ohrstrom Co., the vendee, was carried out by Federal, the assignee of Ohrstrom. Federal did not take the assignment of the March 22 agreement for the limited, planned purpose of acquiring the assets of Peoples Indiana and Peoples Illinois. Federal took the 1214 assignment of that contract only for the purpose of carrying out the terms of the March 22 contract as they were written. After Federal acquired the class B stock of Peoples, the Peoples system was controlled by Federal in substantially the same way that Federal controlled its own holding company system. After March 22, 1927, Federal, in any negotiations and contracts with Peoples, was dealing with a controlled corporation. In reality, after March 22, 1927, the real parties with controlling interests behind both Peoples and its subsidiaries, and Federal and its subsidiaries, were the Ohrstrom Co. and Chenery, the sole stockholders of Federal.21. The agreement of March 22, 1927, was a complete agreement and no provision contained therein obligated Federal to do anything covered by the separate agreement of June 2, 1927, between Federal and Peoples. The agreement of June 2, 1927, was a complete agreement and41 no provision contained therein had any connection with the March 22 agreement.Under the March 22 agreement Federal became the assignee of Foshay of executory contracts with outside companies and individuals without any obligation to Foshay or to Peoples with respect to the subject matter of those contracts. Federal succeeded to Foshay as a party to those contracts but, thereafter, Federal was an independent party thereto. Federal did not acquire the so-called "May 3rd properties" (the properties or securities of Alturas, Platteville Gas, New Jersey Northern Gas, etc.) with any obligation to convey them to Peoples. No debtor-creditor relation between Federal and Peoples existed as a result of Federal's purchase of the so-called "May 3rd properties." When Federal purchased those properties, it did so for its own account and it became the sole owner thereof. When Federal sold some of those properties and securities to Peoples under the June 2 contract it did so independently of any of the terms of the March 22 agreement. Peoples purchased from Federal the properties and securities described in the June 2 contract independently of any provisions in the Foshay contract of March 2242 to which Peoples was not a party. The consideration which Peoples paid to Federal under the June 2 contract consisted of the stock and bonds of Peoples Illinois and Peoples Indiana.Federal did not intend to purchase or to acquire the assets of Peoples Illinois, to wit, the Freeport property, either directly, or indirectly through the purchase of the stock of Peoples Illinois. Federal did not purchase the assets of Peoples Illinois when it purchased the stock of Peoples Illinois under the June 2 contract. Federal did not at any time acquire the assets of Peoples Illinois directly or constructively. Federal did not purchase the Freeport property for the account of petitioner.1215 Federal intended to cause Peoples Illinois to transfer all its assets to petitioner at some time after Federal would acquire all the stock of Peoples Illinois. It was provided and agreed in the June 2 contract between Federal and Peoples that Peoples Illinois would not consummate a sale of its assets as long as it was a subsidiary of Peoples. Peoples Illinois ceased to be a subsidiary of Peoples on June 30, 1927.22. Federal caused Peoples Illinois and petitioner to enter into the contract of 43 May 23, 1927. On that date Federal controlled Peoples Illinois through its ownership of the voting stock of the then parent, Peoples; and Federal controlled petitioner through ownership of all of petitioner's outstanding stock by itself and through its nominees, Champaign, Streator, and Sterling. Peoples Illinois was a subsidiary of Federal on September 16, 1927, when it transferred its assets to petitioner. It was not a subsidiary of Peoples at that time and Peoples had nothing to do with the initiation or the consummation of the sale of the assets of Peoples Illinois to petitioner.23. Peoples Illinois was the transferor of the Freeport property. Federal was not, directly or constructively, the transferor of the Freeport property. The contract of May 23, 1927, between Peoples Illinois and petitioner was a complete contract in itself and was not connected with the June 2 contract between Peoples and Federal.Petitioner received the Freeport property from Peoples Illinois, and Peoples Illinois received from petitioner, in exchange, 3,500 shares of petitioner's stock and petitioner's note for $ 650,000, payable in its bonds. Under this separate transaction, petitioner received44 the Freeport property from Peoples Illinois pursuant to a reorganization.Petitioner was not furnished any funds by Federal with which to purchase the Freeport property, and petitioner did not make a direct purchase of the Freeport property from Peoples Illinois for cash.24. Federal received 3,500 shares of petitioner's stock from Peoples Illinois as a distribution in liquidation. Federal received the note of petitioner, payable in bonds, in the amount of $ 650,000, from Peoples Illinois as payment by that corporation of its indebtedness on its bonds which Federal owned. Federal did not receive 3,500 shares of stock and $ 650,000 of bonds of petitioner from petitioner in exchange for the Freeport property under a constructive transfer thereof to petitioner from Federal.Opinion. -- The Freeport property which petitioner acquired in 1927 from Peoples Illinois had been acquired by that corporation in November of 1926 from the Freeport Water Co. under circumstances which are set forth hereinafter under separate findings of fact. For purposes of computing depreciation allowances, Peoples Illinois had used as the basis of the Freeport property the cost to the Freeport 1216 Water45 Co. After petitioner acquired the Freeport property, it, in turn, used the same basis which Peoples Illinois had used, so that in its income tax returns for 1935 and 1936 petitioner originally carried over the basis of its transferor, with appropriate adjustments for additions and retirements. Respondent accepted as correct the basis used by petitioner in its returns. It was not until after a petition was filed here that petitioner, through amending its petition, made claim for a stepped-up basis for the Freeport property. Respondent reduced the rate of depreciation which petitioner had employed from 2 1/2 to 2 percent, which reduced the amount of the depreciation deduction claimed in each year, which gave rise to the deficiencies. If both of the issues presented are decided against petitioner, the deficiencies will be sustained. If one of the issues is decided in petitioner's favor there will be no deficiencies, but under a Rule 50 recomputation it will appear that petitioner overpaid tax in each taxable year.Petitioner now contends that it did not acquire the Freeport property in 1927 pursuant to a reorganization so that the basis of the transferor corporation became petitioner's46 basis. Petitioner contends that the Freeport property was purchased and, therefore, acquired a new basis in a larger amount than the basis of Peoples Illinois. Such is petitioner's main contention, and its alternative contentions need not be set forth at this point.The broad question is whether petitioner acquired the Freeport property pursuant to a reorganization, and in the broadest reaches of the question all of the following provisions of the revenue acts are pertinent: Sections 114 (a), 113 (b), and 113 (a) (12) of the Revenue Acts of 1934 and 1936; section 113 (a) (7) of the Revenue Act of 1932; section 112 (i) (1) and (j) of the Revenue Act of 1932; sections 203 (b) (3) and (4), 203 (h) (1) and (2), and 203 (i) of the Revenue Act of 1926. See Muskegon Motor Specialties Co., 45 B. T. A. 551, 557, 558; affd., 134 Fed. (2d) 904; certiorari denied, 320 U.S. 741">320 U.S. 741. The transfer of the Freeport property took place in 1927. The Revenue Act of 1926 was then in effect. The provisions of sections 203 (h) (1) and (2) and 203 (i) of the Revenue Act of 1926 are the same as the provisions of section 47 112 (i) (1) and (2) and 112 (j) of the Revenue Act of 1932. Whether we should go to the Revenue Act of 1926 or to the Revenue Act of 1932 for the purpose of determining whether or not there was a reorganization as defined in section 113 (a) (7) of the Revenue Act of 1932, the result necessary would not be different; for the 1932 version of the definition of reorganization is identical with the comparable provisions of the 1926 Act. See Muskegon Motor Specialties Co., supra; cf. Schweitzer & Conrad, Inc., 41 B. T. A. 533, 539, 540; Palm Springs Holding Corporation v. Commissioner, 315 U.S. 185">315 U.S. 185.1217 Petitioner acquired all the assets of Peoples Illinois on September 16, 1927, and gave in exchange 3,500 shares of its common stock (then the only authorized stock) and $ 650,000 in its bonds. This transfer was a reorganization within the definition of section 112 (i) (1) (A) of the Revenue Act of 1932, 1 which includes a merger or consolidation within the definition of a reorganization, Nelson Co. v. Helvering, 296 U.S. 374">296 U.S. 374; Helvering v. Watts, 296 U.S. 387">296 U.S. 387,48 unless other factors were present to prevent the transaction from coming within the statutory definition under unwritten requirements of the statute such as a lack of business purpose, of continuity of interest, and of permanence. See Law of Federal Income Taxation, Mertens, vol. 3, p. 183, par. 20.49; Le Tulle v. Scofield, 308 U.S. 415">308 U.S. 415; Nelson Co. v. Helvering, supra.The above section of the statute is not to be read literally. The acquisition of the assets of one corporation by another does not in every instance constitute a reorganization within the statutory definition. Respondent takes the view that the parenthetical clause in section 112 (i) (1) (A) covers the transaction under which petitioner acquired the Freeport property.49 It is necessary to set forth the arguments of petitioner which call for special construction of three contracts which are fully described in the findings of fact and are called hereinafter the contracts of March 22, June 2, and May 23. All were executed in 1927. With respect to the March 22 contract, petitioner alleges that Federal took assignment thereof from Ohrstrom as a step in a plan to purchase the physical properties, which were waterworks properties, of Peoples Indiana and Peoples Illinois, so that such objective was paramount. Petitioner then contends that Federal took the role of a nominee of some type in purchasing various properties and securities of outside, independent concerns, the so-called May 3 properties, for the purpose of putting them into the Peoples holding company system, and that after making such purchases (under contracts to which Federal had become a party under assignments from Foshay for good consideration) Federal had a "claim for reimbursement" for its expenditures, plus interest, which "was assumed" by Peoples, so that "the arrangement under which Federal acquired the miscellaneous properties" gave rise to a debtor-creditor relationship under which50 Peoples was allegedly 1218 obligated to pay Federal $ 1,392,128.86. From this petitioner argues that Peoples paid the above obligation by causing its subsidiaries, Peoples Indiana and Peoples Illinois, to transfer their physical assets to Federal, constructively, and the fact that the June 2 contract provided only that the stock and bonds of those corporations were to go to Federal (in exchange for the May 3 properties) was a mere matter of form, and the transaction under the June 2 contract, between Peoples and Federal, "should be treated as a purchase of assets by Federal for the amount of money owing to it on account of the Ohrstrom-Foshay contract of March 22, 1927." In support of this theory petitioner relies on Prairie Oil & Gas Co. v. Motter, 66 Fed. (2d) 309, and Ashland Oil & Refining Co. v. Commissioner, 99 Fed. (2d) 588; certiorari denied, 306 U.S. 661">306 U.S. 661. In developing the theory, petitioner construes the three contracts as constituting steps in a unitary transaction beginning on March 22, 1927, and ending in September of 1927, and invokes the doctrine that a series51 of related transactions must be treated as a whole for tax purposes, citing Howard v. Commissioner, 56 Fed. (2d) 781; certiorari denied, 287 U.S. 619">287 U.S. 619; Commissioner v. Schumacher Wall Board Corporation, 93 Fed. (2d) 79, and other cases.Under the above theory of the transaction in which Federal acquired the miscellaneous properties and agreed to transfer them to Peoples, petitioner arrives at its claimed basis for the Freeport property. Petitioner contends that its expenditures of $ 1,392,128.86 for the miscellaneous properties must represent the value of those properties and must represent the amount which Federal paid for the water properties of Peoples Indiana and Peoples Illinois, so that such amount is the value in 1927 of the two groups of water properties. Petitioner allocates eleven-fifteenths of said amount to the Freeport property and one-fifteenth to the property of Peoples Indiana, and after various adjustments arrives at the amount of $ 934,129.78. That amount is the claimed basis of the Freeport property to petitioner. It is unnecessary to set forth the reasons for52 the above percentages and the arithmetical computations used by petitioner in computing the amount of the stepped-up basis it now claims.So far, petitioner has offered the theory that Federal purchased the Freeport property. The next part of petitioner's theory develops an explanation of petitioner's acquisition of the property, as follows: Petitioner is said to have constructively received the Freeport property from Federal in exchange for petitioner's stock and bonds; and, as Federal controlled petitioner after the transfer of the Freeport property by ownership of more than 80 percent of petitioner's voting stock, no gain or loss would be recognized "on this constructive transfer of the Freeport properties from Federal to petitioner under Section 203 (b) (4) of the Revenue Act of 1926 and petitioner would take Federal's cost as its basis under Section 113 (a) (8) of the Revenue 1219 Acts of 1934 and 1936." Petitioner suggests a comparison between the situation, as it construes it, and the situation in Davis v. United States, 88 Ct. Cls. 579; 26 Fed. Supp. 1077; certiorari denied, 308 U.S. 574">308 U.S. 574.53 In any event, petitioner says, "Whether the transaction be treated as a purchase of properties by Federal and a subsequent transfer thereof to petitioner or as a purchase by Federal for the account of petitioner, the cost of the Freeport properties to petitioner is the cost thereof to Federal or the amount of Federal's claim which was paid by transfer of said properties."Petitioner's argument is imposing; it is complex. The parties were able to agree upon a statement of some of the facts, but a great quantity of the evidence consists of many documents which were attached to the stipulation of facts as exhibits and which comprise several volumes. The facts have been carefully brought together and considered. The three contracts of March 22, June 2, and May 23, and the general circumstances have been given particular consideration. Many recent cases have been considered which were not cited by petitioner, to determine their applicability, if any, to this issue in this case; for example, see Helvering v. Bashford, 302 U.S. 454">302 U.S. 454; Groman v. Commissioner, 302 U.S. 82">302 U.S. 82; Anheuser-Busch, Inc. v. Helvering, 115 Fed. (2d) 662;54 certiorari denied, 312 U.S. 699">312 U.S. 699. But the facts, in our opinion, do not support the theories of petitioner and we must reject them.The March 22 contract is perfectly clear, and none of its provisions lend themselves to the theory of petitioner. Executed by the Ohrstrom Co., that contract was immediately assigned to Federal and it is not a reasonable inference that such assignment was made for the narrow and limited purpose of enabling Federal and one of its subsidiary corporations, petitioner, merely to acquire the water properties of Peoples Indiana and Peoples Illinois. The March 22 contract was primarily a contract for the sale of the controlling stock of Peoples, and other provisions in the contract were plainly for the purpose of achieving a complete divorce of the Foshay Co. from the Peoples holding company system, the achievement of which necessitated assigning Foshay's uncompleted contracts with outside concerns. The economic benefits to Federal of all of the rights which it acquired under the March 22 contract were obviously great and far reaching. Once Federal acquired control of Peoples it was in a position, of course, to work out particular55 rearrangements of holdings of particular properties, but it can not be said that there was anything in the March 22 contract which obligated Federal to do any of the particular things which later were done under the June 2 and May 23 contracts. It is not necessary to elaborate upon this observation. Accordingly, we reject petitioner's theory that some unitary transaction relating to the Freeport property had its origin in the March 22 contract; that Federal carried out its 1220 purchases of miscellaneous properties under contracts assigned to it by Foshay with some unwritten understanding that it would be reimbursed and that Peoples assumed Federal's claim for reimbursement. All of such contentions of petitioner represent a picture which is not supported by the terms of the March 22 agreement or by a preponderance of the evidence. That agreement, by its terms, was an independent agreement between Foshay and Federal, the assignee of Ohrstrom, and it must be construed with reference to its clear terms. In fact, after the Foshay contracts were assigned to Federal for valuable consideration as set forth in the March 22 agreement. Federal's execution of those contracts with56 Alturas, Platteville, and other concerns and individuals was, in each instance, a distinct transaction of purchase. The so-called May 3 properties were acquired under distinct contracts which had no connection with the March 22 contract or the June 2 contract. Federal could do as it pleased with those miscellaneous properties and securities. Its decision to sell them to Peoples was the natural disposition of them, but that does not detract from the fact that Federal sold them to Peoples under the June 2 contract. Respondent's contentions lead us to believe that that transaction had a tax consequence separate from the subsequent transfer of the Freeport property to petitioner.The next consideration must be directed to the June 2 contract. Again its terms are the sole guide to the construction of that contract. The consideration received by Federal was only the stock and bonds of Peoples Indiana and Peoples Illinois for Federal's sale of the properties described in the contract. That transaction was not comparable to the transactions in the Prairie Oil & Gas Co. and the Ashland Oil & Refining Co. cases, supra, where the intention of the vendees of stock of certain57 corporations was to acquire the physical properties of those corporations. Here, Federal was not an operating company; it had no intention of acquiring the property of Peoples Illinois; it did not acquire the stock of People Illinois as a step in taking over its property. The above cases are distinguishable upon their respective facts.But the most important circumstance of the June 2 contract is that certainly Federal caused Peoples, a corporation under its control, to enter into the June 2 contract and caused that contract to be written with particular terms which fixed as separate steps any subsequent transfers by Peoples Illinois and Peoples Indiana of their assets to subsidiaries of Federal. It was provided that "no consummation of the sale of the assets of the foregoing companies shall be effective as long as the same shall be subsidiaries of your corporation [Peoples] * ." It was expressly provided, in effect, that Peoples was not to be the promoter of any sale by Peoples Illinois of its properties to another corporation.1221 We are told by respondent that petitioner has at all times treated the transfer of the Freeport property as a tax free transaction up to 58 the present time. 2 Petitioner does not deny that the transaction originally escaped tax. There is no evidence before us upon the point, but the record indicates that petitioner was allowed by the respondent to treat the transfer of the Freeport property as coming within the nonrecognition of gain or loss provisions of the statute. Federal required the clause in the June 2 contract presumably for the purpose of putting Peoples Illinois in the position of transferring its assets to petitioner pursuant to a tax-free reorganization within the statutory definition. Thus, Federal apparently had the deliberate purpose of separating the transaction between Peoples Illinois and petitioner from its own transaction (involving the miscellaneous new properties) with Peoples, and that purpose appears to have had specific tax purposes, the Federal-Peoples transaction of June 2 resulting in a tax, as far as we know, and the Peoples Illinois-petitioner transaction resulting in no tax, as far as we know. In this situation we take the view that neither Federal nor its subsidiary, petitioner, may now complain because respondent has determined that the two transactions were separate, as they were59 intended to be, rather than mere steps in a single unitary plan, as petitioner belatedly urges. See Lyon, Inc. v. Commissioner, 127 Fed. (2d) 210. See also Durand-McNeil-Horner Co. 30 B. T. A. 769, 773; affd., 84 Fed. (2d) 18 (sub nom. Fairbanks Court Wholesale Grocery Co.); certiorari denied, 299 U.S. 582">299 U.S. 582.60 It is essential under the definition of a reorganization that the transferor of property, or its stockholders, continue to have a substantial interest in the property in the hands of the transferee. Our conclusions are premised upon the following views: (1) There was no interdependence in the three contracts of March 22, June 2, and May 23, and the transactions under the contracts were not mere steps in a 1222 unitary plan. The findings of fact so indicate in finding that each contract was independent and not intertwined or essential to the others. (2) Peoples Illinois and petitioner were parties to a reorganization within the meaning of section 203 (b) (3) of the Revenue Act of 1926. Peoples Illinois exchanged its property for stock and bonds of petitioner. (3) Immediately after Peoples Illinois transferred its assets to petitioner, its stockholder, Federal, had a substantial interest in petitioner, and we think it was in control of petitioner, the corporaion to which the assets were transferred. Sec. 203 (h) (1) (A) and (B) Revenue Act of 1926, and sec. 112 (i) (1) (A) and (B), Revenue Act of 1932. On June 30, 1927, Federal owned all of the stock of Peoples Illinois. 61 On September 16, 1927, Peoples Illinois transferred its assets to petitioner in exchange for stock and bonds of petitioner. On September 22 Peoples Illinois transferred the stock of petitioner to Federal. On September 22 Federal owned all of the then outstanding stock of petitioner itself and through its nominees, Champaign and Streator. On September 22, out of 17,500 shares of petitioner's stock, Federal owned directly 8,384 shares and through its two nominees 9,116 shares. We hold that Federal, the sole stockholder of Peoples Illinois, was in "control" of petitioner immediately after the Freeport property was transferred to petitioner under either section 203 (i) of the Revenue Act of 1926 or section 113 (a) (7) of the Revenue Act of 1932. Cf. United Light & Power Co. v. Commissioner, 105 Fed. (2d) 866; certiorari denied, 308 U.S. 574">308 U.S. 574. However, if there be any doubt on the point of Federal's "control" of petitioner immediately after the exchange, we think there is no doubt that Federal had a definite and substantial interest in petitioner so that petitioner's acquisition of all of the assets of Peoples Illinois 62 amounted to a reorganization under sectin 203 (h) (1) (A). Nelson Co. v. Helvering, supra.(4) We reject petitioner's view that the transfer by Peoples Illinois was a step in a sale by Peoples of its interest in the assets of Peoples Illinois. The transaction between petitioner and Peoples Illinois did not begin at any time when Peoples had any interest in the transferor or its assets. It began, rather, after Peoples had disposed of all of its interest and when Federal was the sole stockholder of the transferor, Peoples Illinois. Accordingly, we reject the view that the transaction, as it involved Peoples Illinois, petitioner, and Federal, lacked the required continuity of interest in the Freeport property because Peoples acquired no interest in petitioner.It is held that petitioner acquired the Freeport property pursuant to a reorganization within the definition in section 112 (i) (1) (A), and the basis to petitioner is the same as the basis was in the hands 1223 of Peoples Illinois. Commissioner v. Schumacher Wall Board Corporation, supra, does not apply. Respondent's contentions are sustained.II. 63 Acquisition of Freeport Property by Peoples Illinois.Petitioner's alternative contention is that if petitioner should be required to use the basis of its transferor, Peoples Illinois, that basis was not the basis of the Freeport property to the Freeport Water Co., but was the cost thereof to the Foshay Co. We make the following findings of fact under this second issue:Facts. -- 25. Consumers Public Service Corporation, hereinafter called Consumers, a Delaware corporation, was a holding company in 1926. It owned all of the common stock of Wood River Power Co., an Idaho corporation; and all except 50 shares of the common stock of Freeport Water Co., an Illinois corporation. The Wood River Co. owned all of the stock of Hailey Water Co., an Idaho corporation. The outstanding stock and bonds of all of these companies on or about August 1 1926, were as follows:CorporationCommon stockPreferred stockBondsSharesConsumers4,000$ 400,000Wood River2,000$ 43,400210,000Hailey17517,500Freeport2,500388,400[It is stipulated that there were outstanding 5,000 shares of the Freeport stock, but this is in conflict with the statements and balance64 sheet in Exhibit B that the total authorized issued stock was 2,500 shares.On August 1, 1926, all of the authorized and outstanding common stock of Consumers was owned by three individuals, Edwin J. Smail, Claude F. Baker, and William J. Walsh.The Wood River Co. owned electric plants and distributing systems at Hailey, Ketchum, Cascade, and other towns in Idaho. The Hailey Water Co. owned the water plant and system at Hailey, Idaho. The Freeport Water Co. owned the water plant and system at Freeport, Illinois. As of December 31, 1925, the balance sheets of the above companies showed total assets and liabilities as follows:Wood River$ 468,285.74Hailey87,432.44Freeport830,042.20The consolidated balance sheet of Consumers and subsidiaries as of December 31, 1925, showed total assets and liabilities of $ 1,342,685.28.26. The W. B. Foshay Co. (see paragraph 2 of findings of fact -- I) had organized Peoples Light & Power Corporation in March of 1926 and Foshay owned the controlling stock of Peoples, with a few minor 1224 exceptions, such stock being the class B common stock which had the sole voting rights.27. On August 16, 1926, an agreement was executed 65 between Smail, Baker, and Walsh, as vendors, and the W. B. Foshay Co., as vendee. The agreement provided, inter alia, for the sale of 4,000 shares of the capital stock of Consumers, which was all of its stock, for $ 400,000, payable $ 200,000 in cash at the time of the closing of the contract and $ 50,000 per month thereafter until the balance was paid; i. e., the vendee was to deliver $ 200,000 par value 7 percent cumulative preferred stock of Peoples Light & Power Corporation at the closing and was to repurchase said stock at par at the rate of $ 50,000 per month. The date for the closing of the contract was set forth in the contract to be November 15, 1926. The contract was closed on that date in New York City. The agreement provided that the parties were not to receive any interest in the cash or property which each was to give to the other, respectively, until the closing of the contract.The vendee, Foshay, agreed either to redeem or make provision for the redemption of all the outstanding bonds of Consumers in the principal amount of $ 400,000 prior to or contemporaneously with the closing of the contract, and the obligation of the vendors to close the transaction was66 conditioned upon the vendee's compliance with such agreement.The purchase price of all of the stock of Consumers was based on the balance sheets of Consumers, Wood River, and Freeport as of December 31, 1925, and upon the balance sheet of Hailey as of May 31, 1926, and also upon the income account of Consumers for a 12-month period ended June 30, 1926. The purchase price was subject to adjustments by way of appreciation or depreciation of net assets, as determined by audit as of November 15, 1926, the closing date.The vendors agreed to deposit with a named depository within 15 days from August 16, 1926, 4,000 shares of stock of Consumers. At the time of the closing, the vendors agreed to deliver to Foshay endorsed certificates of stock of Wood River, Freeport, and Hailey as follows: 2,000 shares of Wood River, 2,500 shares of Freeport, and 175 shares of Hailey. The vendors agreed that at the consummation of the purchase said shares of stock would be free and clear of all liens and claims.The agreement of August 16, 1926, provided that all of the physical properties of Wood River, Freeport, and Hailey were to be sold to Foshay, or its nominee, and the following was agreed. 67 13. It is agreed that the stockholders, directors, and officers of the aforesaid corporations, prior to the closing date, will authorize the sale of the physical properties to the vendee, or its nominee, and will execute all such deeds, conveyances, assignments, bonds, notes and trust deeds as may be required, all these, however, to be placed in escrow with Continental and Commercial Trust & Savings Bank of The Equitable Trust Company, as heretofore stated.1225 It was further provided that the vendors would promptly, after August 16, 1926, deliver to the vendee full and complete abstracts of title to all real estate, certified copies of all franchises, licenses, and easements, and all other papers necessary to enable the vendee to examine and pass upon titles of all real estate and other property. As Consumers owned no operating properties, such provisions related to the properties owned by the subsidiaries of Consumers. The vendee agreed to examine all papers within 30 days after deposit thereof and to deliver to the vendors a written memorandum objecting to defects of every kind, and if such defects were not cured within 30 days after notice the entire agreement of August68 16 was to become void.The vendees were to be permitted to examine the plants, property, business, and books of the corporations, and the vendors agreed to furnish all information. The vendors agreed to keep the plants and properties in good condition until the consummation of the purchase. The vendors agreed to furnish the vendee and cause to be executed all deeds, bills of sale, etc., necessary to carry out the agreement.28. Under the August 16 agreement Foshay intended acquiring the physical assets of Wood River, Freeport, and Hailey for its nominees. Foshay intended that the properties should be conveyed to new or existing corporations which were or would become subsidiaries of Peoples Light & Power Co. It was intended that the transfers of the properties would be made contemporaneously with the closing of the August 16 agreement and that thereafter Consumers, Freeport, Wood River, and Hailey would be dissolved.On September 20, 1926, Foshay and Peoples entered into a contract under which Foshay agreed to purchase various securities of Peoples, and in payment therefor Forshay agreed to deliver to Peoples the capital stock and first mortgage bonds of the corporations to which69 Foshay would cause to be transferred various plants and properties, including the properties of Freeport, Wood River, and Hailey. This agreement was amended on October 4 and November 1 only with respect to the amounts of the securities of Peoples which Foshay agreed to purchase. Under the agreement as amended Foshay agreed to purchase the following securities of Peoples: (a) $ 2,100,000 of First Lien 5 1/2 percent bonds; (b) $ 1,000,000 5 1/2 percent gold notes; (c) $ 957,000 one year 5 1/2 percent debenture notes; (d) $ 300,000 7 percent cumulative preferred stock; (e) 9,000 shares of class A common stock. Foshay was to give Peoples $ 2,100,000 first mortgage bonds of new or existing corporations; Foshay was to deliver the bonds and stocks of corporations to Peoples on or before November 15, 1926.29. On October 18, 1926, Peoples Utilities Illinois Corporation was incorporated under the laws of Illinois, with its principal office in Freeport. Its total authorized stock was 6,500 shares, no par value. 1226 W. B Foshay was president of Peoples Illinois. He was also president of the W. B. Foshay Co.30. On October 18, 1926, the Foshay Co. made an offer to Peoples Illinois70 which was accepted the same day. Foshay offered to subscribe for 6,340 shares of the no par value capital stock of Peoples Illinois and to purchase $ 650,000 principal amount of its proposed first mortgage 5 1/2 percent gold bonds, in payment for which Foshay agreed to cause to be delivered to Peoples Illinois, free and clear of all encumbrances, the water plant and distributing system "now belonging to Freeport Water Company." Peoples Illinois was to file an application with the Illinois Commerce Commission requesting the Commission to authorize the transfer of the Freeport properties.It was understood, in the above offer, that if the offer was accepted the Freeport property was to be received by Peoples Illinois as the "full purchase price for said bonds and stock."On October 18, 1926 the Foshay Co. made an offer to Freeport Water Co. which recited that Foshay had previously entered into a contract with Smail, Baker, and Walsh to acquire all of the capital stock of Consumers and that upon the consummation of that contract Foshay would be the absolute owner of all of Freeport's capital stock, and that Foshay desired that all of Freeport's property should be transferred to Foshay71 or its nominee, after which steps would be taken to dissolve Freeport and Consumers. In contemplation of such results, Foshay submitted a proposal to Freeport, as follows: Freeport was to transfer to Peoples Illinois its water plant and distributing system and franchises and was to transfer to Foshay all other property, consisting of cash, notes, and accounts receivable, materials, and supplies. Foshay agreed to pay all of the bonded indebtedness of Freeport and all of its obligations and liabilities and to deliver to Freeport all of its capital stock for cancellation. It was agreed that Freeport would file an application with the Illinois Commerce Commission requesting the Commission to authorize the transfer of its properties. It was also agreed that, upon the transfer of the Freeport property to Peoples Illinois, proceedings for the dissolution of Freeport would be instituted.Freeport accepted Foshay's offer on October 18, 1926.Also, on October 18, Foshay proposed to Consumers that it cause Freeport, Wood River, and Hailey to accept Foshay's offers to purchase their properties in consideration of Foshay's payment of their debts, and that Consumers cause the necessary corporate72 action to be taken in each instance to effect the conveyances of the properties of the above corporations to Foshay or its nominees. Foshay agreed to pay the bonded indebtedness of Consumers in consideration for Consumer's compliance with Foshay's above requests. Consumers agreed to Foshay's proposal. Among other things, Foshay's offer to Consumers 1227 stated that it was Foshay's desire that upon the consummation of the August 16 agreement all of the properties, franchises, and assets of Wood River, Freeport, and Hailey be transferred to Foshay or its nominees and that all necessary steps be taken to dissolve Consumers and each of the above companies, and that, looking to the accomplishment of that result, Foshay was making offers to purchase all of the properties of the above companies.31. On October 23, 1926, Freeport and Peoples Illinois made a joint application to the Illinois Commerce Commission for an order authorizing the transfer of the water plant and distributing system from Freeport to Peoples Illinois. The application made reference to the respective agreements of Freeport and Peoples Illinois with Foshay dated October 18. Peoples Illinois applied for the 73 Commission's authorization for its issuance of its bonds in the amount of $ 650,000 and 6,340 shares of its capital stock without par value, and Peoples Illinois declared that said bonds and stock were to be issued solely for the acquisition of the Freeport water property. The Commission was requested to consent to the dissolution of Freeport.32. On November 9, 1926, the Illinois Commerce Commission gave its approval of the above application, authorizing the sale and purchase of the Freeport water property, free of all liens, for the consideration of $ 650,000 bonds and 6,340 shares of stock of Peoples Illinois. The order of the Commission stated that Peoples Illinois was authorized to issue its bonds and stock upon the condition that Peoples Illinois "shall deliver to the Freeport Water Company all of the bonds and all of the certificates representing the stock herein authorized to be issued, in full consideration of the purchase price of the water utility plant or property and assets of said The Freeport Water Company * * , and that none of said bonds or said stock shall be used or applied for any other purpose whatsoever." The order also directed that Freeport should cease to74 operate as a public utility after the transfer of its assets. The order provided that the approval of the purchase and sale should not be construed as a finding of the value of the property in any rate proceeding or any other proceeding before the Commission, even though the matters submitted in the application indicated that "the value of the property * * * is at least equal to the value of the said bonds and stock," in the absence of evidence of the probable market value of the bonds and stock, but "in the light of common knowledge of security values."33. As of November 1, 1926, all of the assets and liabilities appearing on the books of Consumers were credited and debited respectively and the net book value thereof in the amount of $ 565,049.66 was charged to an open account with Foshay. There were included among the assets of Consumers 2,450 shares of the stock of Freeport.1228 34. On November 15, 1926, Foshay deposited with trustees the funds necessary to accomplish the redemption of all of the securities of consumers and its subsidiaries outstanding in the hands of the public.35. The closing of the August 16 agreement took place on November 15, 1926, in New York City75 and the agreement was carried out according to its terms. At the closing the following were done: Foshay paid in cash to Smail, Baker, and Walsh $ 195,000, the balance due on the agreed cash consideration of $ 200,000, and delivered $ 200,000 par value preferred stock of Peoples Light & Power Company; Foshay provided the funds for the redemption of the outstanding bonds and other securities of Consumers, Wood River, Freeport, and Hailey; Freeport conveyed its water plant and distributing system to Peoples Illinois, as Foshay's nominee, and its other assets consisting of cash, notes, etc., to Foshay; Peoples Illinois issued $ 650,000 bonds and 6,340 shares of stock which Foshay transferred, along with other property and securities, to Peoples; Peoples issued its securities to Foshay. In short, on November 15, 1926, all of the various contracts heretofore described were carried out according to their terms. Subsequently, Foshay paid in cash, at the rate of $ 50,000 a month, the balance of $ 200,000 and recovered the $ 200,000 par value preferred stock of Peoples Light & Power Co. Also, later, Consumers and its subsidiaries, including Freeport, were dissolved.36. All of the transactions76 which Foshay entered into on August 16, 1926, were interrelated and interdependent, and were steps in a single plan, and were undertaken to accomplish the purposes of the August 16 agreement, which included the transfers of all of the properties of Wood River, Freeport, and Hailey to Foshay and/or its nominees. Smail, Baker, and Walsh received $ 400,000 in cash for both their stock in Consumers and their interests in the assets of Consumers' subsidiaries. They did not receive any stock or any interest in Peoples Light & Power Corporation. The preferred stock of Peoples which was delivered at the closing was merely collateral to secure the payment in cash by Foshay of the unpaid balance of the purchase price in the amount of $ 200,000. Also, Smail, Baker, and Walsh did not receive any interest in Peoples Illinois or in any of the other corporations to which were transferred the assets of Consumers' subsidiaries.37. In addition to the consideration of $ 400,000 given by Foshay under the terms of the August 16 agreement, Foshay made additional expenditures in connection with the redemption of the securities of Consumers and its subsidiaries, and expenditures for miscellaneous matters, 77 all of which were made in connection with the contract of August 16, 1926, as follows: 1229 Wood RiverExpendituresTota& HaileyRepayment of advances made by vendorsbetween date of Contract 8/16/26 and 11/15/26 $ 21,610.32Appreciation of Assets 1/1/26 to 7/31/2611,950.71Final payment on contract (includingappreciation to 11/15/26) 6,227.17Engineering and appraisal expense5,418.08Redemption of bonds:DepositedRefundedConsumers$ 434,841.25$ 733.93434,107.32Wood River228,111.002,063.89226,047.11$ 226,047.11Hailey18,375.0018,375.0018,375.00Freeport418,819.104,291.04414,528.06Redemption of pfd. stock of Wood RiverDeposited $ 44,159.50Less: Refunded 152.5944,006.9144,006.91Purchase of 50 shares Freeport com stock7,649.52Trustee expense -- Freeport bond redemption25.00Report on bond interest25.00Legal services8,135.783,551.00Telephone2.47Certificate of dissolution3.00Traveling expenses918.82Incorporation fees569.77Franchise tax125.002% normal tax -- Wood River & Hailey85.0585.052% normal tax -- Freeport52.05Excess of current liabilities over current assets --Hailey & Wood River 245.70245.701,200,107.84292,310.77CreditsCash balance -- Consumers8,507.63Net current assets -- Hailey & Wood River15,731.6915,731.69Cash balance -- Freeport28,551.77Net current assets -- Freeport14,880.83Refund of Federal Tax -- Freeport65.50Refund of Federal Tax -- Consumers747.21Refund of 2% normal tax -- Consumers42.75Interest31.36Total credits 68,558.7415,731.69Net cost of interest in underlying propertiesexclusive of current position 1,131,549.10276,579.0878 To beExpendituresFreeportallocatedRepayment of advances made by vendorsbetween date of Contract 8/16/26 and 11/15/26 $ 21,610.3 Appreciation of Assets 1/1/26 to 7/31/2611,950.7 Final payment on contract (includingappreciation to 11/15/26) 6,227.17 Engineering and appraisal expense5,418.08Redemption of bonds:DepositedRefundedConsumers$ 434,841.25$ 733.93434,107.32Wood River228,111.002,063.89Hailey18,375.00Freeport418,819.104,291.04$ 414,528.06Redemption of pfd. stock of Wood RiverDeposited $ 44,159.50Less: Refunded 152.59Purchase of 50 shares Freeport com stock7,649.52Trustee expense -- Freeport bond redemption25.00Report on bond interest25.00Legal services4,362.17222.61Telephone2.47Certificate of dissolution3.00Traveling expenses918.82Incorporation fees569.77Franchise tax125.002% normal tax -- Wood River & Hailey2% normal tax -- Freeport52.05Excess of current liabilities over current assets --Hailey & Wood River 426,741.80481,055.27CreditsCash balance -- Consumers8,507.63Net current assets -- Hailey & Wood RiverCash balance -- Freeport28,551.77Net current assets -- Freeport14,880.83Refund of Federal Tax -- Freeport65.50Refund of Federal Tax -- Consumers747.21Refund of 2% normal tax -- Consumers42.75Interest31.36Total credits 43,498.109,328.95Net cost of interest in underlying propertiesexclusive of current position 383,243.70471,726.3279 The following are the balance sheets of Freeport, Wood River, and Hailey, as of November 1, 1926:FreeportWood RiverHaileyASSETSCash$ 27,759.59Notes receivable140.00Accounts receivable24,484.02$ 3,062.44Notes receivable -- Consumers P. S. Co25,000.00Accounts receivable -- Consumers P. S. Co9,100.00Accounts receivable -- Peoples West CoastHydro Electric Co $ 11,657.09 10,061.93Accounts receivable -- Hailey Water Co6,116.66 Property accoun777,241.59471,187.45 78,123.16Materials and supplies6,074.543,069.12Work in progress7,693.34517.20 4,887.81Treasury securities (own bonds)3,100.00Investment in Hailey Water Co6,250.00 Unamortized bond discount19,185.54Miscellaneous deferred charges355.19Miscellaneous unadjusted debits185.85Total 900,133.81495,728.40 99,390.31LIABILITIESCash (overdraft)$ 124.54Accounts payable$ 2,605.87409.70Notes payable11,611.35Accounts payable -- Consumers P. S. Co$ 39,497.25 Accounts payable -- Wood River Power Co6,219.48Dividends payable253.16 Accrued interest6,473.322,100.00 241.85Accrued taxes7,620.71955.33Unearned income467.64Consumer's deposits563.47Contributions for extentions3,197.59 Reserve for depreciation70,884.3647,512.13 43,677.31Reserve for contingencies3,500.00Reserve for bad debts860.23Reserve for sinking funds118,333.33Miscellaneous reserves2,213.13 Funded debt391,500.00210,000.00 17,500.00Common stock250,000.00170,000.00 5,070.00Preferred stock43,400.00 Surplus (or deficit)47,324.88(22,444.86)13,580.75Total 900,133.81495,728.40 99,390.3180 1230 38. According to the balance sheets of Freeport and Wood River as of December 31, 1925, and of Hailey as of May 31, 1926, the value of the assets of each company, excluding working capital, to wit, capital stock, surplus, sinking fund reserve, the book value of Wood River's investment in Hailey, and the minority stock interest in Freeport, was as follows:ValuePercentFreeport$ 407,345.0571.80Wood River141,305.1424.91Hailey18,650.753.29Total 567,300.94100.0039. The total amount paid by Foshay for the stock of Freeport on November 16, 1926, was $ 1,009,143.20. That amount was the fair market value on November 16 of the properties of Freeport. The Public Works Engineering Corporation appraisal of the Freeport property as of April 1, 1928, shows that the depreciable property constituted 89.71 percent of all assets of Freeport other than working capital. A reasonable allocation of the fair market value of the Freeport property on November 16, 1926, on the basis of this appraisal would attribute 89.71 percent of the total value to the depreciable properties, subject to adjustments for additions and retirements between November 16, 1926, 81 and April 1, 1928.Opinion. -- Petitioner's contentions under this second issue, which are alternative contentions, follow the same pattern as its contentions under the first issue, but the facts under this issue are wholly different. Petitioner contends that Foshay purchased the assets of Freeport Water Co. (and of the other subsidiaries of Consumers) for cash in a 1231 single transaction beginning with the contract of August 16, 1926, between Foshay and Smail, Baker, and Walsh (hereinafter referred to as S, B, and W), and terminating on November 15, 1926, when that contract was closed. Petitioner argues that the other contracts which Foshay executed on October 18, 1926, with Consumers, Freeport, and Peoples Illinois, and the contract which Foshay executed on September 20 with Peoples were all interdependent and were steps in an integral plan. So viewed, petitioner contends that Peoples Illinois did not acquire the Freeport property pursuant to a plan of reorganization.Petitioner contends, further, that the basis of the Freeport property to Peoples Illinois, and hence to petitioner, in view of our conclusions under issue 1, was the amount expended by Foshay in connection82 with the purchase of the Freeport property, to wit, $ 905,302.36, subject to appropriate adjustments for additions and retirements. Consideration of petitioner's claims relating to the amount of the basis of the Freeport property will be considered last.Respondent contends that Peoples Illinois acquired the Freeport property pursuant to a plan of reorganization, section 203 (h) (1) of the Revenue Act of 1926.The facts need not be repeated. Under this second issue the facts support petitioner's broad contention. We can not find in the facts a plan of reorganization to which Freeport Water Co. and Peoples Illinois were parties within section 203 (b) (3) of the 1926 Revenue Act; we are unable to find the required continuity of interest in the same persons which is essential to a reorganization under (1) (A) of section 203 (h); and we are unable to find the "control" by the transferor corporation or its stockholders in the transferee corporation which is required under (1) (B) of section 203 (h). Accordingly, we must reject respondent's arguments under this issue.It is well recognized that, where a series of related steps are all part of a plan, the various steps of the plan are83 to be regarded as making up one transaction for the purpose of determining the tax consequences. It is, therefore, the situation at the beginning and end of the transaction to which we must look to determine whether there has been a reorganization within the meaning of the statute, or merely a sale or taxable exchange. Republic Steel Corporation v. United States, 94 Ct. Cls. 476; United Light & Power Co. v. Commissioner, supra;Prairie Oil & Gas Co. v. Motter, supra;Diescher v. Commissioner, 110 Fed. (2d) 90; certiorari denied, 310 U.S. 650">310 U.S. 650; Howard v. Commissioner, supra.The contract of August 16 with S, B, and W, the stockholders of Consumers, for the purchase of their stock in Consumers was entered into by Foshay as a means and for the purpose of acquiring the physical 1232 assets of Consumers' subsidiaries. Such purpose is evidenced by clause 13 of that contract which provided that prior to the closing date, November 15, 1926, the vendors would have Consumers and its subsidiaries84 take all corporate action and execute and deposit in escrow all documents necessary to convey their assets to Foshay, or to Foshay's nominee. The whole transaction, ending on November 15, 1926, including Foshay's contracts of October 18 with Consumers, Freeport, and the newly organized corporation, Peoples Illinois, were means adopted to transfer the entire interest in the Freeport property from S, B, and W and Consumers, the equitable owners, to the nominee of Foshay (as well as the entire interest in the assets of Wood River and Hailey). The underlying plan was not for a continuance of ownership in the physical assets by the same persons in a different form, but was to effect a change in ownership. Cf. Republic Steel Corporation v. United States, supra.At the beginning of the transaction the Freeport property was owned by Freeport, whose stock was owned by Consumers, whose stock was owned by S, B, and W. At the end of the transaction the Freeport property was owned by Peoples Illinois, whose stock was owned by Peoples. None of the interest at the beginning carried through to the end of the transaction. The entire transaction was essentially85 in intent, purpose, and result a purchase of the Freeport property by Foshay itself or by Foshay for a nominee. Peoples Illinois received the Freeport property in exchange for its securities which were issued directly to Foshay, which then transferred them to Peoples in payment for securities issued by Peoples to Foshay.Under the August 16 contract Foshay agreed to provide for the redemption of the outstanding bonds of Consumers. In the October 18 contract with Consumers, Foshay advised Consumers that it was offering to provide for the payment of all of the indebtedness of Consumers' subsidiary corporations, and Foshay again agreed to pay the bonded indebtedness of Consumers. All these agreements supplemented the underlying agreement of August 16 and must be regarded as relating to the underlying agreement. Also, under the October 18 agreements among Foshay and Freeport, Wood River, and Hailey, those companies agreed to sell their entire assets to Foshay and/or its nominee. The consideration all moved from Foshay and consisted entirely of cash. Until the November 15 closing, all that Foshay had was an option to purchase the stock of Consumers, and Foshay could not acquire the86 stock of the subsidiary corporations until it carried out its obligations to Consumers. Consumers was not to deliver the stock of the subsidiaries to Foshay until the closing on November 15. The plan as formulated and carried out was in every respect a plan for the sale of the physical assets of the subsidiaries, and all of the sales were 1233 to be carried out, and were carried out simultaneously, on November 15, 1926. At the closing S, B, and W received cash for their stock; Foshay provided funds for the redemption of all of the outstanding securities of Consumers and its subsidiaries; Consumers delivered all of its assets to Foshay, consisting of the stock of the three subsidiaries, cash of $ 9,328.95, and other current assets; Foshay received cash and the current assets of Freeport, and its nominee, Peoples Illinois, received the operating water service properties. (We are not concerned under the issue with the disposition of the assets of Wood River and Hailey, but it appears that their assets were distributed in a similar manner.)Under the facts Foshay, in buying the stock and paying the debts of Consumers and Freeport, in substance purchased all of the assets of 87 Freeport, for cash. Thereafter S, B, and W, Consumers, and Freeport had no interest whatsoever in the assets of Freeport. We can not think of a clearer example of the purchase for money of the assets of a company by another company. Such purchase for cash is outside the purposes of the reorganization provisions of the statute. Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U.S. 462">287 U.S. 462; Prairie Oil & Gas Co. v. Motter, supra;Cortland Specialty Co. v. Commissioner, 60 Fed. (2d) 937; certiorari denied, 288 U.S. 599">288 U.S. 599; LeTulle v. Scofield, supra.The August 16 contract and the contracts dated October 18 are so interlocked and interdependent that a separation of them is impossible. That factor, plus the contemporaneous acts at the November 15 closing, compels our viewing the transactions as steps in a unitary plan, and as fixing the beginning of the transaction at August 16, 1926. Under such view the consideration for the Freeport property was cash, and the persons who owned equitable interests in the Freeport property at the beginning were S, B, 88 and W and/or Consumers. Since neither S, B, and W nor Consumers received any interest in Peoples Illinois, there is not the required continuity of interest in the same persons. Respondent's view implies a break in the transaction at some point so that the transfers of Freeport's assets partly to Foshay and partly to Peoples Illinois were pursuant to a transaction entirely separate from Foshay's transactions with S, B, and W and Consumers and were at a time when Foshay owned all of Freeport's stock. Such "break" would necessarily be at some moment during the closing on November 15. Foshay did not own, and could not have owned, the stock of Freeport at any time prior to November 15 under the express terms of the agreement of August 16. Everything done by Freeport was done with the cooperation of Consumers, which owned the Freeport stock, and during the time that Consumers owned that stock. Respondent's argument is necessitated by respondent's need for finding a "continuity of interest" in the transferred properties, which can only be found by 1234 adopting the premise that Foshay was the sole stockholder of Freeport when Freeport transferred its property to Peoples Illinois. 89 We must reject such premise.Even if we could find a break in the transaction to enable our adopting such premise, we would then face another obstacle to the continuity of interest theory in Foshay's sale of the stock and bonds of Peoples Illinois to Peoples. Thus, Foshay's interest in and control of Peoples Illinois was too transitory to support the conclusion that in Foshay there resided the required continuity of interest. In the end Foshay received the stock of Peoples, whose wholly owned subsidiary, Peoples Illinois, held the property transferred by Freeport. Under those facts, there was no reorganization. See United Light & Power Co. v. Commissioner, supra;Groman v. Commissioner, supra;Helvering v. Bashford, supra.It does not help respondent to argue that Freeport was wholly owned by Foshay when it transferred the Freeport property to Peoples Illinois.It is impossible to find that Foshay was a party to a reorganization of Freeport. See Anheuser-Busch, Inc., 40 B. T. A. 1100; affd., 115 Fed. (2d) 662; certiorari denied, 90 312 U.S. 699">312 U.S. 699. It does not aid respondent to find that the entire transaction between Foshay and S, B, and W and Consumers contained "a plan of reorganization" within the meaning of section 203 (h) (1) (A) of the Revenue Act of 1926. See Anheuser-Busch, Inc., supra.We do not agree that it did. There was no agreement between Freeport and Peoples Illinois; Freeport did not receive the securities of Peoples Illinois.It is held that Peoples Illinois did not receive the Freeport property pursuant to a tax free reorganization within section 203 (h) (1).Since the transaction does not qualify as a reorganization, the basis of the property is not established by section 113 (a) (7) of the Revenue Act of 1932, i. e., the basis to Peoples Illinois is not the same as the basis to Freeport.We come, then, to the matter of the basis of the property to Peoples Illinois.Petitioner contends that the basis of the Freeport property to Peoples Illinois is Foshay's cost in acquiring the Freeport stock less an amount of the total cost which is allocable to the nondepreciable property. Petitioner asserts that Foshay expended $ 1,009,143.20 for91 the Freeport stock, that 89.71 percent of the Freeport property is the depreciable property, so that the cost of the depreciable property is $ 905,302.36. The second question under the second issue relates to the determination of the basis of the Freeport property to Peoples Illinois.Petitioner has three alternative theories: (1) Foshay, in buying the stock and paying the debts of Consumers and Freeport, in substance purchased the Freeport properties (Prairie and Ashland cases) and 1235 then transferred them to Peoples Illinois in a tax-free exchange under section 203 (b) (4) of the Revenue Act of 1926; or (2) Foshay, after acquiring the stock of Freeport, transferred the assets of that company to itself in a taxable liquidation and then transferred the properties to Peoples Illinois in a tax-free exchange; or (3) Foshay, in substance, purchased the Freeport properties for the account of Peoples Illinois, citing Tulsa Tribune Co. v. Commissioner, 58 Fed. (2d) 937. Under (1) and (2), above, the basis to Foshay would carry over to Peoples Illinois as a result of the tax-free nature of the transfer under section 203 (b) (4) of the 192692 Act. 3 Petitioner points out under (2) above that under 201 (c) of the 1926 Act the liquidation of the Freeport properties to Foshay would not have been tax-free, and, as a result, the basis of the Freeport properties to Foshay would have been their value on the date of the liquidation, which, petitioner contends, would be what Foshay paid for them in arm's length transactions with outside interests on the same day. Under all of the three theories the basis of the properties to Peoples Illinois would be $ 905,302.36, the cost of the Freeport stock to Foshay.93 We must reject all of the petitioner's theories. We do not think the facts support the theory of petitioner under (3), above. The facts are dissimilar to the facts in the Tulsa Tribune case; Foshay did not provide Peoples Illinois, constructively or directly, with cash to purchase the Freeport property. With respect to the theories under (1) and (2), we can not agree that Peoples Illinois received the properties pursuant to a tax-free exchange under section 203 (b) (4), because the required control of Peoples Illinois by Foshay immediately after the transfer was lacking, as has been stated before. Foshay's ownership of the stock of People's Illinois was transitory and momentary because it immediately transferred the securities of Peoples Illinois to Peoples.The facts are that Foshay subscribed for securities of Peoples Illinois and paid for them in the property of Freeport which was transferred direct to Peoples Illinois, apparently to save a needless, formal transfer to Foshay. But the exchange of the securities of Peoples Illinois for property was not a tax-free exchange. The cost to Peoples Illinois of the Freeport property was the fair market value of its stock and 94 bonds. There is no evidence of the fair market value of the stock and bonds. At the time Peoples Illinois was a newly organized corporation and it had no other property. Under these circumstances, we think the rule may be applied that where there is 1236 no other method of measuring the fair market value of stock and securities issued in exchange for properties, the fair market value on the date of exchange may be determined to be the equivalent of the fair market value of the property received. Ida I. McKinney, 32 B. T. A. 450; affd., 87 Fed. (2d) 811; Rollestone Corporation, 38 B. T. A. 1093, 1107. We take the view, accordingly, that the basis to Peoples Illinois of the Freeport property is the fair market value on November 15, 1926, of the securities of Peoples Illinois, and that such value is the fair market value of the properties received.Under this theory, we reach the same result, however, which petitioner reached under each of its three theories, because the best evidence before us of the fair market value of the Freeport property is the amount which Foshay paid to acquire the95 Freeport stock in an arm's length transaction with outsiders, on the same day that the property was transferred to Peoples Illinois. We have concluded before that Foshay, in buying the stock and paying the debts of Consumers and Freeport, in substance, purchased the Freeport property. See Warner Co., 26 B. T. A. 1225, and the Prairie case. It is held, therefore, that the fair market value of the Freeport properties on November 15, 1926, was $ 1,009,143.20, and this has been found as a fact. In the October 18 contract between Foshay and Peoples Illinois it was provided that "the purchase price to be paid in property as aforesaid is of a value not less than the value of the aforesaid bonds and stock." We are aware that Peoples took up the stock and bonds of Peoples Illinois received from Foshay on its books at $ 762,200, but there is no explanation before us for that fact. In view of the other evidence we do not regard the book value given by Peoples to said securities as determinative.The sum $ 1,009,143.20 is the total of $ 383,243.70, net, which Foshay expended to purchase 50 shares of the Freeport stock from a minority stockholder and to 96 pay the bonded indebtedness of Freeport, as is shown in the table in the finding of fact, and $ 625,899.50, the amount of the total expended to acquire the stock of Consumers ($ 881,055.27), which petitioner allocates to the stock of Federal on the basis of 71.80 percent of $ 881,055.27. We agree that this computation of petitioner is substantially correct. The explanation is as follows: Foshay paid $ 881,055.27 to acquire the stock of Consumers, which includes the amount provided to pay the bonded indebtedness of Consumers. The purchase price for the stock of Consumers itself was, under the August 16 contract, based upon the balance sheets of Consumers and the three subsidiaries. According to the balance sheets the book value of the Freeport assets represented 71.80 percent of the total values of the assets of Freeport, Wood River, and Hailey. The cost of the Freeport stock, itself, is determinable by reference to the purchase price 1237 of the Consumers stock, and we think it is reasonable to allocate 71.80 percent thereof to the cost of the Freeport stock.Petitioner asserts, next, that 89.71 percent of $ 1,009,143.20, or $ 905,302.36, subject to appropriate adjustments97 for additions and retirements, constitutes the cost of the depreciable portion of the Freeport assets which passed to Peoples Illinois. Petitioner contends that a fair basis for allocating between the depreciable and nondepreciable property is found in the appraisal of the Public Works Engineering Corporation dated as of April 1, 1928. The respondent objects to the use of this appraisal as the basis for such allocation on the ground that it was not made contemporaneously with the acquisition of the property by Peoples Illinois, and that the standards of the appraiser can not be ascertained. We have carefully examined the appraisal in question, together with other evidence before us. We think the appraisal forms a substantially accurate basis for the allocation. It should, however, be adjusted as nearly as possible to the date of transfer by taking into consideration the retirements and additions during the period between the date of the transfer of the Freeport property to Peoples Illinois, November 15, 1926, and the time of the appraisal. We do not undertake to make such adjustments, but leave that to be done by the parties, and such adjustments, we believe, will reduce the98 percentage of 89.71 percent which petitioner has used. We approve, in substance, petitioner's method of allocating the cost of the Freeport property in the amount of $ 1,009,143.20 to the depreciable and nondepreciable properties.The conclusions reached under issue 2 necessitate a recomputation of the allowances for depreciation in the taxable years which shall be done under Rule 50. Petitioner claims that taxes have been overpaid in both years.Decision will be entered under Rule 50. MURDOCK Murdock, J., concurring: I concur in the result reached on the second issue. The general rule of the statute is that the basis for gain or loss and for depreciation shall be the cost of the property to the owner. I do not find that the circumstances of the acquisition of the Freeport assets by Peoples Illinois bring this case within any of the exceptions. Therefore, I agree with the result reached in this case. Perhaps the closest question presented is whether or not this transaction might not have come under section 204 (a) (7). Starting with Foshay owning all of the stock of Freeport, we find that Freeport transferred its operating assets to Peoples Illinois; Foshay received99 a few assets of small 1238 value and assumed the liabilities of Freeport; Foshay surrendered the Freeport stock to Freeport and Freeport was dissolved; and Peoples Illinois issued its stock and securities to Foshay but Foshay immediately passed them on to Peoples. Here there was a reorganization, since Peoples Illinois acquired substantially all of the properties of Freeport. But immediately after the transfer, an interest or control in the property did not remain in the same persons or any of them. Foshay was the sole stockholder of Freeport at the beginning, but immediately after the transaction was complete it held no stock of Peoples Illinois. I disagree with and deem unnecessary that part of the opinion based upon the holding that the purchase of the Consumers stock was an inseparable step in the plan of reorganization of Freeport. I see two different transactions -- one, the purchase by Foshay of the Consumers stock and, two, all of the subsequent things which were done by Foshay to suit its own convenience. Footnotes. Includes 6 shares of petitioner's stock issued to directors which were treated as belonging to Streator.↩1. SEC. 112. RECOGNITION OF GAIN OR LOSS.* * * The credits represent cash and other current assets which were taken over and retained by Foshay upon the liquidation of Hailey, Wood River and Freeport(i) Definition of Reorganization. -- As used in this section and sections 113 and 115 --(1) The term "reorganization" means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are tranferred, or (C) a recapitalization, or (D) a mere change in identity, form, or place of organization, however effected.[The above definition is the same as in section 203 (h) (1)↩ of the Revenue Act of 1926.]2. Respondent makes the following statement and argument in his brief:" * * In the view of the parties involved, as shown by the amounts of stock and bonds issued against it, by the appraisals and the contentions made in the applications to the Illinois Commerce Commission, the Freeport property had undoubtedly appreciated in value when the transfers here involved took place. If its later sale to the city of Freeport for the sum of $ 1,253,400.00 in cash in 1937 (Stipulation, paragraph 67) be given any weight, the property continued thereafter to increase in value. Yet no tax on that appreciation in value has ever been paid, under petitioner's prior adoption of the view in which we concurred and to which we still adhere that the transfers were tax free. To permit petitioner to step up its basis at this time, in the shadow of a profitable sale of the Freeport property, would be to enable petitioner to escape tax upon a very substantial, if not the major portion of, a gain which it has unquestionably realized. It was to prevent such an escape that the provisions compelling a transferee to use the transferor's basis, where the enterprise continued simply in a modified corporation form, were adopted. Where, as here, the petitioner merely carries on as an operating utility company the enterprise of furnishing water which had been formerly carried on by a different corporation, namely, Peoples Illinois, and where both corporations were, at the time of the transfer of the utility property, owned by the same parent, namely. Federal, the situation immediately calls for the application of the provisions preventing the use of a stepped-up basis. The situation is even stronger than that because of Federal's prior control of Peoples Light and Power↩3. (b) (4) No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624539/	RESERVE LOAN LIFE INSURANCE CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Reserve Loan Life Ins. Co. v. CommissionerDocket Nos. 21489, 29554, 32965.United States Board of Tax Appeals18 B.T.A. 359; 1929 BTA LEXIS 2063; November 29, 1929, Promulgated 2063 1. The petitioner issues certain life insurance policies known as "guaranteed premium reduction policies." To such policies are attached coupons. Upon each annual premium-paying date a coupon matures, which may be turned in to the company in payment of the premium to the amount of the face value of the coupon, or if the premium is paid in full in cash the policyholder may use the coupon to purchase nonparticipating paid-up additions to the face of the policy or the coupon may be collected at any time with interest. In some of the policies the coupons may be used to reduce the number of premium payments, while in others the coupons may be used to acquire an annuity. Held that the amount of the reserve which the petitioner is required to hold for the payment of the unsurrendered coupons and interest is a part of the reserve funds of the petitioner for the purpose of computing the deduction from gross income under section 245(a)(2) of the Revenue Acts of 1921, 1924, and 1926. 2. Interest paid and credited to policyholders on coupons attached to "guaranteed premium reduction policies" constitutes a paying off by the company of a policy obligation and therefore held not2064 deductible as interest on indebtedness under section 245(a)(8) of the Revenue Acts of 1921, 1924, and 1926. 3. In computing net income under section 245(a)(2) of the Revenue Acts of 1921, 1924, and 1926, held that petitioner is entitled to a deduction in the amount of 4 per cent of the mean of the reserve funds required by law and held at the beginning and end of the taxable years undiminished by the amount of exempt interest. 4. The petitioner made mortgage loans on farms to which upon default it took title through foreclosure of the mortgages. Upon taking title to the farms the petitioner credited its account of interest on mortgage loans with the interest then accrued and unpaid on such loans, thereby increasing the amount of its gross income. In the absence of evidence showing the amounts at which the petitioner acquired the respective properties at foreclosure or the actual value thereof, the inclusion of the accrued and unpaid interest in gross income is approved. 5. During the first three months of 1924 the petitioner occupied certain real estate as a home office building which it vacated at the end of the three months in order that the building could be razed2065 and a new home office building erected. Petitioner reported as income the rental value of the building for the period of three months and took as a deduction taxes paid and the other real estate expenses for the year. The respondent eliminated from income the rental value reported and disallowed the deduction. The respondent's action in eliminating from income the rental value reported is approved. The disallowance of the deduction for taxes and other expenses was erroneous. Frank G. West, Esq., for the petitioner. Arthur Carnduff, Esq., for the respondent. TRAMMELL360 These proceedings, which were consolidated for hearing and decision, are for the redetermination of deficiencies in income taxes as follows: Docket No.YearDeficiency295541923$1,509.012148919242,630.13192521.78329651926948.43The matters in controversy are, (1) the deductibility of the following amounts representing reserves to cover liability on outstanding coupons attached to "guaranteed premium reduction policies": 1923$11,254.58192412,898.91192514,437.7219267,586.07(2) As an alternative2066 to (1), the deductibility of the following amounts representing interest paid or accrued within the taxable years on matured coupons attached to "guaranteed premium reduction policies": 1923$36,430.11192444,235.11192552,189.92192660,430.73361 (3) The action of the respondent in reducing the amount of the 4 per cent of the mean of the reserve funds required by law by the following amounts representing interest received on the tax-exempt securities: 1923$8,408.3219246,668.9219255,216.66192659,626.20(4) The action of the respondent in including in taxable income the following amounts representing accrued and unpaid interest on loans on mortgages on farms to which the petitioner took title: 1924$220.5019252,638.41192617,043.09(5) The action of the respondent in eliminating from gross income for 1924 the amount of $3,000 representing the rental value of property occupied by the petitioner for home office purposes and eliminating from deductions the amount of $5,642.15 for taxes paid and other real estate expenses. FINDINGS OF FACT. The petitioner is a life insurance corporation organized2067 and existing under the laws of Indiana. It was incorporated in 1909. It is a stock company and not a mutual company. The petitioner had outstanding during the years here involved certain policies commonly known as "guaranteed premium reduction policies," to which were attached numbered coupons, each subsequent coupon being for a larger amount than the preceding one. The coupons were all alike except for the number, amount and date of payment. The following is a typical coupon: On or after Feb. 5, 1929 RESERVE LOAN LIFE INSURANCE CO. of Indianapolis, Indiana Will pay to the order of the insured under Policy No. Sample Ninety and90/100 DollarsProvided all premium due on said policy up to and including said date have been paid (Signed) G. L. STAYMAN Secretary.$90.90 Payable at its Home Office 362 The policyholder had the following options with respect to the coupons: (1) Receive in cash the coupons as they became due; (2) apply the amount of the coupon to the reduction of the premiums, if any; (3) convert the coupons, as they became due, into paid-up nonparticipating insurance, and (4) if the coupons were not used when they became2068 due, the petitioner would allow 3 1/2 per cent interest thereon, compounded annually, so long as the policy should be kept in force by the payment of the required premiums. The policies also provided that the coupons with accrued interest should be withdrawable on demand and that should the policy mature by reason of the death of the insured, all coupons and interest accumulated thereon should be paid in addition to the face of the policy. The following ruling was issued by the Commissioner of Insurance of the State of Indiana on January 22, 1923: To Indiana Life Insurance Companies:You are hereby advised of the following ruling of this Department, effective on and after January 1, 1923. The reserve deposit requirement of the Indiana Statutes shall be construed as follows: net reserve, paid-for basis, plus the extra reserve for disability and double indemnity benefits, plus the present value of supplementary contracts involving and not involving life contingencies, plus the present value of amounts incurred, but not yet due, for disability benefits, plus dividends and coupons left with the company to accumulate at interest and accrued interest thereon. As an offset2069 to excess liability occurring in the above, there shall be deducted from the above total, the net amount of uncollected and deferred premiums, less the excess of premium notes, policy loans and other policy assets, over net value on individual policies. Very truly yours, (Singed) T. S. MCMURRAY, Jr., Commissioner.The amounts the petitioner had on deposit with the Insurance Commissioner of Indiana among other reserves to cover the liability on outstanding coupons on "guaranteed premium reduction policies," the mean of the reserves on account thereof and 4 per cent of the mean of such reserves, were as follows: Amounts on depositYearBeginning of yearEnd of yearMean of reserves4 per cent of mean of reserves1923$260,879.60$301,849.89$281,363.93$11,254.581924301,849.89343,095.28322,472.6312,898.911925343,095.28378,790.80360,943.0414,437.72In determining the deficiencies for 1923, 1924 and 1925, the respondent eliminated as deductions the 4 per cent of the mean of reserves as shown above for the respective years. In determining the 363 deficiency for 1926 the respondent diminished by $7,586.07, 2070 the excess of 4 per cent of the mean reserve fund on account of the reserves to cover liability on outstanding coupons on "guaranteed premium reduction policies" as shown on line 6 of Schedule A of the petitioner's income-tax return for that year. The petitioner paid interest to holders of coupon policies and credited to holders of such policies for interest on outstanding coupons as follows: YearInterest paidInterest credited1923$904.97$35,525.1419241,166.4543,068.6619251,870.4450,319.4819261,921.9358,508.80The petitioner received interest on its tax-exempt securities as follows: 1923$8,408.3219246,668.9219255,216.66192659,626.20In determining the taxable income of the petitioner for the respective years the foregoing amounts of tax-exempt interest were not deducted. In determining the deficiencies for the years here involved, the respondent reduced the amount of 4 per cent of the mean of reserve funds by the amount of the exempt interest received during the respective years. At the commencement of 1924 the petitioner occupied as its home office a building owned by it in Indianapolis, Ind. This2071 building was vacated on April 1, 1924, and razed for the purpose of erecting a new home office building. At the beginning of 1924 the home office property was carried on the books of the petitioner at $196,980. Four per cent of such book value is $7,879.20. In 1924 the petitioner received rents from tenants of its home office building in the amount of $20 and received as rents from tenants occupying other property the amount of $353.81. The petitioner charged itself with a rental of its home office property for the three months prior to vacating it the amount of $3,000. The petitioner expended in connection with the maintenance and occupancy and for the payment of taxes upon its home office property for 1924 the amount of $5,642.15. In determining the deficiency for 1924 the respondent eliminated the $3,000 from the petitioner's income and disallowed the deduction of $5,642.15. During 1924, 1925, and 1926, the petitioner acquired title to certain farms on which it had previously made mortgage loans. Upon 364 acquiring title to the farms the petitioner in its books of account transferred the mortgage loan investments from its mortgage loan account to an account of2072 real estate owned for the full amount then invested in the respective mortgage loans, including accrued and unpaid interest, and as a part of the transaction credited its income account of interest on mortgage loans with the interest then accrued and unpaid, thereby increasing the amount of its gross income for the respective years to that extent. The amounts of interest so accrued and unpaid which were credited to interest on mortgage loans on the petitioner's books for the respective years were as follows: 1924$220.5019252,638.41192617,043.09Only one of the farms so taken over has been sold. This farm, known as the Kirkpatrick farm, was taken over by the petitioner in 1926 and at the time of the hearing the petitioner had entered into a contract to sell it for $1,800. The farm was charged off in 1926 at $5,359.66, of which $5,000 represented the amount of the mortgage and the remainder, $359.66 represented unpaid interest on the mortgage. OPINION. TRAMMELL: In the original petitions filed in these proceedings and in the amended petitions filed prior to the hearing, the petitioner alleges that the respondent erred in eliminating the deductions2073 taken for reserves to cover liability on outstanding coupons attached to guaranteed premium reduction policies. At the hearing the petitioner filed an amendment to its petitions, wherein it asked that it be allowed as deductions in determining net income the amounts paid and credited during the respective years to the holders of coupon policies, and stated that this was "rather an alternative contention" to that arising from the respondent's action in eliminating the deductions taken for reserves to cover liability on outstanding coupons attached to guaranteed premium reduction policies. In its brief the petitioner indicates that the issue raised by the amendment filed at the hearing is the chief issue and the other is the alternative issue. Our consideration, however, will be directed first to the deductibility of the amounts representing reserves to cover liability on outstanding coupons attached to guaranteed premium reduction policies and which were eliminated by the respondent in determining the deficiencies for the respective years. Section 244(a) of the Revenue Acts of 1921, 1924, and 1926 defines the gross income of a life insurance company as "the gross amount 365 2074 of income received during the taxable year from interest, dividends, and rents." Section 245(a) of these Acts defines the net income of a life insurance company as the gross income less - (1) The amount of interest received during the taxable year which under paragraph (4) of subdivision (b) of section 213 is exempt from taxation under this title; (2) An amount equal to the excess, if any, over the deduction specified in paragraph (1) of this subdivision, of 4 per centum of the mean of the reserve funds required by law and held at the beginning and end of the taxable year, plus (in case of life insurance companies issuing policies covering life, health, and accident insurance combined in one policy issued on the weekly premium payment plan, continuing for life and not subject to cancellation) 4 per centum of the mean of such reserve funds (not required by law) held at the beginning and end of the taxable year, as the Commissioner finds to be necessary for the protection of the holders of such policies only; * * * The petitioner contends that the amounts eliminated by the respondent for the respective years as reserves to cover liability on coupons attached to guaranteed premium2075 reduction policies are reserve funds required by law within the meaning of the term as used in the Acts. During the taxable years here involved there was in effect in Indiana the following statute governing the maintenance of reserves by life insurance companies: 4687. Valuation of policies - Deposits. - 10. As soon as practical after the filing of said annual statement of any company organized and doing business under the provisions of this act, in the office of the auditor of state he shall proceed to ascertain the net cash value of each policy in force on the thirty-first day of December immediately preceding, upon the basis of the American experience table of mortality and four per cent. interest, or actuaries' combined experience table of mortality and four per cent. interest, as adopted by the company and should any such company issue any policies based upon a higher standard than the above, such policies shall be valued according to such higher standard. For the purpose of making such valuation, the auditor of state may employ a competent actuary to do the same, who shall be paid by the company for which the services are rendered; but nothing herein shall prevent2076 any company from making said valuation herein contemplated, which may be received by the auditor of state upon such proof as he may determine. Upon ascertaining, in the manner above provided, the net cash value of all policies in force in any company organized or doing business under this act, the auditor of state shall notify said company of the amount thereof, and within sixty days after the date of such notification, the officers of such company shall deposit with the auditor of state, for the security and benefit of all its policy holders, an amount, which together with the sum already deposited with said officer and such additional sums as may be deposited by said company with other states or governments pursuant to the requirements of the laws of such other states or governments in which said company is doing business, shall not be less than the amount of such ascertained valuation of all policies in force, in the securities described in section twenty-two (22) of this act, or in certificates of deposit in any solvent bank or trust company, or satisfactory 366 evidences of ownership of unencumbered, improved real estate, as may be lawfully acquired by such company under2077 the provisions of this act, at such value as may be determined upon by two disinterested appraisers residing in the county in which the real estate is situate; such appraisers to be approved by the auditor of state. Such real estate shall not be sold or encumbered, without the consent of the auditor of state, unless securities of equal value as herein required be deposited with the auditor of state in lieu thereof. But no company organized under this act shall be required to make such deposit until the net cash value of the policies in force as ascertained by the auditor of state, exceeds the amount deposited by said company under sections five (5) and six (6) hereof: * * * Provided, That any policy hereafter issued may provide for not more than one year's preliminary term insurance and if the premium charged for term insurance under a limited payment life preliminary term policy providing for the payment of less than twenty annual premiums of under an endowment preliminary term policy, exceeds that charged for life insurance under twenty payment life preliminary term policies of the same company, the reserve thereon at the end of any year, including the first, shall not be less2078 than the reserve on a twenty payment life preliminary term policy issued in the same year at the same age, together with an amount which shall be equivalent to the accumulation of a new level premium sufficient to provide for a pure endowment at the end of the premium payment period equal to the difference between the value at the end of such payment period of such a twenty payment life preliminary term policy and the full reserve at such time of such limited payment life or endowment policy. All policies of life insurance including policies issued on a reducing premium plan or a return premium plan, shall be valued according to the provisions of this act: And provided further, That in every case in which the actual premium charged for an insurance is less than the net premium for such insurance, computed according to its respective table of mortality and rate of interest, the company shall also be charged with the value of an annuity, the amount of which shall be equal to the difference between the premium charged and that required by the rules above stated, and the term of which in years shall equal the number of future annual payments due on the insurance at the date of valuation. 2079 The foregoing provisions of this section for the valuation of policies shall apply to life insurance policies only. Insurance against permanent mental or physical disability resulting from accident or disease, or against accidental death, combined with a policy of life insurance, shall be valued on a basis of fifty (50) per centum of the additional annual premium charged therefor. The auditor of state, for the purpose of ascertaining the solvency of any company, may at any time during the year proceed to ascertain the net cash value of the policies of any company as hereinbefore provided, and when the value is so ascertained, require such company within sixty days to make deposit, in securities as herein provided, of an amount equal to the total ascertained net value of the policies of any such company. (Burns Annotated Indiana Statutes, Revision 1914, vol. 2, pp. 755, 756.) There was also in force in Indiana during the taxable years the following statutory provision: 4622a. Life policies, contents, Act of 1909. - 5. From and after July, 1909, no policy of life insurance shall be issued or delivered in this state or be issued 367 by a life insurance company organized2080 under the laws of this state, unless the same shall provide the following: * * * (7) A table showing in figures the loan values and the cash, paid-up and extended insurance options upon surrender, or available under the policy each year, upon default in premium payment, during at least the first twenty years of the policy, beginning not later than the end of the third policy year, which values shall be equal to the full reserve on the policy, less not to exceed two and one-half per centum of the sum insured; following this table there shall be a clause specifying the mortality table and rate of interest adopted for computing the reserve and specifying the basis for the values and options after the period covered by the table. This provision shall not apply to term policies nor to any form of paid-up insurance issued or granted in exchange for lapsed or surrendered policies. (Burns Annotated Indiana Statutes, Revision 1914, vol. 2, pp. 728, 729.) The petitioner is a stock life insurance company and the policies here involved are nonparticipating policies. The policyholders, therefore, are not permitted to share in the profits of the company. Two typical policies of the petitioner2081 were introduced in evidence. One is a life payment policy issued for a stipulated premium during the life of the insured. The policy, however, provides for a substantially smaller annual premium after all the coupons attached to it have matured. In addition to the options set out in our findings of fact, the policy contains an "annuity option" which provides that after 20 years from the date of the policy after all premiums have been paid and the coupons have not been employed for any other purpose the company will, upon request by the insured, convert the coupons into an annual life annuity of a stated amount. The other policy is a limited payment life policy with a stipulated premium payable for 20 years or until the prior death of the insured. In addition to the options set forth in our findings of fact, the policy provides that should the insured elect to pay all premiums without using the coupons in reduction thereof, and to leave with the petitioner the amount of all coupons, the company guarantees the policy shall become paid-up in 15 years. It was with respect to these and other various options and provisions that the petitioner was required to put on deposit the amounts2082 here involved to meet its liability on the policies and coupons attached. In , we considered the question of whether the reserve funds a life insurance company was required to keep to meet its liability on coupons on guaranteed premium reduction policies were a part of the "reserve funds" of the company for the purpose of computing the legal deduction from gross income under section 245(a)(2) of the Revenue 368 Acts of 1921 and 1924. After considering the question at some length, we decided that they were. There we said: The essence of the question before us is whether the obligation of the petitioner with respect to the unsurrendered coupons shown upon its annual statements for the years in question on 1 ne 22 of the convention form of report is a part of its "reserve funds" or simply a mere liability of the company. A mere accrued liability does not constitute a part of the reserve funds of an insurance company. The Supreme Court has pointed out in McCoach v.Insurance Company of North America, supra, that the term "reserve funds" as applied to a fire insurance company has "reference to2083 the funds ordinarily held as against the contingent liability on outstanding policies." This definition is not, however, applicable to the reserve funds of a life insurance company. A life insurance company has an absolute liability in respect of every policy so long as premiums are paid thereon. The liability is not contingent. The only uncertainty in the case of the life insurance company is the date upon which the company will have to pay a loss under a policy. The Supreme Court has pointed out that the term "reserve funds" as applied to life insurance companies has reference to "something reserved from premiums to meet policy obligations at maturity." The amounts claimed by the petitioner to represent reserve funds, including the obligation of the petitioner in respect of unsurrendered coupons, meets the test of this definition. It is true that the policyholder may demand the payment of the face of a matured coupon at any time together with interest thereon. If he does that the company is simply paying off a policy obligation and the policyholder has surrendered a part of his policy. * * * We think, however, that the theory that the amount of the premium covered by the premium2084 reduction coupon is simply a deposit of money with the insurance company is not the correct theory in the case. The policyholder has numerous options with respect to the amount represented by the premium reduction coupon. The insurance company is bound to hold an amount in reserve to meet all its obligations upon the policy. We think that in truth and in fact there can be no valid distinction between the amount reserved by the insurance company to meet its liability in respect of the particular premium represented by the premium reduction coupon and the balance of the premium. We think the foregoing is equally applicable to the instant case. In view of the provisions of the Indiana statute and of the requirements of the Insurance Department of that State, we are of the opinion that the amounts reserved by the petitioner for the respective years to meet its liability on outstanding coupons attached to guaranteed reduction policies are a part of the "reserve funds" of the petitioner within the meaning of section 245(a)(2) of the Revenue Acts of 1921, 1924, and 1926. With respect to the contention that it be allowed as deductions the amounts of interest paid and credited during2085 the respective years to holders of coupon policies, the petitioner characterizes the coupons as creating a mere debtor and creditor relationship. As pointed out in , the payment of the face of a matured coupon, together with the interest thereon, 369 constitutes the paying off by the company of a policy obligation and the surrender by the policyholder of a part of his policy. This being true, the amounts paid or credited by the petitioner during the respective years to holders of coupon policies do not, in our opinion, constitute interest paid or accrued on indebtedness within the meaning of section 245(a)(8) of the applicable Revenue Acts. The contention, therefore, is denied. Under the provisions of section 245(a)(2) of the applicable acts quoted above, the respondent allowed as deductions for the years here involved only the excess of the 4 per cent of the mean of the reserve funds required by law over the tax-exempt interest. The petitioner contends that this is erroneous in view of the decision in 2086 . The case there considered by the court arose under the 1921 Act, the pertinent provision of which is the same in the Acts of 1924 and 1926. The court said: Considering what has been said, together with the saving clause just quoted, and the manifest general purpose of the statute, we think that provision of the Act which undertook to abate the 4% deduction by the amount of interest received from tax exempt securities cannot be given effect as against petitioner under the circumstances here disclosed. It was unlawfully required to pay $92,490.20 and is entitled to recover. We think that under the above decision this contention of the petitioner must be sustained. . The petitioner contends that the inclusion by it in its gross income of the accrued and unpaid interest on mortgages on farms to which it acquired title was erroneous and that the amount should be eliminated. While there is no evidence as to whether the farms were acquired by the foreclosure of mortgages, the petitioner and the respondent state in their briefs that2087 they were acquired in this manner, and for the purpose of our discussion will be so considered. In , we had before us a question in some respects similar to that presented here. There the property sold at foreclosure was purchased by the taxpayer and another, who were the holders of the mortgage. Their bid was the highest and was for the principal sum of the mortgage. At the time of foreclosure there was due certain accrued and unpaid interest on the mortgage. There were also certain expenses incident to the foreclosure and sale of the property. The respondent sought to apportion the net purchase price of the property between the principal and the interest in the proportion that each bore to the 370 total of the two. We there held that, since the net proceeds of the foreclosure were less than the principal, the taxpayer had suffered a loss of part of its principal and that no part of the accrued and unpaid interest constituted income to the taxpayer. In the instant case the record is silent as to whether the bid prices at which the petitioner acquired the farms were for the principal and the interest2088 of the mortgage or for the principal only, or for less than the principal or at prices in excess of principal and interest. The facts show that upon acquiring title to the farms the petitioner in its books of account transferred these mortgage loan investments from its mortgage loan account to an account of real estate owned, for the full amount then invested in the respective mortgage loans, including the accrued and unpaid interest here involved, and as a part of the transaction credited its income account of interest on mortgage loans with the amount of interest then accrued and unpaid. In the absence of evidence showing at what prices the petitioner acquired the respective farms at foreclosure, we are not in a position to hold that the amounts of interest here in controversy were improperly included in the petitioner's income for the respective years. The petitioner contends that the amounts of interest for the respective years should not be included in income, as it will ultimately have losses on these transactions which it can never deduct. In support of its contention as to the ultimate losses, the petitioner points to the disposition being made of the Kirkpatrick farm, 2089 which was transferred in 1926 from the mortgage loan account to the account of real estate owned at an amount of $5,359.66, of which $359.66 represented interest and the remainder represented principal. From the evidence it appears that some time during the early part of 1929 the petitioner contracted to sell the farm for $1,800. As indicated above, it is what occurred during the years in which petitioner took title to the farms that governs the disposition of the question as to the taxability of the amounts of interest here being considered, and not what occurs in 1929 or later years. The petitioner contends that the respondent erred in eliminating from its income for 1924 the amount of $3,000, representing the rental value for three months of the building occupied by it as a home office for that period and in the disallowance of the deduction of $5,642.15 representing amounts expended in connection with the maintenance and occupancy of the building and for taxes paid on the home office property for 1924. The petitioner contends that it should be permitted either (1) to eliminate the amount of $3,000 as part of gross income and deduct three-fourths of the $5,642.15 371 2090 representing the fractional part of the year when the building was not occupied, it having been demolished during such period, or (2) there should be included in income the amount of $3,000 and a deduction allowed for the taxes and expenses aggregating $5,642.15, thereby reducing the net income determined by the respondent by the difference between the two items or $2,642.15. Among the deductions provided in section 245(a) of the Revenue Act of 1924 is the following: (6) Taxes and other expenses paid during the taxable year exclusively upon or with respect to the real estate owned by the company, not including taxes assessed against local benefits of a kind tending to increase the value of the property assessed, and not including any amount paid out for new buildings, or for permanent improvements or betterments made to increase the value of any property. Paragraph (b) of section 245 provides: (b) No deduction shall be made under paragraphs (6) * * * of subdivision (a) on account of any real estate owned and occupied in whole or in part by a life insurance company unless there is included in the return of gross income the rental value of the space so occupied. Such rental value2091 shall not be less than a sum which in addition to any rents received from other tenants shall provide a net income (after deducting taxes, depreciation, and all other expenses) at the rate of 4 per centum per annum of the book value at the end of the taxable year of the real estate so owned or occupied. In , we considered the validity of section 245(b). We there held invalid the requirement that no deduction shall be made of taxes, expenses and depreciation in respect of real estate occupied by the owner unless the rental value of such real estate be included in gross income in computing taxable net income. We think our decision in that case is applicable and controlling here. As paragraph (a)(1) of section 245 of the Act provides for the deduction of taxes and other expenses paid during the taxable year exclusively upon or with respect to the real estate owned by the company and as paragraph (b) of the same section is inoperative, we think the petitioner is entitled to the deduction of $5,642.15 representing taxes and other expenses paid during the taxable year, without including the $3,000 or any other2092 amount representing the rental value of the space occupied by it. Accordingly, we think the respondent properly eliminated the $3,000 from the petitioner's income, but erroneously disallowed the deduction of $5,642.15. Reviewed by the Board. Judgment will be entered under Rule 50.SMITH dissents on the fourth point.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624541/	W. Stanley Barrett, Petitioner, v. Commissioner of Internal Revenue, RespondentBarrett v. CommissionerDocket No. 17356United States Tax Court13 T.C. 539; 1949 U.S. Tax Ct. LEXIS 66; October 10, 1949, Promulgated 66 Decision will be entered for the respondent. Family Partnership -- Husband and Wife -- Wife Not Recognized. -- The evidence does not support the petitioner's contention that his wife contributed original capital and, furthermore, a consideration of all of the evidence in the case does not indicate that the other partners really intended to join together with the petitioner's wife for the purpose of carrying on the business as partners. Andrew P. Quinn, Esq., for the petitioner.Paul P. Lipton, Esq., for the respondent. Murdock, Judge. MURDOCK 540 The Commissioner determined a deficiency of $ 18,251.88 in the petitioner's income tax for 1943. The deficiency is computed with respect to the petitioner's income for the two taxable years 1942 and 1943 according to the provisions of the Current Tax Payment Act of 1943. The only issue for decision is whether the Commissioner erred in determining that the petitioner's wife, Irene B. Barrett, was not recognizable as a partner for tax purposes and that the partnership income credited to her, in accordance with the partnership agreement, is taxable to the petitioner.FINDINGS OF FACT.The petitioner and his wife, Irene, 67 were married on May 1, 1920. They have one child, a daughter, born in 1922. The petitioner's income tax returns for 1942 and 1943 were filed with the collector of internal revenue for the district of Rhode Island.The petitioner has been engaged in the stock brokerage business since 1921. The petitioner, together with George Barrett, Jr., and Wallace L. Mossop, formed the firm of Barrett & Co. in July 1929. He contributed $ 25,000 to the capital of that partnership. The other partners originally contributed no capital. There was no written partnership agreement and the record does not show what their oral agreement was.The following table shows the amount of income of the partnership for five years ended June 30, 1935, how that income was shared, and the capital accounts of the three partners at the end of the period:Income193119321933Petitioner$ 13,262.56$ 2,824.40$ 15,216.77Mossop2,654.362,824.4015,216.77George Barrett, Jr1,242.282,824.3815,216.76Total17,159.208,473.1845,650.30IncomeCapitalaccount,6-30-3519341935Petitioner$ 16,249.15$ 16,441.14$ 41,514.86Mossop16,249.1416,441.1430,898.64George Barrett, Jr16,249.1316,441.1432,694.03Total48,747.4249,323.4268 The petitioner asked his partners at some time in 1935 whether they had any objection to Irene Barrett becoming a partner. They indicated that they had no objection. The petitioner, his two old partners, and Irene Barrett entered into a written partnership agreement which was dated July 1, 1935, and provided in part as follows:541 6. Capital. The interest of the parties in the capital of the partnership shall be as shown by the balance sheet attached to this agreement and as shown by the books of account subsequent thereto. Undistributed profits shall be credited in equal shares to the interest of each partner in the capital and any losses shall be charged in equal amounts to the interest of each partner in the capital. Each partner shall receive interest at the rate of 6% per year on his or her share in the capital, to be charged as an expense of the business.7. Salaries. The partners shall be paid such salaries as may be agreed upon, to be charged as an expense of the business.8. Profits. Each partner shall be entitled to one-fourth of the net profits as shown by the books at the end of each fiscal year.The record does not show whether that agreement69 was actually entered into on July 1, 1935, or whether it was entered into later.The partnership issued its check for $ 35,000 to Irene Barrett on December 28, 1935, and on the same day she delivered her check for that amount to the partnership. There are entries in the partnership books under date of July 1, 1935, debiting the petitioner's capital account with $ 35,000 and crediting a capital account in the name of Irene Barrett with $ 35,000.The petitioner engaged an attorney on December 28, 1935, who prepared an assignment of one-half of his interest in the partnership as of July 1, 1935, to his wife. The petitioner at that time executed an insurance trust and transferred to it, for the benefit of his wife policies of life insurance on his life. The same attorney who prepared the partnership agreement prepared the assignment and the insurance trust.The petitioner filed a gift tax return on March 16, 1936, for the calendar year 1935, reporting gifts described as follows:Date ofValue atgiftdate of giftLife insurance policy, Puritan Life #924612/31/35$ 681.42Life insurance policy, Mutual Benefit #1,337,86812/31/3572.03Life insurance policy, Equitable Life #3,116,35912/31/352,719.44Cash35,000.00Partnership in Barrett & Co7/1/3520,757.4370 Irene Barrett filed, on March 10, 1936, a return as donee of gifts described exactly as shown in the petitioner's gift tax return.The petitioner, in 1937, in a letter to the Commissioner relating to his gift tax return for 1935, stated that he had made a gift on July 1, 1935, of one-half of his interest in the partnership, and in his gift tax returns filed for 1941 and 1944 he reported as net gifts for preceding years amounts including the gifts shown on the 1935 return.The following table shows the total amount and distributive shares of net income of Barrett & Co for the years 1939 to 1943, as reported on partnership information returns: 542 193919401941Petitioner$ 28,592.54$ 23,213.90$ 14,224.99 Irene Barrett12,854.207,475.56(1,444.58)George Barrett, Jr15,619.1010,240.461,485.68 Wallace Mossop16,932.5611,548.602,921.62 Total73,998.4052,478.5217,187.71 19421943Petitioner$ 19,124.03$ 24,441.00Irene Barrett13,128.4224,328.09George Barrett, Jr16,054.7821,949.07Wallace Mossop17,492.1623,488.97Total65,799.4594,207.13The record does not show how the amounts shown in the 71 above table were determined or what part represents salaries.The following table shows the total amount credited or debited to Irene's capital account for each fiscal period as her share of the profits or losses of the partnership and the balance in that account as of the end of each fiscal period up through 1943:Period ended June 30 --ProfitsCapital1936$ 38,021.60 $ 73,021.60193745,523.64 111,118.371938(9,340.24)57,898.7919384,290.29 60,389.67193912,854.20 69,868.7619407,475.56 62,770.651941(1,444.58)57,596.72194213,128.42 65,382.94194324,328.09 61,120.59The capital account of Irene up to the end of 1943 contains, inter alia, debits for the following entries: Income tax paid each year on her behalf; a total of $ 408.75 designated "donations" but not otherwise explained; $ 27,300.50 on July 1, 1937, $ 9,483.86 on March 7, 1940, $ 9,146.12 on January 1, 1943, to represent securities distributed by the partnership; $ 2,362.50 on December 7, 1942, representing a transfer to the customer ledger; and $ 5,200 on December 31, 1943, representing salary for that year, with the explanation "Dr. Acct." The account contains numerous72 other entries, none of which are self-explanatory and none of which were explained. Many of the entries do not represent cash withdrawals by Irene and there is no evidence that any of the entries represent actual withdrawals by her. The active partners decided on three occasions during this period to distribute securities belonging to the partnership. They decided what securities would be taken out of the partnership accounts and charged to the accounts of the individual partners. The accounts of the other three partners have entries under the same dates and in approximately the same amounts as those mentioned above representing distributions of securities to Irene. The record does not show what was actually done with the securities or that Irene ever received any of them or exercised any control over them.Irene Barrett did not render any services to or participate in any way in the management or operation of the partnership business during the period from July 1, 1935, to the end of 1943.543 The petitioner did not include in his income for 1942 and 1943 any part of the share of the partnership income credited to Irene Barrett on the partnership books. The Commissioner, 73 in determining the deficiency, added to the petitioner's income the partnership income for 1942 and 1943 credited to Irene Barrett on the books of the partnership. He held that the wife "was not a bona fide partner recognizable as such for tax purposes."The petitioner, Wallace Mossop, and George Barrett, Jr., did not really and truly intend to join with Irene Barrett for the purpose of carrying on the business as partners, and Irene is not recognizable as a partner for income tax purposes.OPINION.The Supreme Court has said that in cases like this all of the surrounding circumstances must be examined in order to determine "whether the partners really and truly intended to join together for the purpose of carrying on a business and sharing in the profits or losses or both." . See also ; . The Court in the Tower case said that a wife could become a partner for tax purposes with her husband "if she either invests capital originating with her or substantially74 contributes to the control and management of the business, or otherwise performs vital additional services or does all of these things." The petitioner concedes that his wife did not contribute in any degree to the control and management of the business and did not otherwise perform vital services. She took no part in the partnership activities. The petitioner bases his case entirely upon the proposition that his wife contributed $ 35,000 of her own money to the business in 1935 and, therefore, is entitled to her share of the partnership profits in accordance with the partnership agreement dated July 1, 1935, with the result that no part of those profits is taxable to him. The Supreme Court, in the Culbertson case, stated that the "isolation of 'original capital' as an essential of membership in a family partnership also indicates an erroneous reading of the Tower opinion." An effort has been made herein to give consideration not only to the question of whether or not the wife contributed "original capital," but also to all of the various facts and circumstances which might shed any light upon the intent of the parties. However, the petitioner's contention will be discussed75 first.He contends that his wife loaned him the proceeds of the sale of her real estate, with the understanding that he would repay her, and he transferred to her in 1935, in settlement of that debt, $ 35,000, which she then invested in a one-fourth interest in the partnership. The 544 evidence in support of this contention is somewhat vague and uncertain at several critical points and also contains contradictions, with the result that the Court has been unable to make a finding that the wife contributed any "original capital" to the business.The money which the petitioner claims his wife loaned him came from the sale of their home in November 1929. The petitioner purchased a lot in 1925 and built a house on it. He and his wife occupied that house as their home until it was sold in 1928, at which time other land was obtained and a new house was built, which was or was to be their home. There were mortgages on each home, but, aside from the mortgages, the petitioner invested about $ 30,500 of his own money in the properties. He, rather than his wife, was the active person in obtaining the properties, applying for the loans, and building the houses. The second home was 76 to cost about $ 72,000, but not all of that amount had been paid in November 1929. The petitioner had placed the title to each of these homes in his wife's name. He said he did that for the purpose of giving her some security in case something happened to his business, but he also testified that it was his policy to put all of his property, aside from the partnership property, in his wife's name. A partnership, of which the petitioner was a member, had pledged securities belonging to a customer for a debt of the firm and, in November 1929, had to have $ 13,000 immediately to redeem those securities in order to return them to their owner. The petitioner requested his wife to sell their new home in order to obtain the needed funds. The new home was sold and about $ 23,500 was realized from the sale. The petitioner's wife received a check for that amount on November 14, 1929. She immediately turned over $ 13,000 to the petitioner, who contributed it to the capital of the partnership and the partnership used that money to redeem the pledged securities. The wife later transferred the remaining $ 10,500 to the petitioner to enable him to pay off some personal indebtedness. An adjoining77 lot was sold in 1930 for $ 7,500 and the wife transferred that amount immediately to the petitioner to enable him to pay off additional personal indebtedness. Thus, the petitioner received about $ 31,000 from the proceeds of the sales of property standing in his wife's name, in which properties, beginning in 1928, he had invested about that much of his own money.The petitioner, with some leading from his attorney, referred to those transactions as loans from his wife. He was asked by that attorney to give the substance of any conversation he had had with his wife at or about the time the money was turned over to him, and he replied, "That is so many years ago, the only recollection I have was that in the talks I expected to pay the money back." His attorney 545 then said, "I am going to ask you once more about that, Mr. Barrett. Will you please tell us, as best you can, the substance of what you told Mrs. Barrett about those various loans and the repayment, if there was any talk about them?" His answer was, "When I was financially able I would repay the loans." They had no notes or other written evidence of any indebtedness existing between them. There is no evidence that78 the wife ever requested the petitioner to repay her any money or to give her an interest in the partnership. Were these home properties in the name of the wife for her benefit, for his, or for mere convenience? Were his statements in 1929 sufficient to create a debt? A debt must be certain and payable unconditionally. Cf. , affirming ; ; ; .It is not clear whether the new partnership agreement was actually entered into on or about July 1, 1935, at the time the fiscal year of the old three-man partnership terminated, or whether it was entered into in the latter part of December 1935. It is clear, however, that shortly after December 1935, when these events were probably clearer in the petitioner's mind than they are now, he reported that he had made a gift of $ 35,000 to his wife and had made her a gift of one-half of his capital interest in the partnership. 79 He reaffirmed that position on several subsequent occasions. The position taken by him in his gift tax returns, and subsequently affirmed, that the transfers to his wife in 1935 were gifts, is inconsistent with his present contention that he owed his wife at least $ 31,000 and was merely repaying her. He says now that his reporting the transfers as a gift was due to confusion and stupidity on his part and he has filed a claim for refund of those taxes. The petitioner apparently was not in position to give his wife a one-fourth interest in the proposed new partnership and retain a one-fourth interest for himself, since he was receiving only one-third of the profits in the existing partnership. It is difficult to understand why his partners were willing to have him bring in his wife, which meant that they would take a smaller share of the profits. Apparently no new capital was needed. Certainly none was brought in by the change.The record as a whole leaves real doubt as to what happened and does not justify a finding that the petitioner ever owed his wife anything or a finding that she contributed any capital originating with her to the partnership. This destroys the whole 80 foundation of the petitioner's case as he presented it.The Court has considered other circumstances, including the fact that the Commissioner apparently recognized this partnership as 546 valid for tax purposes for about six years. The evidence shows that the old partnership had been increasingly successful for several years up to and including 1935, and the saving of taxes to the petitioner is the only obvious benefit that the petitioner might have expected in taking in his wife as a partner. Her share of the earnings under the agreement for the fiscal year ended June 30, 1936, was $ 38,021.60, or substantially more than the amount of capital which she is supposed to have contributed, the contribution of which is said to entitle her to a share of the earnings. It is not easy to assume that mere capital could earn so much (cf. ) or that any such arrangement would have been made except for some ulterior purpose. The record does not show the extent to which capital was an income-producing factor in the business.The Court has also considered the extent, if any, to which the wife actually controlled or enjoyed profits81 of the partnership credited to her account, and, here again, the record is not clear. She had no other income and the payment by the partnership of income taxes on her allotted share of partnership income is not very significant. The wife was on the stand and evinced almost no knowledge of the affairs of the partnership. She did not testify that she had ever exercised her own initiative in any way in connection with funds standing in her name on the books of the partnership or had ever withdrawn any money or securities to use as she saw fit. There is some evidence to indicate that her husband decided to make and made a gift to their daughter of some of the securities charged to the wife's account without his wife knowing very much, if anything, about the gift. Also, there is evidence that $ 5,200 was credited to her account at the end of 1943 as salary, although she did absolutely nothing to earn any salary. These and other circumstances suggest that the petitioner used his wife's name in transactions without any real interest or participation on her part. Of course, the credits to her account are not significant if others actually earned all of the income. .82 The evidence as a whole indicates that the petitioner and the other two active partners, using the capital in the business prior to July 1, 1935, and earnings thereafter left in the business, earned the income; the wife made no contribution of capital or services to the business; the wife exercised no control over any of the amounts or securities credited to her on the books of the partnership; and no part of the income of the business for 1942 or 1943 should be recognized as taxable to the wife.Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624543/	Charles Town, Incorporated v. Commissioner.Charles Town, Inc. v. CommissionerDocket No. 3517-62.United States Tax CourtT.C. Memo 1966-15; 1966 Tax Ct. Memo LEXIS 267; 25 T.C.M. (CCH) 77; T.C.M. (RIA) 66015; January 19, 1966267 Held, the income derived from the operation of two horse racing meets was earned by petitioner, and petitioner is subject to Federal income taxes on such income. George T. Altman and Stanley H. Wilen, for the petitioner. Stuart E. Seigel and Dennis R. Powell, for the respondent. ARUNDELLMemorandum Findings of Fact and Opinion ARUNDELL, Judge: Respondent determined deficiencies in petitioner's income tax for the period May 22, 1958, to November 30, 1958, of $258,616.93, and for the fiscal year ending November 30, 1959, of $117,367.57. Petitioner assigned error as follows: (a) The Commissioner erred by including the income of Fairmount Steel Corporation in the income of the petitioner in the following amounts: GrossTaxableIncomeIncomeFiscal YearErroneouslyErroneouslyEndedIncludedIncludedNovember 30, 1958$2,808,220.18$497,833.02November 30, 19592,056,444.34234,466.84Findings of Fact Some facts are stipulated and are found accordingly. Charles Town, Incorporated, hereinafter sometimes referred to as Charles Town, is a corporation incorporated on May 22, 1958, under the laws of the State of West Virginia. Charles Town filed Federal corporation income tax returns for the period May 22, 268 1958, to November 30, 1958, and for the fiscal year ended November 30, 1959, with the district director of internal revenue, Baltimore, Md.Fairmount Steel Corporation, hereinafter sometimes referred to as Fairmount, was incorporated on July 5, 1951, under the laws of the Commonwealth of Pennsylvania. The issued and outstanding stock of Fairmount, at all times material hereto, consisted of Class A common stock, which had the exclusive voting rights, and Class B common stock. The Class A common stock was issued for $1 per share as follows: Ben Cohen50 sharesHerman Cohen50 shares At all times material hereto, Ben Cohen and Herman Cohen have held all the issued and outstanding Class A common stock of Fairmount. The Class B common stock was issued for $50 per share as follows: Ben Cohen (younger brother of Herman)175 sharesHerman Cohen (older brother of Ben)175 sharesHerman Cohen, Ben Cohen, andStanley H. Wilen, Trustees forCharlotte Cohen (daughter of Ben)now Charlotte Weinberg100 sharesRosalee Cohen (daughter of Ben)100 sharesJacob Kartman, Ben Cohen, and RosaL. Cohen (wife of Herman) Trus-tees for Nathan L. Cohen, son ofHerman)200 sharesRaymond Voyes250 sharesIn March 1953 the shares 269 of stock originally issued to Raymond Voyes were transferred to a partnership consisting of Herman Cohen and Ben Cohen. In 1957 the shares of stock originally issued to the aforementioned trustees for Charlotte Cohen were distributed by said trustees to Charlotte Cohen, individually. There were no other changes in the ownership of the Class B common stock at any time material hereto, and the foregoing represented all the issued and outstanding Class B common stock. The officers of Fairmount, from its inception and at all times material hereto, all of whom constituted its board of directors, were as follows: PresidentHerman CohenVice President and Secretary-TreasurerBen CohenAssistant Secretary-TreasurerRosa L. CohenAssistant Secretary-TreasurerZelda G. Cohen(wife of Ben)In addition, in 1954 and at all times material thereafter, Richard Davison (husband of Rosalee) became an assistant secretary of Fairmount, although he did not serve as a director. Housing Engineering Corporation, hereinafter sometimes referred to as Housing, was incorporated under the laws of the State of Maryland, on June 25, 1952. Its issued and outstanding capital stock, all of which was common stock, was held at 270 all times during its existence as follows: No. ofNameSharesBen Cohen100Herman Cohen100Zelda G. Cohen100Rosa L. Cohen100Herman Cohen, Zelda G. Cohen, and Ja-cob Kartman, Trustees for CharlotteCohen, now Charlotte Weinberg100Herman Cohen, Zelda G. Cohen, and Ja-cob Kartman, Trustees for Rosalee Co-hen, now Rosalee Davison100Ben Cohen, Rosa L. Cohen, and JacobKartman, Trustees for Nathan L. Cohen200At all times during its existence, the following were the officers and also constituted the board of directors of Housing: PresidentBen CohenVice PresidentHerman CohenTreasurerBen CohenSecretaryHerman CohenAssistant TreasurerRosa L. CohenAssistant SecretaryRichard DavisonAssistant Secretary-TreasurerZelda G. CohenHousing was liquidated on April 29, 1958, and was succeeded by a partnership known as C.B. Associates, composed of the same persons who were the stockholders of Housing, retaining the same percentage interest in the partnership as they had held in the corporation. In December 1952 Herman and Ben Cohen acquired controlling interest in the Maryland Jockey Club of Baltimore City, Inc., hereinafter sometimes referred to as the Maryland Jockey Club. At or about the same time Louis Pondfield 271 (a first cousin of Herman and Ben) acquired an interest in the Maryland Jockey Club which eventually amounted to 7 1/2 percent. Since that time the Maryland Jockey Club has owned and operated the Pimlico Race Course, Baltimore, Md. Ben Cohen had at various times dating back to the 1930's been interested in acquiring the Charles Town Race Course in Charles Town, W. Va. , hereinafter sometimes referred to as the Race Course. In his discussions and negotiations in that connection Ben Cohen was always accompanied by Pondfield who brought this opportunity to his attention. Albert Boyle, the owner of the Charles Town Race Course, died in November 1957. Some time thereafter Ben and Herman Cohen, hereinafter sometimes referred to collectively as the Cohen brothers, accompanied by Pondfield, had negotiations, with regard to purchasing the Race Course, with Harry Byrer, an attorney who represented Boyle's widow, Helene W. Boyle, hereinafter sometimes referred to as Helene Boyle, and the Estate of Albert Boyle, deceased. Ben Cohen was the primary negotiator on behalf of the Cohen brothers during these negotiations. Ben Cohen carried on these negotiations on behalf of himself and Herman Cohen 272 in their individual capacities and had not determined whether the purchase, if consummated, would be effected in their individual capacities, by some existing corporation, or by a corporation to be organized for that purpose. He intended to make the decision after the deal was concluded. He never advised Byrer that he was acting on behalf of Fairmount. By letter dated February 3, 1958, from Byrer to "Messrs. Cohen Bros.," an offer was made to sell the Race Course upon specified terms and conditions. The proposal provided, in part, that the property would not be assignable to any person or corporation without the written consent of Helene Boyle except that a West Virginia corporation could be formed to which the property could be transferred. However, such a corporation was to be prohibited from assigning or transferring the property without Helene Boyle's written consent. By letter dated February 5, 1958, from Ben Cohen to Byrer, a counteroffer was made in accordance with the terms of an offer made in the previous year. By memorandum dated March 24, 1958, Herman Cohen advised Ben Cohen that further proposals which he and Pondfield had discussed that day with Byrer were under consideration. 273 On March 28, 1958, Housing paid $900,000 to Fairmount. Said payment was reflected on Fairmount's books as follows: A debit to cash in the amount of $900,000 and a credit to an account entitled "Loans Payable #1," entry dated April 3, 1958. Said payment was reflected on Housing's books as a credit to cash and as a debit to an account entitled "Accounts Receivable. " This payment was not evidenced by any notes or other debt instrument, did not bear interest, was made without security, and no date for repayment was specified. At the time these funds were advanced to Fairmount, Fairmount was insolvent. By letter dated March 31, 1958, from Byrer addressed to "Messrs. Cohen Bros.," the proposals referred to by Herman Cohen in the memorandum of March 24, 1958, were rejected. Subsequently, about the middle of May 1958, the West Virginia Racing Commission issued an ultimatum to Helene Boyle that if a summer meet of that race track was not operated, they would take her franchise away. This led to the immediate negotiations between Ben Cohen and Byrer relative to the leasing of the track by Helene Boyle to a West Virginia corporation to be formed, known as Charles Town, Incorporated. On May 274 20, 1958, a lease was executed, the first paragraph of which read as follows: THIS LEASE made and executed this 20th day of May, 1958, by and between Helene W. Boyle * * * as the Lessor, and Ben Cohen, acting for Charles Town Incorporated, a corporation to be hereinafter created under the laws of the State of West Virginia, hereinafter designated and referred to as the Lessee. [Emphasis supplied.] The Cohen brothers requested Clarence E. Martin, Jr., an attorney in Martinsburg, W. Va., to cause Charles Town to be created. Martin prepared the application for charter which was executed on May 17, 1958. Charles Town was duly incorporated under the laws of the State of West Virginia on May 22, 1958. Its certificate of incorporation provided, in part, that the principal office of the corporation would be located at 1229 Mt. Royal Avenue, Baltimore, Md., which address was the office of the Cohen brothers. The objects for which the corporation was formed were to engage in and carry on the business of operating a race track. The corporation's authorized capital stock was 1,000 shares of common stock of a par value of $10 each. However, only 100 shares were issued by certificates dated May 275 22, 1958, as follows: CertificateNo. ofNo.Issued toShares1Herman Cohen12Ben Cohen13Louis Pondfield98The said stock was issued for the total sum of $1,000 which was not paid until July 22, 1958. During the taxable periods here involved, no additional stock was issued to any person and the aforementioned 100 shares represented all of the issued and outstanding stock during said periods of time. The previously mentioned lease executed on May 20, 1958, between Helene Boyle and Ben Cohen, acting for Charles Town, provided in part as follows: This lease shall begin on the 22nd day of May, 1958, and unless sooner terminated as herein provided shall continue to and include the 10th day of September, 1958. As rental for said premises for the full term of this lease, said Lessee shall pay to the Lessor the sum of Two Hundred and Twenty Five Thousand Dollars. * The Lessee shall be entitled to all income from the operation of the horse racing meets to be conducted on said premises and from any and all other commercial operations conducted thereon * . * * and the Lessee assumes all risks to persons or property from latent or patent defects in the premises and fixtures thereon; the Lessor 276 shall not be liable to the Lessee or any other person for any loss or claim of any kind whatsoever resulting from the operation of the aforesaid premises and the use thereof by the Lessee; that the Lessee shall immediately, upon execution of this instrument secure and keep in force and effect during the continuance of this lease, proper and effective comprehensive liability insurance in the sum of $500,000.00, issued by a reputable solvent insurance company qualified and authorized to do business in the State of West Virginia. * It is expressly understood and agreed between the parties hereto, that this lease is entered into, upon the express condition that the Lessee or his assignee aforesaid, shall be able to secure from, and be granted, a license by, the West Virginia Racing Commission, permitting him or his said assignee to conduct a horse race meeting on the aforesaid premises for at least 56 days during the leasehold period aforesaid, and in the event such license shall not be granted or secured as aforesaid, then this lease shall be forthwith null and void and of no effect and thereupon all rights and obligations of the parties hereto will be at an end, except that the Lessor 277 shall forthwith return to the Lessee the consideration paid to the Lessor by the Lessee as aforesaid; the Lessee agrees, however, to make prompt and diligent application for such license and use every available effort to secure the same, subject to the check for $225,000.00 being good. By check dated May 20, 1958, Fairmount paid the sum of $225,000 to Helene Boyle, which payment was reflected on Fairmount's books as a debit to an account entitled "Charles Town, Inc." and a credit to cash. A supplemental agreement dated May 22, 1958, was executed between Helene Boyle and Ben Cohen, acting for Charles Town whereby an additional rental of $25,000 was agreed upon in view of the fact that the West Virginia Racing Commission authorized racing dates at the Race Course for a period in excess of that originally contemplated by the parties. The additional $25,000 was to be paid "$15,000.00 upon the execution of this agreement and $10,000.00" on September 2, 1958. By check dated May 22, 1958, Fairmount paid the sum of $15,000 to Helene Boyle, which payment was reflected on Fairmount's books as a debit to an account entitled "Charles Town, Inc." and a credit to cash. Fairmount also paid to or 278 on behalf of Charles Town the following amounts on the dates indicated, which amounts were all reflected on Fairmount's books as debits to the account of "Charles Town, Inc." and credits to cash: May 26, 1958$ 5,000May 26, 19585,000May 28, 19582,025 May 28, 19581,000May 28, 19581,000May 28, 1958$225,000Nov. 5, 1958224,250 Nov. 5, 195863,250 Dec. 5, 1958200,000Nov. 24, 195920,000The foregoing advances made by Fairmount to Charles Town in the total amount of $986,525 were reflected on Charles Town's books as credits to an account entitled "Account Payable - Fairmount Steel Corp." with the exception of the payment of $20,000, which was credited to a ledger account entitled "Advances from Fairmount Steel Corp." The advances from Fairmount to Charles Town were not evidenced by any notes or other debt instruments, did not bear interest, were made without security, and no date for repayment was specified. They were not intended as loans. The said advances were made pursuant to and in accordance with the agreement hereinafter mentioned, 279 dated May 20, 1958, between Fairmount and Charles Town for the purpose of furnishing the capital necessary to run the racing meets and were used to make rental payments to Helene Boyle, for deposits of opening balances in various bank accounts, and for "bankroll," which are the funds necessary to be on hand to commence wagering operations. The officers of Charles Town, from its inception until May 15, 1961, all of whom constituted its board of directors, were as follows: PresidentBen CohenVice PresidentLouis PondfieldSecretary-TreasurerHerman CohenThe bylaws of Charles Town provided that the board of directors shall have the control and management of the affairs, business, and properties of the corporation. Because of the poor condition of the grandstand and other hazardous conditions when the May 20, 1958, lease was executed, over 100 improvements were required by the insurance company as a condition of writing the policy; and the said improvements were made. Despite such improvements there was still danger of claims in excess of the insurance coverage. One of the purposes of forming Charles Town was to limit liability for possible claims for personal injuries and other liability 280 that could arise out of the operation of the meet. Its chief purpose, however, was to operate a race track. On May 20, 1958, concurrently with the execution of the lease of that date, an agreement was entered into between Fairmount and Charles Town under which Fairmount agreed to provide the funds necessary for conducting said meet and Charles Town agreed to operate said meet for the benefit of Fairmount. The agreement provided as follows: THIS AGREEMENT, Made and entered into this 20th day of May, 1958 by and between FAIRMOUNT STEEL CORPORATION, a Pennsylvania corporation (hereinafter referred to as "Fairmount") and CHARLES TOWN INCORPORATED, a corporation created under the laws of West Virginia (hereinafter referred to as "Charles Town"). STATEMENT OF FACTS Fairmount, through its officers, has for sometime been negotiating with the attorneys representing Helene W. Boyle, in her own right and as Executrix of the Estate of Albert J. Boyle, deceased, for the purchase of the Charles Town Turf Club in Charles Town, Jefferson County, West Virginia, and WHEREAS, Charles Town has leased the said Charles Town race track for the purpose of operating a racing meet for such number of days as 281 the West Virginia Racing Commission will grant a license to conduct a horse racing meet on the premises, and WHEREAS, Charles Town does not have the funds, nor the credit, with which to operate the said racing meet, and WHEREAS, Charles Town has negotiated with Fairmount for the purpose of obtaining the necessary funds for the financing of the said racing meet and WHEREAS, Fairmount has agreed to advance to Charles Town a minimum of Four Hundred Fifty Thousand Dollars ($450,000.00) for the financing of the racing meet, including the sum of Two Hundred Twenty-Five Thousand Dollars ($225,000.00) which Fairmount has already advanced for the payment of the rent due pursuant to the said lease, provided that Charles Town agree to operate the said race meet for the benefit of Fairmount and shall receive for this operation ten per cent (10%) of the net profits for its services thereunder, and if the result of the operation shall result in a loss, such loss shall be borne by Fairmount, and WHEREAS, it was understood that the operations of said race meeting shall be conducted pursuant to the terms of this Agreement. NOW THEREFORE THIS AGREEMENT WITNESSETH that in consideration of the mutual 282 covenants and conditions herein contained and other good and valuable considerations, the parties agree as follows: 1. Charles Town shall apply for a license to conduct a racing meet at the Charles Town Race Track in Charles Town, Jefferson County, West Virginia for as many days as said club shall be permitted to operate, said meeting to be conducted between the days of May 23, 1958 and September 10, 1958. 2. The said race meeting shall be operated by Charles Town, but the profits therefrom shall be for the benefit of Fairmount except that Charles Town shall receive ten per cent (10%) of the profits for its services in the operation of the said racing meet and any loss shall be borne entirely by Fairmount. 3. In consideration of Fairmount receiving ninety per cent (90%) of the profits of the said meet, Fairmount agrees to advance all monies necessary for the operation of the said meet, it being understood that Fairmount will advance a minimum of Four Hundred Fifty Thousand Dollars ($450,000.00) to finance said costs of operations of said meet. 4. No interest will be charged by Fairmount for the use of its monies, it being understood that its share of the profits shall be in lieu of 283 all interest charges of any kind. 5. Charles Town shall pay all officers for their services on behalf of both corporations, out of its share of the profits of the meet and no part thereof shall be charged to Fairmount. 6. Full and complete records of all receipts and disbursements in connection with the said meet shall be maintained by Charles Town and no expenditures, out of the ordinary course of business shall be made without the approval of Fairmount. Charles Town shall, at the request of Fairmount, make a complete accounting of all such receipts and disbursements. 7. So long as Charles Town shall be indebted to Fairmount, the officers and directors of Charles Town shall be as follows: President and DirectorBen CohenVice President and Direc-torLouis PondfieldSecretary, Treasurer andDirectorHerman Cohen8. The majority of the above officers shall make all major decisions as to the allocation of income and expenses and in the management of the race meet. 9. Federal and State taxes on income of the respective parties shall be a separate obligation to be borne by each party as to its own income. 10. Charles Town shall carry all necessary insurance to protect itself as well as Fairmount284 from all hazards. The cost of said insurance shall be regarded as an expense of operation of the said racing meet. IN WITNESS WHEREOF, the parties have caused this Agreement to be executed the day and year first above written. This agreement was executed on behalf of Fairmount by Herman Cohen as its president, and on behalf of Charles Town by Pondfield as its vice president. At this time, Fairmount had allowable net operating loss carryovers from its taxable years ended June 30, 1955, June 30, 1956, and June 30, 1957, in the total amount of $852,105.37. The minutes of the organization meeting of the stockholders of Charles Town, dated May 22, 1958, state in part as follows: Thereupon, discussion was had relative to the lease contract between Ben Cohen, agent, and Helene W. Boyle concerning the lease by him on behalf of this corporation * , said lease agreement being laid before the meeting. Upon motion duly made and seconded it was unanimously, RESOLVED that the lease agreement between Helene W. Boyle and Ben Cohen, agent, acting on behalf of this corporation, dated the 20th day of May, 1958, and the supplemental agreement affixed thereto, dated the 22nd day of May, 1958, be and 285 the same are, in every respect, hereby accepted, ratified, confirmed and approved by this corporation, all acts of the said Ben Cohen, acting as aforesaid, be and the same are hereby ratified, confirmed and approved by this corporation, and that all obligations and rights thereunder, be and the same are hereby, assumed by this corporation, without recourse upon the said Ben Cohen. Thereupon, a discussion was had relative to the financing of the racing meeting provided for under the lease agreement aforesaid. Upon motion duly made and seconded, it was unanimously RESOLVED that the Directors and Officers of this corporation, enter into and execute such loans, agreements and obligations on behalf of this corporation, as necessary in order to provide for and conduct a horse race meeting on the properties leased by this corporation as aforesaid. Thereupon a proposed contract between this corporation and Fairmount Steel Corporation, having been read to the meeting, discussion was had upon the same, and thereupon on motion duly made and seconded, it was unanimously RESOLVED that this corporation enter into such contract with Fairmount Steel Corporation, that the appropriate officers of this 286 corporation, when elected, execute the same on behalf of this corporation, and a copy thereof be placed in the files of this corporation. * * The minutes of a meeting of the board of directors of Charles Town dated May 22, 1958, authorized the Peoples Bank of Charles Town, Charles Town, W. Va., the Bank of Charles Town, Charles Town, W. Va., and the Merchants and Farmers Bank of Martinsburg, W. Va., as depositories of the corporation and resolved that "all funds belonging to the corporation be deposited in said banks." A press release contained in the files of Charles Town, located at the offices of Cohen Brothers, 1229 Mt. Royal Ave., Baltimore, Md., stated in part: Charles Town, W. Va., race track will open a 75-day meeting on Friday, June 6, under new management headed by the present officers of Pimlico Race Course in Baltimore, Maryland, it was announced at noon today. Assuming operating control of the three-quarter mile track is Charlestown, Inc., headed by Ben Cohen, President, Herman Cohen, Secretary-Treasurer, and Louis Pondfield, Vice-president. All are native Baltimore businessmen who have operated Pimlico Race Course since 1953. The new corporation will assume operating 287 control of the Charlestown track immediately under terms of a private agreement with Mrs. Albert J. Boyle, widow of the founder of the West Virginia track who died last November. On November 3, 1958, a lease hereinafter sometimes referred to as the second lease, was executed between Helene W. Boyle and Charles Town covering a lease of the Race Course for the period November 20, 1958, through February 20, 1959. This lease was in all material respects similar to the first lease except that the rental provided for was the sum of $63,250 payable on execution of the lease, plus an additional sum of $5,750 per day, multiplied by the number of racing days to be allotted by the West Virginia Racing Commission, hereinafter sometimes referred to as the Racing Commission, during the period January 1, 1959, through February 14, 1959. It was further provided, however, that in the event 2 percent of the total amount wagered at the track during the period of the lease should aggregate a sum in excess of the aggregate thereinbefore provided on a daily basis of $5,750 a day for the total number of racing days, Charles Town was to pay such excess at a specified time. The lease also required Charles 288 Town, during the period of the lease, to keep in force and effect comprehensive liability insurance in the sum of $1,000,000. Charles Town was also required to make application to the Racing Commission for a license permitting it to conduct a horse racing meeting on the leased premises beginning December 17, 1958, through February 14, 1959. This lease was not assignable without the written consent of the lessor. It was executed by Ben Cohen as president of Charles Town. The negotiations for the second lease were conducted by Byrer representing the owner, and by Ben Cohen on behalf of Charles Town. Horse racing meets were conducted at the Race Course by Charles Town during the period June 6, 1958, through September 1, 1958, hereinafter referred to as the summer meet, and during the period December 18, 1958, through February 7, 1959, hereinafter referred to as the winter meet. Charles Town's business was operating the track. When Charles Town filed with the Racing Commission its application for license to conduct the meets, it was required to file a supporting statement to the application. In the supporting statements, Charles Town represented to the Commission that Charles Town was 289 the applicant; that the name to be used in the operation was "Charles Town Incorporated;" that the race track and racing were to be conducted by a corporation; that Charles Town was that corporation; that its stockholders, officers, and directors were Ben Cohen, Pondfield, and Herman Cohen; that the Fairmount Steel Corporation had "advanced by loan, or otherwise, the capital invested in the business" in the amount of $500,000; and that Herman Cohen, Pondfield, and Ben Cohen had all been interested in the operation of a race track in Baltimore, Md., called the Maryland Jockey Club, in the capacity of president, vice president, and secretary-treasurer, respectively. Charles Town was duly licensed by the Racing Commission to conduct horse racing meets for the period June 6, 1958, through September 1, 1958, excepting June 16, 1958, through June 21, 1958, and for the period December 18, 1958, through February 7, 1959, excluding December 25, 1958. Charles Town maintained its own books of account which included a cash receipts book, a cash disbursements book, a general ledger, and a general journal. These books of account reflected the receipts, disbursements and other accounting entries 290 with respect to the operation of the two racing meets in question. The cash receipts book contained columns which provided for the classification of cash receipts as follows: Pari-mutuel commissions and surplus; program sales; admissions; parking; concessions; and other miscellaneous items. The cash disbursements book contained columns for the classification of disbursements as follows: track expenses; payrolls; repairs; publicity; programs; travel and entertainment; stationery and printing; office expense; photofinish; totalisator; film patrol; West Virginia Racing Commission; racing purses; and other miscellaneous entries. Charles Town's books were kept at the offices of the Cohen brothers under the supervision of a bookkeeper employed by them. During the period July 5, 1958, through February 10, 1959, Charles Town paid $1,741,112.47 to Fairmount. These amounts were reflected as debits to the following accounts on Charles Town's books: Rent$ 731,500.00Account Payable - FairmountSteel Corp.1,009,612.47Total$1,741,112.47Charles Town maintained bank accounts as follows: Title ofDateDateName of BankAccountOpenedClosedPeoples Bank of Charles Town, Charles Town, W. Va.Regular5/28/5811/11/63Peoples Bank of Charles Town, Charles Town, W. Va.Payroll5/28/586/16/59Bank of Charles Town, Charles Town, W. Va.Racing5/29/5810/31/63Bank of Charles Town, Charles Town, W. Va.Outs5/29/5810/31/63291 The receipts from the operation of both racing meets here concerned were deposited in the regular account of Charles Town in the Peoples Bank of Charles Town, Charles Town, W. Va., from which account all expenses and charges incident to the operation of both racing meets were paid by Charles Town. During the period May 28, 1958, through February 17, 1959, deposits in the total amount of $6,523,215.27 were made in the regular account at the Peoples Bank. During the period February 21, 1959, through November 6, 1959, additional deposits totaling $78,234.80 were made in this account. During the period May 29, 1958, through February 20, 1959, 847 checks were drawn by Charles Town on the regular account totaling $6,270,972.25. During the period February 24, 1959, through June 17, 1960, 65 additional checks were drawn on the regular account totaling $305,115.47. Signature cards for these accounts were signed by Herman Cohen, Ben Cohen, and Pondfield. The payroll account had a $5,000 balance. At the end of the regular payroll period the net payroll would be withdrawn from the regular account and deposited in the payroll account against which the payroll checks would be drawn. The racing 292 account was used to pay winning purses on races. The necessary amounts were withdrawn from the regular account and deposited in the racing account, against which the checks for this item of expense were drawn. The outs account was maintained to comply with the provision of state law requiring amounts due on uncashed winning wagering tickets to be kept in a separate account. Negotiations and correspondence with the Racing Commission concerning the summer and winter meets were transacted in the name of Charles Town by Ben Cohen as president. A comprehensive liability insurance policy was issued by the Standard Accident Insurance Company covering the period November 1, 1957, to November 1, 1960, to Cohen Brothers, et al., which was a comprehensive policy insuring property of the various Cohen enterprises including: Bodily injury, except auto. Bodily injury, auto. Property damage, auto. Automobile physical damage. The name of the insured on such policy was set forth as follows: "Herman, Ben, Rosa L. and Zelda G. Cohen, t/a Cohen Brothers and" 21 financially controlled subsidiary corporations (including Housing, Maryland Jockey Club, Fairmount, but not Charles Town). On May 20, 1958, the 293 policy was extended to cover public liability of Charles Town for hazards such as injury to the public, horse racing, and accidents to participants. This coverage was limited to a maximum amount of $1,000,000. This coverage was in effect during both the summer and winter meets. There was a substantial risk of liability in excess of this amount, due in part, to the fire hazard created by the location of the boiler room in relation to the clubhouse. Certificates of insurance were furnished to Helene Boyle's insurance company and attorney, stating, inter alia: Name of insured: Charles Town, Inc., a West Virginia corporation. Location of works: Charles Town, Jefferson Co., W. Va. Description of operations: Thoroughbred Racing and club operations. Coverage of Fairmount under this policy was limited to its operations at New Cumberland, Pa., which involved construction of a housing project. An endorsement dated June 5, 1958, attached to the comprehensive dishonesty, disappearance and destruction policy issued by the Standard Accident Insurance Company in favor of the Maryland Jockey Club provided that in consideration of an additional premium of $1,837.52, additional insurance was added 294 as follows: "Charles Town, Incorporated, Charles Town, West Virginia, owned, operated, and controlled by the owners of the Maryland Jockey Club of Baltimore City, Pimlico Race Course, Baltimore, Maryland." This endorsement was accepted as follows: /s/ Ben Cohen, SecretaryMarylandJockey Club of Baltimore./s/ Ben Cohen, PresidentCharlesTown,Inc.Charles Town secured jockeys' accident insurance covering both meets and paid the premiums thereon. The fire insurance covering the premises at the Charles Town Race Track during the time that the two racing meets here in question were conducted had been secured by the lessor, Helene Boyle. Charles Town paid a pro rata share of the fire insurance premiums for said periods to Helene Boyle. On June 2, 1958, Charles Town became a member of the Thoroughbred Racing Associations of the United States, Inc., hereinafter referred to as TRA, an organization dedicated to the promotion and maintenance of public interest and confidence in thoroughbred racing. The bylaws of TRA provide that members of TRA shall consist of thoroughbred racing associations duly organized and conducting business in any state, district, or territory of the United States or in Canada. 295 While a member of the TRA, Charles Town paid $7,283.34 and $11,750 as assessments during the periods here involved. Charles Town entered into contracts with the American Totalisator Division of Universal Controls, Inc., for totalisator services during the periods here involved. The contracts were signed by Ben Cohen, president. Charles Town received and deposited in its bank account the commissions or royalties due from the catering firm of Harry M. Stevens Company on sales of refreshments at the Race Course during the two racing meets here in question. All disbursements relative to the operation of the two horse racing meets here involved were made by Charles Town on checks bearing its name. Charles Town used stationery bearing the name, "Charles Town, Inc., Charles Town Race Course, Charles Town, West Varginia," during the periods here before the Court. Charles Town maintained a telephone in its own name at the Race Course and paid the telephone charges. Legal fees incident to organizing Charles Town, and representing Charles Town before the Racing Commission and in other incidental legal matters in connection with the operation of the horse racing meets here concerned, were paid 296 by Charles Town to Martin. Charles Town filed quarterly report of total earnings of employees with the West Virginia Workmen's Compensation Department for the second, third, and fourth quarters of 1958, and the first and second quarters of 1959, reflecting its business to be "Race Track." Charles Town filed an election agreement to participate in the Workmen's Compensation Plan of the State of West Virginia for the periods here in question. On the election form, Charles Town stated its business to be "Operation of Race Track and all operation incidental thereto." Charles Town filed an employer's initial statement with the West Virginia Department of Employment Security for the periods here in question, reporting employment of over 350 employees during a typical week for its reported business of "Thoroughbred Horse Racing." Charles Town filed annual business and occupation tax returns with the State of West Virginia for the years 1958 and 1959, reporting its business to be "Race Track." Charles Town filed domestic corporation license tax returns with the State of West Virginia for the years 1958 and 1959, stating the kind of business it was engaged in to be "operation of race track." 297 During the periods here involved, Charles Town operated under an oral agreement with the advertising agency of Kal, Ehrlich & Merrick, Washington, D.C., with respect to advertising the racing meets here in question. Monthly billings from June 1958 through February 1959 were sent to Charles Town, thereafter reverting to the Charles Town Race Course, the previous account title. Charles Town filed Form 941, employer's quarterly Federal tax return, reflecting the following total number of employees employed during each of the indicated quarters: No. ofQuarterEmployees2d/Q/584163d/Q/584224th/Q/583391st/Q/59388Charles Town issued 569 W-2 Forms to persons employed at the Charles Town Race Track during the two meets here in question. Charles Town paid total payrolls to the persons employed in the operation of the two racing meets here in question in excess of $630,000. Charles Town paid West Virginia consumers sales tax on parking fees, program sales, and additional charges collected during both of the horse racing meets here in question. Charles Town contracted, in its name, with the Baltimore & Ohio Railroad Company for the operation of special race track trains to the Race Course during 298 both of the horse racing meets here in question. In the ordinary course of business, while operating the two horse racing meets here involved during 1958 and 1959, in addition to the contracts specifically mentioned in other paragraphs, Charles Town entered into contracts, oral or otherwise, in its own name and paid from its own accounts, among others, with the following companies: Name of CompanyNature of ServiceCentral Printing Co.PrintingLincoln Maintenance Co.Track cleaningConfirmation Photos, Inc.Photo finishserviceColeman LaboratoriesSaliva testingShepherdstown RegisterPrintingAmerican Bank Stationery Co.StationeryPlotkin Tire & SalesAutomotiveWhite Motor Co.AutomotivePotomac Light & PowerElectricityPeoples Water Service Co.WaterThe Kastle Co.UniformsWestern UnionTelegraphPlaza Wine & LiquorEntertainmentCharles Town filed quarterly Federal excise tax returns, Form 720, and remitted the Federal admissions taxes due with respect to both horse racing meets here concerned as follows: Quarter EndingAmount Paid6/30/58$ 7,185.649/30/5822,453.1012/31/583,586.923/31/5910,235.78Charles Town filed Federal withholding and Federal Insurance Contributions Act (FICA) tax returns, Form 941, 299 with respect to persons it employed in the operation of both horse racing meets as follows: QuarterFICA TaxesWithholdingEndingPaidTaxes Paid6/30/58$ 4,518.97$12,659.579/30/5813,324.1038,664.5712/31/583,186.7315,604.823/31/598,146.0620,338.74By letter dated May 28, 1959, Ben Cohen as president of Charles Town closed out the corporation's account with the State compensation commissioner. Fairmount never filed the information with the appropriate state authority to qualify to do business in West Virginia. All income and expenses with respect to both race meets were reflected on the books of Charles Town. By means of a journal entry all the income and expenses, with the exception of officers' salaries, were transferred to the books of Fairmount. By means of another journal entry, 10 percent of the net profits was allocated to Charles Town. These entries were made on June 30, 1958, covering the period of the summer meet through said date which was the end of Fairmount's fiscal year; in November 1958, covering the remainder of the summer meet; and, in the spring of 1959, covering the winter meet. Fairmount reported on its Federal income tax returns the gross receipts and all the expenses 300 in connection with the operation of the two racing meets. In addition, it claimed a deduction for commission expense representing the 10 percent of the net profits allocated to Charles Town. Fairmount's return for the taxable year ended June 30, 1959, reflected a net profit of $732,299.86 from the racing meets. By virtue of the available net operating loss carryover it paid no Federal income tax with respect thereto. On its Federal income tax returns for the taxable periods ended November 30, 1958, and November 30, 1959, Charles Town reported gross receipts in the respective amounts of $64,886.53 and $26,051.87, which amounts represented the 10 percent allocated to Charles Town and which corresponded with the deductions claimed by Fairmount for commission expense. On its Federal income tax return for the taxable period ended November 30, 1958, Charles Town claimed a deduction in the amount of $40,000 for compensation of officers as follows: Louis Pondfield$25,000Herman Cohen7,500Ben Cohen7,500In addition, it claimed a deduction of $1,000 for a contribution to the Herman and Ben Cohen Charitable Foundation, Inc. On its Federal income tax return for the taxable year ended November 30, 301 1959, Charles Town claimed a deduction in the amount of $20,000 for compensation paid to Pondfield. In addition, it claimed relatively small amounts for other deductions, including $200 for contributions to the Herman and Ben Cohen Charitable Foundation, Inc. The income and expenses of the two horse racing meets here concerned were reported only on the Federal income tax returns of Charles Town and Fairmount. No partnership information returns were filed with the Internal Revenue Service reflecting any of the income or expenses of the two horse racing meets here concerned. Fairmount and Charles Town never declared or paid formal dividends on the capital stock they issued. On July 29, 1959, Charles Town instituted an action in the Circuit Court of Jefferson County, West Virginia, against Helene Boyle to recover an alleged overpayment of rental due in accordance with the provisions of the second lease. As a result of said litigation, Helene Boyle, on November 6, 1959, paid to Charles Town the sum of $38,698.82, which amount was deposited by Charles Town in its regular account at the Peoples Bank, Charles Town, W. Va.On March 26, 1959, Fairmount paid to C.B. Associates $400,000 which 302 was debited on Fairmount's books to the account entitled "Loans Payable #1." On September 29, 1959, Fairmount received from C.B. Associates $100,000, which was credited to the account entitled "Loans Payable #1." As of September 29, 1959, $600,000 of the $900,000 advance made by Housing to Fairmount was still outstanding. At this time C.B. Associates had succeeded Housing. This amount of $600,000 was repaid as follows: a $5,000 cash payment and, by applying $595,000 against the purchase price of $654,867.13 payable by C.B. Associates to Fairmount for Fairmount's interest in a partnership with Forest Hill Village, Inc., known as Forest Hill Village, which partnership interest was assigned by Fairmount to C.B. Associates on March 28, 1962. Charles Town Properties, Inc., hereinafter sometimes referred to as Properties, is a corporation incorporated on April 19, 1958, under the laws of the State of West Virginia. On April 24, 1959, Properties entered into a contract with Helene Boyle for the purchase of the Race Course. On or about May 7, 1959, Properties closed the contract for the purchase of the Charles Town Race Track and acquired said race track. On or about May 19, 1959, there were 303 issued and outstanding 10 shares of the capital stock of Properties, which 10 shares were acquired by Pondfield on the same date for a consideration of $1,000. The previous directors of Properties tendered their resignations, and Pondfield, Herman Cohen, and Ben Cohen became the directors of Properties on said date. On the same day the following officers of properties were elected: PresidentBen CohenVice PresidentLouis PondfieldSecretary-TreasurerHerman CohenOn or about May 19, 1959, additional shares of the capital stock of Properties were issued upon payment of the sum of $9,000 as follows: No. ofNameSharesBen Cohen5Carroll A. Weinberg, Charlotte CohenWeinberg, and Zelda G. Cohen, Trus-tees for the Descendants of CharlotteCohen Weinberg20Richard S. Davison, Rosalee CohenDavison, and Zelda Cohen, Trusteesfor the Descendants of Rosalee CohenDavison20Ben Cohen, Herman Cohen, and Stan-ley H. Wilen, Trustees for the De-scendents of Nathan L. Cohen45 No additional capital stock of Properties has been issued since that time. Since that time and until the present, Properties has owned and operated the Charles Town Race Track and there has been no change in the ownership. On May 20, 1959, 304 the Equitable Trust Company of Baltimore, Md., loaned $2,000,000 to Properties, bearing interest at 5 percent per annum. Cohen brothers participated in the loan to the extent of $1,500,000. The note for $2,000,000 executed by Properties to the Equitable Trust Company was endorsed by Ben Cohen and Herman Cohen. These funds were used by Properties for the purchase of the Race Course. Fairmount was liquidated on June 1, 1962, and has since then been dormant. The minutes of the annual meeting of stockholders of Charles Town held on May 15, 1961, provide in part as follows: The Corporation has finished its racing season and has concluded its arrangements with Fairmount Steel Corporation according with the agreements previously entered into. Mr. Louis Pondfield stated that the two (2) shares heretofore held in the names of Herman Cohen and Ben Cohen had been returned to him in view of the completion of the arrangements with Fairmount Steel Corporation. * * The meeting then proceeded to the election of Directors for the ensuing year or until their successors are duly elected and qualified. Upon motion duly made, seconded, and passed, the following were elected: Louis Pondfield, John J. 305 Pondfield, Rose Pondfield Charles Town never conducted any business other than the operation of the two racing meets in question and was a dormant corporation at the time of the trial of this case. In a statement attached to the deficiency notice the respondent explained his adjustments for the period May 22, 1958, to November 30, 1958, as follows: (a) Additional income$497,833.02It is held that income in the amount of $2,808,220.18, included in the return of Fairmount Steel Corporation for the taxable year ended June 30, 1959, constituted additional income to you under the provisions of section 61 and section 482 of the Internal Revenue Code of 1954, resulting in additional taxable income in the amount of $497,833.02, computed as follows: Mutuel Dept. Commission$2,389,657.03Mutuel Dept. Breakage220,678.86Programs21,837.60Grandstand51,984.45Clubhouse49,208.81Box Seats8,958.64Clubhouse Complimentary9,878.13Concessions43,773.12Valet Parking8,824.25Miscellaneous Income3,254.80Federal Admission164.49Total Income$2,808,220.18Less: Total Expenses2,308,885.46$ 499,334.72Less: Unknown Difference1,501.70Additional Income from CharlesTown Race Track$ 497,833.02 A similar explanation was made 306 for the additional income of $234,466.84 for the fiscal year ended November 30, 1959. Ultimate Findings of Fact Charles Town was organized for the purpose of conducting the racing meets in question in its own right. Charles Town performed substantial income-producing activities. The total net income derived from the operation of the two racing meets in question was produced and earned by Charles Town. The respondent, in allocating the income reported by Fairmount from these racing meets to Charles Town, did not act unreasonably, arbitrarily, or capriciously. Said determination of the respondent was necessary in order to prevent the evasion of taxes and to clearly reflect the taxable income of Charles Town, within the meaning of section 482 of the 1954 Code. The advances to Charles Town by Fairmount constituted in substance an equity investment. Opinion The question presented is whether net income in the amounts of $497,833.02 and $234,466.84, representing 90 percent of the profits derived from the operation of two horse racing meets during the years 1958 and 1959, is taxable to Fairmount, as petitioner contends, or to Charles Town, the petitioner, as the respondent has determined. 307 We agree with the respondent that the said net income is taxable to Charles Town. The answer to the question depends upon the legal effect of the May 20, 1958, agreement between Fairmount and Charles Town, which agreement we have set out in full in our findings. Under this agreement Fairmount was to furnish the necessary capital with which to conduct the meets and Charles Town agreed to operate the meets "for the benefit of Fairmount" and to receive for this operation 10 percent of the net profits for its services. On its face, the agreement has the appearance of a pure agency. But when we look at how the racing meets were actually conducted the agency feature melts away. First, Ben Cohen, in obtaining the lease of the race track property from Helene Boyle, acted not for Fairmount but "for Charles Town Incorporated, a corporation to be hereinafter created." Nowhere in the lease was Fairmount ever mentioned. The lease was the property of Charles Town. As rental for the leased property the lease provided that "said Lessee [Charles Town, not Fairmount] shall pay to the Lessor the sum" of $225,000. The lease was made subject to the express condition that the lessee "shall be able to secure 308 from, and be granted, a license by, the West Virginia Racing Commission" permitting the lessee to conduct a horse race meeting on the leased premises. In applying for the license, Charles Town gave no indication that it was acting as agent for another. The Racing Commission granted the license to Charles Town and authorized Charles Town to hold race meetings on Charles Town's premises. Charles Town operated the property as if it was its own. It secured the leases; it secured the licenses; it hired all the employees; it collected all the receipts; it paid all the expenses; it entered into written and oral contracts in its own name for materials and services needed to conduct the meets; it filed all the necessary State and Federal reports; it joined TRA, an association of race track operators; it sued the lessor in its own name for excessive rent allegedly paid to the lessor; and in fact it did all the things necessary to earn the income in question. Charles Town's activities were not the usual activities of an agent and its business purpose was not the carrying on of the normal duties of agent but, rather, to conduct and operate the race track meets in its own right. We think the facts 309 and principles here are very much like the facts and principles involved in National Carbide Corp v. Commissioner, 336 U.S. 422">336 U.S. 422. In that case the taxpayers were three wholly owned subsidiaries of another corporation, Airco. The taxpayers and Airco had entered into contracts which provided, in substance, that the subsidiaries were, employed as agents to manage and operate plants designed for the production of products assigned to it, and as agents to sell the output of the plants. Airco was to furnish working capital, executive management, and office facilities. The subsidiaries were to pay Airco all profits in excess of 6 percent on their outstanding capital stock, which in each case was nominal in amount. Title to the assets utilized by the subsidiaries was held by them, and the amounts advanced by Airco for the purchase of assets and working capital were shown on the books of the subsidiaries as accounts payable to Airco. No interest ran on these accounts. The profits turned over by the taxpayer subsidiaries to Airco were reported as income on Airco's returns. The taxpayers reported as income only the 6 percent return on capital specified in the contracts. The Commissioner determined 310 that the taxpayers were taxable on the income turned over to Airco as well as on the nominal amounts retained. The Court sustained the Commissioner's determination and rejected the taxpayers' contention that they acted merely as agents of Airco. In so holding, the Court noted that the fact that Airco furnished the funds necessary to acquire the assets held by the taxpayers did not detract from the reality of their ownership of such assets. Moreover, the Court held that it made no difference whether the funds advanced constituted capital contributions or loans - the important fact was that the taxpayers held title to the assets and regardless of the characterization of the source of the funds, it could not make the income earned by the utilization of the assets the income of Airco, the supplier of the funds. In so holding, the Supreme Court stated: We think that it can make no difference that financing of the subsidiaries was carried out by means of book indebtednesses in lieu of increased book value of the subsidiaries' stock. A corporation must derive its funds from three sources: capital contributions, loans, and profits from operations. The fact that Airco, the sole stockholder, 311 preferred to supply funds to its subsidiaries primarily by the second method, rather than either of the other two, [n15] does not make the income earned by their utilization income to Airco. We need not decide whether the funds supplied to petitioners by Airco were capital contributions rather than loans. It is sufficient to say that the very factors which, as petitioners contend, show that Airco "supplied" and "furnished" their assets also indicate that petitioners were the recipients of capital contributions rather than loans. [n16] Nor do the contracts between Airco and petitioners by which the latter agreed to pay all profits above a nominal return to the former, on that account, become "agency" contracts within the meaning of our decisions. The Tax Court felt that the fact that Airco was entitled to the profits by contract shows that the income "belonged to Airco" and should not, for that reason, be taxed to petitioners. Our decisions requiring that income be taxed to those who earn it, despite anticipatory agreements designed to prevent vesting of the income in the earners, foreclose this result. Lucas v. Earl, 1930, 281 U.S. 111">281 U.S. 111* * What we have said does not foreclose 312 a true corporate agent or trustee from handling the property and income of its owner-principal without being taxable therefor. Whether the corporation operates in the name and for the account of the principal, binds the principal, by its actions, transmits money received to the principal, and whether receipt of income is attributable to the services of employees of the principal and to assets belonging to the principal [n19] are some of the relevant considerations in determining whether a true agency exists. If the corporation is a true agent, its relations with its principal must not be dependent upon the fact that it is owned by the principal, if such is the case. Its business purpose must be the carrying on of the normal duties of an agent. [n20] * * * [Footnotes omitted.] Application of the standards set forth by the Supreme Court in National Carbide to determine the existence of a true agency relationship reveals that the agency form here was a mere facade and that such a relationship did not exist as a matter of substance. The evidence clearly establishes that Charles Town, the purported agent, did not operate in the name and for the account of Fairmount, it did not bind Fairmount313 by any of its actions, did not transmit money received to Fairmount on a regular and preestablished basis, nor was the receipt of income attributable to the employees or assets of Fairmount. Finally, and conclusively, Charles Town's business purpose was not the carrying on of the normal duties of agent. Its business purpose, as revealed in its certificate of incorporation and by the testimony of both Ben Cohen and Pondfield was to conduct horse racing meets, with no limitation that such activity be conducted in the capacity as agent for another. Significantly, its charter does not authorize it to conduct business in the capacity of an agent. There is a factual distinction between National Carbide and the instant case which we think is of no importance. In National Carbide, Airco, the alleged principal, owned all the stock of the three subsidiaries, the alleged agents. Here, Fairmount, the alleged principal, owned no stock in Charles Town, the alleged agent. Ninety-eight percent of the issued and outstanding stock of Charles Town was owned by Pondfield for which he paid $980 on July 22, 1958. This technical ownership of stock and the small capital furnished by him are, we think, of 314 little importance when compared with the control exercised, and the capital arranged for, by Ben and Herman Cohen. These two brothers controlled and dominated a group of organizations, including Housing, Fairmount and Charles Town. They caused Charles Town to be incorporated. They caused Housing to turn over to Fairmount, who was then insolvent, $900,000 so that Fairmount could furnish to Charles Town the capital necessary to conduct the two contemplated racing meets. Fairmount actually advanced to Charles Town $986,525 for that purpose. We think it is obvious that what the Cohen brothers were trying to accomplish was to arrange the operation of the racing meets in such a way that at least the greater part of the earnings from the meets would be the income of Fairmount, so that Fairmount could take advantage of the net operating loss carryovers in the total amount of $852,105.37 and thus pay no tax on the income from the meets until that sum was realized. The Cohens evidently did not want Fairmount to carry on the actual operations. They organized Charles Town for that purpose and by the agreement dated May 20, 1958, attempted to create a principal-agent relationship between Fairmount315 and Charles Town. For reasons previously given we do not think a true agency relationship was thus created. National Carbide Corp. v. Commissioner, supra; Spicer Theatre, Inc., 44 T.C. 198">44 T.C. 198, affd. 346 F. 2d 704 (C.A. 6, 1965). See also Fairmount Park Raceway, Inc. v. Commissioner, 327 F. 2d 780 (C.A. 7, 1964), affirming a Memorandum Opinion of this Court. In that case a group of individuals formed a partnership which obtained a lease of a race track. The same individuals formed a corporation which, as indicated in the minutes of a meeting of its board of directors was "to function only as an agent" for the partnership in the operation of racing meets under a sublease from the partnership. These minutes further indicated that the corporation will serve only "as the agent of the partnership, be supplied with operating and construction funds by the partnership, and will account to the partnership for all actions taken and monies expended on its behalf." The partnership subleased the race track to the corporation, which during the years before the Court provided that 100 percent of the net profits from the operation would be paid over to the partnership as rental. Applications for 316 race meetings were filed with the state racing commission by the corporation in its name. At the end of a racing meet, the corporation paid its entire net income over to the partnership, deducted these amounts as "rent," which amounts were reflected as rents received in the partnership returns. The amounts claimed as rent by the corporation were disallowed in part by the Commissioner as being excessive. The taxpayers contended in part, that the corporation was the agent of the partnership and that a proper way to ascertain a reasonable rental for the property was to determine the amount of the corporation's earnings the partnership would allow the corporation to retain as compensation for operating the track. In rejecting the contention that the corporation was a mere agent, the U.S. Court of Appeals, Seventh Circuit, said: The Tax Court could properly reject the notion advanced that the corporation was in reality - considering the investments of the partners in the track and the corporation's use of the partners' borrowing power, and its capital of only $17,500.00 - merely an agency of the partners which was entitled not to the earnings the Commissioner determined for it, but really 317 entitled to only a fee. The "business purpose" of the corporation was operation of the track in its own right and not the normal duties of an agent. National Carbide Corp. v. Commissioner, 336 U.S. 422">336 U.S. 422, 437 * . By the lease it appears that the partnership chose to avoid the burdens of principalship. 336 U.S. at 438, 69 S. Ct. at 734. In the instant case, we think the business purpose of Charles Town was the operation of the track in its own right and not the normal duties of an agent and that Fairmount chose to avoid the burdens of principalship. There are, of course, other considerations that require comment. For instance, the large payments made by Fairmount to Charles Town, although reflected on Charles Town's books as accounts payable, were definitely not loans and petitioner does not so contend. In fact, in paragraph 18 of its requested findings of fact, it requested us to find that "The said advances to petitioner were not made to it as a loan." The payments were not evidenced by any notes or other debt instruments, did not bear interest, were made without security, and with no date for repayment. In fact, according to the agreement between Fairmount and Charles Town, 318 if the payments were lost, "any loss shall be borne entirely by Fairmount." The Supreme Court, in National Carbide Corp. v. Commissioner, supra, said that a corporation must derive its funds from three sources, namely, (1) capital contributions, (2) loans, and (3) profits from operations. The payments here were not from class (3) and, since they were not loans, they must be regarded as capital contributions. Although the Supreme Court in National Carbine Corp. v. Commissioner, supra, said it was not necessary in that case to decide whether the funds supplied by Airco were capital contributions or loans, it said by way of obiter dictum that the facts "indicate that petitioners were the recipients of capital contributions rather than loans" and, in footnote 16, said in part: Since no interest ran on these accounts, the "loans" were identical, except in name, with contributions of capital. [citing several cases] In holding that the payments made by Fairmount to Charles Town were capital contributions, it is immaterial that Fairmount itself was not a stockholder of record in Charles Town. Motel Co. v. Commissioner, 340 F. 2d 445, (C.A. 2, 1965), affirming a Memorandum Opinion of this 319 Court; Sherwood Memorial Gardens, Inc., 42 T.C. 211">42 T.C. 211, affd. 350 F. 2d 225 (C.A. 7, 1965). Petitioner makes a belated argument to the effect that it and Fairmount were joint venturers. That is not the way the contract between them was drawn. The agreement was that Charles Town was to operate the race track "for the benefit of Fairmount" except that "Charles Town shall receive ten per cent (10%) of the profits for its services." This is not the language of a joint venture. The parties did not hold themselves out of the public as joint venturers. Much that we said of the pure agency relationship can be repeated here. The fact that the parties treated the income returned by Charles Town as "commissions" is further indicative that the parties were not joint venturers. Under West Virginia case law, a joint venturer is considered to be a limited partner. Horchler v. Van Zandt, 120 W. Va. 452">120 W. Va. 452, 199 S.E. 65">199 S.E. 65 (S. Ct. App. 1938). No partnership returns were filed. The only returns that were filed were those of Fairmount and Charles Town as separate corporations. We hold that Fairmount and Charles Town were not joint venturers. It follows from all of the foregoing that Charles Town earned the 320 income in question. The attempted shifting of this income to Fairmount may properly be corrected by the application of the provisions of section 482 of the 1954 Code. 1Petitioner contends that there was insufficient common control existing between Fairmount and Charles Town to sustain the applicability of section 482 to this case. In support of this position petitioner states that the agreement which provided for the Cohens' control of Charles Town, by placing both Herman and Ben on the board of directors of 321 Charles Town, also provided for the division of income between Charles Town and Fairmount, and that as section 482 applies only to transactions "between already controlled taxpayers," control required for the application of section 482 is wanting. The only authority cited in support of this position is section 1.482-1(c) 2322 of the regulations. A perusal of that section reveals that it sets forth the general circumstances in which the Commissioner's authority under section 482 may be exercised. Of itself, it lends no support to petitioner's position. Petitioner is in error in assuming that only by virtue of the agreement between it and Fairmount were the Cohens endowed with control of Charles Town. That was only one of several facts, previously mentioned herein, by which their actual and effective control of the corporation was acquired and exercised. The statute speaks in terms of organizations "owned or controlled directly or indirectly by the same interests." [Emphasis supplied.] Furthermore, the term "controlled" as used in section 482, "'includes any kind of control, direct or indirect, whether legally enforceable, and however exercisable or exercised. It is the reality of the control which is decisive, not its form or the mode of its exercise.'" L. E. Shunk Latex Products, Inc., 18 T.C. 940">18 T.C. 940, 956. No serious question can arise as to the control of both Fairmount and Charles Town by the Cohen brothers. That they owned all 323 of Fairmount's voting stock alone establishes their control of that entity. Their actual control of Charles Town is made evident by the facts of record disclosing that they constituted, at all times material, the majority of the board of directors of Charles Town; that they caused its creation; were principal officers of the corporation and active in its management; that they caused the capital necessary to conduct the meets to be furnished to Charles Town; and, by the fact that as the majority of the officers of Charles Town, they were, according to the May 20, 1958 agreement, to "make all major decisions as to the allocation of income and expenses in the management of the race meet." The shifting of profits from one controlled entity to another for the purpose of utilizing a net operating loss carryover, as is the situation here, warrants the reallocation of that income under the provision of section 482. Spicer Theatre, Inc., supra. The respondent's determination is sustained. Decision will be entered for the respondent. Footnotes. Reimbursed by Charles Town to Fairmount on June 10, 1958. ↩. Payable to the Citizens National Bank of Martinsburg, West Virginia. ↩. Payable to Helene Boyle.↩1. SEC. 482. ALLOCATION OF INCOME AND DEDUCTIONS AMONG TAXPAYERS. In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Secretary or his delegate may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses.↩2. § 1.482-1 Determination of the taxable income of a controlled taxpayer. * *(c) Application. Transactions between one controlled taxpayer and another will be subjected to special scrutiny to ascertain whether the common control is being used to reduce, avoid, or escape taxes. In determining the true taxable income of a controlled taxpayer, the district director is not restricted to the case of improper accounting, to the case of a fraudulent, colorable, or sham transaction, or to the case of a device designed to reduce or avoid tax by shifting or distorting income, deductions, credits, or allowances. The authority to determine true taxable income extends to any case in which either by inadvertence or design the taxable income, in whole or in part, of a controlled taxpayer, is other than it would have been had the taxpayer in the conduct of his affairs been an uncontrolled taxpayer dealing at arm's length with another uncontrolled taxpayer.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624544/	APPEAL OF NEWMAN THEATRE CO.Newman Theatre Co. v. CommissionerDocket No. 3694.United States Board of Tax Appeals4 B.T.A. 390; 1926 BTA LEXIS 2280; July 27, 1926, Decided 2280 Leaseholds valued for invested capital purposes and as a basis for an allowance for depreciation. Perry W. Shrader, Esq., and E. J. Dillon, C.P.A., for the petitioner. A. H. Fast, Esq., for the Commissioner. ARUNDELL390 Before STERNHAGEN, LANSDON, and ARUNDELL. The Commissioner has determined a deficiency in income and profits taxes for the calendar year 1920 in the amount of $11,158.05. The deficiency arises from the exclusion from invested capital of $350,000, alleged to be the value of certain leaseholds assigned to be corporation by one of its stockholders, and from the consequent refusal of the Commissioner to allow depreciation on the leaseholds. FINDINGS OF FACT. The petitioner was incorporated under the laws of Missouri on August 9, 1918, with its principal place of business at Kansas City. The purpose was to construct and operate a motion-picture theatre. Frank L. Newman, the promoter of the enterprise and the president, manager and chief stockholder in the corporation, came to Kansas City in 1913 and immediately engaged in the operation of motionpicture houses. He organized the Royal Theatre Co. and the Regent Theatre2281 Co. and was their president and manager. The same persons who were associated with him in these corporations later were associated with him in the Newman Theatre Co. In 1915 Newman negotiated a lease on a tract of land on Main Street in Kansas City, Missouri, having a frontage of approximately 391 24 feet, known as the McGonegal property, which he had T. H. Cochrane take in his own name. The lease so taken was dated November 30, 1915, ran for 99 years from January 1, 1916, and provided for a rental of $12,500 per annum and the payment of all taxes, special assessments and other public levies. The rental of this property for a period of 2 1/2 years was paid by the Royal Theatre Co. This lease was assigned to Newman on June 12, 1918, and by the latter to the petitioner on March 1, 1919. Under date of May 15, 1918, Newman secured a lease for a period of 99 years from May 1, 1918, on the property immediately adjoining the McGonegal property, which property had a frontage on Main Street of substantially the same width. By the terms of the agreement Newman was to pay an annual rental of $12,960 and all taxes, special assessments and other levies. This lease was on what2282 is known as the Turner property. On March 1, 1919, Newman assigned the Turner lease to the petitioner. Newman also secured a lease on the Brady property, immediately adjoining the Turner property, with a frontage of approximately 48 feet on Main Street. This lease was for a term of 99 years from May 1, 1918, and provided for a rental of $35,000 for the first 20 years and thereafter a rental of $40,000, the lessee to pay all taxes, special assessments and other public levies. On March 1, 1919, this lease was assigned to the petitioner. The purpose of Newman had been to secure a lease of property on Main Street, having a frontage of 50 feet, on which to erect and operate a motion-picture theatre. To that end the McGonegal tract was leased in 1915, the lease being taken in the name of Cochrane. Difficulties were encountered, however, in securing the adjoining tract owned by Turner, and it was not until 1918 that a lease was secured. The original plans did not contemplate the lease of the Brady property. This was made possible solely because the building there-on was destroyed by fire, thus affording an opportunity for the acquisition of the lease which was taken. Newman2283 took all the steps necessary to secure these leases and acted on his own initiative, although there was an informal understanding between him and his associates that the leases would be turned over to a corporation thereafter to be organized for the purpose of constructing and operating a motion-picture theatre should that course be later determined on. The restrictions of the Government incident to the World War made difficult the securing of certain building materials and lent uncertainty to the carrying out of the plans, and it was understood between the several interested parties that, should it become impracticable to erect the theatre. Newman would retain the leases and proceed with his own plans. It was 392 his intention, in that event, to erect business buildings on the property. Some money was expended by Newman in securing the leases and also in starting the building of the theatre, the latter expenditure being incurred prior to the incorporation of the petitioner but after a charter had been applied for. The authorized issue of common stock of the petitioner was $550,000, divided into shares of the par value of $100 each. By April 22, 1919, there had been2284 paid in by the stockholders in cash approximately $157,000. All advances made by Newman in securing the leases and in construction of the building were credited to his stock account and stock was issued against the same. At the stock-holders' meeting of April 22, 1919, there was voted to Newman stock in the amount of $25,000, in recognition of his efforts on behalf of the corporation. Three shares of stock were issued for each share paid for and, in determining the amount to be received by Newman, the stock voted to him was treated as if purchased. After the issuance of the stock on the basis of three shares for one, Newman held 2,250 shares, T. H. Cochrane 845 shares, J. G. L. Harvey, secretary of the company, 600 shares, and others in less amount. The leases were valued by the company at $350,000 and this valuation was the principal basis for the issuance of stock in an amount in excess of the cash paid in. The fair market value of the three leases when turned in to the corporation on March 1, 1919, was $140,000. OPINION. ARUNDELL: We are satisfied from the evidence that the leases acquired by Newman were his individual property until such time as they were turned2285 over by him to petitioner. It is true there was an informal understanding between Newman and his associates that the leases would be turned in to a theatre company thereafter to be organized, should that course prove desirable, but the record does not disclose any formal or binding agreement to that end, and in fact it was clearly understood, should the theatre project not be carried through, that Newman would proceed in his own way to develop the leases. This being true, the company would be entitled to take the leases into its invested capital, assuming that they had a value when paid in to it by Newman, and as stock was not issued directly for the leases, they would form a part of petitioner's paid-in surplus. At the time the leases were acquired no steps looking to the organization and incorporation of petitioner had been undertaken and it was then uncertain whether a company would ever be organized and a theatre built. 393 The authorities are not uniform as to the relationship which a promoter bears to a corporation organized by him. The rule in Missouri, where petitioner was incorporated and where it operates, is that a promoter can not be an agent of a corporation2286 not then in existence. . The United States Supreme Court has stated, however, in the case of , that, "The promoter is the agent of the corporation and subject to the disabilities of an ordinary agent." In many jurisdictions a corporation may ratify the acts of its promoters, though the rule appears to be to the contrary in Missouri. The Supreme Court of that State, in the case of , states: Strictly speaking, there can be no ratification by a corporation of a contract formed by its promoters prior to the completion of the corporate organization. The so-called "ratification" by the corporation is nothing more nor less than the making of an original contract. * * This is plainly so for the reason that there was no corporation in existence at the time these promoters made the contract in question * * . The several decisions examined by us are directed rather to the right of the promoter to make secret profits and to the right of the corporation2287 to secure the benefits of contracts made by promoters in its behalf, and not to a state of facts such as we have here. On the facts before us we have no hesitancy in reaching the conclusion that petitioner is entitled to include in its invested capital the value of the leases. We are left then to determine the value of the leases at the time they were turned in to petitioner on March 1, 1919. The evidence establishes to our mind that the rental exacted for the Brady lease represented the full rental value of the property and that the lease has no bonus value. On the contrary, we believe that the Turner and McGonegal leases had a distinct value on March 1, 1919. The three assembled leases when turned in to petitioner we have found to be of a fair market value of $140,000, and its invested capital should reflect that value. This amount should also be used as a basis for an annual deduction for depreciation. Order of redetermination will be entered on 15 days' notice, under Rule 50.PHILLIPS dissents, on the ground that the transaction involves section 331 of the Revenue Act of 1918.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624546/	KERRY D. HICKS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentHicks v. CommissionerDocket No. 3985-83.United States Tax CourtT.C. Memo 1985-141; 1985 Tax Ct. Memo LEXIS 490; 49 T.C.M. (CCH) 1039; T.C.M. (RIA) 85141; March 26, 1985. Kerry D. Hicks, pro se. Ronald Rosen and Mark Priver, for the respondent. FEATHERSTONMEMORANDUM OPINION FEATHERSTON, Judge: This case was assigned to Special Trial Judge Helen A. Buckley pursuant to the491 provisions of section 7456 and Rules 180, 181, and 183. 1 The Court agrees with and adopts her opinion which is set forth below. OPINION OF THE SPECIAL TRIAL JUDGE BUCKLEY, Special Trial Judge: This case is before us on respondent's motions to dismiss and for an award of damages. We grant respondent's motions. Respondent determined deficiencies in Federal income tax for the year 1980 in the amount of $9,263.52, together with additions to tax under the provisions of section 6651(a) of $2,315.88, under section 6653(a) of $463.18 and under section 6654(a) of $592.86. The determination was based upon a failure to file income tax returns and to report income in the amount of $33,958. Petitioner, a resident of Sylmar, California, timely filed his petition with this Court, a form petition which was identical in nature with those filed by several hundred others in the southern California area. We have, time and again, held such petitions to be meritless. 2 In the petition492 it is alleged that respondent bore the burden of proving the allegations in the deficiency notice; that petitioner was not required to file a return or pay a tax under the Internal Revenue Code; that petitioner received nothing of tangible value that qualified as income and he enjoys no gant of privilege or franchise; that petitioner was not in receipt of either gain or profit; that petitioner did not volunteer to self-assess himself; and that the income tax system is based on voluntary compliance and petitioner did not volunteer. After filing his petition, petitioner requested a jury trial which was denied. He also filed a document which was treated as a motion to dismiss in which he stated that he had mistakenly filed his petition with this Court and493 that this Court had no authority to decide the matter. This motion was denied. A second document entitled "Purgatory/Decisiory Oath" was treated as a motion to dismiss and denied. The gist of this document was that petitioner's earnings were his alone, that he had learned through the teachings of Your Heritage Protection Association that he was not under the jurisdiction of the Internal Revenue Code and he did not have personal income tax liability. Petitioner appeared at the call of the calendar on August 28, 1984, at which time he was fully advised by the Court that the various allegations in his petition were frivolous. He was advised that he had invoked the jurisdiction of the Court through filing his petition. At the date set for trial the Court explained to petitioner, a lay person, that the burden of proving the deficiency notice incorrect rested upon him and that it was his obligation to go forward with evidence in that regard. Additionally, since he had stated that he intended to "stand on the Fifth," the Court explained that a claim of self-incrimination did not serve to shift the burden of going forward with the evidence to respondent. Petitioner testified that494 he worked under a union contract, that when he cashed his check he "was paid in whatever the bank had to offer at the time." His argument apparently is that he received nothing ov value. This was his only argument in regard to the amount of income he received. He refused to place into evidence any information about any deduction, credits or exemptions to which he was entitled. In this posture, it is appropriate to dismiss the petition. Rules 123(b) and 149(b) provide: RULE 123. DEFAULT AND DISMISSAL * * * (b) Dismissal: For failure of a petitioner properly to prosecute or to comply with these Rules or any order of the Court or for other cause which the Court deems sufficient, the Court may dismiss a case at any time and enter a decision against the petitioner. The Court may, for similar reasons, decide against any party any issue as to which he has the burden of proof; and such decision shall be treated as a dismissal for purposes of paragraphs (c) and (d) of this Rule. * * * RULE 149.FAILURE TO APPEAR OR TO ADDUCE EVIDENCE * * * (b) Failure of Proof: Failure to produce evidence, in support of an issue of fact as to which a party has the burden of proof*495 and which has not been conceded by his adversary, may be ground for dismissal or for determination of the affected issue against that party. We turn to respondent's motion for damages. Petitioner was advised at the call of the calendar and at the trial that his petition was frivolous and he was nevertheless given the opportunity to present evidence indicating that the deficiency notice was incorrect. He chose not to do so despite the urging of the Court. Accordingly, it is apparent that petitioner filed and maintained his petition primarily for purposes of delay. In addition, the petition is frivolous. See ; , affd. . We therefore award damages to the United States pursuant to the provisions of section 6673 in the amount of $5,000. An appropriate order and decision will be entered.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise noted. All Rules references are to the Tax Court Rules of Practice and Procedure unless otherwise noted.↩2. See, e.g., ; Gabaldon v. Commissioner,↩ T.C. 1984-107; ; ; ; ; .	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624547/	Miron Kroyt and Claire Sheftel Kroyt v. Commissioner.Kroyt v. CommissionerDocket No. 80798.United States Tax CourtT.C. Memo 1961-322; 1961 Tax Ct. Memo LEXIS 27; 20 T.C.M. (CCH) 1665; T.C.M. (RIA) 61322; November 30, 196127 The petitioners are husband and wife. Miron Kroyt, a professional musician, plays the piano. His professional activities in the several years prior to the European trip to be referred to hereafter were largely devoted to teaching music. He had also appeared in concert as a soloist, and in duo with his wife who, on such occasions, played the violin or viola. Claire Kroyt was likewise a professional musician. Prior to said European trip, Claire played the violin and viola. Her professional activities had been in part devoted to teaching, but she had also played concert engagements and had played chamber music both in public and in private gatherings. Petitioners went to Europe in June of 1955 and remained there until November of 1957. The purposes of the trip were to enable Claire to receive training and coaching in order to learn to play the viola d'amore, an instrument differing materially from the violin and viola; to enable Claire and Miron to receive training and coaching to play the viola d'amore and piano in concert as a duo; and to enable petitioners to establish a European reputation as duo performers with the objective of ultimately being accepted as such in the United States28 and with the anticipation that concert engagements as a duo in the United States would be forthcoming as a result. Held: That the deductions claimed by petitioners for the years 1955 and 1956 in the respective amounts of $3,401.01 and $3,094.80 as expenses in connection with their European trip are not ordinary and necessary expenses paid in carrying on a business or traveling expenses paid in the pursuit of a business, or ordinary and necessary expenses paid in the production of income within the meaning of sec. 162(a) or 212(1) of the Code of 1954. David Hoffman, Esq., 165 Broadway, New York, N. Y., for the petitioners. Gerald J. Robinson, Esq., for the respondent. FISHERMemorandum Findings of Fact and Opinion FISHER, Judge: Respondent determined deficiencies in income tax and addition to tax of petitioners as follows: YearDeficiencyAddition to Tax1955$1,885.62$146.721956708.02NoneSome of the issues have been disposed of by stipulation and will be reflected in our decision under Rule 50. The only issue for our consideration is whether or not petitioners may deduct amounts paid by them in connection with a European trip undertaken by them to enable them to learn new skills and to establish a reputation therefor. Findings of Fact Some of the facts are stipulated and are incorporated herein by this reference. The joint income tax returns of petitioners for the years 1955 and 1956 were filed with the district director of internal revenue, Upper Manhattan, on April 13, 1956, and April 13, 1957, respectively. Petitioners, both professional musicians30 for many years, were married in 1952. Miron was a pianist. His professional activities in the several years prior to a European trip in 1955 were largely devoted to teaching music. He had also performed in concert as a soloist, and occasionally in duo with Claire who, on such occasions, played the violin or viola. Prior to the European trip in 1955, Claire played the violin and viola. Her professional activities had been to some extent devoted to teaching, but she had played concert engagements and had played chamber music both in public and private engagements. Petitioners went to Europe in June of 1955 and remained there until November of 1957. The purposes of the trip were to enable Claire to receive training and coaching in order to learn to play the viola d'amore as a professional artist; to enable Claire and Miron to receive training and coaching to play the viola d'amore and piano in concert performances as a duo; and to enable petitioners to establish a reputation in Europe as such a duo with the ultimate objective of being accepted as such in the United States and the anticipation that concert engagements as a duo in the United States would be forthcoming as a result. 31 The viola d'amore differs materially from the violin and viola. It is a seven stringed instrument and is well adapted to the playing of music which, with its background literature, had been described as esoteric and baroque. There was much interest therein during the period in question. When petitioners went to Europe, they did not know how long they would stay. They did not expect to make any money on the trip and planned to spend what was required to achieve their aims. Upon their arrival, petitioners went to Holland for preliminary talks about possible appearances. They then went to Berlin to renew old musical connections. Shortly thereafter, they went to Rome and spent the remainder of 1955 in Rome for training and coaching under Sabatini. Claire was coached and trained on the viola d'amore and she and Miron were coached and trained as a viola d'amore and piano duo. They also practiced four or five hours a day and studied the esoteric literature relating to the viola d'amore. When Sabatini considered them ready for concert work, a manager was engaged and concerts were booked for April 1956 in Italy. (They gave no concerts in 1955.) The expenses of the concerts were borne32 by petitioners, who received no remuneration except the unsolicited sum of $24 in Lugo, Italy. Part of the expense for the 1956 concerts was paid in 1955 and part in 1956. In 1955, in an emergency, Claire, as a substitute for Sabatini, played the viola with the Milan Orchestra for two weeks and received compensation of $94.22. The 1956 concerts were well received. Petitioners received favorable notices which, together with programs and advertisements, were retained by them and arranged for later use in their effort to establish a reputation in the United States. Claire played both the viola and viola d'amore at these concerts. After the 1956 concerts, other managers were engaged and concerts for 1957 were booked in Berlin, Vienna, and London. Petitioners paid all expenses, part of them in 1956 and part in 1957. The concerts were well received and there were favorable notices which again were retained by petitioners and arranged with the 1956 notices for later use in the effort to establish a United States reputation. On petitioners' return to the United States in November 1957, a few concerts were booked including one in Carnegie Hall. In 1960, petitioners were engaged as a33 duo by the State Department, receiving a grant from the Speakers and Artists Bureau of the United States Information Service for several concerts in Germany. They likewise participated as visting artists in the American Cultural Centers program. Artists, such as petitioners, who were not well known had great difficulty in procuring concert work in the United States without prior publicity in Europe and it was a practice for those who could afford it to go to Europe and perform in order to get European press notices. The presentation of such notices was a material factor in facilitating later acceptance in the United States. The amounts (but not the deductibility) of the expenditures claimed by petitioners as deductions for 1955 and 1956 are stipulated. The respondent determined that the deductions in issue are unallowable upon the ground, inter alia, that they were not ordinary and necessary business expenses within the meaning of section 162(a) or allowable within the purview of section 212. Petitioners kept their books and filed their income tax returns for the years in question on a calendar year and cash basis. Opinion The purposes of the European trip which is the focal34 point of this case have been fully set forth in our Findings. In addition to expenditures for travel and subsistence, petitioners paid for coaching and training, largely for developing a new skill by Claire (i.e., performance on the viola d'amore) but also for instruction and training of both petitioners in performance as a piano and viola d'amore duo. Their prior experience as professional musicians did not include these activities. Petitioners likewise engaged managers to arrange concert performances. All of the expenses of the concerts here significant were paid by petitioners. The purpose of the concerts was to build up a European reputation as duo performers as a basis for subsequent acceptance in the United States. In support of this objective they gathered press notices, programs, and advertisements to be presented to concert managers upon their return to the United States. Petitioners had no expectation of profit from the concert performances in Europe. Of the European expenditures, petitioners claim deductions of $3,401.01 and $3,094.80 for the years 1955 and 1956, respectively, as ordinary and necessary business expenses, or ordinary and necessary expenses for the production35 of income. The amounts are stipulated, but respondent maintains that such amounts are not allowable as deductions. We agree with respondent's contentions in this respect. We do not think that the expenditures were paid in carrying on a business within the meaning of section 162(a). The "business" to which they relate was nonexistent during the period in question. The expenditures were rather in connection with acquiring new skills and preparing for engaging in a new business activity to be begun in the future. . Illustrative, though in a somewhat different factual setting, is . On the basis of like reasoning, it is apparent that the expenditures were not in the "pursuit of a trade or business" within the meaning of section 162(a)(2). See . The controlling principles are equally applicable under section 212(1). The expenditures were not paid in the production of income. They were made in preparing for the production of income in the future. See . No direct or immediate profit was expected. 36 James M. Osborn, supra, p. 604. We add that we do not think that the expenditures in question were ordinary and necessary expenses within the meaning of either section 162(a) or 212. The amounts paid by petitioners, in the setting here described, for travel, coaching management, concert training, and the building of a European reputation as a basis for what might in part, at least, be described as good will, may well represent a segment of the capital structure from which income may ultimately emerge, but, upon the facts before us they do not represent ordinary and necessary expenses. In , the Supreme Court said in part (pp. 115-116): Reputation and learning are akin to capital assets, like the good will of an old partnership. Cf. . For many, they are the only tools with which to hew a pathway to success. The money spent in acquiring them is well and wisely spent. It is not an ordinary expense of the operation of a business. See also ; James M. Osborn, supra, p. 605.37 Petitioners rely heavily upon (C.A. 9, 1959), reversing ; and Frieda Hempel, a Memorandum Opinion of this Court. We think both of these cases clearly distinguish themselves from the instant case on the facts. In Brooks, taxpayer was a research scientist. To adequately perform her research duties, it was necessary for her to travel in Europe. To maintain her existing position with the University of California, she was required by her contract to engage in continuous research. She had derived outside profit from her previous years of research and expected to derive such profit in the future. The expenses in question were incurred in her sole present activity and not for the purpose of gaining any new or better job. In Hempel, the activities involved were in pursuit of her lifelong and primary occupation, that of an opera and concert signer. In the light of the foregoing discussion we hold that the claimed deductions are not allowable under either the general provisions of section 162(a) or the provisions of section 162(a)(2) or 212(1). No other basis for allowance suggests itself. In view of our holding, *38 there is no occasion for us to consider the several alternative arguments advanced by respondent. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624548/	Estate of John H. Boogher, Sara Gardner, Administratrix, Petitioner, v. Commissioner of Internal Revenue, RespondentBoogher v. CommissionerDocket No. 39250United States Tax Court22 T.C. 1167; 1954 U.S. Tax Ct. LEXIS 107; September 16, 1954, Filed September 16, 1954, Filed 107 Decision will be entered under Rule 50. Decedent purchased 37 United States savings bonds entirely with his own funds. He had each bond registered in coownership form in the name of himself or another, for example, John H. Boogher or Edward Bland. Subsequently, decedent delivered each bond to the other coowner and did not have any of said bonds in his possession at the time of his death. The pertinent savings bond regulation permits either coowner to redeem the bond "upon his separate request without requiring the signature of the other co-owner," in which case the latter "shall cease to have any interest in the bond." The regulation further provides, in effect, that upon the death of one coowner, the surviving coowner will be recognized as the sole and absolute owner, as though the bond were registered in his name alone. Held:1. United States savings bonds purchased, registered, and held as above were held by the coowners as joint tenants within the meaning of section 811 (e) of the Internal Revenue Code of 1939.2. There is no evidence that decedent yielded or transferred his rights as potential surviving coowner by delivery of possession of the bonds to the other coowners. Davis Haskin, Esq., for the petitioner.Melvin A. Bruck, Esq., for the respondent. Fisher, Judge. FISHER1167 Respondent determined a deficiency in estate taxes in the amount of $ 4,509.62. An issue involving valuation is disposed of by stipulation. The stipulation also provides for allowance of attorneys' fees under Rule 50 or 51.The issues before us for determination are (a) whether United States savings bonds registered in coownership form in the name of decedent or another were held by the coowners as joint tenants within the meaning of section 811 (e) of the Internal Revenue Code of 1939; and (b) whether decedent, by delivery of possession of the bonds to other coowners, yielded or transferred his rights as potential surviving coowner.1168 OPINION. 109 Counsel for the parties stipulated in the opening statements that decedent was unmarried at the time of his death. The remaining facts are stipulated in writing. The facts are found in accordance with the stipulations.John H. Boogher died a resident of the city of St. Louis, Missouri, on December 18, 1948. A Federal estate tax return was filed by Olive Boogher Moffitt as surviving executrix of the Estate of John H. Boogher and the tax shown to be due on the return was paid to the collector of internal revenue for the first district of Missouri on March 15, 1950.The decedent, during his life, purchased a number of United States Savings Bonds, Series D and F, with his own funds, and had them registered in coownership form, such as, for example: "John H. Boogher or Edward Bland." In December 1946 and January 1947, the decedent delivered such bonds in each instance to the person named as coowner. There was a total of 37 of such bonds, all in denominations of $ 1,000, and the names of the coowners, relationship, issue dates, and redemption values at the date of decedent's death are as follows:RedemptionCoownerRelationshipPurchasevalue as atdatedate of deathSeries D1. Edward Blandgrand-nephewApr. 1940$ 9402. Nancy Blandgrand-niece9403. Lawrence B. Gardnergrand-nephewJan. 19399804. George Gardner, Jrgrand-nephew9805. Benjamin Gardnergrand-nephew9806. Nathaniel M. Griffingrand-nephew9807. Ralph D. Griffin IIgrand-nephew9808. Holly Hollidaygrand-nieceApr. 19409409. Willett Hollidaygrand-nephew94010. John Hollidaygrand-nephew94011. Olive HollidaynieceJan. 194190012. Olive Hollidayniece90013. Natalie Reevegrand-nieceJan. 193998014. Josephine ReevenieceJan. 194115. Josephine Reeveniece16. Glenn V. Russell, Jrgrand-nephewJan. 193998017. Eleanor Russellgrand-niece98018. Sophie RussellnieceJan. 194190019. Sophie Russellniece90020. John Shewmakergrand-nephewApr. 194094021. Hillary Shewmakerniece94022. Hillary Shewmakerniece94023. Frank M. Whitestep-grandsonJan. 193924. Gertrude Whitestep-granddaughter25. William R. Whitestepson980Series F26. Mrs. Frances BlandnieceMay 194127. Mrs. Frances Blandniece28. Arnold Booghernephew86129. Arnold Booghernephew86130. Lawrence BoogherbrotherOct. 194184831. Lawrence Boogherbrother84832. Mrs. Sara GardnernieceMay 194186133. Mrs. Sara Gardnerniece86134. Mrs. Natalie Griffinniece86135. Mrs. Natalie Griffinniece36. Olive MoffittsisterOct. 194184837. Olive MoffittsisterMay 1941861Total$ 27,650110 1169 None of the 37 bonds was in the possession of the decedent at the date of his death and no part of the value of the bonds was included in decedent's gross estate in the Federal estate tax return. Each of the bonds was purchased entirely with decedent's own funds. Seven of the bonds had been redeemed by the coowners prior to decedent's death. The 30 unredeemed bonds had a total redemption value of $ 27,650 on the date of his death.Treasury Department Regulations, Department Circular No. 530, Sixth Revision, February 13, 1945 (stipulated by the parties to be applicable to the bonds herein involved), provide, in part, with respect to a savings bond registered in the names of two persons as coowners (section 315.45) that (1) during the lives of both coowners, it will be paid to either coowner upon his separate request without requiring the signature of the other coowner, or to both upon their joint request; and (2) upon the death of one coowner, the surviving coowner will be recognized as the sole and absolute owner, as though the bond were registered in his name alone.Respondent, in his111 deficiency notice, included in gross estate the value of all of the savings bonds except those which had been redeemed prior to decedent's death.Respondent takes the position that the unredeemed bonds were acquired entirely with decedent's funds and were held by the decedent and the other coowners as joint tenants within the meaning of section 811 (e) of the Internal Revenue Code of 1939.Petitioner contends, on the other hand, that coowned bonds were not held as joint tenants and points in particular to the provisions of the Treasury regulations applicable to savings bonds which permit one coowner to redeem the bond, receive the entire proceeds, and thus completely terminate and cut off the rights of the other coowner.The form in which savings bonds are issued, and the provisions prescribing the conditions, restrictions, and consequences relating to ownership and transfer thereof are prescribed by Treasury regulations for administrative convenience and for the protection of both the issuer and the owner. They are intended for practical purposes and are based upon practical experience. For the purposes of this case, the two significant provisions relating to bonds issued in the112 coownership form here involved are (1) the right of either coowner (or both) to redeem during the life of both, and (2) the fact that upon the death of one, the surviving coowner will be recognized as the sole owner.The only bonds with which we are concerned are those which were not redeemed. While possession of the bonds was turned over to the other coowners by the decedent, there is nothing in the record to support the view that the decedent, during his lifetime, yielded up his potential survivorship right.1170 From the perspective of the general principles of law, there are numerous decisions which set forth the elements of joint tenancy. We think it would serve no helpful purpose to review such decisions here. They recognize that a joint tenant may cause a partition of the property and thus obtain his proportionate share free from the restrictions of the joint tenancy. We realize that this is not the equivalent of the right (under the applicable Treasury regulations under which the bonds here involved were issued) of one coowner in possession to dispose of the whole, to the exclusion of the rights of the other. We point out, at the same time, that the decisions recognize113 as the most significant single characteristic of joint tenancy the right to take the whole by survivorship, as a result of which the interest of a deceased joint tenant will not pass to his heirs, devisees, or personal representatives, but will pass, instead, to the surviving joint tenant or tenants by operation of law.The issue which we must resolve is whether the form of coownership now under consideration is a joint tenancy within the meaning of section 811 (e) of the Code of 1939. In the light of the following discussion, we do not think that the fact that one coowner has the right, by virtue of the provisions of Treasury regulations, to redeem a bond to the exclusion of the interest of the other coowner (as distinguished from the customary right of one joint tenant to realize only upon his proportionate share of the jointly owned property) is determinative of the problem.Upon consideration of the basic objectives of the Federal estate tax laws, the requirement of a practical implementation of such objectives, and the well-established administrative interpretation of section 811 (e) in its proper setting of the lengthy legislative history hereinafter outlined, we have concluded114 that the value of the bonds in question is includible in decedent's gross estate under the provisions of that section.Before going into the broader outlines of the history of the applicable administrative interpretation, we think it significant to point out that the treatment of bonds held in coownership form has likewise been practical in the coordinated implementation of both gift and estate tax laws. In this connection, Mimeograph 5202 (1941-2 C. B. 241) is applicable to the specific problem which we face. It provides, in part, as follows (p. 242):If "John Jones" purchases with his separate funds savings bonds and has them registered in his name and that of another individual in the alternative as co-owners, for example, "John Jones or Mrs. Ella S. Jones," there is no gift for Federal gift tax purposes, unless and until he during his lifetime gratuitously permits "Mrs. Ella S. Jones" to redeem them and retain the proceeds as her separate property, in which event a gift of the then redemption value of the 1171 bonds would be made. Of course, such bonds if not previously redeemed would, on the death of "John Jones" be includible in his gross 115 estate for estate tax purposes at their full redemption value.We find that the administrative interpretation of the law has been consistent from the time of its first expression. Regulations 37, promulgated pursuant to the 1916 Act, contained no provisions here applicable. When revised in 1921, in relation to the 1918 Act, however, Regulations 37 provided in part as follows:The statute provides for the taxation of interests held jointly * * * by the decedent and any other person or persons. This class of property includes all interests, whether in real or personal property, in which the survivor takes the entire property by right of survivorship, and it consequently does not form part of the decedent's estate for purposes of administration. It does not include interests held as tenants in common, where the interest of each tenant passes to his estate, free from any right of survivorship.The following are examples of this class of property: * * * stocks and bonds held in the joint names of several owners. [Emphasis added.]Article 23 of Regulations 63, relating to the 1921 Act, was substantially similar to that quoted above except that the example was changed116 to read as follows:and, in general, all securities and other personal property, where the title thereto was vested in the decedent and one or more other persons, subject to the right of survivorship.Article 22 of Regulations 68, promulgated under the Revenue Act of 1924, was the first interpretation of the "held as joint tenants" language. (Former statutes used the words "held jointly.") That article stated in part:The foregoing provisions of the statute extend to joint ownerships, wherein the right of survivorship exists, and specifically reaches property held jointly by the decedent and any other person or persons, * * provided the decedent contributed towards the acquisition of the property so held or deposited, or acquired it by gift, bequest, devise, or inheritance. The statute applies to all classes of property, whether real or personal, where the survivor takes the entire interest therein by right of survivorship, and no interest therein forms a part of the decedent's estate for purposes of administration. It does not include property held by the decedent and any other person or persons as tenants in common. [Emphasis added.]The current117 regulation, Regulations 105, section 81.22, uses language substantially similar to that contained in Regulations 68 above. It is noted that the import of the regulatory language was the same throughout substantially the entire history of the Federal estate tax. During the same period, there were a number of reenactments of the statute. The only difference in the material language of the statutes was that the provisions prior to the Revenue Act of 1924 used the words "held jointly," while the Revenue Act of 1924 and subsequent acts used the words "held as joint tenants," which language is now in 1172 the Internal Revenue Code. In the Senate and House reports relating to the change of language in the 1924 Act, the only comments were to the effect that the existing laws were "reworded to secure greater clarity" (S. Rept. No. 398, 68th Cong., 1st Sess., p. 35; reproduced in 1939-1 C. B. (part 2) 290), and "for purposes of clarity" (H. Rept. No. 844, 68th Cong., 1st Sess., p. 25; reproduced in 1939-1 C. B. (part 2) 308).We must assume that Congress, in repeated reenactments of the law over a substantial period of time, was118 aware of the consistent administrative interpretation of the law, and we must give substantial weight to such interpretation in the light of the apparent approval thereof to be implied from the fact that Congress found no reason to alter or correct such interpretation. Helvering v. Bliss, 293 U.S. 144">293 U.S. 144; D. E. Alexander, 22 T.C. 234">22 T. C. 234.Petitioner further argues that the action of decedent in delivering possession of the bonds to the several coowners achieved the result of transferring to them his entire interest in the bonds because he put them in a position where they could, by redemption of the bonds, secure the proceeds thereof and eliminate his rights therein. We find nothing in the record, however, to show that decedent intended to, or did, in any manner yield up or release his interest in the bonds as potential survivor. The burden of proof in this respect is upon petitioner, and in the absence of evidence, we must hold that decedent continued to retain his right of survivorship until his death with respect to the bonds which were not redeemed by the coowners.We hold, therefore, that the value of the bonds (as119 determined by stipulation) which were not redeemed are to be included in decedent's gross estate for Federal estate tax purposes.Decision will be entered under Rule 50. Footnotes*. Each of these bonds was redeemed by the coowner prior to the decedent's death.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624549/	Kate F. Thompson v. Commissioner.Thompson v. CommissionerDocket No. 21440.United States Tax Court1949 Tax Ct. Memo LEXIS 21; 8 T.C.M. (CCH) 1011; T.C.M. (RIA) 49271; November 30, 194921 Leonard B. Levy, Esq., for the petitioner. John W. Alexander, Esq., for the respondent. OPPERMemorandum Findings of Fact and Opinion OPPER, Judge: By this proceeding petitioner challenges respondent's determination of deficiencies in income tax for the years 1941 and 1943 of $1,393.68 and $3,689.05, respectively. The year 1942 is in question by reason of the Current Tax Payment Act. The only issue is whether amounts received by petitioner as rents on real property and as beneficiary of a trust are community income taxable one-half to petitioner and one-half to her husband, as reported, or petitioner's separate income fully taxable to her, as determined by respondent. Findings of Fact Petitioner filed Federal income tax returns for the years in question with the collector of internal revenue for the New Orleans district of Louisiana. Petitioner and her husband were married in 1926 and in 1931 moved from Memphis, Tennessee, to New Orleans, Louisiana, where they have lived continuously since that time. During the taxable years petitioner owned the following undivided interests in four pieces of real property located in Memphis: PropertyInterestAcquired59 South Main1/319286 South Main1/6193577 South Main1/12193823 North Main1/6193822 The properties were received as gifts from petitioner's parents and are owned by her, her son, and her brothers and sisters as tenants in common. During the taxable years, the properties were managed by an attorney named E. L. Williamson, who was employed by petitioner and the other owners at a salary of $300 per year. He collected rents, supervised repairs, and paid commissions to real estate agents for securing tenants. In connection with the collection of rents Williamson had an account in a Memphis bank under the name "Eighty Union," in which he deposited all rental receipts from the above properties as well as others in which petitioner owned no interest. He drew checks on the account payable to petitioner and the other owners each month for their proportionate share of the net income from the various properties. He prepared and filed Federal income tax returns for "Eighty Union" for the years in question on Form 1065, captioned - "PARTNERSHIP RETURN OF INCOME (To be Filed Also by Syndicates, Pools, Joint Ventures, Etc.)." "Eighty Union" is not a partnership, but merely a name used for convenience for the purpose of making tax returns, collecting and distributing rents, and23 maintaining records. The property at 59 South Main had been leased to Peggie Hale, Inc., which vacated upon termination of the lease on September 30, 1940. The same property was leased to McLellan Stores Co. by an instrument dated September 1, 1939, for the period from October 1, 1940, to September 30, 1960. The second lease was amended to include additional space, by an instrument dated August 1, 1942. Petitioner's husband participated in discussions with the owners concerning the terms of the leases. A deed of trust covering this property was executed on May 15, 1939, securing a loan of $75,000. Annual payments of $3,000 were required by the deed, at 4 per cent interest. The deed of trust was refunded by a deed of trust on the same property, dated October 21, 1943, in which the interest rate was reduced and prepayment of principal allowed. Petitioner's husband discussed the deeds of trust with Mr. Smithwick (one of the other owners) and Williamson. The property at 6 South Main had been leased to Mulford Jewelry Co. in 1931, prior to petitioner's acquisition of her interest therein. The lease expired in 1941, and the property remained vacant until December 1942, when a fruit stand24 proprietor was permitted under an oral contract to store his fruit in the building at night for $30 a week. Rents of $120 were received in 1942. The property is now leased for a long term to Walkover Shoe Co. The property at 77 South Main contains space for six stores carrying on retail businesses. The lease on one store was renewed on July 18, 1941, to Mangels of Tennessee, Inc., for a term beginning September 1, 1941, and ending August 31, 1947. The second store was leased on September 27, 1941, to Dr. Sydney Usdan, optometrist, for the period from November 1, 1941, to October 31, 1943. The third store was leased on January 12, 1939, for the period from March 1, 1939, to December 31, 1943. The fourth store was leased on September 26, 1940, to Slater Shoe Co. for the period from September 1, 1942, to December 31, 1943. The fifth store was leased on September 25, 1936, prior to petitioner's acquisition of her interest therein, to Florsheim Shoe Store Co. for a term of ten years. And the sixth store was leased in 1941 for a term of about six years. In connection with some of the leases on this property, petitioner's husband had discussions with Tom Farnsworth, one of the owners. 25 The property at 23 North Main had been leased in 1938, prior to petitioner's acquisition, to John Gerber Co. for a term of twenty years. A deed of trust was executed on March 28, 1939, to secure indebtedness of $50,000. It was refunded by a deed of trust on the same property executed October 21, 1943. Petitioner's husband discussed the terms with the owners. When petitioner's signature was required on documents relating to the rental properties, her husband would read the documents and advise her whether she should sign them. Petitioner has had no business training or experience. Her husband had extensive experience in the cotton business in Memphis prior to 1931, became vice-president of Canal Bank and Trust Company of New Orleans in 1931, and from 1933 to 1948 was special agent of the state bank commissioner in charge of liquidating that bank. Several times during each of the taxable years petitioner visited her son, brothers and sisters in Memphis. She discussed with them how the properties were renting, and their prospects for the future. Petitioner had a checking account in a Memphis bank, in which Williamson or her son would deposit the checks drawn by Williamson on26 the account of "Eighty Union" representing petitioner's share of rental receipts. She kept her own check book, and on its stub entered deposits in accordance with information received from Williamson or her son that amounts had been deposited. She drew checks on the account to buy clothing for herself and to pay household expenses. Petitioner and her husband each filed separate returns for the years in question, in which they reported the following amounts as receipts from "Eighty Union": YearAmount1941$6,265.3319425,307.1019437,525.87 They each reported one-half of the above amounts as taxable income. On December 31, 1934, petitioner's son created a trust in which petitioner was named sole beneficiary and her brother, S. W. Farnsworth, was named trustee. Williamson was substituted as trustee in May, 1943. The corpus of the trust originally consisted of second mortgage bonds of Mid-South Realty Co. in the amount of $50,000. Subsequently 88 shares of stock of the same corporation were substituted for the bonds. On December 24, 1938, the 88 shares were withdrawn and replaced by the settlor's non-negotiable note for $50,000. At that time the settlor agreed27 to secure the note within 90 days by a deed of trust on real property. But on December 30, 1939, the settlor agreed to secure the note by pledging accrued rentals instead of by executing the deed of trust. In connection with each of the above modifications of the trust agreement, petitioner's husband participated in conferences and discussions and advised petitioner to consent. Petitioner did not participate in the conferences and discussions, but on his advice she consented to the changes. In their returns for the years in question petitioner and her husband reported the following amounts received from the trust: YearAmount1941$2,211.8919423,389.0619434,130.23 They each reported one-half of the above amounts as taxable income. Petitioner and her husband owned a one third interest as tenants by the entirety in real property located at 163 South Main Street, Memphis. In the year 1943 the property was sold at a capital gain to the one-third interest of $1,548.18. In their returns for the year 1943 petitioner and her husband each reported one-half of the gain. In his notice of deficiency, respondent determined that the amounts received as rents from28 "Eighty Union," and the amounts received from the trust were not community income but were taxable in full to petitioner. Respondent further "held that your distributive share of the net long-term capital gain * * * $1,545.18, is your separate income." The trust and the real properties in question were not administered by petitioner's husband or by him and petitioner indifferently during the taxable years. Opinion Respondent has conceded the issue with respect to gain from sale of the property at 163 South Main Street, Memphis. The two remaining questions depend for their answer upon whether petitioner's Louisiana residence entitled her to report as community income the rents from real property located in Tennessee and income from a trust of which petitioner was beneficiary. Both items arose from sources which were concededly petitioner's separate property, but which she insits were under the administration of her husband and hence, under Louisiana law, gave rise to community income. 129 It is in the highest degree improbable that on any state of facts the rents from Tennessee real estate could be community property under Louisiana law. Tennessee law would govern the ownership of real property and it does not recognize the marital community; unaccrued rent is considered a part of the realty, and Commissioner v. Skaggs 2 is authority for the proposition that "the law of another State [would not] be effective to change the ownership of the crop on its gathering or of the rent on its becoming due," citing Robinson's Succession, 23 La. Ann. 174">23 La. Ann. 174. If the rents thus remained separate property after becoming due even under the law of Louisiana, no state of facts as to the husband's administration would suffice to make them community income. But in any event we are not convinced by the record that acts by the husband in connection with the property amounted to administration by him. Mere advice or even agency does not suffice but what is required is a type of dealing which simulates the relationship to that of ownership by the30 husband. "What is meant by leaving the administration of the wife's property to the husband is the exercise of a voluntary election by which the wife abandons her own rights of authority and control and suffers the husband to manage not as her agent subject to her authority but as if the property were his own." Lazard v. Commissioner (C.C.A., 5th Cir.), 153 Fed. (2d) 348, 349. "We do not think that this is a case of separate property of the wife 'under the administration' of her husband. Such a case is presented only when the husband with the consent of the wife uses the separate estate of the wife for his own benefit or that of the community. It is not presented when the husband acts merely as the agent of his wife and for her benefit." Paul v. Arxbult, 164 La. 841">164 La. 841, 114 So. 706">114 So. 706. As to the husband's dealings with the real property, it is difficult to bring them within the concept so described. Actual administration of the properties appears to have been primarily in the hands of a Tennessee attorney named Williamson, who received compensation for acting as the agent for petitioner and other members of her family. See Lucas v. Commissioner (C.C.A., 5th Cir.), 134 Fed. (2d) 319.31 Details of the leasing and mortgaging of the properties were apparently discussed informally among petitioner's husband, the members of her family, and Williamson. Some discussion was also participated in by petitioner to an extent which it is difficult to estimate from her testimony. The husband is not shown to have taken part in the actual execution of any of the leases. He "had entire confidence that Mrs. Thompson's interest was being taken care of." (Italics supplied.) The husband's participation thus resembles more that of an advisor and consultant whose examination of the leases and other documents was a preliminary to petitioner's signature. And the proceeds of the management were in each case delivered to petitioner and not to her husband; if they were used to any extent for community purposes, they were so used by her and not by him. We think the evidence totally inadequate to show that the administration of the real property was by the husband, and for his benefit or that of the community, within the principles previously stated. Mary Louise Guste, 8 T.C. 1261">8 T.C. 1261. Even less persuasive are the facts relating to the trust of which petitioner was the beneficiary. 32 Petitioner's son created the trust, naming her brother as the trustee. No actions whatever with respect to this trust are shown to have been undertaken by the husband in any of the tax years before us. The latest modification of the trust, concerning which petitioner's husband participated in discussions and gave petitioner advice, took place in 1939, two years prior to the earliest year now in controversy. Even if that could be said to have been an administration, a point which seems highly doubtful, 3 nothing of the kind appears during the period we are considering. The situation is more like that in Mary Louise Guste, supra, 1266, 1268, where we said: "* * * The evidence is clear that the complete operation of the restaurant is in the hands of petitioner's brother * * . Here, obviously, the restaurant, the principal source of income, was not under the administration of the husband. * " That trusts are no exception to the rule requiring actual administration by the husband appears conclusively from Trorlicht v. Collector (La. Ct. of Appeal), 25 So. (2d) 547, as to which the following comment has been made: $"In the * * [Trorlicht] case it is clear33 that there was no administration of the trusts by the husband. They of necessity had to be administered by the trustee. [7 La. L. Rev. 588">7 La. L. Rev. 588, 591.]" We conclude that as to receipts from both the rentals and the trust there was no such administration by the husband as to constitute them community income. Decision will be entered under Rule 50. Footnotes1. "2383. DEFINITION. - All property, which is not declared to be brought in marriage by the wife, or to be given to her in consideration of the marriage or to belong to her at the time of the marriage, is paraphernal." * "2386. When the paraphernal property is administered by the husband, or by him and the wife indifferently, the fruits of this property, whether natural, civil, or the result of labor, belong to the conjugal partnership, if there exist a community of gains. If there do not, each party enjoys, as he chooses, that which comes to his hand; but the fruits and revenues which are existing at the dissolution of the marriage, belong to the owner of the things which produced them."↩2. Commissioner v. Skaggs (C.C.A., 5th Cir.), 122 Fed. (2d) 721, certiorari denied, 315 U.S. 811">315 U.S. 811↩.3. " * * We say this because we think that the mere * * * giving of advice now and then, does not constitute such an administration by the husband as is contemplated by the Code. * * *" Trorlicht v. Collector (La. Ct. of Appeal), 25 So. (2d) 547, 551↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624550/	GERALD F. DORSCH, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentDorsch v. CommissionerDocket No. 28569-90United States Tax CourtT.C. Memo 1992-384; 1992 Tax Ct. Memo LEXIS 406; 64 T.C.M. (CCH) 74; July 8, 1992, Filed 406 An appropriate order and decision will be entered for respondent except as to the additions to tax under sections 6653(a)(2) and 6661(a). For Petitioner: Terrence M. Spears (specially recognized). For Respondent: John Q. Walsh. JACOBSJACOBSMEMORANDUM FINDINGS OF FACT AND OPINION JACOBS, Judge: Respondent determined deficiencies in petitioner's Federal income tax and additions to tax as follows: Additions to TaxSec.Sec.Sec.Sec.Sec.YearDeficiency6651(a)(1)6653(a)(1)6653(a)(1)(A)6654(a)6661(a)1987$ 5,562$ 1,350- 0-1 $ 278$ 2902 $ 1,35019885,4421,0753 $ 272-0-2671,075407 All section references are to the Internal Revenue Code as amended and in effect for the years in issue. All Rule references are to the Tax Court Rules of Practice and Procedure. The issues for decision are: (1) Whether respondent correctly determined the amount of income which petitioner failed to report for both years in issue; (2) whether petitioner is liable for the additions to tax under sections 6651(a)(1), 6653(a)(1), 6653(a)(1)(A), and 6654(a); (3) whether petitioner should be required to pay a penalty to the United States under section 6673(a)(1); and (4) whether petitioner's counsel is liable for excessive costs, expenses, and attorney's fees under section 6673(a)(2). FINDINGS OF FACT Some of the facts have been stipulated, and the stipulation of facts and accompanying exhibits are incorporated by this reference. Petitioner resided in Bellwood, Illinois, when he filed the petition. During 1987 and 1988, petitioner received income as follows: SourceType of Income19871988Hunter Corp.Wages$ 28,855$ 27,544StateUnemployment compensation1,1763,336of IllinoisPrudentialGross distribution-0-1,249Insurance Co.IRA distribution1,618-0-Interest8385408 Petitioner failed to file returns for 1987 and 1988. Based on third party reporting information provided to the IRS reflecting payment of the aforementioned income to petitioner, on September 18, 1990, respondent mailed two notices of deficiency (one for 1987, another for 1988) to petitioner at his last known address. Petitioner filed pro se. In his petition, petitioner claims that the tax deficiencies determined against him "have no basis in fact and are mere estimates." He claims that "the Sixteenth Amendment to the Constitution of the United States is null and void owing to the fraud committed in the ratification process." By notice dated August 28, 1991, petitioner was informed that his case was set for trial during the term of the Court's Chicago trial session beginning on January 27, 1992. The Court's Standing Pre-Trial Order (Standing Order) was attached to the August 28 notice. The Standing Order stated that each party must prepare a trial memorandum and submit it directly to the Court and to opposing counsel not less than 15 days before the first day of the trial session. The Standing Order required each party to list its witnesses in the trial memorandum with a brief409 summary of the anticipated testimony of each witness. The Standing Order also warned that witnesses who were not identified in the trial memorandum would not be permitted to testify at the trial without leave of the Court upon a sufficient showing of cause. Petitioner engaged Terrence M. Spears (Spears) as counsel around January 24, 1992. On January 27, 1992, Spears appeared at the calendar call for this case and moved for a continuance. Spears argued that he did not have ample time to prepare petitioner's case. The Court denied Spears' motion in accordance with Rule 134 which states that "employment of new counsel ordinarily will not be regarded as ground for continuance." Petitioner's case was then set for trial on February 5, 1992. At trial, Spears presented the Court with a trial memorandum. The Court accepted Spears' trial memorandum even though it was not timely filed. The trial memorandum did not list any witnesses for petitioner. Spears attempted to call Sherman Skolnick (Skolnick) as a witness for petitioner. Because petitioner failed to give advance notice that he intended to call Skolnick as a witness, as required by the Standing Order, and petitioner did not 410 make any showing of cause concerning this failure, the Court refused to hear Skolnick's testimony. Spears proffered that if Skolnick had been permitted to testify, he would have testified: the IRS sets up private individuals to lure others into shooting-gallery situations where they incite other people to participate in the tax protester movement, that Mr. Dorsch has been labelled an illegal tax protester -- a bill of attainder -- and that the case law upon which the 16th Amendment is precluded from being raised in Tax Court and in the District Court is based on fraudulent events that were perpetrated by private actors and IRS agents. No witnesses testified on behalf of petitioner. Petitioner presented no evidence to refute respondent's deficiency and additions to tax determinations. OPINION At the outset, we note that respondent's determinations are presumptively correct, and petitioner bears the burden of proving otherwise by a preponderance of the evidence. Rule 142(a); Welch v. Helvering, 290 U.S. 111 (1933). In petitioner's post-trial memorandum, Spears argues: (1) Petitioner "was entrapped into the jurisdiction of the Tax Court"; (2) petitioner411 was "terrorized" into not testifying; (3) the Court did not have proper jurisdiction over this case; and (4) respondent did not follow certain procedural and policy requirements. Spears' memorandum contained many unsubstantiated bizarre allegations. For instance, Spears alleges that: [persons] on behalf of the IRS Intelligence, regularly held meetings which encouraged otherwise innocent citizens, including but not limited to Dorsch, to use a variety of methods to fight the IRS, all of which were intended to entrap such innocents into a battle with the IRS, and to ultimately ruin those innocents either financially or through criminal proceedings. [Persons acting on behalf of the IRS] were and are adjuncts to joint Mossad/CIA projects, referred to as American death squads. The alleged purpose of which was and is to eliminate "undesirables" from the United States, either by death or by complete financial ruin, employing IRS intelligence, among other palpably American intelligence operatives, to execute such "undesirables." Petitioner was offered an opportunity to testify, but took the stand only when called by respondent. And then, he refused to testify, invoking his Fifth Amendment412 privilege. With respect to petitioner's refusal to testify, the following dialogue is deemed apposite: THE COURT: Do you wish Mr. Dorsch to testify? MR. SPEARS: No, your Honor. There is [sic] a number of reasons that I don't want to put him on the stand. THE COURT: Would you wish to state them? MR. SPEARS: For one reason, he is fearful of you and the IRS attorneys in this Court. THE COURT: Have I done anything to you, Mr. -- I don't understand what Mr. Dorsch is fearful of me about. MR. SPEARS: He is terrorized by this Court. THE COURT: Well, you know, I can't help that Mr. Spears. As far as I know, I have done nothing to justify such a fear. MR. SPEARS: He -- I am not properly prepared to have him take the stand because I haven't had time to prepare, and he has already stipulated to whatever the IRS wanted him to stipulate to. We asked if they wanted him to stipulate to anything more, and they said no. MR. WALSH: That is not true, Your Honor. We wanted further stipulation, but this was the extent of the stipulation we were able to get. I believe Your Honor will see it if you review the stipulation of facts and compare it to the notices of deficiency413 that Petitioner has conceded he received the income items that were the subject of the notices. For the sake of completeness, we shall address petitioner's various arguments. First, petitioner argues that he was denied due process under the Fifth Amendment because he was "entrapped into the jurisdiction of the Court" and that he was "terrorized" into not testifying. The record simply does not support these arguments. Petitioner chose to litigate this case in this Court. He had an opportunity to testify on his own behalf but he refused to do so. No one "terrorized" petitioner. Petitioner next argues that the Court lacks jurisdiction because the notices of deficiency are invalid. He contends that the notices of deficiency are invalid because respondent prepared substitute returns for petitioner which did not comply with section 6020 and the regulations thereunder. We need not address whether respondent properly prepared the substitute returns. Section 6020(b)(1) does not require that the Secretary of the Treasury file a return for the taxpayer before issuing a notice of deficiency. Hartman v. Commissioner, 65 T.C. 542">65 T.C. 542, 544-546 (1975); see also United States v. Verkuilen, 690 F.2d 648">690 F.2d 648, 656-657 (7th Cir. 1982).414 Thus, petitioner's contention that this Court lacks jurisdiction is without merit. Finally, petitioner argues that this Court lacks jurisdiction because he was not permitted to exhaust his administrative remedies. We need not address the legal merits of this argument because there are no facts in the record which indicate that respondent did not permit petitioner to exhaust his administrative remedies. Petitioner failed to dispute the dollar amounts of income he received in 1987 and 1988 as determined in respondent's notices of deficiency. (In fact, the dollar amounts stipulated as those petitioner received in 1987 and 1988 are exactly the same as those shown in respondent's notices of deficiency.) Petitioner disputes, however, that he is subject to liability for income tax on these amounts. We hold that he is. Petitioner's argument that he is not liable for income tax is based on his claim that the 16th Amendment was not properly ratified. Every court, including this Court, that has considered this and related arguments has rejected them. Brushaber v. Union Pacific Railroad Co., 240 U.S. 1 (1916); Knoblauch v. Commissioner, 749 F.2d 200 (5th Cir. 1984);415 Woods v. Commissioner, 91 T.C. 88">91 T.C. 88 (1988). Petitioner argues that the cases upholding the validity of the 16th Amendment were fraudulently obtained by the IRS. The only evidence intended to support petitioner's argument was a proffer as to Skolnick's testimony. (As previously noted, we refused to hear Skolnick's testimony.) The validity of the 16th Amendment was laid to rest many, many years ago. It is a well-settled legal proposition. We will not revisit this area of the law. Accordingly, petitioner is liable for the amount of income tax as shown in the notices of deficiency. Respondent determined that petitioner is liable for additions to tax under sections 6651(a)(1), 6653(a)(1), 6653(a)(1)(A), 6654(a), and 6661(a). At trial, respondent conceded that petitioner is not liable for the additions to tax under section 6661(a) and, as previously noted, respondent's determination of a section 6653(a)(2) or section 6653(a)(1)(B) addition to tax for 1988 is erroneous. With respect to the remaining additions to tax, petitioner did not offer any evidence to refute respondent's determination. Accordingly, petitioner is liable for these additions to tax. Respondent416 seeks the imposition of a penalty against petitioner under section 6673(a)(1). Section 6673(a)(1) provides: (1) PROCEDURES INSTITUTED PRIMARILY FOR DELAY, ETC. -- Whenever it appears to the Tax Court that -- (A) proceedings before it have been instituted or maintained by the taxpayer primarily for delay, (B) the taxpayer's position in such proceeding is frivolous or groundless, or (C) the taxpayer unreasonably failed to pursue available administrative remedies, the Tax Court, in its decision, may require the taxpayer to pay to the United States a penalty not in excess of $ 25,000. Petitioner's position in this proceeding was clearly frivolous and groundless. He stipulated all dollar amounts of income determined by respondent in the notices of deficiency and presented no evidence (nor proffered any meaningful evidence). Petitioner and his counsel chose to use this Court as a forum to advance frivolous tax protester arguments. Their pursuit of a groundless claim resulted in an unnecessary expenditure of this Court's time and resources. We, therefore, require petitioner to pay a $ 5,000 penalty to the United States under section 6673. Respondent also seeks to have this 417 Court impose sanctions against Spears pursuant to section 6673(a)(2). Section 6673(a)(2) provides: (2) COUNSEL'S LIABILITY FOR EXCESSIVE COSTS. -- Whenever it appears to the Tax Court that any attorney or other person admitted to practice before the Tax Court has multiplied the proceedings in any case unreasonably and vexatiously, the Tax Court may require -- (A) that such attorney or other person pay personally the excess costs, expenses, and attorneys' fees reasonably incurred because of such conduct * * * Section 6673(a)(2) is derived from section 1927 of the Judicial Code, 28 U.S.C. sec. 1927 (1988). H. Rept. 101-247, at 1399-1400 (1989). 28 U.S.C. section 1927 provides: Any attorney or other person admitted to conduct cases in any court of the United States or any Territory thereof who so multiplies the proceedings in any case unreasonably and vexatiously may be required by the court to satisfy personally the excess costs, expenses, and attorneys' fees reasonably incurred because of such conduct. Because this case is appealable to the United States Court of Appeals for the Seventh Circuit, we apply its standards for imposing sanctions under 28 U.S.C. section 1927 to section418 6673(a)(2). Golsen v. Commissioner, 54 T.C. 742">54 T.C. 742, 756-757 (1970), affd. on other grounds 445 F.2d 985">445 F.2d 985 (10th Cir. 1971). In Walter v. Fiorenzo, 840 F.2d 427">840 F.2d 427, 433 (7th Cir. 1988), the Seventh Circuit stated: A court may impose sanctions under 28 U.S.C. § 1927, against an attorney where that attorney has acted in an objectively unreasonable manner by engaging in a "serious and studied disregard for the orderly process of justice", or where a "claim [is] without a plausible legal or factual basis and lacking in justification." * * [Citations omitted.] We agree with respondent that petitioner's attorney failed to show a plausible legal or factual basis to support the issues set forth in the petition. While we admonish Spears that a reoccurrence of these types of assertions will not be tolerated, in the exercise of our discretion, we decline to impose a sanction under section 6673(a)(2) against Spears in this instance. To reflect the foregoing and respondent's concession, An appropriate order and decision will be entered for respondent except as to the *419 additions to tax under sections 6653(a)(2) and 6661(a). Footnotes1. Plus 50 percent of the interest payable under sec. 6601 with respect to the portion of the underpayment due to negligence pursuant to sec. 6653(a)(1)(B). ↩2. At trial, respondent conceded the addition to tax under sec. 6661(a) for both years in issue. ↩3. For 1988, respondent determined that petitioner was liable for an addition to tax for negligence under sec. 6653(a)(2). However, for tax years in which the return is due after Dec. 31, 1988, the Code no longer provides an addition to tax for negligence under sec. 6653(a)(2) or sec. 6653(a)(1)(B). Thus, respondent's determination of this addition to tax is erroneous.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624551/	LAWRENCE C. PHIPPS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Phipps v. CommissionerDocket No. 78915.United States Board of Tax Appeals34 B.T.A. 641; 1936 BTA LEXIS 668; June 2, 1936, Promulgated 668 Since a gift tax is an excise on the transfer of property and not a tax on the property itself, a gift of First Liberty Loan bonds is taxable, notwithstanding a provision in the authorizing statute and on the face of the bond that the principal and interest of the bond "shall be exempt, both as to principal and interest, from all taxation, except estate or inheritance taxes, imposed by authority of the United States, or its possessions, or by any State or local taxing authority." David A. Reed, Esq., and W. A. Seifert, Esq., for the petitioner. E. G. Smith, Esq., for the respondent. VAN FOSSAN 641 OPINION. VAN FOSSAN: Respondent determined a deficiency of $4,108.17 in gift taxes due from petitioner for the calendar year 1933. The petitioner alleges that: The Commissioner has erred in including in the total taxable gifts for the calendar year 1933 $160,000 par value Liberty Loan First 3 1/2 per cent Bonds, due June 15, 1947, representing gifts from petitioner to members of his family during 1933. Said bonds contained the express provision that they are free of all taxation except state and federal estate and inheritance taxes, and669 under the terms of that provision, the assessment of a gift tax upon the transfer of said bonds is erroneous and void. It is established by the pleadings that on October 3, 1933, petitioner made a gift to his son, Allen R. Phipps, of $100,000 par value of First Liberty Loan 3 1/2 percent bonds due June 15, 1947, and on December 25, 1933, made six gifts of $10,000 each par value of the same issue of bonds to other members of his family. The following provision appears on the face of the bonds: * * The principal and interest of this bond shall be payable in United States gold coin of the present standard of value and shall be exempt, both as to principal and interest, from all taxation, except estate or inheritance taxes, imposed by authority of the United States, or its possessions, or by any State or local taxing authority. * * * The above provision is quoted from the authorizing statute (40 Stat. 35, ch. 4). Section 501 of the Revenue Act of 1932 provides: (a) For the calendar year 1932 and each calendar year thereafter a tax, computed as provided in section 502, shall be imposed upon the transfer during such calendar year by any individual, resident or nonresident, 670 or property by gift. (b) The tax shall apply whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible; * * 642 Petitioner relies chiefly on the maxim "Expressio unius est exclusio alterius" and argues that had Congress intended to permit the imposition of gift taxes where Liberty bonds were the subject of the gift, it would have done so expressly as it did as to other obligations in the "Federal Home Loan Bank Act" (47 Stat. 725, 735, ch. 522) which exempts obligations of the bank "from all taxation (except surtaxes, estate, inheritance, and gift taxes) * " and as it did in the act creating the "Reconstruction Finance Corporation" (47 Stat. 5, ch. 8) where language identical to that just quoted was used. The most obvious answer to petitioner's petition is that a gift tax is not a tax on "the principal and interest of this bond" but is an excise on the transfer of the property to another. ; 671 ; . Consequent on the reasoning of , is the holding in , that a legacy of United States bonds is not exempted from the inheritance tax laws of a state by the provisions of the Act of Congress of July 14, 1870, and the declaration on the face of the bonds issued thereunder exempting them from taxation in any form by or under state authority, for the reason that the inheritance tax is not imposed on the bonds but on the privilege of acquiring property by will or inheritance, which is a right and privilege created and regulated by the state. Following the same principles, we held in ; affd., , that: The estate tax being a transfer or transmission tax and not a tax on property, the value of Federal Farm Loan bonds issued under the provisions of section 26 of the Federal Farm Loan Act approved July 17, 1916, should be included in a decedent's gross estate for Federal estate tax purposes, 672 notwithstanding that by the provisions of the act such bonds and the income derived therefrom are exempted from "Federal, State, municipal and local taxation." The logic of these cases leads irresistibly to a conclusion adverse to petitioner's contention. A tax under the provisions of section 501 is an excise on the privilege of making a gift and not a tax on the property given. The taxes referred to in the bond and the taxes provided by section 501 are basically dissimilar. In view of the fact that the basic nature of the gift tax controls our decision, we do not deem it necessary to discuss seriatim the several arguments advanced in support of petitioner's position. The legal principles on which we base our holding are so well established that, in our judgment, merely to state them is to indicate their applicability. See Regulations 79, arts. 1, 2. Reviewed by the Board. Decision will be entered for the respondent.MCMAHON 643 MCMAHON, dissenting: I dissent from the holding of the majority that the gifts of First Liberty Loan bonds and accrued interest thereon are taxable under section 501 of the Revenue Act of 1932. On the face of673 each bond is language taken from the authorizing statute as follows: " * * The principal and interest of this bond * * * shall be exempt, both as to principal and interest, from all taxation, except estate and inheritance taxes, imposed by authority of the United States, or its possessions, or by any state or local taxing authority. * * " (Emphasis supplied.) This is a mandatory exemption statute, expressly incorporated into the bonds in question. Its language is ordinary, simple and plain, as it should be, for the benefit of prospective purchasers of these bonds and others. It provides that "The principal and interest of this bond * * shall be exempt * * * from all taxation." This is broad, inclusive, comprehensive language. It would be difficult, if not impossible, to find English that is more so. These bonds are, in express language, made "exempt * * * from all taxation", "both as to principal and interest." The words "as to", as here used, have broad, inclusive, comprehensive significance. They make the bonds "exempt from all taxation" touching either principal or interest or both, except as their "taxation" is expressly permitted in674 other language of the statute and bonds. There are only two of such express exceptions from this provision making them "exempt * * from all taxation." They are the express exceptions imposing "estate or inheritance taxes" "both as to principal and interest", as specified in the statute and in the bonds. These express exceptions were necessary to permit "estate or inheritance taxes." Without such exceptions neither "estate" nor "inheritance taxes" touching the principal or interest could be imposed. If only "estate" taxes were expressly excepted from the exemption then they alone, and not "inheritance taxes", could be imposed. And by a parity of reasoning, since gift taxes were not expressly excepted, they likewise can not be imposed in view of the broad exemption "from all taxation." Obviously, if Congress had intended to add other exceptions to the exemption, in addition to "estate or inheritance taxes", it would, at the same time, have expressed its intention to do so. In any event, it did not except gift taxes from the exemption. It is apparent from the omission of Congress to expressly except gift taxes from the exemption that Congress intended that675 they should be included in the exemption. To hold otherwise is, in effect, to exercise the power of legislation which is reserved, under the Federal Constitution, to Congress alone, by amending the words of the exemption provision "except estate or inheritance taxes" by inserting therein immediately before the word "taxes" the words "or gift." We have not authority, 644 under the Constitution or otherwise, to do this. Even courts are not at liberty to ingraft upon a statute exceptions other than those expressed. . The majority opinion correctly points out that the gift tax imposed by section 501 of the Revenue Act of 1932 is an excise tax on the transfer of property; and also correctly recognizes, and it can not be successfully challenged, that estate and inheritance taxes are likewise excise takes upon the transfer of property. Thus the gift tax imposed by section 501 of the Revenue Act of 1932 is in the same category as inheritance or estate taxes in that all of them are excise taxes on the transfer of property. Since Congress in the statute authorizing the issuance of the Liberty bonds deemed it necessary676 to except Federal and state estate and inheritance taxes, which, like gift taxes, are excise taxes, from the exemption provided, it is clear that Congress considered that such excise taxes, as well as gift or other excise taxes, would have been prohibited under the general exemption provision had exceptions not been made. It is well settled that the exception of a particular thing from general words of a statute proves that, in the opinion of the lawmakers, the thing excepted would be within the general clause had the exception not been made. ; and . It is also well settled that an exception in a statute amounts to an affirmation of the application of its general provisions to all other cases not excepted. , and These cases well illustrate the maxim of expressio unius est exclusio alterius, which is a maxim of universal application in the construction of statutes. 677 . Under the above authorities it is clear that the exemption "from all taxation" contained in the authorizing statute and in the bonds includes gift taxes, since gift taxes are not made the subject of an exception as are estate and inheritance taxes - other excise taxes. There is another well accepted rule of general application to the effect that taxing laws are to be interpreted liberally in favor of the taxpayer. ; and ; and it is also well settled that exemptions in the Federal income tax laws, when begotten from motives of public policy, are not to be narrowly construed. . There can be no question that the tax exemption provided for as to the Liberty bonds in question was provided from motives of public policy. The raising of funds for the prosecution of the World War was a matter of the most vital public concern; and necessary inducements to the lending public were held out. Exemption "from all taxation"678 excepting only "estate or inheritance taxes" was a major inducement. 645 Doubtless, it never occurred to any of the purchasers of the type of bond in question that the exceptions to the exemption extended beyond "estate or inheritance taxes." It has been held that the words of a statute are to be taken in the sense in which they will be understood by that public in which they are to take effect. . Ordinary laymen, such as those who undoubtedly formed a large part of the public who bought Liberty bonds of the type in question, did not have knowledge of the technical differences between an excise tax, such as a gift tax, and other types of tax, direct or indirect, and were fully justified in concluding that the words "exempt * * * from all taxation" meant exactly what they said literally; and they undoubtedly so concluded. Too, in a sense a gift tax is imposed upon the principal and accrued interest of all bonds, since it is elementary that such tax is measured by the value of the bonds, including the principal and accrued interest thereof. Too, as heretofore pointed out, the exemption is "as679 to" the "taxation" of "both principal and interest."As stated, the provision for exemption from taxation of gifts of the Liberty bonds in question and the accrued interest thereon was not only definitely prescribed by the Congress, but was inserted in the bonds themselves. It thus created a binding contract obligation upon the Federal Government. . In this case, in which the Supreme Court of the United States had under consideration the provision in the Fourth Liberty Loan bonds that the principal and interest should be payable in United States gold coin "of the present standard of value", the Court stated in part: * * There is a clear distinction between the power of the Congress to control or interdict the contracts of private parties when they interfere with the exercise of its constitutional authority, and the power of the Congress to alter or repudiate the substance of its own engagements when it has borrowed money under the authority which the Constitution confers. In authorizing the Congress to borrow money, the Constitution empowers the Congress to fix the amount to be borrowed and the terms of payment. 680 By virtue of the power to borrow money "on the credit of the United States," the Congress is authorized to pledge that credit as an assurance of payment as stipulated, - as the highest assurance the Government can give, its plighted faith. To say that the Congress may withdraw or ignore that pledge, is to assume that the Constitution contemplates a vain promise, a pledge having no other sanction than the pleasure and convenience of the pledgor. This court has given no sanction to such a conception of the obligations or our Government. * * * * * The binding quality of the promise of the United States is of the essence of the credit which is so pledged. Having this power to authorize the issue of definite obligations for the payment of money borrowed, the Congress has not been vested with authority to alter or destroy those obligations. The fact that the United States may not be sued without its consent is a matter of procedure which does not affect the legal and binding character of its contracts. * * * 646 We conclude that the Joint Resolution of June 5, 1933, in so far as it attempted to override the obligation created by the bond in suit, went beyond the681 congressional power. Even if section 501 of the Revenue Act of 1932 were ambiguous when construed in the light of the authorizing statute, and, hence, it were not clear that Congress intended to exempt the gifts of the Liberty bonds and the accrued interest in question from gift taxes, which is definitely not conceded, the section should be construed as providing for the exemption in order to sustain the constitutionality of such section. Statutes must be construed, if fairly possible, so as to avoid the conclusion of unconstitutionality. . To hold, as is held in the majority opinion, that section 501 imposes a tax upon the gifts of the Liberty bonds and accrued interest thereon in question herein, constitutes an alteration, repudiation or destruction of the obligations of the United States under the bonds. This, as pointed out in , is beyond the Congressional power conferred by the Constitution. It is to be noted that in 682 , the Supreme Court had under consideration a provision as to the payment of the bond in United States gold coin "of the present standard of value", language identical with that contained in the bonds involved in the instant proceeding and found in the same paragraph with the provision for tax exemption, both provisions being included in the contract obligation of the Federal Government and being of major importance. It may be added that we are here confronted with no question of "procedure" such as was presented there. Here the petitioner is following a "procedure" and resorting to a remedy expressly afforded by statute, in search of relief. In Treasury Department Circular No. 78, issued May 14, 1917, for the purpose of inducing purchases of these very bonds in question, it is correctly stated as to them that "the bonds will be exempt, both as to principal and interest, from all taxation, except estate or inheritance taxes imposed by authority of the U.S. or its possessions, or by any State or local taxing authorities." (Emphasis supplied.) It is well settled that the current, practical interpretation of a statute placed thereon683 by officials charged with its administration will not be disturbed except for weighty reasons. . No such weighty reasons exist in the instant proceeding. As pointed out herein there are weighty reasons to the contrary. Subsequent developments, imaginary or real, unexpected or anticipated, can not be permitted to be determinative in a situation such as we have here presented, upon grounds of expediency or otherwise. See In the annual report of the Secretary of the Treasury on the state of the finances for the fiscal year ended June 30, 1917, is the following 647 statement with regard to this issue of bonds: "The bonds are exempt, both as to principal and interest, from all taxation, except estate or inheritance taxes imposed by authority of the United States or its possessions or by any state or local taxable [taxing] authorities." (Emphasis supplied.) This is another practical interpretation of the Treasury Department which, likewise, should not be disturbed. Respondent contends that, since the gift tax was not in force at the time of the authorization and the684 issuance of the Liberty bonds, Congress could not have intended to exempt gifts of Liberty bonds from any gift tax enacted subsequent to the issuance of the bonds in question. However, Congress, in stating that the exemption should be "from all taxation", undoubtedly intended and meant to exempt these bonds from gift and other taxes subsequently imposed and to convey to the buying public that the exemption should apply to taxes then in force or those which might thereafter be enacted. Such interpretation was correctly placed upon the exemption statute in question by the Treasury Department in Department Circular No. 300, dated July 31, 1923, captioned "United States Treasury Department Regulations with Respect to United States Bonds and Notes." That circular contains the following language: "Fully tax-exempt obligations. - [including the bonds in question here] * * * the 3 1/2 per cent bonds of the First Liberty Loan, are exempt * * * from all taxation, except estate or inheritance taxes, now or hereafter imposed * * ." (Emphasis supplied.) This is another practical interpretation which, likewise, should not be disturbed. Article 2 of Regulations 79, relating to685 the gift tax under the Revenue Act of 1932, as amended by Treasury Decision 4550, approved May 21, 1935, C.B. XIV-1, p. 381, provides in part as follows: * * * Various statutory provisions, which exempt bonds, notes, bills and certificates of indebtedness of the Federal Government or its agencies and the interest thereon from taxation, are not applicable to the gift tax since this tax is an excise tax on the transfer, and is not a tax on the subject of the gift. * * * To the extent that there is anything in such provision of the regulations calculated to impose a tax upon the gift of the bonds in question in the instant proceeding, it is contrary to the earlier correct current departmental constructions of the statute as heretofore pointed out and contrary to the express provisions of the special statute authorizing the issuance of the bonds and hence void, and it should not be applied in the instant proceeding. The Treasury Department can not, by its regulations, either limit the provisions of a statute of define the boundaries of their constitutional application. 686 . 648 The cases of , and ; affd., , relied upon in the majority opinion, , and , and similar cases are distinguishable, since they involved different exemption statutes, which do not provide any exceptions to the exemption which would give rise to the application of the maxim of expressio unius est exclusio alterius. Furthermore, , involved the question of the right of a subdivision of a state to tax an estate containing Federal bonds which Congress had declared exempt from taxation by both the Federal and the local governments. That question is not involved here. Even if the Federal Government may not render the transfer of its obligations exempt from local taxation, it may render the transfer thereof, as well as the transfer of the accrued interest thereon, exempt from the Federal gift tax, as it did in the case*687 of the issue of bonds with which we are concerned in the instant proceeding. The case of , in which it was held that the gain or profit derived upon the sale of Liberty bonds of the same issue as those here involved is subject to the Federal income tax, is distinguishable. There the tax sustained by the court is an income tax imposed upon, based on, and measured by the amount of the profit. It is in reality a profits tax. It is not imposed upon, based on, or measured by the "principal and interest" of the bonds. It is not a tax "as to" such "principal and interest." The gift tax involved in the instant proceeding is, in all of these respects, different from the tax there involved. There is no sound escape from the conclusions that Congress did intend to exempt the bonds in question here "both as to principal and interest" from gift taxes or similar excise taxes, other than estate and inheritance taxes which were expressly excepted from the exemption; and these bonds and accrued interest thereon are not taxable under section 501 of the Revenue Act of 1932.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624552/	S. Weisbart and Company, a dissolved Colorado corporation v. Commissioner.S. Weisbart & Co. v. CommissionerDocket No. 84329.United States Tax CourtT.C. Memo 1964-130; 1964 Tax Ct. Memo LEXIS 205; 23 T.C.M. (CCH) 788; T.C.M. (RIA) 64130; May 8, 1964205 Petitioner, a cattle raiser, valued its inventories at cost or market, whichever is lower. To identify the animals in its closing inventories petitioner used a modified FIFO method. Held, petitioner's inventory method is acceptable. Held, further, petitioner is entitled to value its 1952 and 1955 closing cattle inventories at market value, having shown that market value was lower than cost for both years. Market value of inventories determined. Value of property transferred, in redemption of stock in minority shareholder, determined. Ellis J. Sobol and Leslie H. Wald, Tower Bldg., Denver, Colo., for the petitioner. Richard J. Shipley, for the respondent. TRAINMemorandum Findings of Fact and Opinion TRAIN, Judge: Respondent determined deficiencies in petitioner's206 income tax as follows: FY EndingDeficiency10-31-51$760,441.1510-31-542,836.2810-31-55279,002.85The issues here presented are: (1) Whether petitioner's cattle inventories of October 31, 1952, and October 31, 1955, should be written down from cost, under the lower of cost or market method, and if so, by what amount; (2) Whether petitioner is entitled to an unused excess profits credit carry-back from its fiscal year ending October 31, 1952, to its fiscal year ending October 31, 1951; and (3) The correct amount of cost to be transferred to petitioner's treasury stock account on the redemption by petitioner during the fiscal year ending October 31, 1955, of the stock of Jack Boxer, a minority stockholder. Other issues have been conceded by both parties, necessitating a Rule 50 computation. Findings of Fact Some of the facts are stipulated and are hereby found as stipulated. During the taxable years ending October 31, 1951, 1952, 1953, 1954 and 1955 petitioner was a corporation existing under the laws of the State of Colorado. It was dissolved on December 31, 1957, and the petition herein was verified for the petitioner by persons having authority207 to do so under applicable Colorado law. Petitioner was incorporated June 1, 1947, continuing in corporate form a business which had been operating as a partnership under the same name. Petitioner kept its books and filed its Federal corporate income and excess profits tax returns on a fiscal year beginning November 1 and ending October 31, on the accrual method of accouting. In its initial return, for the period ending October 31, 1947, petitioner indicated its election to value inventories on the basis of the lower of cost or market. Petitioner filed its income and excess profits tax returns for the years involved with the district director of internal revenue, Denver, Colorado. Petitioner and its predecessor partnership were in the business of buying and fattening cattle for slaughter as beef cattle. Petitioner did not breed cattle nor did it slaughter cattle. Petitioner sold its cattle principally to packing houses. Petitioner's operations were widespread. It owned a ranch of approximately 64,000 acres in Wyoming and a ranch of approximately 1,000 acres in Morgan County, Colorado. Petitioner leased summer and winter pasture lands in Colorado, Kansas, Montana and Texas and208 in addition, placed cattle under the care of others. In 1955 petitioner also owned cattle located in Nebraska and Oklahoma, as well as the above-mentioned states. Petitioner maintained a feedlot in Brush, Colorado, about 80 or 90 miles from Denver, which would accommodate between 22,000 to 30,000 head of cattle. Here petitioner performed the final fattening (finishing) of its cattle for sale as slaughter animals. Purchases of cattle included in the October 31, 1952, inventory were made for petitioner both by its officers and principal stockholders and by commission agents in Colorado, Texas, Nebraska, Oklahoma, Missouri, Wyoming, New Mexico and Kansas, and purchases of cattle included in the October 31, 1955, inventory were made in Colorado, Texas, Oregon, Nebraska, Oklahoma, Idaho, Arizona, New Mexico, Montana, Wyoming, Kansas, South Dakota, Missouri and Nevada. During its fiscal years 1951 through 1955, petitioner was engaged in buying cattle of various ages, from calves to mature animals, feeding them in many instances on pasture and roughage feeds, finishing all animals by a concentrated grain feeding in a feedlot until they were fat, and then selling them on the slaughter209 cattle market. Many of the heavier cattle acquired were placed directly in the feedlot without preliminary pasture or roughage feeding. Petitioner purchased many different types, weights, and classes of cattle. During the fiscal year ended October 31, 1952, petitioner made total cattle purchases of $10,279,397.57 and total feed purchases of $4,656,179.36. During the fiscal year ended October 31, 1955, the petitioner made total cattle purchases of $5,792,741.76 and total feed purchases of $4,598,725.40. As of October 31, 1952, according to a physical count, petitioner had 29,599 head of cattle in inventory. Of this number 22,474 head were in the feedlot, 6,170 head were on pasture in the area of Brush, Colorado, 706 head were in transit, and 186 head were in the stockyards at Brush, Colorado. As of October 31, 1955, according to a physical count, petitioner had 41,089 head of cattle in inventory. Of this number 27,306 head were in the feedlot, 580 head were in transit and 13,203 head were on pasture and on farms in Colorado, Oklahoma, Texas, Montana and Nebraska. The cattle-feeding operation of petitioner differed from most other beef-raising and cattle-feeding operations during210 the years in question in that petitioner bought cattle of all ages, types and weights and not only fed them in a feedlot but also grazed cattle on summer and winter pastures. In effect petitioner combined three distinct types of cattle operations (feeding on grass, feeding on roughage, and feeding in the feedlot). The lighter weight ("green") cattle were put out on pasture, while the heavier cattle went directly into the feedlot for final finishing. Also, buyers would often select only certain cattle from a given pen in the feedlot, after which petitioner's employees would transfer the remaining animals to different pens. Due to the constant sorting of cattle and the large scale operations of petitioner, precise identification of animals was extremely impractical. The petitioner chose a fiscal year ending October 31 because in the fall of the year cattle normally would be moved off pasture and into the feedlot. At this time of your petitioner would have the greatest number of cattle in the feedlots and the fewest number of fat cattle (cattle ready for sale) on hand. Cattle coming into petitioner's feedlots were first fed on roughage, such as corn ensilage and green hay, and a small211 amount of grain. Gradually over a 10- to 14-day period the amount of grain was increased until the cattle were on a so-called "high-ration' grain diet. The daily cost of early feeding in the feedlot was much cheaper than the later feeding. Because grain is relatively expensive, a commercial feeder, who buys all of his feed for the cattle in the feedlot, as contrasted with a farmer feeder who raises some or all of his feed, is more interested in fattening and selling his cattle in as short a period as possible. Petitioner and its predecessor, for each fiscal year commencing in 1946, made a count of cattle on hand on inventory date. During the years in issue a physical count was taken and was certified to by petitioner's certified public accountant, Sam Butler (hereinafter sometimes referred to as Butler), who went into the feedlot to observe the taking of the count. Petitioner's tax returns for the taxable years or periods ending October 31, 1947, 1948 and 1949 were examined in 1950 by an internal revenue agent who proposed adjustments to the amounts of cattle inventories reported by petitioner. Petitioner had computed the value of these inventories under what it called an average212 cost method, based on certain selected purchases which were deemed typical or average. The agent proposed to determine the cost of these inventories by application of a strict average cost method. When petitioner objected to this method the agent computed the values under a first-in, first-out method to which he made several adjustments. Petitioner agreed in principle with the revenue agent's use of a modified first-in, first-out method, but objected to the agent's application of that method. Petitioner requested an informal conference with the field conferee, and several conferences were held in December 1950 and in 1951. The field conferee disagreed with the agent's approach and computed petitioner's inventories on a strict first-in, first-out basis. Petitioner protested the findings of the field conferee to what is now the Appellate Division in February 1952. The case was finally settled sometime in 1953 or 1954 at a unit cost figure midway between the proposals of petitioner and the revenue agent. Subsequent to the revenue agent's 1950 examination, petitioner calculated the cost value of its cattle inventory on October 31, 1950, under a method of identifying the animals in213 inventory which it has called modified first-in-first-out. This method is sometimes hereinafter referred to as modified FIFO. Thereafter, petitioner used the same modified FIFO method of identifying animals and determining cost for its cattle inventories on October 31, 1951 through 1957, and on January 1, 1958, the day following petitioner's dissolution and liquidation. The modified FIFO method devised by Butler is based upon the physical count of cattle on hand at the inventory date, both those on pasture and those in the feedlots. Petitioner also had available the purchase invoices showing when each group of cattle was acquired and the average weight of the animals in each group when acquired. Butler divided the cattle into four weight classifications, and on the assumption that the lightest weight animals would be held the longest time, determined which invoices pertained to the cattle on hand at the inventory date. The following schedule was used as a basis for these calculations: On hand if acquired dur-ing the followingPurchasemonths beforeWeightinventoryUnder 500 lbs.15 months500-650 lbs.4 months, possibly 5 or 6650-850 lbs.2 months, possibly 3 or 4Over 850 lbs.1 month, possibly 2214 Where doubt existed as to which animals were on hand, an officer of petitioner would consider factors such as place of origin, weight, feed, weather conditions and possible sickness in a herd, and determine whether or not a particular animal was on hand on the inventory date. These situations involved the cattle referred to in the above schedule as "possibly" on hand. Under the modified FIFO method, petitioner determined that the following numbers of animals in the respective weight classes, and acquired in the months indicated, comprised the closing inventories of its fiscal years 1952 and 1955: 1952Weight Class When PurchasedUnderOverMonth Acquired500 lbs.500-650 lbs.650-850 lbs.850 lbs.Oct. 19522,2662,7365,0431,363Sept. 1952186777442,748Aug. 19521776671,361July 19521021,070June 195264May 195252April 195266Nov. 1951 to Mar. 19521,867Oct. 19515,675Sept. 19511,046Aug. 19511,2841955Oct. 19551,2143,1021,8192,156Sept. 1955571,9671,357315Aug. 1955203959769July 19551,7291,206June 19552,5291,640May 19555,4001,166Adjustment 1(4,050)(2,235)Nov. 1, 1954 to Apr. 30,195512,098Oct. 19545,016Sept. 19542,517Aug. 1954155215 The data developed by petitioner through application of its modified FIFO method included the date of each purchase invoice for cattle included in inventory on October 31, 1952 and 1955, the place of purchase, the supplier, the number of head, the sex of the animal if known, the invoice weights, and the basic invoice costs. Commencing with its closing inventory for the fiscal year ending October 31, 1950, and until the liquidation of petitioner on January 1, 1958, petitioner computed the cost of its inventories by arriving at an identification of cattle on hand, and the purchase price of those cattle, by the modified FIFO method. Petitioner then added together the purchase price of cattle on hand and the estimated costs of pasture, feed and freight attributable to the cattle on hand. The amounts thus computed for its 1952 and 1955 fiscal years are as follows: 1952Basic Invoice cost$4,493,172.48Feed in cattle795,793.23Pasture228,458.52Freight62,157.90$5,579,582.131955Basic invoice cost$3,585,355.48Feed in cattle626,319.00Pasture368,176.18Freight86,286.90$4,666,137.56 2216 For its 1952 and 1955 fiscal year closing inventories petitioner computed the lower of cost or market value by a "component parts" method; that is, by comparing the cost and the market values of the various component parts of the cattle in inventory. Petitioner used this method in an attempt to follow as closely as possible its technique in arriving at cost. Its computations were as follows: 1952Cattle (per invoices)$3,089,788.81Feed in cattle431,751.00Pasture228,458.52Freight62,157.90$3,812,156.231955Cattle (per invoices)$2,757,991.95Feed in cattle375,932.81Pasture368,176.18Freight86,286.90$3,588,387.84Petitioner presented at trial computations of replacement market values of its inventories using various markets. Replacement for these purposes was defined as what it would cost to replace the inventory on inventory date by purchases on the market in the quantities in which petitioner normally bought. In order to calculate the Denver replacement market amounts, petitioner used the invoices representing cattle in inventory217 on October 31, 1952 and 1955 according to its modified FIFO method. Petitioner calculated the weights of those cattle on the inventory dates and applied the Denver livestock market prices for stockers and feeders as reported by the USDA, using the choice grade slaughter cattle prices for cattle determined to be fat or nearly fat. Petitioner compared the cost of cattle as computed for its income tax returns, with the market value of the same cattle, and took the lower of the two. The total lower of cost or market thus computed with reference to the Denver livestock market prices was $4,083,149.93 for October 31, 1952, and $3,870,197.19 for October 31, 1955. According to its modified FIFO calculations petitioner determined that its Texas purchases comprised 36 percent of its closing 1952 inventory and 41 percent of its closing 1955 inventory, and that other than its Oklahoma purchases in 1952 which comprised 23.5 percent of its purchases in that year, no other market purchases represented more than 15 percent of the inventory cattle in either year. To compute a Texas replacement market petitioner used the Fort Worth livestock market because it considered that that market represented218 the type of cattle it was purchasing in Texas, although most of petitioner's Texas purchases were made in the Panhandle, between Ft. Worth and Denver, and none were made in Ft. Worth. The total lower of cost or market thus computed with reference to the Ft. Worth livestock market prices was $4,063,228.47 for October 31, 1952, and $3,967,000.2.20 for October 31, 1955. Petitioner also computed replacement market figures by applying average prices shown by purchase invoices for purchases made during the last week in October and the first three weeks in November in 1952 and 1955, to the cattle in each weight classification. These amounts included the estimated freight costs for the cattle. Petitioner took into account the time lags on contract sales in determining which invoices represented purchases made on or about the inventory date. The total lower of cost or market thus computed with reference to petitioner's purchases made around the inventory date, including freight to Brush, Colorado, was $4,169,399.79 for October 31, 1952, and $4,618,917.84 for October 31, 1955. Petitioner also computed the lower of cost or market values of its inventory for October 31, 1952, based on all219 of its November 1952 purchases except purchases made under contracts entered into prior to inventory date. The value thus computed was $4,231,467.61. For the 1952 and 1955 fiscal years, respondent determined that the market values of petitioner's closing cattle inventory was not less than $5,579,582.13 and $4,666,117.56, 3 amounts identical to the cost figures reported by petitioner. Petitioner reported a feed and cattle inventory of $4,103,688.76 as of November 1, 1950, a cattle inventory of $5,665,518.14 as of November 1, 1951, and a cattle inventory of $4,686,991.47 as of November 1, 1954; these items were not challenged by respondent and the amounts thereof have not been put in issue in this case. Since its inception petitioner has computed the cost value of its closing cattle inventories without including administrative or overhead costs. It is not normal or custommary practice of cattle feeders in this area to include such costs in their cattle inventories. To compute the cost of feed attributable to cattle in the feedlot petitioner first determined from its records the number of cattle that had entered the feedlot during the months preceding220 the inventory date. Then the number of days each animal had been in the feedlot was calculated by assuming, as a matter of convenience, that each had entered the feedlot on the 15th of any given month. The number of days all cattle were in the feedlot was then multiplied by the average cost of feeding an animal per day to arrive at the total feed cost attributable to the cattle in the feedlot on the inventory date. Petitioner determined pasture costs attributable to the cattle in closing inventory by subtracting from total pasture costs the amount determined to be attributable to cattle which had been sold during the year. The amounts thus determined to be attributable to cattle in the 1952 and 1955 closing inventories were $228,458.52 and $368,176.18, respectively. In determining the freight cost to be added to the cost values of its 1952 and 1955 closing inventories, petitioner used an estimated amount of $2.10 per head. Exact computation of freight costs attributable to inventory cattle was difficult since petitioner had to take into consideration certain "fabrication-in-transit" credits received from the railroads. These credits are based upon the amount of weight shipped221 in to petitioner by rail, and could be applied to outgoing shipments. These credits could be utilized only when petitioner made a shipment to a point where the credit applied. In computing the market value of its cattle inventories, petitioner applied the following market prices, which it based upon its purchases on the Denver livestock market and on the current quotations on that market: October 31, 1952Weight ClassesUnderOverType500 lbs.500-650 lbs.650-850 lbs.850 lbs.Steers$20.00$14.75$16.25$17.75Heifers20.0014.7516.7517.50Mixed20.0014.7516.5017.63October 31, 1955Steers$16.75$13.25$13.25$13.25Heifers14.2511.7511.7511.75During petitioner's 1952 fiscal year, cattle market prices declined substantially. The average prices paid for feeder and stock steers on eight markets 4 declined from a high of $32 per cwt. during November 1951 to slightly over $23 per cwt. during October 1952. The largest break in the market came between May 1952 and July 1952, when the average fell from $31 to $25. Petitioner's records indicate that the two principal sources of the cattle222 on hand for its October 1952 inventory were Texas and Oklahoma. Also, petitioner bought large quantities of cattle directly from rancher-producers, through commission agents, rather than at the public markets used by the USDA in compiling the above statistics. Delivery of these purchases was not immediate, unlike those made at sale barns of public markets. Invoices bore the date of delivery, but the price would be agreed upon at the time of purchase. The time gap between these two dates was often from seven days to three months. On February 2, 1953, petitioner executed a chattel mortgage on 20,305 head of its feedlot cattle to the First National Bank of Denver, in connection with a bank loan. The mortgage also covered enough feed to fatten the cattle for 90 days. On January 29, 1953, petitioner's officers had furnished to the bank a signed valuation of these cattle, listing the number of head, sex, breed, age, brand, weight, and estimated value per head. The estimated per head values, when converted to a weight basis, reflect223 values of $20 to $25.25 per cwt. Petitioner's evaluation, together with a report by the bank's inspectors, was used by the bank to assure that adequate collateral would be given for the $1,750,000 short-term loan applied for by petitioner. The estimated value of the cattle securing the loan was $4,760,080. On July 30, 1955, petitioner prepared an inventory and valuation of its cattle for the purpose of a settlement whereby all of the stock of Jack Boxer (sometimes hereinafter referred to as Boxer), a minority shareholder, was to be redeemed. The settlement was to become effective on September 1, 1955. The cattle inventory on that date was 38,838 head, of which 18,147 were in the feedlots. Of the feedlot cattle, 9,818 were classified as "long fed" and the remainder were classified as "short fed." The long-fed cattle were those where the feedlot-entry date indicated that most had been there from four to six months. The dates on the short-fed animals indicated they had been on feed from one to three months. The cattle in this inventory were valued for purposes of the settlement at a fair market value arrived at as a result of negotiations between the parties. The long-fed cattle were224 valued at between $20.50 and 22.25 per cwt. The short-fed cattle were valued at between $15 and $17 per cwt. Sick cattle were valued at $90 per head. The valuation of the short-fed animals was based on the medium grade feeder and stocker market, and the valuation of the long-fed animals was based on the fat cattle market. The average feeder and stocker prices paid on ten midwestern and western markets during the months of July and October 1955 were each approximately $17.45 per cwt. The Denver market slaughter cattle prices for the week ended November 4, 1955, were an average of about $.50 to $1 per cwt. lower than for the week ended July 30, 1955. Of the 38,838 cattle in inventory at the time of the inventory taken for the Boxer settlement, 20,691 were on pasture. Petitioner valued the pasture cattle as follows: No. HeadValue per Cwt.4,288$14.0013,78416.0035017.0061615.501,275 heifersNot valued37890.00 each These values indicate that petitioner valued most of these cattle in the common to medium range. The USDA establishes grades for slaughter cattle. These grades depend on such factors as the conformation of the carcass, the amount of225 fat or marbling in the meat, and the texture and color of the meat. Consistently throughout the years 1952 and 1955 petitioner sold its cattle at choice slaughter grades. The average weight gain of petitioner's cattle while on pasture was approximately one pound per day during 1952 and 1955. The average weight gain of petitioner's cattle while in the feedlots was approximately two pounds per day in 1952 and approximately 2.25 pounds in 1955. During its fiscal year 1952, petitioner purchased cattle as indicated below: Number of head by weight classUnderOverMonth500 lbs.500-650 lbs.650-850 lbs.850 lbs.Nov. 1951 to May19521,9853,1174,9375,490June 19526419215570July 19521021,0701,326999August 19521756411,6511,731September 1952207037963,185October 19522,2662,7365,0431,363Total4,6128,45913,90812,838 Petitioner also purchased 8,569 head during the year for speculative purposes. These are not included in the above totals. During its fiscal year 1955, petitioner purchased cattle as indicated below: Number of head by weight classUnderOverMonth500 lbs.500-650 lbs.650-850 lbs.850 lbs.Nov. 1954 to May195517,4985,0405,8521,328June 19552,5291,64022418July 19551,7291,20668426August 19552039593,457503September 1955572,2401,0844,030October 19551,6413,7701,8752,471Total23,65714,85513,1768,376Less Boxer cattle(4,050)(2,235)19,59712,62013,1768,376226 The market values of petitioner's October 31, 1952, and 1955, cattle inventories were $4,355,223 and $3,945,000, respectively. During 1955, petitioner redeemed all of its stock held by Boxer, a minority (20.6 percent) stockholder. The consideration given by petitioner consisted of cash, a promissory note, cancellation of Boxer's indebtedness to petitioner, and other assets including petitioner's Wyoming ranch and 6,285 head of cattle. The cattle included 2,235 feedlot animals and 4,050 pasture animals. The agreement between Boxer and petitioner for redemption of Boxer's stock provided that Boxer was not to be charged any amount for feeding the cattle in the feedlot until the date he took possession. The cost of pasture in connection with cattle at other locations and the expenses of the Wyoming ranch to be transferred to Boxer were to be Boxer's expenses from and after September 1, 1955. Boxer took possession of the feedlot cattle on September 9, 1955. Petitioner computed its cost of the cattle transferred to Boxer and adjusted this amount out of its asset accounts and assigned it to treasury stock. The cost of the cattle was computed as follows: 4,050 head on grass$291,033.302,225 head in feedlot 5166,991.50Total cattle cost$458,024.80Pasture and feed10,930.50Total$468,955.30227 Respondent, in the statutory notice of deficiency, determined that the cost assigned by petitioner to the cattle transferred to Boxer was understated by $137,153.90. The amount of cost to be allocated to the cattle transferred to Boxer is as follows: Pasture (grass) cattle$289,906.59Feedlot cattle169,348.65Pasturage costs14,867.98Fred Costs70,476.00Freight12,058.80Indirect Costs5,587.50$562,245.70Opinion During 1952 there was a substantial decline in the market prices for stocker and feeder cattle on the mid-western and western markets. The main inquiry in this case is into the loss in value, if any, of petitioner's inventory due to this market decline, based on petitioner's valuation of its inventories at cost or market, whichever is lower. Underlying this is the question of the validity of petitioner's use of its modified FIFO method of identifying the animals on hand at inventory date. Petitioner on its income tax return for its fiscal year ending October 31, 1952, reported228 a cost of $5,579,582.13 and a market value of $3,812,156.23 for its closing cattle inventory. In his statutory notice of deficiency respondent stated: It is determined that the cost value of your cattle inventory as at October 31, 1952 in an amount of not less than $5,579,582.13 more clearly reflects your income than does the value used by you on your income tax return of $3,812,156.23. Accordingly, your taxable income is increased in the amount of $1,767,425.90. The closing inventory valuation involved here directly affects petitioner's cost of goods sold, and hence its income. Cost of goods sold is equal to opening inventory, plus purchases, minus closing inventory. Therefore, a higher value of closing inventory will decrease the cost of goods sold and increase income. The first issue to be decided is when petitioner would suffer a loss in market value, for inventory purposes, from the 1952 market declines. Petitioner contends that it suffered a loss in its 1952 fiscal year. Respondent contends that the loss, if any, was suffered in petitioner's 1953 fiscal year. We agree with petitioner. It is respondent's contention that petitioner did not suffer a "real" loss on its cattle229 inventory until its 1953 fiscal year, and has failed to support its reduction of inventory value for its 1952 fiscal year. Respondent bases this conclusion on the fact that petitioner's resale market did not decline sharply until its 1953 fiscal year. Respondent states: This is in line with theory of the lower of cost or market value which is to recognize losses which have been suffered but not to provide for losses which are not in fact anticipated. D. Loveman & Son Export Corp., (1960) 34 T.C. 776">34 T.C. 776, 798. Respondent's use of D. Loveman & Son Export Corporation, 34 T.C. 776">34 T.C. 776 (1960), which was affirmed on appeal (296 F. 2d 732 (C.A. 6, 1962)), is inapposite and out of context. In the portion of Loveman referred to by respondent, the losses "not in fact anticipated" related to that petitioner's use of major steel mill prices when those markets were inaccessible to petitioner. In holding that those markets could not be used for the computation of lower of cost or market, we pointed out that since petitioner could not replace its inventory from these sources, it could not reduce its inventory values to these market prices. We did not say that230 it could not have reduced its cost figures to the prices on the market upon which it would actually have replaced its goods. The "unanticipated" nature of the loss in Loveman refers to the difference between the major mill prices and the prices which petitioner would have paid on the markets where it could purchase its replacement inventory. To construe our statement in Loveman to refer to resale market as respondent would have us do would deny a reduction to market value in every situation where resale price was greater than cost and would nullify the entire accounting concept of lower of cost or market. The lower of cost or market method is one instance where the tax law permits the deduction of an unrealized loss, and is a recognized exception to the necessity of reflecting in income tax returns only closed transactions. As we said in Loveman: Whatever the defects of the lower of cost-or-market method in actual practice, its underlying theory, as stated in Finney and Miller, Principles of Accounting (Intermediate) (5th ed. 1958), is as follows (p. 251): The cost-or-market basis of inventory pricing conforms with an old rule of accounting conservatism often stated as follows: 231 Anticipate no profit and provide for all possible losses. If market purchase prices decline, it is assumed that selling prices will decline with them; reducing the inventory valuation to market purchase price reduces the profit of the period when the cost price decline took place and transfers the goods to the next period at a price which will presumably permit the earning of a normal gross profit on their sale. If the market purchase price increases, the inventory is valued at cost so that a profit will not be anticipated. The evidence introduced by both parties established that there was a substantial decline in petitioner's purchase market values during its 1952 fiscal year. We must compare the purchase market values with the cost of the cattle in petitioner's 1952 fiscal year closing inventory. If respondent's disallowance of petitioner's market value computations is based upon a contention that there was no such decline, it is clearly incorrect. Respondent's alternative contention is that petitioner's modified FIFO method is unacceptable. It is incumbent upon petitioner to establish the validity of its method of valuation in order to provide a means of ascertaining the proper232 value of its inventories, and to show that the market decline reduced the market value of its inventories below its cost. It is respondent's contention that he has accepted petitioner's cost figure for purposes of computing lower of cost or market without accepting the method by which this figure was arrived at by petitioner, and that petitioner has failed to show that market value was any lower than this amount. Respondent then proceeds to argue that the modified FIFO method used by petitioner is unacceptable under the pertinent statute and regulations, and may not be used by petitioner for computing the market value of its closing inventory. Respondent specifically states that he is not attempting to change petitioner's cost figures for either closing or opening inventory for its 1952 fiscal year but that he is merely disputing petitioner's computation of market value for closing inventory. Despite respondent's disclaimer, petitioner maintains that respondent's use of petitioner's cost figures results in an acceptance of its modified FIFO method, upon which such figures are based. Petitioner argues that, if respondent has stipulated to the number of cattle in closing inventory233 and also accepted petitioner's cost figures, then an acceptance of the modified FIFO method of identification is implicit. We cannot agree. Respondent has consistently objected to the modified FIFO method. While the use of petitioner's cost figures in the statutory notice of deficiency might have been an arbitrary attempt by respondent to determine a value for petitioner's inventory, there is no basis for construing this action as an acquiescence to petitioner's modified FIFO method. There is merit, however, in petitioner's objection to respondent's attempt to impeach petitioner's modified FIFO method for purposes of market value only, despite the fact that it is also the basis of petitioner's cost figures. By arguing that the modified FIFO method is inaccurate and that petitioner has not established that the market value was not below petitioner's cost amount, respondent attempts to use this amount as an inflexible ceiling. This overlooks several aspects of an inventory valuation. The cattle inventory valuations in this case are part of the computations necessary to determine petitioner's cost of goods sold, and ultimately, petitioner's income. Once it has been established that234 petitioner's cattle inventory decreased in value because of the market declines, the question that remains is whether the resulting values were less than petitioner's cost for these animals, and if so, by how much. In order that there be no distortion of income, if closing inventory is adjusted, a corresponding adjustment must be made to opening inventory. Fruehauf Trailer Co., 42 T.C. 83">42 T.C. 83 (April 13, 1964); The Thomas Shoe Co., 1 B.T.A. 124">1 B.T.A. 124 (1924); Boyne City Lumber Co., 7 B.T.A. 36">7 B.T.A. 36 (1927); Justus & Parker Co., 13 B.T.A. 127">13 B.T.A. 127 (1928). If petitioner's modified FIFO method is inaccurate, adjustments must be made to both opening and closing inventory costs, as well as to market value, since all of these computations are dependent upon this method. If petitioner's modified FIFO method is an improper method of inventory identification, as contended by respondent, then all of petitioner's computations would have to be revised. Section 22(c) of the 1939235 Code 6 provides two tests which an inventory valuation must meet: (1) it must conform as nearly as may be to the best accounting practice in the trade or business, and (2) it must clearly reflect income. Petitioner contends that it has met these requirements, and has complied with respondent's regulations as well. Respondent's regulations provide, in part, that greater weight is to be given to consistency than to any particular method of inventorying or basis of valuation so long as the method or basis used is substantially in accord with the regulations under section 22(c). 7 Petitioner has consistently valued its inventories at cost or market, whichever is lower, and since its 1950 fiscal year, inventory values have been based upon its modified FIFO method of identification. Until its 1952 fiscal year market value had never been lower than cost, so that petitioner valued its inventory at cost for each fiscal year prior to 1952. The aspect of consistency in inventory valuation helps to assure a clear reflection of income in each accounting period. 236 Petitioner's inventory method involves at least three distinct steps. First, modified FIFO is used to identify which animals are on hand at inventory date. Second, cost and market values are arrived at for the cattle identified under modified FIFO. Third, under lower of cost or market, the lower of the two amounts is selected for use in assigning a value to the identified cattle. The main thrust of respondent's argument is an attack on petitioner's modified FIFO method of identification. Respondent contends that this method, although used consistently by petitioner, is based upon too many estimates, is inaccurate, and is internally inconsistent. The modified FIFO method was instituted by petitioner's accountant, Butler, because it was impractical to round up and weigh the cattle on hand at inventory date, due to (1) the extremely large area over which the cattle were situated, (2) the cost and difficulty of transportation to weighing stations, and (3) the weight loss which would be incurred by interrupting the feeding process. An actual physical count was taken to determine how many cattle were on hand. To determine the identity of these cattle, Butler divided purchase invoices237 into four categories according to weight at time of purchase. He then used an estimated average daily gain of one pound for pasture feeding and two pounds for feedlot feeding, to ascertain how many months an animal in each weight category would be on hand before being sold. Where there was doubt as to whether particular invoice purchases were still on hand at inventory date, Butler and petitioner's officers would consider various factors and decide whether or not to include them in inventory. The invoices representing the cattle determined to be in inventory were then used as the basis for the cost and market values of the purchased animals. Respondent's position, as manifested by the field conferee, is that petitioner cannot properly identify the animals in its inventory and must, therefore, use a strict FIFO method. See section 39.22(c)-2, Regs. 118. 8 We find that the modified FIFO method does provide a reasonable identification of the animals in inventory and is in accord with the theory of inventory valuation. In view of the manifold differences in weight and dates of acquisitions made by petitioner, the use of a straight FIFO method would cause a distortion of income far greater238 than any which would be caused by petitioner's application of its modified FIFO method. The value of inventories under straight FIFO would depend largely on the weight of animals purchased close to inventory date each year. Methods of inventory are frequently modified to suit sets of unusual circumstances. See E. Rauh & Sons Fertilizer Co., 12 B.T.A. 468">12 B.T.A. 468 (1928), and cases cited therein. Where experienced persons, well acquainted with market conditions and prices, modify the usual inventory methods, their calculations are often accorded substantial weight in the absence of contradictory indications that these calculations are inaccurate. See E. Rauh & Sons Fertilizer Co., supra; Crown Manufacturing Co., 12 B.T.A. 37">12 B.T.A. 37 (1928); Justus & Parker Co., supra.239 Petitioner's consistent use of the modified FIFO method resulted in a reasonably accurate identification of the animals in inventory. It is not necessary that petitioner's inventories be absolutely accurate or correct. As used in the pertinent Code sections, "clearly" to reflect income means plainly, honestly, straightforwardly and frankly, not accurately, precisely, exactly, correctly, or without error or defect. Huntington Securities Corporation v. Busey, 112 F.2d 368">112 F. 2d 368, 370 (C.A. 6, 1940). We are satisfied that petitioner's modified FIFO method provides a reasonable basis for clearly reflecting income, and is in accord with the best inventory accounting practices. Petitioner has amply documented its computations and has consistently applied its method during the years in question. It is not necessary for petitioner to value each animal; a separation into groups according to weight provides a sufficient basis for valuations. See e.g., S. G. Sample Co. v. Commissioner, 23 F. 2d 671, 672 (C.A. 5, 1928), remanding 5 B.T.A. 1034">5 B.T.A. 1034 (1927). Wood & Ewer Co. v. Ham, 14 F. 2d 995 (N.D. Me., 1926); Klein Chocolate Co., 32 T.C. 437">32 T.C. 437 (1959),240 supplemental findings and opinion 36 T.C. 142">36 T.C. 142 (1961). This is not a situation where a taxpayer has made an arbitrary percentage reduction of cost based upon an estimate of overall market decline. Cf. Coon Auto Co. v. Commissioner, 35 F. 2d 504 (C.A. 8, 1929), affirming 8 B.T.A. 763">8 B.T.A. 763 (1927); O. A. Steiner Tire Co., 9 B.T.A. 1289">9 B.T.A. 1289 (1928). The weight categories chosen by petitioner are similar to those used by the USDA in its listings of market prices. The purchase invoice weights were used to determine into which category given animals should be placed, and a computation of market value can be easily made by applying the market prices for each weight group. In order to determine which animals were no longer on hand at inventory date because they had reached slaughter weight and been sold, petitioner estimated that the average slaughter weights varied from 900 pounds for heifers to 1200 or 1300 pounds for steers, with the usual average slaughter weight for steers being in the 1100 to 1200 bracket and for heifers, in the 900 to 1000 bracket. From its experience, petitioner had calculated that the average daily weight gain of cattle241 in the feedlot was two pounds. Respondent has attempted to show that the average daily weight gain of feedlot cattle was less than two pounds. The experience of respondent's witnesses was mainly with smaller or experimental operations, and we accept petitioner's calculation as correct, since it has been amply supported by the testimony and records. Respondent maintains that even if we accept petitioner's figure of two pounds per day of feedlot weight gain, the feedlot periods used by petitioner in its modified FIFO computations are too short. Respondent contends that petitioner could not have fattened its cattle to slaughter weight in the periods it had estimated, and that by using shorter feedlot periods to the inventory cattle petitioner understated their weights at inventory date. Because the average weight gain on pasture was one pound per day rather than the two pounds per day gained in the feedlot, a determination that the inventory cattle entered the feedlots later than they actually did, would materially increase their weight at inventory date. For example, even a one-day shortening of the feedlot period for each animal would decrease the weight of the herd by almost 30,000242 pounds. At the 1952 market prices this would lower market value by approximately $5,000. We are aware, as petitioner maintains, that there is a great variance in weight gains and slaughter weights even within a given weight group, but in using any sort of average, we find that the lengths of time which petitioner ascribed to its feedlot period are materially shorter than a feedlot weight gain of two pounds per day would justify. We agree with respondent that a weight gain of two pounds per day is inconsistent with petitioner's calculations of the periods required to fatten its cattle to slaughter weight. This inconsistency does not invalidate the modified FIFO principle, but it does point out a flaw in its application. The only reasonable explanation which we have been able to arrive at is that petitioner's cattle entered the feedlots at an catrher time than petitioner has calculated under modified FIFO, and that petitioner's average feedlot weight gain of two pounds [] day is inaccurate when applied only to there cattle in closing inventory. The earlier entry of cattle into the feedlots would increase their weight at inventory date by substituting feedlot gain for pasture gain, 243 and would partially explain the relatively short period of time in which some cattle were deemed to have reached slaughter weight before inventory date under modified FIFO. This also results in an increase in the total weight of those animals remaining in closing inventory. The application of the two pound per day feedlot weight gain to the animals in closing inventory also appears to be incorrect. Though an animal may average two pounds per day over the entire feedlot period, the gain is not an even one. The greatest daily feedlot weight gains take place during the earlier part of the feedlot operation, while the period during which an animal approaches slaughter weight an animal approaches slaughter weight produces the lowest daily feedlot gains. Since a large number of the animals still in inventory had not reached the final stages of the feeding process, they would have gained more than the two pounds per day average used under modified FIFO. This results in an increase in the overall weights of these animals at inventory date. The parties have not presented us with sufficient evidence to come to an exact calculation of the amount of additional weight to be added to the cattle244 in closing inventory because of the above observations as to why the weight gains and feedlot periods are inconsistent; but based upon the record before us and using our best estimate, we have increased the weight of the cattle in closing inventory by an average of 60 pounds each. In doing so, we bear most heavily on petitioner whose figures are inconsistent and who has not come forward with sufficient evidence to support completely its burden of proof in this connection. In computing the market value of its closing inventory, petitioner used what it termed a "component parts" method to calculate the market value of the four items which comprised the basic elements of its inventory costs. Section 39.22(c)-4, Regs. 118, provides, in part, that: Under ordinary circumstances and for normal goods in an inventory, "market" means the current bid price prevailing at the date of the inventory for the particular merchandise in the volume in which usually purchased by the taxpayer * * The use by petitioner of its "component parts" method is most closely similar to a "reproductive cost" computation, 245 whereby goods which have not reached a form salable on the open market are valued at the current bid price for the preceding salable form plus the necessary labor and burden of bringing the goods to their form on inventory date. The use of this method by petitioner was improper, as is tacitly admitted by petitioner on brief. Without passing on the general acceptability of this method, we need only point out that petitioner was not a "manufacturer," cf. Bedford Mills v. U.S., 75 Ct. Cl. 412">75 Ct. Cl. 412, 59 F. 2d 263 (1932), motion for new trial overruled, 2 F. Supp. 769">2 F. Supp. 769 (1933), and at all times had a marketable product. There was, therefore, a readily available gauge for the calculation of market value, i.e., the replacement market, where petitioner would have purchased replacements for the cattle in inventory. This is the proper criterion for market value. D. Loveman & Son Export Corporation, supra. The purpose of requiring the use of "reproductive cost" is to provide a substitute gauge for market value where there are no available market prices for goods as found in inventory. At all relevant times there were market quotations for cattle at various246 stages of development, so that resort to a "reproductive market" calculation was both unnecessary and incorrect. Petitioner's consistent use of its "component parts" method is not sufficient to make this an acceptable method in these circumstances. As alternative valuations to its "component parts" figures at trial, petitioner submitted replacement market computations to establish the value of its cattle on several different markets. Each computation was based upon the same cattle, i.e., those identified under modified FIFO. Each computation indicated that the replacement of those cattle at the various market prices would cost less than the amounts paid by petitioner on its original invoices. This is strong corroboration for petitioner's contention that the market value of its 1952 closing inventory was lower than cost, and that petitioner did suffer a loss in value which would entitle it to write down closing inventory from cost to market. Accepting the fact that market value was lower than cost, there remain two further inquiries. First, which replacement market should be used? Second, should the slaughter cattle market or the stocker and feeder market prices be used? In its247 original computations, petitioner employed the USDA Denver market prices. On brief, however, petitioner contends that the replacement market value of its inventory would be most clearly reflected if the USDA Ft. Worth market prices were used. Petitioner points out that the largest number of its 1952 fiscal year purchases were made in Texas, and that the types of cattle sold on the Ft. Worth market were most representative of the types petitioner was purchasing. Respondent contends that the use of the Ft. Worth market is not justified and "because of the widespread nature of petitioner's purchases the correct market for valuation (assuming any sort of valuation can properly be made) is the market most centrally located, the Denver market." As an alternative respondent suggests the use of the USDA average prices on eight western and midwestern markets. Respondent admits that petitioner's purchases on the Denver market were not a major part of its total purchases and "were not representative of the quality of petitioner's cattle generally," but concludes that "still this market is probably as satisfactory a basis for valuation as anything available." We cannot agree. Respondent objects248 to petitioner's use of the Ft. Worth market because of "the widespread nature of petitioner's purchases" and then goes on to select Denver because it is the market "most centrally located." The only plausible interpretation of this statement is that Denver is the major market closest to petitioner's feedlot operations, in Brush, Colorado. However, the advantage of not having to adjust market prices for freight and shrinkage differentials does not outweigh the advantage of obtaining a more accurate "replacement" of petitioner's inventory animals. The fact that petitioner, in the exercise of its business judgment, found it to be more profitable to make more of its purchases in the Ft. Worth market area than in any other area, such as Denver, indicates to us that additional freight costs and shrinkage were more than compensated for by the Ft. Worth purchase prices. Respondent's alternative suggestion that certain USDA averages be used to determine replacement market is likewise less satisfactory than petitioner's use of the Ft. Worth market prices. This average figure has no correlation to the volume, quality or markets of petitioner's purchases. Petitioner made no purchases on some249 of the markets, only a few on others, and bought predominantly lower grades than those used in the USDA averages. See E. T. Bamert, 8 B.T.A. 1099">8 B.T.A. 1099 (1927); D. Loveman & Son Export Corporation, supra. Petitioner contends that, since it made more purchases in Texas than in any other state, the Ft. Worth market prices would most clearly reflect the replacement market value of its inventories. If only one market were to be used, Ft. Worth probably would be the most logical choice, but because many of petitioner's purchases were not made at the public markets, and because the majority of its purchases were made in states other than Texas, we have used a weighted average of several market prices to arrive at a valuation. Since the Ft. Worth market prices were substantially lower in October 1952 than most of the other markets where petitioner would "replace" its inventory, the use of only the Ft. Worth market prices would understate the replacement market value of its entire inventory. We have taken into account the fact that the Ft. Worth market prices would reflect the type of cattle purchased by petitioner for a large percentage of its inventory, but that petitioner250 would make many other "replacement" purchases elsewhere. The issue of what grade animals comprised the bulk of petitioner's inventory was the subject of much testimony. Witnesses called by respondent testified that as a general rule cattle feeders consider that they can upgrade cattle about one grade and that petitioner's consistent sale of finished animals at choice slaughter grade prices indicated that it fed medium to good stocker and feeder animals. Petitioner's witnesses testified that its cattle were predominantly common to medium grade stockers and feeders. The lines of demarcation between common, medium and good cattle are not sharp and definite. There is a certain amount of overlapping and much of the classification is left to individual discretion. As a general rule, the longer and more effective the feeding process, the higher an animal will ultimately grade. We are persuaded by the testimony of petitioner's witnesses that the bulk of its cattle purchases were of common to medium grade. These witnesses included some of petitioner's competitors, its employees, and other ranchers with a great deal of experience with cattle and a familiarity with petitioner's operations. 251 The testimony of respondent's principal witnesses related to smaller feeding operations and academic experiments. These witnesses had little personal knowledge of petitioner's large commercial operation, and much of their testimony, while obviously sincere, is of far less probative value in our inquiry than that of petitioner's witnesses. Smaller cattle feeders had to depend to a far greater degree on the appearance of their animals than did petitioner, whose reputation for grade and yield was well established. Therefore, the market prices we have used for all except fat or very nearly fat cattle are those for common to medium stockers and feeders. Fat or very nearly fat cattle have been valued at the market prices for choice grade slaughter cattle, as petitioner has done in its original computations. We have also considered, but reject as not probative of the grade of petitioner's 1952 closing inventory cattle, the valuation statement submitted by petitioner in connection with a bank loan in February 1953. The purpose of this statement was to assure that adequate collateral would be given for the loan, not to accurately reflect the value of petitioner's inventory, and the value of252 the collateral given was well in excess of the amount loaned even if the cattle were valued at lower grades. Respondent objects to petitioner's use of a $2.10 per head figure to represent its freight costs rather than its actual freight cost each year. Petitioner has consistently used this figure for freight costs. While a more accurate computation might be made by subtracting fabrication-in-transit credits during the year from actual freight costs from purchase points to Brush, Colorado, we are satisfied that petitioner's consistent use of the $2.10 figure is reasonable and does not distort its income. There is no indication that any adjustment of opening and closing inventories to reflect actual freight costs would not offset each other since the number of cattle in each group was approximately the same. Taking into account the above factors, we conclude that the market value of petitioner's closing inventory for its 1952 fiscal year was $4,355.223. The extent to which petitioner is entitled to an unused excess profits credit carryback adjustment will be calculated under section 432(c)(1) of the Internal Revenue Code of 1939. 9253 For its 1955 fiscal year petitioner also reported its closing cattle inventory at market value after determining by its modified FIFO method that market value was less than cost. The decline in market prices of stocker and feeder cattle during this time was less substantial than in 1952. Petitioner reported a market value of $3,588,387.84 but respondent determined that petitioner's cost figure of $4,666,117.56 more clearly reflected its income. Respondent's position here is similar to his position with regard to the 1952 fiscal year, i.e., that market value was not lower than cost, that modified FIFO is an unacceptable method, and that in any event petitioner has failed to show that market value was lower than cost. On its tax returns petitioner used its "component parts" and modified FIFO methods to compute cost and market value. At trial petitioner presented alternative computations based upon several replacement markets. These computations corroborate petitioner's contention that market value of its closing cattle inventory was lower than cost. In dealing with petitioner's 1952 fiscal year inventories we have discussed the arguments of both parties. That discussion is equally254 applicable here. 10 We approve of petitioner's use of its modified FIFO method and, using replacement markets similar in principle to those used for the 1952 fiscal year, we determine petitioner's 1955 fiscal year closing inventory to have had a market value of $3,945,000. In arriving at this figure, we have considered that according to its modified FIFO identification petitioner purchased a slightly higher percentage of its cattle in Texas than in 1952 and purchased animals on markets in which petitioner had not dealt in 1952. Also, petitioner was feeding a higher grade animal in 1955 than in 1952, and had raised the weight gains of its animals from two to two and one-quarter pounds per day in the feedlots. Our other calculations are similar to those used for petitioner's 1952 fiscal year closing inventory. In 1955 petitioner redeemed the stock of Jack Boxer, a minority stockholder, for cash, cancellation255 of indebtedness, and various assets. Included in these assets were 6,285 head of cattle (five of which were dead but were charged to Boxer in the settlement). To reflect the transfer of these cattle, petitioner removed the amount of $468,955.30 from its asset account and assigned it to treasury stock. Respondent determined that petitioner understated its cost of these cattle by $137,153.90. The issue to be decided is the proper amount allocable to the cattle transferred, so that petitioner's cost of goods sold in its 1955 fiscal year may be determined. On brief petitioner concedes that it did not transfer a large enough amount properly to reflect the cost of feed, pasture and freight, but maintains that its computation of invoice costs of the cattle was substantially accurate. Respondent contends that despite testimony by petitioner's witnesses and various records, that many of the feedlot cattle did not come from the sources specified by petitioner. While there are some cattle which are not specifically accounted for by petitioner's records, we are persuaded by the testimony and records as a whole that the computations made with regard to the purchase prices of the cattle transferred256 to Boxer, as corrected on brief by petitioner, are reasonably accurate. In connection with its concession that the pasture and feed costs allocated to these cattle were understated, petitioner has submitted revised computations of these amounts. These figures reflect longer pasture periods and costs attributable to petitioner's Wyoming ranch, and result in an increase in pasture costs of $10,639.48. We accept this amount as an accurate calculation of the pasture costs attributable to the cattle transferred to Boxer. We arrive at a similar conclusion with regard to feed costs, as increased by petitioner on brief by $63,774. Petitioner has not included any amount for indirect costs attributable to the Boxer cattle. Such costs must also be added. The consistency of petitioner's exclusion of such costs from its inventory is irrelevant here, since we are dealing with a determination of the over-all cost of assets transferred, not petitioner's annual inventory valuation where the cost of goods sold during the year depends partially upon the difference in opening and closing inventories. Indirect costs of the Wyoming ranch have been already included in the costs that are applicable to257 contract cattle under the care of others. An adjustment for the remaining 2,235 head at $2.50 per head (an amount estimated by petitioner's accountant and not challenged by respondent) results in a further increase in the cost of cattle transferred to Boxer of $5,587.50. The amount of freight costs attributable to the transferred cattle must also be recomputed. Petitioner did not include freight costs for the feedlot animals and for 1313 head on pasture around Brush, and used its $2.10 per head figure as the freight cost for the remainder of the cattle. As with indirect costs, the consistent use of the $2.10 figure is not relevant here. As part of its alternative computations of closing inventory petitioner arrived at an average actual freight cost of $3.09, taking into account freight credits. This figure includes the entire year's freight costs and credits. We recognize that, as petitioner contends, most of the cattle transferred to Boxer were lighter than the average cattle shipped by petitioner, making average freight costs lower on these cattle than on the total inventory purchases. Therefore, we have lowered the $3.09 figure and have calculated the attributable freight costs258 at a rate of $2.90 per head. Freight costs of $2.10 per head were included in petitioner's original figures for 2937 cattle, so that the total additional freight costs are $12,058.80. Thus, we have found the total cost of the cattle transferred to Boxer to be $562,245.70. Decision will be entered under Rule 50. Footnotes1. Distribution of cattle in redemption of the stock of Jack Boxer, a minority shareholder, to be discussed infra.↩2. Because of an arithmetic error this total was erroneously stipulated to be $4,666,117.56.↩3. See footnote 2.↩4. Based upon U.S. Department of Agriculture (USDA) reports for Chicago, Omaha, Kansas City, St. Paul, Sioux City, Denver, Ft. Worth and Oklahoma City.↩5. On brief, petitioner states that a mechanical error was made in the feedlot figures. The number of cattle should be 2,235 and the cost should be increased to $167,066.25.↩6. SEC. 22. [I.R.C. 1939] GROSS INCOME. * * (c) Inventories. - Whenever in the opinion of the Commissioner the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Commissioner, with the approval of the Secretary, may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income. ↩7. § 39.22(c)-2. [Regs. 118] Valuation of inventories. * (b) It follows, therefore, that inventory rules cannot be uniform but must give effect to trade customs which come within the scope of the best accounting practice in the particular trade or business. In order clearly to reflect income, the inventory practice of a taxpayer should be consistent from year to year, and greater weight is to be given to consistency than to any particular method of inventorying or basis of valuation so long as the method or basis used is substantially in accord with these regulations. An inventory that can be used under the best accounting practice in a balance sheet showing the financial position of the taxpayer can, as a general rule, be regarded as clearly reflecting his income.↩8. § 39.22(c)-2. Valuation of inventories. * (d) * * Goods taken in the inventory which have been so intermingled that they cannot be identified with specific invoices will be deemed to be the goods most recently purchased or produced, and the cost thereof will be the actual cost of the goods purchased or produced during the period in which the quantity of goods in the inventory has been acquired. * * ↩9. SEC. 432. UNUSED EXCESS PROFITS CREDIT ADJUSTMENT. * *(c) Amount of Carry-Back and Carry-Over. - (1) Unused excess profits credit carry-back. - If for any taxable year beginning after July 1, 1950, the taxpayer has an unused excess profits credit, such unused excess profits credit shall be an unused excess profits credit carryback for the preceding taxable year.↩10. The inventory provisions of the 1954 Code and Regulations are substantially the same as those of the 1939 Code and Regulations. These provisions have existed and continued without substantial change since the Revenue Act of 1918 and Regulations 45, promulgated thereto.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624553/	Houghton P. Metcalf, Petitioner v. Commissioner. Katharine H. Metcalf v. Commissioner.Metcalf v. CommissionerDocket Nos. 39791, 39792.United States Tax Court1953 Tax Ct. Memo LEXIS 16; 12 T.C.M. (CCH) 1428; T.C.M. (RIA) 54003; December 22, 195316 Gift taxes. - Value of shares of corporate stock on date of gifts determined. Thomas R. Wickersham, Esq., and Harold B. Tanner, Esq., 1030 Hospital Trust Building, Providence, R.I., for the petitioners. Joseph Landis, Esq., for the respondent. TIETJENSMemorandum Findings of Fact and Opinion TIETJENS, Judge: The respondent determined deficiencies in gift tax for the calendar year 1949 of $8,087.62 for Houghton P. Metcalf and $6,932.25 for Katharine H. Metcalf. The question presented is the valuation of 11,000 shares of common stock of the Wanskuck Company, a Rhode Island corporation, and 16 shares of common stock of the Providence Journal Company, also a Rhode Island corporation, for the purpose of determining the gift tax on transfers of the stock on December 13, 1949. The petitioners' gift tax returns for the calendar year 1949 were filed with the collector of internal revenue for the district of Rhode Island. Findings of Fact The stipulated facts are so found, and the exhibits attached to the stipulation are included herein by this reference. On December 13, 1949, the petitioner Houghton P. Metcalf made a gift of 11,000 shares of stock of the Wanskuck17 Company and 16 shares of stock of the Providence Journal Company in trust for the benefit of various persons. The valuation of numerous other gifts made at the same time is not in controversy. The petitioners, husband and wife, consented to have the gifts before us considered as having been made one-half by each of them, and accordingly each reported one-half the claimed value of the gifts in separate gift tax returns for the calendar year 1949. By letter of March 5, 1952, the petitioners were notified of the determination of deficiencies in gift tax for 1949 based on a revaluation of the shares of Wanskuck and Providence Journal by the respondent. On their returns the petitioners had valued the Wanskuck stock at $15 a share and the Providence Journal stock at $5,500 a share; whereas the respondent's valuation of each share was $18.42 and $7,000, respectively. In their petitions the petitioners valued Wanskuck stock at $9.16 a share and Providence Journal at $4,439 a share, and claimed a total overpayment of tax of $19,738.90. The Wanskuck Company is a manufacturer of woolen and worsted cloth in Providence, Rhode Island. On December 13, 1949, its outstanding capital stock was 381,40018 shares of common stock of a par value of $20 a share. Prior to September 30, 1949, its outstanding capital stock consisted of 7,628 shares of common stock of a par value of $1,000 a share. On the latter date there was a 50 shares for 1 share stocksplit. On December 31, 1948, Wanskuck's total net assets amounted to $16,357,090.44. One year later its total net assets were $15,791,202.02. Wanskuck's profit and loss statements reveal that it had net profits after taxes for each year between 1940 and 1948, and in each of these years it declared a dividend. It incurred a net loss in 1949 of $414,087.57, but nevertheless declared a dividend. Between 1940 and 1949 Wanskuck's earned surplus increased from about three to six million dollars. The company's earnings after taxes and its dividends per share were as follows: (Adjusted to shares outstanding onDecember 31, 1949)EarningsDividendsYearper shareper share1940$ 2.34$ 1.8019412.441.7019422.09.8019431.52.6019441.45.6019451.34.6019463.621.2019474.401.2019484.751.201949-1.75.40The net worth per share of Wanskuck stock as of the end of each19 year between 1940 and 1949 was as follows: (Adjusted to shares outstanding onDecember 31, 1949Net WorthNet WorthYearper shareYearper share1940$29.181945$33.67194129.85194636.06194231.17194739.34194331.92194842.89194432.85194941.40At the end of 1949, Wanskuck's current assets amounted to 6.6 times its current liabilities. For the five years immediately preceding 1949, the ratios of its current assets to current liabilities at the end of each year were 10 in 1944, 16.5 in 1945, 9.3 in 1946, 5.5 in 1947, and 5.02 in 1948. The Providence Journal Company is in the newspaper publishing business in Providence, Rhode Island. It publishes a daily morning newspaper with a Sunday edition and a daily evening paper. Its outstanding capital stock consists of 1,260 shares of common stock of a par value of $1,200 a share. According to the company's balance sheet its net assets on December 31, 1949, were $5,644,522. The Journal Company's by-laws provide that no share of its capital stock may be sold or transferred to anyone not already a shareholder without having been first offered to the corporation at the20 same price the shareholder is willing to sell to any other party. In each of the years 1940 through 1949 the Providence Journal Company had consistently high earnings and a good dividend record. Following are the company's earnings per share after taxes and the dividends for this period: Earningsper shareDividendsYearafter taxesper share1940$537.88 $5281941490.304921942421.884201943434.834321944414.414201945462.574681946538.204801947520.474801948661.594321949814.10432At the end of 1949 a share of the Providence Journal Company had a book value of $4,479.70, and in the same year the company's current assets were 3.7 times its current liabilities. The shares of Wanskuck andthe Providence Journal Company are not listed on a stock exchange, nor are they dealt in by brokers. There were sales of both stocks before and after December 13, 1949. In 1943 there were five sales of Wanskuck Company stock, involving a total of 340 shares, some of which were sold by the company to its own executives. All of these shares were sold for $676, prior to the 50 for 1 split of the company's stock in 1949. 21 The only other purchase of Wanskuck Company stock shown was the company's own purchase of one share in 1951 for $12.50. In 1945 there were two sales of Providence Journal Company stock, involving a total of six shares. In 1947 only one share was shown to have been sold; two sales, each involving one share, were made in 1948. Between 1949 and 1952 there were eight sales of Providence Journal stock, involving a total of nine shares, most of which were sold by the company to its own employees. The selling prices of these shares ranged from $5,000 to $5,500 a share. On December 13, 1949, the fair market value of Wanskuck Company stock was $16 a share. On the same date, a share of Providence Journal Company stock had a fair market value of $6,200 a share. Opinion The petitioners argue that the fair market values on December 13, 1949, of Wanskuck and Providence Journal stock were $11.875 a share and $5,500 a share, respectively. The respondent has determined their values at $18.42 and $7,000. For Federal gift tax purposes the value of a gift of stock is the fair market value on the date of transfer. Actual sales are, of course, important factors to be considered in arriving at fair22 market value. Nevertheless, the sales of both companies' shares mentioned in the findings of fact are not too helpful in this respect, being either too few in number or remote in time, or between related parties. Where, as here, actual sales do not accurately reflect a fair market value, other considerations are helpful, including the corporation's net worth, its earning power, and dividend-paying capacity. To support their contention for lower valuations than determined by the respondent the petitioners called two expert witnesses. Both witnesses arrived at their opinions of fair market value by using what they called the "comparable companies method". One used a group of twelve companies in his study of the Wanskuck stock; the other used a selection of five. For comparative purposes the first witness selected periods of three, six, and ten years; the other used periods of three, five, and ten years. Both weighed earnings as more important than dividends and both gave consideration to Wanskuck's strong financial position. The first arrived at a fair market value for the Wanskuck stock of between $12.50 and $13 per share; the opinion of the second was $11 per share. With reference23 to the Providence Journal Company only the first witness testified for the petitioners. Using the same method described above he set a value of $5,700 per share on the Journal stock. The respondent's witness took into consideration, among other things, Wanskuck's earning power, its dividend paying capacity, the character of its business, its location, net worth, and new fixed assets acquired in 1948 and 1949. In his opinion the stock had a fair market value of $18.42. This same witness, after studying the data in the record concerning the Providence Journal and after considering the growth and trend of the Company's business, its capital structure, financial position, earnings, dividend paying capacity and dividend record, net assets value, and the prices and yields of other newspaper company stocks, gave as his opinion a fair market value of $7,000 per share. We have carefully studied the testimony of these witnesses and have considered all of the factors relied on by them in reaching their conclusions as well as other factors appearing in the record which we deem pertinent. As has often been said, value is after all a matter of opinion. It calls for the application of the*24 experience and judgment of the Court. This we have done to the best of our ability and we conclude that the fair market value on the critical date of the Wanskuck stock was $16 per share and of the Providence Journal stock was $6,200 per share. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624556/	William E. Borbonus and Georgia Borbonus, Petitioners, v. Commissioner of Internal Revenue, RespondentBorbonus v. CommissionerDocket No. 3623-62United States Tax Court42 T.C. 983; 1964 U.S. Tax Ct. LEXIS 53; August 27, 1964, Filed 53 Decision will be entered under Rule 50. Petitioner, pursuant to a written property settlement agreement incorporated in a divorce decree, was obligated to pay his former wife $ 300 a month for the support, maintenance, and education of his daughter. Petitioner defaulted in payment and his former wife brought suit for the back payments, totaling $ 6,540, plus interest and court costs. Judgment was rendered in her favor in the total amount of $ 7,055.79. Petitioner and his former wife settled their differences for $ 7,000. During the years petitioner was in default, his daughter was over 18 but under 21 years of age. Held, no part of the $ 7,000 paid by petitioner to his former wife is deductible as alimony by virtue of sec. 71(b), I.R.C. 1954. Held, further, that part of the $ 7,000 which represents interest on the payments in default is deductible by petitioner as interest paid. Bernard Sherl, for the petitioners.John B. Murray, Jr., for the respondent. Fay, Judge. FAY984 OPINIONThe Commissioner determined a deficiency in petitioners' income tax for the year 1958 in56 the amount of $ 2,260.73. The only issue left for decision 1 is whether any portion of $ 7,000 paid by petitioner William E. Borbonus to his former wife, Lillian Borbonus, in 1958 is deductible as alimony and interest.All of the facts have been stipulated and are so found.Petitioners William E. Borbonus (hereinafter referred to as petitioner) and Georgia Borbonus are husband and wife with their present residence in Houston, Tex. During the year 1958 they resided in New York City. They filed their joint income tax return for the year 1958 with the district director of internal revenue, Lower Manhattan, N.Y.Petitioners used the cash basis method of accounting and reporting for income tax purposes.Petitioner was formerly married to Lillian B. Borbonus (hereinafter referred to as Lillian) with their date of marriage being August 17, 1929. A daughter, Carole Borbonus (hereinafter referred to as Carole), born on July 24, 1935, was the only issue57 of the marriage.On April 26, 1951, in Philadelphia, Pa., the petitioner and Lillian entered into a written property settlement agreement. The material parts of the agreement provide as follows:Agreement made this 26th day of April, 1951, by and Between Lillian B. Borbonus (hereinafter referred to as "Mrs. Borbonus") and William E. Borbonus, her husband (hereinafter referred to as "Mr. Borbonus").Whereas, the parties hereto married on the 17th day of August, 1929, at Philadelphia, Pa., one child, Carole, aged 15, being born of said marriage; andWhereas, in consequence of disputes and unhappy differences, the parties have heretofore separated and are now, and for some time have been living apart, under an agreement of separation dated January 28, 1949, a copy of which is attached hereto as Exhibit "A"; andWhereas, Mrs. Borbonus has indicated her intention to file suit for divorce against Mr. Borbonus in the Second Judicial District Court of the State of Nevada, in and for the County of Washoe, of which Reno is the county seat; andWhereas, the parties desire to settle their respective property rights and the question of the support of Carole, thus removing the subject matter thereof58 from the field of litigation in said contemplated divorce proceedings;Now Therefore:In consideration of the premises and the mutual promises and undertakings herein contained, the parties, intending to be legally bound thereby, promise and agree as follows:985 1. Mr. Borbonus, in full satisfaction of his obligation to support Mrs. Borbonus, shall pay to her the sum of One Hundred Twenty-Five Thousand ($ 125,000.00) Dollars, the said payment to be made in escrow to William A. Gray, Esquire, and Lester J. Schaffer, Esquire, attorneys for Mr. Borbonus, and to Herman L. Sundheim, Esquire, and George S. Munson, Esquire, attorneys for Mrs. Borbonus. * * 2. Mr. Borbonus further agrees to pay to Mrs. Borbonus for the support, maintenance and education of his daughter Carole the annual sum of Three Thousand Six Hundred Dollars ($ 3600.00) in equal monthly installments of Three Hundred ($ 300.00) Dollars per month. It is agreed that said payments shall continue until Carole attains the age of twenty-one (21) years, or until she shall marry, whichever date shall first occur. It is further agreed that in the event of Carole's decease, she then being unmarried, the payments shall 59 continue for a period of one year from the date of such decease, or until she would have attained the age of twenty-one years, whichever shall first occur.3. The parties agree that the United States Savings Bonds registered in their joint names, in the approximate amount of Six Thousand Three Hundred ($ 6300.00) Dollars, now in the physical possession of Mrs. Borbonus, shall be retained by Mrs. Borbonus and disposed of as she thinks proper for Carole's use. It is the intention of the parties that the said bonds shall be used for Carole's education, if necessary, or shall be turned over to Carole upon her attaining twenty-one years of age, or upon her marriage, whichever shall first occur.4. The parties agree, insofar as they are permitted by law to do so, that Carole shall live with Mrs. Borbonus and be under her custody and control. * * 8. All matters affecting the interpretation of this agreement and the rights of the parties hereto in relation to this agreement shall be governed by the laws of the State of Nevada.9. The parties have incorporated in this agreement their entire understanding. No oral statement or prior written matter extrinsic to this agreement shall have any60 force or effect. The parties are not relying upon any representation other than those expressly set forth herein.10. The parties hereto declare that each has had independent legal advice by counsel of his or her own selection; that each fully understands the facts and has been fully informed of all legal rights and liabilities as heretofore set forth; and that both parties believe the agreement to be just, fair and reasonable and that each signs the same freely and voluntarily.On June 27, 1951, a decree of divorce was granted to Lillian by the State of Nevada. The pertinent parts of the decree are as follows:Now, Therefore, It Is Hereby Ordered, Adjudged and Decreed that the bonds of matrimony heretofore and now existing between the plaintiff and defendant be, and the same hereby are, forever dissolved, and the same are declared forever at an end; that the said plaintiff and defendant are each forever released from the obligations thereof and each is hereby restored to the status of an unmarried person, and that the plaintiff be, and she is hereby granted an absolute decree of divorce herein forever dissolving the bonds of matrimony existing between plaintiff and defendant.It61 Is Further Ordered, Adjudged and Decreed that the written agreement between plaintiff and defendant, dated the 26th day of April, 1951, settling the property rights of the parties, and providing for the support of plaintiff herein and for the support, maintenance, custody and control of the minor child of the parties, a copy of which agreement was introduced in evidence herein and marked plaintiff's Exhibit "A", be, and the same is hereby, ratified, approved 986 and the terms thereof are specifically incorporated by reference as a part of this decree, and the parties hereto are hereby ordered to comply with the terms of said agreement.Under the terms of the decree of divorce which incorporated the property settlement agreement, petitioner paid to Lillian a lump sum of $ 125,000.Petitioner defaulted in the monthly payments due under paragraph 2 of the property settlement agreement for the period from October 1, 1954, to July 24, 1956, inclusive. Lillian brought suit for recovery of the payments due from the petitioner in the Cape May County Court, New Jersey. The complaint, filed by Lillian some time after July 1, 1956, was as follows:Plaintiff, Lillian B. Borbonus, residing62 at the Cambridge Apartments in the City and County of Philadelphia, Commonwealth of Pennsylvania, complaining against defendant says that:1. Plaintiff sues for the sum of $ 6,540.00 plus interest representing arrearages at $ 300.00 per month for 22 months covering the period from October 1, 1954 through July 1, 1956 which arrearages have become due and owing under a certain agreement dated April 26, 1951 entered into between plaintiff and defendant whereby the defendant agreed to pay to plaintiff for support, maintenance and education of Carole Borbonus, minor daughter of the parties hereto, the annual sum of $ 3600.00 in equal monthly installments of $ 300.00 per month.2. Said daughter, Carole Borbonus, became of full age on July 24, 1956 and therefore the amount due for the twenty-second month is calculated at 5/6ths of the monthly rate fixed in the agreement or the sum of $ 240.00.3. Said agreement for the support, maintenance and education of said minor daughter, was ratified, approved and its terms specifically incorporated in a certain final decree of divorce involving the plaintiff and the defendant herein entered on June 27, 1951 in the Second Judicial District Court of63 the State of Nevada in and for the County of Washoe.4. Plaintiff has demanded payment of said arrearages but payment has been refused.Wherefore, plaintiff demands judgment against the defendant in the sum of $ 6,540.00 together with interest and costs of suit.On October 15, 1956, the New Jersey court entered judgment for Lillian in the total amount of $ 7,055.79. The judgment stated:Judgment by Default, in a Civil Action, is hereby entered in favor of Lillian B. Borbonus, Plaintiff and against William E. Borbonus, Defendant, in the sum of Six thousand nine hundred eighty-three dollars and forty cents ($ 6,983.40) damages, and Seventy-two dollars and thirty-nine cents ($ 72.39) costs amounting in all to the sum of Seven thousand fifty-five dollars and seventy-nine cents ($ 7,055.79).Carole was 18 years old on July 24, 1953, and 21 years old on July 24, 1956. Carole was married in the year 1957, during the same year that Lillian was remarried.Lillian, on February 15, 1957, brought suit on the New Jersey judgment in the Supreme Court of the State of New York, county of New York. On September 27, 1957, a motion for summary judgment was made by Lillian and on November 27, 1957, 64 such motion was granted.987 On January 6, 1958, the attorneys for petitioner and Lillian entered into a stipulation for the purpose of settling their disputes. The stipulation, which was filed with the New York court, provides, in part, as follows:Whereas, plaintiff, Lillian B. Borbonus, on June 27, 1951, recovered a decree of divorce against the defendant, William E. Borbonus, her then husband, which decree, among other things, required and directed the defendant to pay to the plaintiff the sum of $ 300.00 per month as and for the support, maintenance and education of their then minor daughter, Carole Borbonus; andWhereas, defendant failed to pay said plaintiff the sum of $ 300.00 per month as directed by said decree of divorce thereby necessitating plaintiff to commence a civil action against the defendant in the Cape May County Court of the State of New Jersey in which, after personal service of process upon the defendant, a judgement was rendered and entered on October 15, 1956 in favor of the plaintiff against the defendant in the sum of $ 7,055.79; andWhereas, defendant failed to satisfy the judgment mentioned in the preceding paragraph thereby necessitating plaintiff65 to commence an action upon said New Jersey judgment against the defendant in the Supreme Court, New York County, which action bears the above entitled index number, 5154/1957 and in which action the defendant appeared by Frederick E. Klein, Esq., his attorney, 52 Wall Street, New York, N.Y. and interposed an answer to the complaint; andWhereas, the plaintiff, by notice of motion dated September 27, 1957, duly moved this Court for an order striking out the defendant's answer and directing the entry of judgment summarily in plaintiff's favor for the sum demanded in her complaint, which application was opposed by the defendant and which came on to be heard before Hon. Henry Clay Greenberg, a Justice of this Court who, after argument and due deliberation determined said application in favor of plaintiff and against the defendant and directed the entry of judgment in the sum of $ 7,055.79 with interest from October 15, 1956 plus costs and disbursements. A copy of said opinion of Mr. Justice Greenberg is hereto annexed marked Exhibit "A"; andWhereas, the parties hereto have agreed to compose their differences and to settle plaintiff's claims against the defendant as hereinafter set forth. 66 Now, Therefore, it is Hereby Stipulated and Agreed by and between the attorneys for the respective parties hereto --(a) That the above entitled action be, and the same hereby is, settled for the sum of Seven Thousand Dollars ($ 7,000.00) which the defendant agrees to pay to Bernard H. Fitzpatrick, Esq., plaintiff's attorney, 37 Wall Street, New York, N.Y., and which the plaintiff agrees to accept in full settlement and satisfaction of all her claims against the defendant;(b) The defendant has deposited with Bernard H. Fitzpatrick, Esq., plaintiff's attorney, the sum of Seven Thousand Dollars ($ 7,000.00) to be held in escrow until the following documents have been delivered by him to defendant's attorney, Frederick E. Klein:Also included as part of the settlement were the satisfaction of the New Jersey judgment and the discontinuance of the New York suit.Pursuant to the stipulation agreement, petitioner paid $ 7,000 to Lillian during the year 1958. Petitioner claimed this amount as a deduction for alimony on his 1958 income tax return. Respondent has disallowed the deduction in its entirety.988 Petitioner contends that of the $ 7,000 paid to Lillian $ 6,540 constituted67 the payment of alimony which, by reason of section 71(a)(1) of the Internal Revenue Code of 19542 was includable in her income and thus deductible by him by virtue of section 215. He further contends that the payments were not support payments for minor children, as provided in section 71(b), because the written agreement did not "fix" an amount which was exclusively allocable to the support of his minor child. He relies heavily upon Commissioner v. Lester, 366 U.S. 299">366 U.S. 299 (1961), and Weil v. Commissioner, 240 F. 2d 584 (C.A. 2, 1957), affirming in part and reversing in part 22 T.C. 612">22 T.C. 612 (1954) and 23 T.C. 630">23 T.C. 630 (1955). In the alternative, petitioner argues that under Nevada State law, which he claims controls the question of minority, his child was not a minor during the years which generated the $ 7,000 payment. Accordingly, he maintains that section 71(b) is not applicable to this case. Respondent, on the other hand, contends that the $ 7,000 payment was for the support of petitioner's minor child and as such not includable in the income of Lillian under section68 71(b) and correspondingly not deductible by petitioner under section 215. Respondent argues that the written agreement does specifically "fix" an amount for the support of a child and that the child was a "minor." We agree with respondent.Section 71(a)(1) provides that:(a) General Rule. -- (1) Decree of divorce or separate maintenance. -- If a wife is divorced or legally separated from her husband under a decree of divorce or of separate maintenance, the wife's gross income includes periodic payments (whether or not made at regular intervals) received after such decree in discharge of (or attributable to property transferred, in trust or otherwise, in discharge of) a legal obligation which, because of the marital or family relationship, is imposed on or incurred by the husband under the decree or under a written instrument incident to such divorce or separation.Section 71(b) provides, in part, that:(b) Payments69 To Support Minor Children. -- Subsection (a) shall not apply to that part of any payment which the terms of the decree, instrument, or agreement fix, in terms of an amount of money or a part of the payment, as a sum which is payable for the support of minor children of the husband. * * Respondent concedes that the $ 7,000 meets the formal requirements of section 71(a)(1). However, respondent contends that section 71(b) applies and accordingly the petitioner does not get a deduction. The Supreme Court in Commissioner v. Lester, supra, in interpreting section 22(k) of the Internal Revenue Code of 1939, the predecessor of section 71(b), had this to say:We have concluded that the Congress intended that, to come within the exception portion of § 22(k), the agreement providing for the periodic payments must 989 specifically state the amounts or parts thereof applicable to the support of the children. * * ** * * The agreement must expressly specify or "fix" a sum certain or percentage of the payment for child support before any of the payment is excluded from the wife's income. * We feel that the agreement herein comes squarely within70 the principles stated by the Supreme Court. The agreement provides in paragraph 1 that petitioner, "in full satisfaction of his obligation to support Mrs. Borbonus [Lillian], shall pay to her the sum of One Hundred Twenty-Five Thousand ($ 125,000.00) Dollars." In paragraph 2, petitioner agrees to "pay to Mrs. Borbonus [Lillian] for the support, maintenance and education of his daughter Carole the annual sum of * * * ($ 3600.00) in equal monthly installments of * * * ($ 300.00)." The payments called for in paragraph 2 were specifically allocated for the benefit of petitioner's daughter and no portion thereof was to be paid out for Lillian's benefit. Petitioner, by the provisions of paragraph 1 of the agreement, intended to and did fulfill his complete legal obligation to Lillian. The provisions of paragraph 2 were for the exclusive benefit of petitioner's daughter.Petitioner argues that certain parts of paragraph 2 of the agreement indicate that Lillian had a beneficial interest in the $ 3,600 and that under the decision of Weil v. Commissioner, supra, the payment would not be considered for the exclusive support of his child. Petitioner relies71 upon the following language of paragraph 2 of the agreement:It is agreed that said payments shall continue until Carole attains the age of twenty-one (21) years, or until she shall marry, whichever date shall first occur. It is further agreed that in the event of Carole's decease, she then being unmarried, the payments shall continue for a period of one year from the date of such decease, or until she would have attained the age of twenty-one years, whichever shall first occur.While it is true that the payments to Lillian could have continued for a maximum period of 1 year after the death of Carole if, and only if, she died before 21 while she was still unmarried, we feel this contingency, which never became operative, does not indicate that Lillian was to have or did have any beneficial interest in the funds during the period October 1, 1954, through July 24, 1956. Cf. Henrietta S. Seltzer, 22 T.C. 203">22 T.C. 203, 208 (1954). What effect, if any, Carole's death prior to her 21st birthday while she was still unmarried would have had on petitioner's right to a deduction for any payments made pursuant to paragraph 2 of the agreement does not concern us.The72 facts in both Commissioner v. Lester and Weil v. Commissioner, supra, upon which petitioner relies heavily are materially different from the facts in the instant case. In Lester and Weil, the husband 990 agreed to pay the wife for the support and maintenance of herself and the children. The amounts given to the wife and children were not separately stated nor was any specific sum earmarked for the support of the children only. In contrast, the agreement in the instant case clearly contemplates that $ 125,000 was to be given to the wife in full satisfaction of the husband's obligation to support her. It is also equally clear that the $ 3,600 per year was to be given to the wife for the support, maintenance, and education of the petitioner's child. Accordingly, we conclude that within the principles of the Lester case, the agreement herein does "fix" a sum certain to be used exclusively for child support. Cf. Eugene F. Emmons, 36 T.C. 728">36 T.C. 728, 738 (1961), affd. 311 F. 2d 223 (C.A. 6, 1962).In order for alimony payments to be excluded from the wife's income under section 71(b), the payments, 73 besides being "fixed," must be for the support of the minor children of the husband. Carole was 18 on July 24, 1953, and 21 on July 24, 1956. Although the $ 7,000 in issue was paid in 1958, the liability for payment arose during the period from October 1, 1954, to July 24, 1956. Petitioner argues that the agreement provides that "All matters affecting the interpretation of this agreement and the rights of the parties hereto in relation to this agreement shall be governed by the laws of the State of Nevada." In brief, he refers us to section 129.010, Nev. Rev. Stat., which provides as follows:All male persons of the age of 21 years and all females of the age of 18 years, and who are under no legal disability, shall be capable of entering into any contract, and shall be, to all intents and purposes, held and considered to be of lawful age.Petitioner then concludes that under Nevada law Carole was no longer a minor when the liability to make the payments in issue accrued, and, accordingly, the exception of section 71(b) does not apply. We disagree with petitioner when he says Nevada law is controlling here.We are dealing here with a Federal statute, and as was said in Burnet v. Harmel, 287 U.S. 103">287 U.S. 103, 110 (1932):74 we are concerned only with the meaning and application of a statute enacted by Congress, in the exercise of its plenary power under the Constitution, to tax income. The exertion of that power is not subject to state control. It is the will of Congress which controls, and the expression of its will in legislation, in the absence of language evidencing a different purpose, is to be interpreted so as to give a uniform application to a nationwide scheme of taxation. * * State law may control only when the federal taxing act, by express language or necessary implication, makes its own operation dependent upon the state law. * * This Court, as well as other courts, has applied the above-quoted language in construing numerous sections of the Code. See Estate of Ida Wray Nissen, 41 T.C. 522 (1964), on appeal (C.A. 4, Apr. 13, 1964) (sec. 167(g)); Estate of Rebecca Edelman, 38 T.C. 972 (1962) (sec. 991 2041); Miller v. Commissioner, 299 F. 2d 706 (C.A. 2, 1962), affirming 35 T.C. 631">35 T.C. 631 (1961), certiorari denied 370 U.S. 923">370 U.S. 923 (1962)75 (sec. 1221).We are concerned here with section 71(b). The statute uses the phrase "minor children of the husband." The precise question is what did Congress mean when it uses the word "minor." The section itself does not contain a definition of the word nor is the word "minor" defined any place in the Code. We do know that when the present section 71 came into the law in 1942 one of the main purposes of Congress in enacting this provision was that there would be uniformity of tax treatment of alimony regardless of variations in the laws of the different States. Commissioner v. Lester, supra;Bardwell v. Commissioner, 318 F. 2d 786 (C.A. 10, 1963), affirming 38 T.C. 84">38 T.C. 84 (1962); H. Rept. No. 2333, 77th Cong., 2d Sess., p. 72 (1942), 2 C.B. 372">1942-2 C.B. 372; S. Rept. No. 1631, 77th Cong., 2d Sess., p. 83 (1942), 2 C.B. 504">1942-2 C.B. 504. We also know that State law is not binding upon the Federal courts in determining income tax questions arising out of this section. Commissioner v. Lester, supra;Bardwell v. Commissioner, supra.76 In view of the above, we feel, that in order to effectuate the purpose of Congress in enacting this provision of the Code, Federal law regarding minority should control. A look to the States for the definition of a minor would bring different and varied results depending upon such factors as age, sex, and marital status. Furthermore, a minor can be defined differently by the States for such varied purposes as drinking, voting, driving, marriage, contracts, wills, etc. 3 Therefore, we conclude that a look to the States for the meaning of the word "minor" would frustrate the clear and sharply defined purpose of Congress. We feel, instead, that a uniform definition of "minor" would more clearly express the intention of Congress. In arriving at a uniform age for the definition of a minor, we are concerned mainly with the fact that we are dealing here with the Internal Revenue Code, a Federal statute. We have searched the Code and find the word "minor" is used in at least three sections besides the one in issue, section 2503(c), section 1239(a), and section 682(a). Section 2503(c), although using the word "minor" in the heading of the subsection, goes on to use age 21 as the dividing77 line. In Calvin D. Mitchell, 35 T.C. 550">35 T.C. 550 (1960), reversed on other grounds 300 F.2d 533">300 F.2d 533 (C.A. 4, 1962), section 1239(a) was involved. There the children were 19 years old during the years in issue. If they were minors, their stock interests in a corporation would be counted to see if their father had control. If they were not minors, their stockholdings were not to be included. The Commissioner, as well as the taxpayer, 992 took it for granted that for purposes of the section the children were minors. Accordingly, this Court included their stockholdings in determining the question of control. As far as we were able to determine, this is the first case wherein the meaning of the word "minor" in section 71(b) is in issue.78 Having decided that Congress intended a uniform meaning for the word "minor," our next consideration is what definition they had in mind. The common law definition of minor for both males and females was anyone who had not reached his 21st birthday. This is still the rule generally in force throughout the United States. See 27 Am. Jur., Infants, sec. 5, and cases cited therein. The Uniform Gifts to Minors Act, which has been adopted by 46 States 4 and the District of Columbia, defines a minor as "a person who has not attained the age of twenty-one years." Uniform Gifts to Minors Act, sec. 1. We feel that Congress, in using the word "minor," used it in the context of its generally accepted meaning which, we believe, is anyone who has not attained 21 years of age. Accordingly, we hold that Carole was a minor child, as that term is used in section 71(b) and, therefore, the payments for her support and maintenance are not deductible by petitioner.79 The only remaining point raised in this case is whether part of the $ 7,000 paid by petitioner to Lillian is deductible as interest. Petitioner claims that of the $ 7,000 paid $ 443.40 represents interest which is deductible by a cash basis taxpayer in the year paid. Respondent maintains that no part of the $ 7,000 paid represents interest. We agree with petitioner, but not as to the amount claimed.Petitioner was obligated to pay Lillian for the support of his child the annual sum of $ 3,600 at the rate of $ 300 per month. For the period from October 1, 1954, through July 24, 1956, petitioner was in default of his payments. The total arrearages were $ 6,540. Lillian brought suit in a New Jersey court for the $ 6,540 plus interest and court costs. The court awarded her judgment in the total amount of $ 7,055.79. Of this amount, the court stated $ 6,983.40 represented "damages" and $ 72.39 represented court costs. After further litigation in the New York court, a settlement was reached between petitioner and Lillian whereby petitioner would pay $ 7,000 in full discharge of the New Jersey judgment.If petitioner had paid the entire judgment rendered against him in the amount80 of $ 7,055.79, we have no doubt that $ 443.40 would represent the payment of interest on an indebtedness and would be deductible. Lillian sued for the back support payments plus interest. The legal rate of interest in New Jersey is 6 percent. N.J. Stat. Ann. 993 sec. 31:1-1. The difference between $ 6,983.40, the sum awarded Lillian, and $ 6,540.00, the amount sued for, is $ 443.40, which represents accurately 6-percent interest on each monthly payment of $ 300 from the due date of each payment up to the date of judgment. The court's designation of $ 6,983.40 as damages does not change the fact that $ 443.40 represents interest on an indebtedness which would have been deductible in full if petitioner paid off the entire judgment.However, petitioner did not pay the entire judgment. He settled for a payment of $ 7,000, which is $ 55.79 less than the total judgment. We were given no evidence regarding the composition of the settlement figure. Therefore, mindful of the fact that the burden of proof was on the petitioner, we find that of the $ 7,000 paid $ 387.61 represents the payment of deductible interest. Cf. Cohan v. Commissioner, 39 F. 2d 540*81 (C.A. 2, 1930). The case of Automatic Sprinkler Co. of America, 27 B.T.A. 160">27 B.T.A. 160 (1932), relied upon by respondent is distinguishable from the instant case for the reason that the settlement figure therein was less than the principal liability.Decision will be entered under Rule 50. Footnotes1. Petitioner has conceded all other adjustments made by respondent.↩2. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954.↩3. Nev. Rev. Stat. sec. 202.020, etc., dealing with intoxicating liquor defines a minor as anyone who has not reached 21 years of age. See also fn. 4, infra. Accordingly, even if we were to look at Nevada law, we are not convinced that Nev. Rev. Stat. sec. 129.010↩, relied upon by petitioner, would control here.4. Nevada adopted the act in 1957 as Nev. Rev. Stat. sec. 167.010↩, etc. Thus, even Nevada recognizes that for some purposes Carole was a minor. It was this variation even within one State that we feel will be avoided by a uniform meaning for the word "minor."	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624557/	Arthur T. Miller, Willia V. Miller v. Commissioner.Miller v. CommissionerDocket No. 30020.United States Tax Court1951 Tax Ct. Memo LEXIS 84; 10 T.C.M. (CCH) 930; T.C.M. (RIA) 51288; September 28, 195184 A railway mail clerk, who from personal choice, resided at a point distant from his principal place of employment, is not entitled to deduct as traveling expenses under section 23 (a) (1) (A) the cost of his personal living expenses consisting of meals and lodging at his principal place of employment. Arthur T. Miller, pro se. W. B. Riley, Esq., for the respondent. RICEMemorandum Findings of Fact and Opinion RICE, Judge: This case involves an income tax deficiency for 1947 in the amount of $120.08. The issues presented are whether respondent erred: (1) in increasing the amount of Arthur T. Miller's salary and withholding tax for the taxable year; (2) in disallowing a deduction of $501.00 claimed for expenses of meals and lodging85 while away from home in the pursuit of a trade or business; and (3) in disallowing miscellaneous deductions in the amount of $68.61 representing alleged telephone and supply expenses in connection with Arthur T. Miller's trade or business. Findings of Fact Petitioners are husband and wife. They have resided in Little Rock, Arkansas, since 1906. For the calendar year 1947, they filed a joint income tax return with the collector of internal revenue for the district of Arkansas. Arthur T. Miller, hereinafter referred to as petitioner, is and for many years has been a clerk in the employ of the Railway Mail Service of the Post Office Department. During 1947 petitioner was assigned to duty in trains running between Memphis, Tennessee, and Little Rock, Arkansas. The schedules for these trains were approximately as follows: Train No. 45Leave Memphis8:30 a.m.Arrive Little Rock11:05 a.m.Train No. 50Leave Little Rock3:20 p.m.Arrive Memphis7:05 p.m.Prior to November 16, 1947, petitioner commenced his tour of duty at little Rock at 3:20 p.m. in Rock Island train No. 50, spent the night in Memphis, returned to Little Rock the next morning in Rock86 Island train No. 45, and finished his tour of duty on arrival at Little Rock at 11:05 a.m. By order dated November 14, 1947, effective November 16, 1947, the Railway Mail Service discontinued Sunday RPO service in trains 45 and 50 and provided for closed pouch service. Railway mail clerks were ordered to commence a series of six trips at Memphis in train No. 45 on Monday and finish in Memphis in train No. 50 on Saturday. In or about 1935, the Railway Mail Service designated Memphis as petitioner's terminal post of duty. Memphis continued to be petitioner's terminal post of duty throughout the taxable year; and his expense allowance, his salary, and the amount of time he put in were computed as though he lived in Memphis. Petitioner was allowed to continue to live in Little Rock as a matter of convenience to him regardless of the fact that his post of duty was Memphis. The order of November 14, 1947, did not affect petitioner's terminal post of duty; it changed the starting point of his tour of duty from Little Rock to Memphis. After the change, petitioner had to "deadhead" from Little Rock to Memphis in order to start his tour of duty. The train schedules between Memphis and Little87 Rock during the taxable year were such that had petitioner resided in Memphis, he would have been able to spend each night at home. Due to his continued residence in Little Rock, petitioner secured overnight lodgings and dinners in Memphis when on tours of duty. On his income tax return for 1947, petitioner claimed the following sums as traveling expenses while away from home in the pursuit of a trade or business: Room167 days at $1.50 per day$250.50Dinner167 days at $1.50 per day250.50During the year 1947, petitioner received a travel allowance from his employer in an undisclosed sum. The amount of the travel allowance was based upon the time his employment required him to be away from his terminal post of duty in Memphis. On his tax return for 1947, petitioner claimed two additional deductions as expenses in connection with his work; viz.: Supplies for work - $8.85, and Telephone - $59.76. Petitioner failed to testify or offer any evidence respecting these two deductions. On his 1947 income tax return, petitioner reported his salary and income tax withheld thereon as $3,478.47 and $407.80, respectively. His salary and the income tax withheld thereon88 for the taxable year 1947 were $3,524.08 and $416.30, respectively, as determined by the respondent. Petitioner reported no amount as income received from his employer representing reimbursement for travel expenses, nor did he reduce the deduction claimed for lodgings and meals by any sum representing such reimbursement for traveling expenses. In determining the deficiency, the respondent disallowed the $501.00 deduction claimed for room and dinners, the $8.85 deduction claimed for supplies for work, and the $59.76 deduction claimed for telephone. Opinion Section 23 (a) (1) (A) of the Internal Revenue Code authorizes a taxpayer to deduct trade or business expenses in computing his net income. Among the expenses that Congress specifically allowed, as deductible trade or business expense items, are " * * traveling expenses (including the entire amount expended for meals and lodging) while away from home in the pursuit of a trade or business; * * ." The deduction allowed by section 23 (a) (1) (A) does not, however, cover personal, living, or family expenses which are specifically made nondeductible by section 24 (a) (1) of the Code. In Commissioner v. Flowers, 326 U.S. 465">326 U.S. 465 (1946),89 the Supreme Court stated that three conditions must be satisfied before a traveling expense may be deducted under section 23 (a) (1) (A), namely: "(1) The expense must be a reasonable and necessary traveling expense, as that term is generally understood. This includes such items as transportation fares and food and lodging expenses incurred while traveling. "(2) The expense must be incurred 'while away from home.' "(3) The expense must be incurred in pursuit of business. This means that there must be a direct connection between the expenditure and the carrying on of the trade or business of the taxpayer or of his employer. Moreover, such an expenditure must be necessary or appropriate to the development and pursuit of the business or trade." The Supreme Court further pointed out that whether particular expenditures fulfilled these three conditions so as to entitle the taxpayer to a deduction is purely a question of fact in most instances. The facts here show that the expenditures were for meals and lodging in Memphis, that petitioner lived in Little Rock, that his post of duty was Memphis, that had he lived in Memphis the above expenditures would have been unnecessary, that90 his work schedule throughout most of the taxable year was arranged for his convenience because he resided in Little Rock, that the Railway Mail Service, while willing to accommodate petitioner in his preference for a place to live, nevertheless, computed his time, his salary, and his travel expense upon a scheduled departure from Memphis in the morning and a return to Memphis each evening, and that although petitioner's work schedule was changed effective November 16, 1947, so that his tour of duty started from Memphis, he still continued, as a matter of personal choice, to reside in Little Rock. Under these circumstances petitioner cannot say that his lay-over expenses in Memphis had any direct connection with carrying on the postal railway business. He made the expenditures for meals and lodgings in Memphis so that he could continue to maintain his place of abode or residence in Little Rock. Obviously, petitioner's meals and lodging on his lay-over nights in Memphis were neither necessary nor appropriate to the development or the pursuit of any trade or business of his employer. He preferred to stay 167 nights in Memphis during the taxable year rather than move from Little Rock91 to Memphis where he could have spent each night at his place of abode. This election was a personal choice of the petitioner; the expense was a personal living expense, and had no direct connection with carrying on the business of his employer, the Railway Mail Service of the Post Office Department. In reaching our conclusion, we have avoided discussion of the statutory expression "away from home" in an effort to explain sympathetically to the petitioner why the deduction can not be allowed. There is, however, ample authority for the proposition that "'away from home' means place of business, employment, or the post or station at which he is employed." See Walter M. Priddy, 43 B.T.A. 18">43 B.T.A. 18, 31 (1940), and cases there cited; Grover Tyler, 13 T.C. 186">13 T.C. 186 (1949); and Beatrice H. Albert, 13 T.C. 129">13 T.C. 129 (1949). It is the function of Congress to determine what deductions shall be allowed a taxpayer in computing his taxable net income. This Court has no such authority. The parties are agreed, and we have found as a fact the amount of petitioner's salary and the amount of tax withheld for the taxable year. On the remaining issue, relating to deductions*92 for telephone and supplies, petitioner failed to testify or offer other evidence in support of his allegation that respondent erred in disallowing the deductions. In the absence of proof showing that respondent erred, we must sustain his determination. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4338913/	T.C. Memo. 2011-283 UNITED STATES TAX COURT OMAR J. NASIR, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 16721-08L. Filed December 5, 2011. P filed a petition for review of a lien filing pursuant to sec. 6320, I.R.C., in response to R’s determination that the collection action was appropriate. Held: R’s determination is sustained. Omar J. Nasir, pro se. Najah J. Shariff, for respondent. MEMORANDUM FINDINGS OF FACT AND OPINION WHERRY, Judge: This case is before the Court on a petition for review of a notice of determination concerning collection - 2 - action(s) under section 6320 and/or 6330 (notice of determination).1 Petitioner seeks review of respondent’s determination sustaining a tax lien filing. The collection action stems from late returns petitioner filed for the 2000 and 2002 tax years. The issue for decision is whether petitioner had reasonable cause for his failure to comply with sections 6651(a)(1) and (2) and 6654(a). FINDINGS OF FACT Some of the facts have been stipulated. The stipulations, with accompanying exhibits, are incorporated herein by this reference. At the time the petition was filed, petitioner resided in California. Petitioner worked as an engineer in 2000 and 2002, reporting adjusted gross income of $120,992 and $83,069, respectively. Petitioner failed to timely file his Federal income tax returns for tax years 2000 and 2002 and failed to timely pay his tax liabilities for those years. For 2000 respondent initially assessed an income tax deficiency of $29,436 on April 10, 2006, on the basis of a substitute for return he prepared pursuant to section 6020(b). The substitute for return also showed, and petitioner was assessed, a section 6651(a)(1) failure to timely file addition to 1 Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986, as amended and applicable to the periods at issue. - 3 - tax of $1,265.40, a section 6651(a)(2) failure to timely pay addition to tax of $3,301.50, and a section 6654 failure to pay estimated income tax addition to tax of $609.06. Petitioner subsequently, on or about April 23, 2006, filed a Form 1040A, U.S. Individual Income Tax Return, for his 2000 tax year, showing a tax liability of $21,958. Thereafter, respondent abated $7,478 of his assessment and reduced the tax deficiency to $21,958. Respondent also abated $1,895.50 of the late payment addition to tax, reducing the late payment addition to tax amount to $1,406, and removed the section 6654 addition to tax for failure to pay estimated income tax. For 2002 respondent initially assessed an income tax deficiency of $37,734 on the basis of a substitute for return he prepared pursuant to section 6020(b). The substitute for return also showed, and petitioner was assessed, a section 6651(a)(1) failure to timely file addition to tax of $4,261.50, a section 6651(a)(2) failure to timely pay addition to tax of $6,980.79, and a section 6654 addition to tax for failure to pay estimated income tax of $628. Petitioner subsequently, on or about October 14, 2007, filed a Form 1040A for his 2002 tax year, showing a tax liability of $20,205. Thereafter, respondent abated $17,529 of his assessment and reduced the tax deficiency amount to $20,205. Respondent also abated $4,382.25 of the addition to tax for late payment, reducing the amount to $2,598.54. - 4 - On September 4, 2007, respondent mailed petitioner a Letter 3172, Notice of Federal Tax Lien (NFTL) Filing and Your Right to A Hearing under IRC 6320, advising petitioner that respondent would on the next day file an NFTL for 2000 and 2002. On September 5, 2007, respondent filed an NFTL to collect the unpaid tax liabilities. In response, respondent timely received petitioner’s Form 12153, Request for a Collection Due Process or Equivalent Hearing, dated October 2, 2007. Petitioner checked the boxes on the Form 12153 for withdrawal and discharge of the tax lien. Petitioner also checked boxes for the collection alternatives of an installment agreement and an offer-in- compromise. From February to June of 2008, respondent processed petitioner’s request, and on May 21, 2008, respondent ultimately conducted a collection due process hearing by phone with petitioner, although petitioner had requested a face-to-face conference. Petitioner requested penalty relief as it relates to the additions to tax for failure to timely file and the failure to timely pay on the grounds that he suffered undue financial hardship. Petitioner also requested collection alternatives, including an offer-in-compromise, but failed to provide the requested documentation.2 Respondent sent a notice of 2 The required documentation included a completed Form 433-A, Collection Information Statement for Individuals, proof of (continued...) - 5 - determination to petitioner on June 2, 2008, informing him of the decision to deny penalty relief and sustain the lien filing. Petitioner filed a petition on July 7, 2008, and an amended petition on July 31, 2008. This case was set for trial on June 22, 2009, but was continued on the joint motion of the parties. However, because the requested face-to-face conference had not been afforded to petitioner, respondent’s San Francisco Appeals Office agreed to reconsider the case. In a letter dated May 7, 2009, in response to petitioner’s new request for an offer-in- compromise, respondent again requested that petitioner provide a variety of items for consideration to the settlement officer in San Francisco before the face-to-face conference.3 Among the items requested if petitioner still wished to pursue collection alternatives was a Form 433-A, Collection Information Statement for Individuals, and a Form 656, Offer in Compromise, both of 2 (...continued) estimated tax payments for 2008, and delinquent tax returns for 2006 and 2007. Consequently, without these items, petitioner was not eligible for any collection alternatives. 3 Respondent requested nine documents, plus the completed Form 656, Offer in Compromise, and Form 433-A. The other documents were: (1) Bank statements from January 2008 to date; (2) paycheck stubs for the previous 6 months; (3) payoff letters from mortgage lenders; (4) a copy of petitioner’s current lease agreement; (5) copies of previous 6 months of rent payments; (6) copies of previous 6 months of mortgage payments; (7) 2008 Federal tax return; (8) an amended 2002 Federal tax return; and (9) documentation to substantiate any medical expenses incurred during the tax years 2000 and 2002 for treatment of petitioner’s former wife’s breast cancer. - 6 - which were sent to petitioner with detailed instructions. As a followup to the May 7 letter, Settlement Officer Deborah Conley (Officer Conley) sent a letter to petitioner on May 19, 2009, scheduling a face-to-face conference for June 16, 2009. This letter once again requested that petitioner file delinquent tax returns and provide respondent with a Form 433-A and other documents pertaining to his finances and expenses. Over the next 3 months petitioner provided the necessary documents to discuss the offer-in-compromise. During this period respondent granted additional time and rescheduled the face-to- face conference with petitioner twice, in order that petitioner could gather and provide all of the necessary documents.4 A face-to-face conference between Officer Conley and petitioner finally occurred on August 20, 2009. At the conference petitioner submitted a completed Form 656. Under the terms of the offer-in-compromise petitioner offered $6,544 as a short-term periodic payment offer, which required him to pay 24 monthly installments of $272.66.5 4 A face-to-face conference was originally scheduled for June 16, 2009. On June 4, 2009, petitioner requested that the conference be rescheduled to a later date. Respondent granted the request and rescheduled the face-to-face conference for Aug. 5, 2009. On July 27, petitioner once again requested that the conference be rescheduled to a later date. Respondent granted the request and rescheduled the face-to-face conference for Aug. 20, 2009. 5 Petitioner originally wrote $10,000 as his offer-in- (continued...) - 7 - A condition of the offer, stated on the Form 656 that petitioner completed and signed, explained that he had to continue to make the installment payments while the offer was being investigated. Officer Conley further explained to petitioner that a failure to make the payments would result in the offer’s being deemed withdrawn. Petitioner paid the application fee and made the first installment payment at the face-to-face conference. On August 20, 2009, after concluding the face-to-face conference with petitioner, Officer Conley assembled the offer- in-compromise package and sent it to the offer-in-compromise unit in Memphis, Tennessee (Memphis Unit). Petitioner received a letter dated September 17, 2009, from the Memphis Unit informing him that his offer-in-compromise had been received and was being investigated. The Memphis Unit reached a preliminary decision to reject the offer, conveying this to petitioner in a letter dated January 5 (...continued) compromise but did so under the erroneous belief that refunds, such as his stimulus refund, which the IRS had already taken, would be considered as part of his offer. Petitioner modified the Form 656 to change the offer-in-compromise amount to reflect these amounts. - 8 - 15, 2010.6 The case was subsequently sent back to respondent’s San Francisco office for a final determination. Petitioner made timely payments under the terms of the installment plan for the months of September, October, November, and December of 2009. However, beginning in January 2010, petitioner began to fall behind. In a letter dated March 4, 2010, Officer Conley sent petitioner a notice that payments for January and February had not been received and that he owed $545.32. The letter informed petitioner: “If I do not receive the payment or proof that you made the payments, per IRC 7122(c)(1)(B)(ii) your offer will be considered withdrawn.” Officer Conley requested that the payment be submitted by March 19, 2010. The letter also stated that if petitioner wished to propose other alternatives he should also submit them to Officer Conley by March 19. In response, petitioner submitted two payments of $272.66 by the March 19, 2010, deadline. Petitioner failed to timely submit his March, April, and May installment payments under the terms of the offer-in-compromise. In a letter dated June 15, 2010, Officer Conley informed petitioner that she had not received his payments for March, 6 In the Memphis Unit’s preliminary decision to reject petitioner’s offer-in-compromise, a clerical mistake was made as to the amount petitioner offered. The introduction of the letter stated that the offer was “in the amount of $1,200.” However, a further reading of the letter reveals that the decision was based on an offer of the correct amount of $6,544. - 9 - April, and May and that he had to submit a payment of $817.98 by June 29, 2010, or the offer-in-compromise would be withdrawn. In correspondence dated June 25, 2010, petitioner submitted a single payment of $272.66 and indicated that the April and May payments would be made by September 2010. In a letter dated July 26, 2010, respondent sent petitioner a supplemental notice of determination sustaining the NFTL. The letter also stated that the offer-in-compromise was withdrawn because of failure to comply with the payment terms. OPINION I. Standard of Review Section 6320(a) and (b) provides that a taxpayer shall be notified in writing by the Commissioner of the filing of a notice of Federal tax lien and provided with an opportunity for an administrative hearing. An administrative hearing under section 6320 is conducted in accordance with the procedural requirements of section 6330. Sec. 6320(c). If an administrative hearing is requested in a lien or levy case, the hearing is to be conducted by the Appeals Office. Secs. 6320(b)(1), 6330(b)(1). At the hearing, the Appeals officer conducting it must verify that the requirements of any applicable law or administrative procedure have been met. Secs. 6320(c), 6330(c)(1). The taxpayer may raise any relevant issue with regard to the Commissioner’s intended collection activities, - 10 - including spousal defenses, challenges to the appropriateness of the proposed levy, and alternative means of collection. Sec. 6330(c)(2)(A); see also Sego v. Commissioner, 114 T.C. 604, 609 (2000); Goza v. Commissioner, 114 T.C. 176, 180 (2000). Taxpayers are expected to provide all relevant information requested by Appeals, including financial statements, for its consideration of the facts and issues involved in the hearing. Secs. 301.6320-1(e)(1), 301.6330-1(e)(1), Proced. & Admin. Regs. If a taxpayer’s underlying liability is properly at issue,7 the Court reviews any determination regarding the underlying liability de novo. Sego v. Commissioner, supra at 610; Goza v. Commissioner, supra at 181-182. We review any other administrative determination regarding the proposed collection action for abuse of discretion. Sego v. Commissioner, supra at 610; Goza v. Commissioner, supra at 181-182. If raised at or before the Appeals hearing by the taxpayer, a taxpayer’s underlying liability is properly at issue if the taxpayer “did not receive any statutory notice of deficiency for such tax liability or did not otherwise have an opportunity to 7 The parties stipulated that the underlying tax liabilities for 2000 and 2002 are not in dispute. However, the Court is not bound to stipulations as to matters of law, especially when the stipulations are erroneous. King v. United States, 641 F.2d 253, 258 (5th Cir. 1981); Greene v. Commissioner, 85 T.C. 1024, 1026 n.3 (1985). - 11 - dispute such tax liability.” Sec. 6330(c)(2)(B). Under section 6330(d)(1) a taxpayer’s underlying tax liability is “any amounts owed by a taxpayer pursuant to the tax laws”, including assessed additions to tax. Katz v. Commissioner, 115 T.C. 329, 339 (2000). Petitioner challenged respondent’s assessed additions to tax. Petitioner did not receive a statutory notice of deficiency.8 Respondent has not shown, indicated, or alleged that petitioner had an opportunity to dispute the tax liabilities. Consequently, these underlying liabilities are properly at issue. See sec. 6330(c)(2)(B). II. Review De Novo Petitioner requested relief as it relates to the assessed additions to tax pursuant to sections 6651(a)(1) and (2) and 6654(a) on the grounds of reasonable cause. The aforementioned sections permit relief from assessed additions to tax when it is shown that the taxpayer’s failure to comply was due to reasonable cause and not willful neglect.9 See sec. 6651(a)(1) and (2). 8 Inasmuch as petitioner filed delinquent tax returns for 2000 and 2002 reporting tax due of $21,958 and $20,205, respectively, respondent was authorized under sec. 6201(a) to assess said amounts without issuing a notice of deficiency. In addition, respondent was free to assess the additions to tax under secs. 6651(a)(1) and (2) and 6654 without first issuing a notice of deficiency. See sec. 6665(b). 9 No general reasonable cause exception exists with regard to an addition to tax assessed under sec. 6654(a). Relief is available, however, pursuant to the narrow exception of sec. 6654(e)(3)(B). - 12 - The Court’s standard of review on what elements must be present to constitute “reasonable cause” is de novo. United States v. Boyle, 469 U.S. 241, 249 n.8 (1985) (“[W]hat elements must be present to constitute ‘reasonable cause’ is a question of law.”). Whether those elements are present in a given case is a question of fact. Id. The burden of proving reasonable cause and lack of willful neglect rests on the taxpayer. Id. at 244. A. Section 6651(a)(1): Failure To File a Timely Return Section 6651(a)(1) imposes an addition to tax for failure to file a timely Federal income tax return unless the taxpayer can demonstrate that such failure is due to reasonable cause and not due to willful neglect.10 The Code does not define reasonable cause nor willful neglect. However, the regulations explain that reasonable cause for the failure to file a timely return exists if the taxpayer exercised ordinary business care and prudence but was unable to file his return within the time prescribed by law. Sec. 301.6651-1(c)(1), Proced. & Admin. Regs. The term “willful neglect” has been read as meaning “conscious, intentional failure or reckless indifference.” United States v. Boyle, supra at 245. Respondent determined that petitioner is liable for an addition to tax under section 6651(a)(1) for tax years 2000 and 10 The amount of the addition to tax is 5 percent of the amount required to be shown as tax on the return for each month or portion thereof that the delinquency continues, up to a maximum of 25 percent. Sec. 6651(a)(1). - 13 - 2002. The parties stipulated that petitioner filed late returns for both of the years at issue, filing his return for 2000 in 2006 and his return for 2002 in 2007. Petitioner was assessed a tax liability of $21,958 for 2000 and $20,205 for 2002. Petitioner sets forth two arguments as to why he had reasonable cause and was thus excused from filing a timely return for the tax years 2000 and 2002: (1) Petitioner claims to have suffered undue financial hardship, and (2) petitioner experienced the prolonged sickness and illness of an immediate family member. Without venturing into whether petitioner actually did suffer undue financial hardship, we reject the argument that reasonable cause due to financial hardship is a basis to abate additions to tax. Under the standard of “ordinary business care and prudence” set forth in the regulations, petitioner was not excused from timely filing even if he would have been unable to pay. One’s ability to pay a tax liability has no bearing on the ability to file one’s tax return. Sec. 301.6651-1(c)(1), Proced. & Admin. Regs. Ordinary business care and prudence required petitioner to file his return timely and address the inability to pay the liability as a separate issue. Petitioner also alleges reasonable cause because of prolonged sickness and illness of an immediate family member. In the Ninth Circuit, where this case would be appealable absent a stipulation to the contrary, a taxpayer’s or a member of his immediate - 14 - family’s serious illness can constitute reasonable cause. Van Camp & Bennion v. United States, 251 F.3d 862, 867 (9th Cir. 2001); see United States v. Boyle, supra at 243 n.1; sec. 301.6651-1(c)(1), Proced. & Admin. Regs. The Court of Appeals for the Seventh Circuit has determined that “the type of illness or debilitation that might create reasonable cause is one that because of severity or timing makes it virtually impossible for the taxpayer to comply--things like emergency hospitalization or other incapacity occurring around tax time.” Carlson v. United States, 126 F.3d 915, 923 (7th Cir. 1997). Petitioner provided some medical billing records of his former wife, who he was married to during the tax years at issue. The records indicate that she underwent a mastectomy in the end of April 2002 and then possibly had reconstructive surgery related to the mastectomy in July 2002.11 When determining whether a taxpayer had reasonable cause due to serious illness of an immediate family member we consider whether “tax duties were attended to promptly when the illness passed”. Internal Revenue Manual pt. 20.1.1.3.2.2.1(3)(G) (Nov. 25, 2011). We sympathize with petitioner and his former wife regarding her previous health problems. However, the two procedures occurred approximately 1 11 Petitioner’s former wife’s treatments for cancer did not begin until 1 year after his 2000 Federal income tax return was due, and therefore did not constitute reasonable cause for his failure to timely file the return for the 2000 tax year. - 15 - year and 8 months, respectively, before the filing deadline that petitioner missed. Even if we give petitioner the benefit of the doubt that his former wife’s ailments precluded the timely filing of his 2002 tax returns by April 15, 2003, petitioner did not file his 2002 tax return until October 2007, more than 5 years after his former wife’s last procedure. Petitioner was required to promptly file his return for 2002 once his former wife’s illness had passed; petitioner offered no evidence to show that his former wife was still ailing until October 2007. We also note that petitioner did not attempt to comply with his duty to timely file his 2002 Federal income tax return by requesting an extension of time to file. During this time petitioner still managed to conduct the rest of his financial affairs with ordinary business care and prudence, such as paying his mortgage on time. He was also able to perform the essential functions of his day-to-day activities, including going to work and making an income in excess of $100,000 during the 2002 tax year. See Wright v. Commissioner, T.C. Memo. 1998-224, affd. without published opinion 173 F.3d 848 (2d Cir. 1999). We conclude that petitioner has failed to establish reasonable cause to abate the addition to tax pursuant to section 6651(a)(1) for 2000 or 2002. - 16 - B. Section 6651(a)(2): Failure To Pay Amount of Tax Section 6651(a)(2) imposes an addition to tax for failure to pay the amount of tax shown on the taxpayer’s Federal income tax return on or before the payment due date, unless such failure is due to reasonable cause and not due to willful neglect.12 A failure to pay will be considered due to reasonable cause if the taxpayer makes a satisfactory showing that he exercised ordinary business care and prudence in providing for payment of his tax liability and was nevertheless either unable to pay the tax or would suffer undue hardship if he paid on the due date. Sec. 301.6651-1(c)(1), Proced. & Admin. Regs. Petitioner asserts the same reasonable cause arguments for section 6651(a)(2) as he did for section 6651(a)(1)--undue financial hardship and the prolonged illness of an immediate family member. In determining whether the taxpayer was unable to pay the tax in spite of the exercise of ordinary business care and prudence in providing for payment of his tax liability, consideration will be given to all the facts and circumstances of the taxpayer’s financial situation. Van Camp & Bennion v. United States, supra at 867. For the same reasons we found that 12 The sec. 6651(a)(2) addition to tax is 0.5 percent of the amount of tax shown on the return, with an additional 0.5 percent per month during which the failure to pay continues, up to a maximum of 25 percent. The 5-percent failure to file penalty is reduced to 4.5 percent for any month that the failure to pay penalty is also assessed. Sec. 6651(c). - 17 - petitioner failed to show reasonable cause for failing to file his Federal returns on time, petitioner has failed to show that he exercised ordinary business care and prudence in failing to pay his tax liabilities for 2000 and 2002 on time. Petitioner cannot rely on undue financial hardship alone to excuse his inability to pay taxes. The regulations require a showing of reasonable cause even if undue hardship would be suffered. As the District Court noted in Wolfe v. United States, 612 F. Supp. 605, 608 (D. Mont. 1985), affd. 798 F.2d 1241 (9th Cir. 1986), opinion amended, 806 F.2d 1410 (9th Cir. 1986): “Almost every non-willful failure to pay taxes is a result of financial difficulties.” We conclude that petitioner is liable for the section 6651(a)(2) addition to tax for 2000 and 2002. C. Section 6654(a): Failure To Pay Estimated Tax Section 6654(a) imposes an addition to tax for the underpayment of any installment of estimated tax.13 The underpayment addition rate is determined pursuant to section 6621 and is applied to the amount of the estimated tax underpayment for the period of underpayment. Sec. 6654(a) and (b). Except for the narrow circumstances provided for in section 13 Sec. 6654(c)(1) requires the payment of four installments of a taxpayer’s estimated tax liability for each taxable year. Each required installment of estimated tax is equal to 25 percent of the required annual payment. - 18 - 6654(e)(3)(A) and (B), no reasonable cause exception exists to the section 6654(a) addition to tax. The narrow exceptions to section 6654(a) provide that an addition to tax will not be imposed if the Secretary determines that (1) By reason of casualty, disaster, or unusual circumstances the additions assessed would be inequitable or unfair or; (2) the taxpayer retired (after reaching age 62) or became disabled in either the taxable year for which estimated tax payments were required or in the taxable year preceding such year and such underpayment was due to reasonable cause and not willful neglect. Petitioner asserts the same reasonable cause arguments for section 6654(a) as he did for section 6651(a)(1) and (2). Petitioner did not introduce any evidence that he was retired, nor did he put forth any evidence that he was disabled. Therefore he does not fall into the narrow exception for reasonable cause pursuant to section 6654(e)(3)(B). The record does not establish that petitioner’s failure to make estimated tax payments for 2002 was due to casualty, disaster, or other unusual circumstances, and we are not persuaded that the imposition of the section 6654 addition to tax would be against equity and good conscience. We conclude that petitioner is liable for the section 6654 addition to tax for 2002. - 19 - D. Offer-in-Compromise Petitioner submitted an offer-in-compromise based on doubt as to collectability during the face-to-face conference on August 20, 2009. The offer-in-compromise was a 24-month short-term periodic payment offer made pursuant to section 7122(c)(1)(B). The payment offer required petitioner to make monthly payments of $272.66. Pursuant to section 7122(c)(1)(B)(i) petitioner submitted payment of the first installment with the offer-in- compromise. Section 7122(c)(1)(B)(ii) required petitioner to make regular payments during the period respondent was evaluating the offer-in-compromise. Petitioner failed to make continuous payments beginning in January 2010. In late March of 2010 petitioner made his January and February payments after being notified by Officer Conley that a failure to pay would result in the offer-in-compromise’s being deemed withdrawn by petitioner. Petitioner subsequently failed to make timely payments for March, April, and May 2010. Once again Officer Conley sent a letter to petitioner notifying him of the consequences of a failure to pay and to adhere to the terms of his offer-in- compromise. Petitioner responded by sending in only one payment for the month of March. We conclude that pursuant to section 7122(c)(1)(B)(ii), petitioner’s continued payment noncompliance - 20 - was permissibly treated by respondent as a withdrawal by petitioner of his offer-in-compromise. III. Conclusion As detailed above petitioner is liable for the sections 6651(a)(1) and (2) and 6654(a) additions to tax. Further, respondent did not abuse his discretion in rejecting petitioner’s offer-in-compromise. Therefore, the notice of determination respondent issued to petitioner dated June 2, 2008, is sustained in its entirety. To reflect the foregoing, Decision will be entered for respondent.	01-04-2023	11-14-2018
https://www.courtlistener.com/api/rest/v3/opinions/4624558/	ESTATE OF EDITH P. GARLAND, CHARLES P. GARLAND, EXECUTOR, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Garland v. CommissionerDocket No. 105777.United States Board of Tax Appeals46 B.T.A. 1243; 1942 BTA LEXIS 756; May 28, 1942, Promulgated 756 The deduction allowable to decedent's estate on account of property acquired from the estate of a prior decedent, held, to be the value at which such property was included in the estate of the prior decedent (reduced in accordance with a concession made by the petitioner) without reduction on account of the liabilities of the estate of the prior decedent. Percy W. Phillips, Esq., for the petitioner. Charles P. Reilly, Esq., for the respondent. SMITH 1243 OPINION. SMITH: This proceeding involves a deficiency in estate tax of the estate of Edith P. Garland, deceased, in the amount of $7,946.69. All of the issues raised in the original petition and answer have been waived or settled by stipulation. At the hearing the respondent was granted leave to file an amendment to his answer in which he avers: * * * that in computing the deficiency set forth in the notice of deficiency the Commissioner of Internal Revenue erred in his method of computing the deduction for property previously taxed in that he used as a basis for computing said deduction an amount greater than the value of the decedent's interest in the estate of the prior decedent757 at the time of the death of said prior decedent. The question thus raised is submitted on the following stipulation of facts: 1. Edith p. Garland died May 4, 1938. 2. Harry P. Garland died April 10, 1935. Edith P. Garland was the executrix and sole legatee of the Estate of Harry P. Garland. 3. Gross and net estate of Harry P. Garland as finally determined were: Gross estate for Federal estate tax purposes$617,651.33Deductions: (exclusive of exemption)22,458.41Specific bequestsnoneNet estate$595,192.92The Federal estate tax liability on the above estate as finally determined was $63,742.93. The state inheritance and estate tax liability on the above estate was $13,807.72. 4. In the deficiency notice the gross estate of Edith P. Garland was determined to be $802,409.18. It is stipulated that the gross estate is $773,614.68. In the deficiency notice the deductions, exclusive of the statutory exemption and before any deductions for previously taxed property, were determined to be $49,019.46. It is stipulated that such amount should be $26,324.96. 5. There has been included in the gross estate of Edith P. Garland, property received758 by her from the Estate of Harry P. Garland. The value at which such property was included in the gross estate of Harry P. Garland and the value at which the same property was included in the gross estate of Edith P. Garland are as follows: Estate of Edith p. GarlandEstate of Harry P. GarlandReal estate and securities$604,651.84$567,224.951244 At the date of death of Edith P. Garland there remained unpaid liabilities of the Estate of Harry P. Garland in the amount of $14,031.50, said liabilities consisting of the unpaid portion of the items of $22,458.41, $63,742.93 and $13,807.72 referred to in paragraph 3 above. To the extent of $35,551.18, debts of the Estate of Harry P. Garland, expenses of administration thereof and taxes thereon had been paid from income or capital gains of his estate before the death of Edith P. Garland. 6. The only question presented to the Board for decision is the determination of the proper amount to be used as a deduction for previously taxed property. All other issues are waived or disposed of by this stipulation. An estate tax return was filed on behalf of decedent's estate with the collector of internal759 revenue for the district of Maine. It is the respondent's contention that in determining decedent's net estate the deduction allowable under section 303(a)(2) of the 1926 Act, as amended, on account of property previously taxed in the estate of the prior decedent is limited to the value of decedent's interest in the estate of the prior decedent at the time of such prior decedent's death. Specifically, respondent contends that the deduction allowable to the estate of this decedent on account of the previously taxed property should be computed as follows: Gross estate (of prior decedent)$617,651.33Less:Federal estate tax$63,742.93State inheritance tax13,807.72Deductions22,458.41100,009.06Deductible from decedentS estate517,642.27Although it is stipulated that there fell into decedent's estate specific property which was included in the estate of the prior decedent at a value of $567,224.95 and in decedent's estate at a value of $604,651.84, respondent contends that the excess of the latter amount over $517,642.27 represented an interest acquired by decedent after the prior decedent's death "as income beneficiary of the prior estate, 760 and not an interest in the corpus of the prior decedent's estate." Respondent's contention, we think, does not comport with the plain provisions of the statute. Stripped of its impedimenta the statute, section 303(a)(2) of the Revenue Act of 1926, as amended by sections 402 and 403(a) of the Revenue Act of 1934, and by section 806(a) of the Revenue Act of 1932, reads as follows: SEC. 303. For the purpose of the tax the value of the net estate shall be determined - (a) * * by deducting from the value of the gross estate - * * * (2) An amount equal to the value of any property (A) forming a part of the gross estate situated in the United States of any person who died within five years prior to the death of the decedent, * * * where such property 1245 can be identified as having been received by the decedent * * from such prior decedent by * * * bequest, devise, or inheritance, * * * This deduction shall be allowed only where * * * an estate tax imposed under this or any prior Act of Congress, was finally determined and paid by or on behalf of * * * the estate of such prior decedent, * * * and only in the amount finally determined as the value of such property in761 determining the value of * * the gross estate of such prior decedent, and only to the extent that the value of such property is included in the decedent's gross estate, and only if in determining the value of the net estate of the prior decedent no deduction was allowable under this paragraph in respect of the property * * . Where a deduction was allowed of any mortgage or other lien in determining the * * estate tax of the prior decedent, which was paid in whole or in part prior to the decedent's death, then the deduction allowable under this paragraph shall be reduced by the amount so paid. * * * The deduction allowed is the value at which the property was taxed in the estate of the prior decedent, to the extent of its value in the present estate, reduced by the amount of any mortgage or lien thereon allowed as a deduction to the prior estate. There is no provision anywhere in the statute that the deduction allowable to the second decedent's estate must be reduced by any and all obligations of the estate of the prior decedent. In 762 ; affirming , the court said with reference to section 303(a)(2) that: * * The language used is adapted to one or more particular pieces of property specifically given or inherited. It is not adapted to an unadministered estate as a whole. * * * The provision that the deduction allowable must be reduced by the amount of any mortgage or other lien allowed as a deduction in computing the estate of the prior decedent obviously has no application here. The stipulated facts make no reference to any mortgage or lien on the specific property here involved or any other property of the prior decedent. It is stipulated merely that the gross estate for Federal estate tax purposes was $617,651.33 and that there were deductions (exclusive of exemptions) of $22,458.41. We do not know what these deductions comprised and can not assume that they were secured by any mortgage or lien on any of the assets of the prior decedent's estate. The only provision of section 303(a)(2) that might apply here to reduce the deduction allowable to decedent's estate on account of the previously763 taxed property below $567,224.95, the amount at which it was valued in the prior estate, is the provision that "this deduction shall be allowed only where * * an estate tax imposed under this or any prior Act of Congress, was finally determined and paid by or on behalf of * * * the estate of such prior decedent." It is stipulated that at the death of Edith P. Garland there remained unpaid $14,031.50 of the liabilities of the estate of the prior decedent. The 1246 stipulation does not show whether such unpaid liabilities included any of the $63,742.93 of Federal estate taxes of the prior decedent's estate or whether those taxes have since been paid. Petitioner concedes in his brief, however, that the amount of $14,031.50 should be deducted from the $567,224.95 in computing the amount allowable as a deduction to the decedent's estate because the decedent in effect was required to return that amount of the assets of the prior decedent's estate after they had been distributed to her. Petitioner thus concedes that the deduction properly allowable on account of the previously taxed property is $553,193.45 instead of $567,224.95, the amount allowed in the deficiency notice. 764 The respondent in his brief cites , as authority for his contentions in the present case. In that case the decedent acquired the assets of the estate of a prior decedent who died within less than four months of the date of death of the prior decedent. We held that the second decedent was not entitled to deduct from the gross estate the debts and taxes due from the prior decedent's estate. That question is not before us in the instant case. The petitioner here is claiming no deduction of any liabilities of the prior decedent's estate, but only the deduction of the value of property taxed in the prior decedent's estate. A question was raised in the Bender case as to the amount of the deduction to which the estate of the second decedent was entitled under section 303(a)(2), but was not deemed essential to our determination in that case and was not ruled upon. See discussion, . On the basis of the stipulated facts and the concession made by the petitioner in his brief, we determine that the amount of $553,193.45 is deductible from decedent's gross estate on account of the previously taxed property. *765 Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624559/	CORPORATE INVESTMENT COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Corporate Inv. Co. v. CommissionerDocket No. 78363.United States Board of Tax Appeals40 B.T.A. 1156; 1939 BTA LEXIS 742; December 20, 1939, Promulgated 742 1. LOSS ON STOCK. - The distribution of stock of other corporations as a dividend does not give rise to deductible loss where the dividend resolution provides for payment in the stock, following General Utilities & Operating Co. v. Helvering,296 U.S. 200">296 U.S. 200. 2. ACCRUED INTEREST AND CHARGES. - The evidence does not sustain respondent's affirmative allegation that he erred in allowing in 1929 part of a deduction for accrued interest and charges on amounts received by the petitioner under contracts with its shareholder where the contracts themselves and the consistent interpretation of them by the contracting parties indicate the amount of accrued interest and charges allowed by the respondent has been correctly computed. 3. SECTION 104 OF THE REVENUE ACT OF 1928. - The petitioner was not formed or availed of in 1929 for the purpose of preventing the imposition of the surtax upon its shareholder through the medium of permitting its gains and profits to accumulate instead of being divided or distributed within the meaning of section 104 of the Revenue Act of 1928. 4. Id. - Amounts received by a corporation which are offset by larger amounts accruable743 as liabilities payable to its shareholder, under valid contracts, are not available for distribution as dividends and the accumulation of such amounts or receipts does not constitute an accumulation of "gains and profits" within the meaning of section 104. 5. Id. - Congress intended section 104 to apply to a corporation "availed of" within the taxable year through the medium of permitting its gains and profits of that year to accumulate, but did not intend to tax a corporation under section 104 merely because it had been availed of in other years or because it did not distribute in the taxable year a surplus accumulated in prior years. 6. Id. - Where, for the purpose of preventing the application of section 104, the sole shareholder of a corporation, who is also the person primarily responsible for its formation and operation, determines to have the corporation distribute all of its gains and profits for the taxable year, and honestly believes that the distribution determined upon and made constitutes a distribution of all the gains and profits, such a purpose is inconsistent with a purpose to avail of the corporation to avoid surtax upon him through the medium744 of permitting gains and profits to accumulate even though later developments may disclose and actual accumulation of gains and profits. 7. Id. - Loans made by a corporation to its sole shareholder are not disguised dividends of its earnings and do not show a purpose to avoid surtax where principal and interest are paid in full and the shareholder at all times intended to pay them. J. G. Korner, Jr., Esq., Frank J. Wideman, Esq., and Richard S. Doyle, Esq., for the petitioner. Frank D. Strader, Esq., W. Herdman Schwatka, Esq., and Edward L. Updike, Esq., for the respondent. MURDOCK 1157 The Commissioner determined a deficiency of $335,908.89 in the income tax of the petitioner for 1929, solely upon the ground that the petitioner is subject to tax under section 104 of the Revenue Act of 1928. The respondent, in his answer, has raised the following issues by affirmative allegations and has made claim for the increased deficiency which would result if he should win: (1) Did he err in allowing deductions of $37,662.50 and $25,740.00 for losses upon the distribution as dividends of 2,300 shares of Loew's Inc. 6 1/2 percent preferred745 stock and 1,000 shares of Chase National Bank common stock on December 26, 1929? and (2) Did he err in allowing a deduction of $31,096.19 as accrued interest and fees payable under contracts of September 13, 1922, and March 5, 1923? FINDINGS OF FACT. Charles A. Munroe was admitted to the bar in 1897, but ceased to practice law several years thereafter. He has been actively associated for many years with a number of corporations as president, vice president, or director. Most of the corporations are public utilities. One of the corporations, the Federal Electric Co., sold various electric applicances upon the installment plan and received promissory notes for the deferred purchase price. It sold large quantities of the notes to acceptance corporations which made about 18 percent upon their investments in the notes. Munroe decided in 1922 that he would like to purchase some of the notes and was encouraged to do so by the president of the company. Munroe owned stocks and bonds worth approximately $2,000,000 at that time, but he did not have sufficient funds to make the purchases which he desired. He could not make satisfactory credit arrangements with his bankers without746 personally guaranteeing the payment of the notes. He did not desire to personally guarantee the notes and decided to organize the petitioner and have it purchase the notes. The petitioner was incorporated on August 16, 1922, under the laws of Illinois, to carry out Munroe's plan. He transferred 120 shares of stock of the Public Service Trust to the petitioner on August 16, 1922, in exchange for all of the authorized capital stock of the petitioner, consisting of 600 common shares of no par value. The shares were issued to three nominees of Munroe on September 13, 1922, and were immediately endorsed in blank and delivered to Munroe. He has since been the owner of all of the shares and has exercised complete control over the petitioner. 1158 The purpose and powers of the petitioner as stated in its articles of incorporation are as follows: to purchase or otherwise acquire and to sell or otherwise dispose of, and genally to deal in capital stock of corporations and bonds, debentures, notes, open accounts and other evidences of indebtedness of corporations, partnerships, trusts, associations and individuals; to buy, sell and deal in bills of lading, warehouse receipts, 747 instalment contracts and all kinds of personal property; and to act as agent for corporations, partnerships and individuals; provided that the foregoing objects shall not include any business prohibited by the statutes of Illinois. The assets worth $6,000 acquired by the petitioner in exchange for its stock were insufficient for the purpose of carrying on the business of purchasing the installment notes. Munroe had decided to furnish the petitioner with a basis for credit by means of a plan which had been used by an acquaintance of his. He accordingly entered into a contract with the petitioner dated September 13, 1922, and transferred to the petitioner under that contract securities belonging to him of the value of $1,575,695. The material parts of the agreement were as follows: WHEREAS, the party of the first part [the petitioner] is about to engage in the business of purchasing deferred payment contracts for merchandise, said contracts to be signed by the original purchaser and to be endorsed and guaranteed by the respective vendor corporations; WHEREAS, in the conduct of said business, the party of the first part requires a large amount of capital; and WHEREAS, 748 the said party of the second part [Munroe] has agreed and is willing to supply the credit basis for securing such capital on the terms and conditions hereinafter set forth. WHEREFORE, IT IS AGREED BY AND BETWEEN the parties hereto, as follows, to-wit: The said party of the second part does hereby give, grant, assign, sell, transfer and set over, unto the said party of the first part, to be the absolute property of the said party of the first part, with the right to sell, transfer, pledge and dispose of all or any of the following described property, to-wit: [Here follows a detailed description of the property transferred.] That in consideration of said transfer of said property to said party of the first part, the party of the first agrees for itself, its successors or assigns, as follows: Ten years from the date hereof, any of the above securities transferred and delivered to said party of the first part which have not been sold or disposed of shall be delivered to the party of the second part, his heirs, executors, administrators, or assigns, at the time above stated, and in addition to said securities, there will be paid in cash the proceeds, if any, derived, as interests749 or dividends from said securities, plus one-fifth (1/5) of such amount each year, and said aggregate sum will bear interest at the rate of six (6) per cent per annum from the time the money is received until it is paid, but not compounded. It is the purpose of this contract that in consideration of the furnishing of the capital to the said party of the first part, that the said party of the first part will pay as a fee for said capital, not only the amount that said company 1159 receives as interest or dividends from said capital but an additional sum equivalent to one-fifth (1/5) of such receipts. In case all or some part of the securities this day delivered have been sold, that then ten years from the date hereof there will be paid to the said party of the second part, his administrators, executors or assigns, in cash, the proceeds of the sale of said securities, plus seven (7) per cent interest per annum on the proceeds of such sale, to be computed from the time the money is received until it is paid, but said interest shall not be compounded. IT IS UNDERSTOOD AND AGREED THAT all interest or dividends received shall be used by said party of the first part as additional750 capital. Said party of the first part agrees that it will exact deferred payment contracts with unpaid balances equal to 110% of any loan, and that it will not extend credit in excess of One Hundred Fifty Thousand Dollars ($150,000) to any one corporation or individual. The period of 10 years was fixed by Munroe as a reasonable one in which the petitioner could either acquire sufficient working capital from earnings or demonstrate that it would be a failure. One purpose of the contract was to supply the petitioner immediately with a means of acquiring credit with which to purchase installment notes. The petitioner used some of the securities transferred to it as collateral for bank loans and used the proceeds of the loans to purchase installment notes. The first purchase of the latter was made on September 21, 1922. The following table shows the cost of installment notes purchased by the petitioner: YearVendorCost to petitioner1922Federal Electric Co$26,590.83Pascoe Oil Burner Co6,599.141923Federal Electric Co281,738.341924Federal Electric Co39,003.061925Laclede Gas Light Co108,868.481926Laclede Gas Light Co119,640.711927None1928None1929New York Oil Co8,432.33751 The notes were for periods ranging from 6 to 24 months. The petitioner required additional working capital early in 1923 and Munroe entered into a second contract, practically identical with that of September 13, 1922, whereby he transferred additional securities to the petitioner. They were worth $175,100. The second contract was dated March 5, 1923. The securities transferred under the two contracts between Munroe and the petitioner had been acquired by Munroe after February 28, 1913, at a total cost of $944,650. They were entered upon the books of the petitioner at their cost to Munroe. They represented all of Munroe's assets, except some preferred stock worth about $300,000. The petitioner in March or April 1923 began negotiations which 1160 resulted in the sale of two securities received under the contract of September 13, 1922. Their total value was $1,205,000 and they were sold for that amount in May 1923. The purchase price was paid by 5 percent notes of the purchaser due May 1, 1924. Some of the notes were discounted at par by the petitioner. All were paid in full at maturity. The petitioner kept its books and made its income tax returns upon752 an accrual method of accounting. Munroe used the cash method. The petitioner, during the years 1922 to 1929, inclusive, accrued on its books as liabilities owed to Munroe under the agreements of September 13, 1922, and March 5, 1923, items in the following total amounts: (1) Proceeds from sales of securities$1,959,068.33(2) Income from securities168,248.85(3) Interest and fees213,070.96(4) Interest on proceeds from sales673,126.70The proceeds from sales exceeded the cost to Munroe of the securities sold by $1,256,638.33. Neither the latter amount nor item (2) above was reported as income by Munroe or the petitioner and, although the Commissioner has been fully aware of the facts, he has never included those amounts in the income of Munroe or the petitioner. The petitioner has claimed and has been allowed deductions during the period for items (3) and (4) above. Munroe has not reported and has not been required by the Commissioner to report those items in his income. The petitioner from time to time has loaned money to Munroe and has borrowed money from Munroe. All loans have been evidenced by interest-bearing notes of the borrower. The following753 table shows for each year the loans to Munroe and the payments made thereon: YearTotal loans madePayments on principalInterest paymentsLoans out-standing at end of year1922$65,744.04NoneNone$65,744.041923119,097.42None$8,256.55184,841.46192480,950.00None14,057.62265,791.461925110,870.70None23,117.47376,662.161926184,588.20None36,553.64561,250.3619271,253,000.00$757,250.3640,446.361,055,000.0019281,140,000.002,195,000.00n1 6,115.31None19292,441,000.001,272,320.00(1)1,168,680.0019306,000.00651,445.01(1)n2 523,234.99All outstanding loans to Munroe were paid in full on November 30, 1927, on five occasions in 1928, and on three occasions in 1929. The petitioner borrowed $91,378.31 from Munroe during 1929. The petitioner loaned over $200,000 to a third party during 1928 and 1929, 1161 for which it received interest and a fee of six or seven thousand dollars. The petitioner entered into a contract with Ohio Gas & Electric754 Co. on September 30, 1922, whereby, in consideration of a cash payment of $30,000, it agreed to "undertake for a period of five (5) years from the date hereof, to sell and dispose of such preferred stock" of the Ohio Gas & Electric Co. as the latter "may from time to time, during said period, wish to dispose of, at a price to be mutually agreed upon between the two parties." The petitioner also agreed in the same contract to sell, within 30 days from the date thereof, 1,000 shares of Ohio Gas & Electric preferred stock at a net price to Ohio Gas & Electric of $95 per share. The contract was performed. The petitioner, on February 2, 1924, had an opportunity to buy 53,600 shares of the common stock of the Laclede Gas Light Co. (hereinafter called Laclede Gas), the controlling interest in that company, for $5,650,000, but did not have sufficient funds at that time to purchase that stock. The petitioner assisted in the formation of a new corporation, the Laclede Gas & Electric Co. (hereinafter called Laclede Electric), in order to effect the purchase of the Laclede Gas stock. Laclede Electric was organized under the laws of the State of Delaware. Its capital stock consisted of 200,000755 shares of common stock, $20,000,000 par value of preferred stock, and $20,000,000 par value of prior lien preferred stock. It was authorized to issue 15-year 7 percent debentures in the face amount of $15,000,000. Laclede Electric, with the assistance of Munroe and the petitioner, sold $4,700,000 face amount of its debentures to a syndicate for $4,465,000. The petitioner purchased 12,600 shares of Laclede Electric's preferred stock for $1,200,000 and acquired at the same time 120,000 shares of Laclede Electric's common stock without cost. The petitioner made this purchase with the proceeds from the stocks which it had sold in May 1923. Laclede Electric then purchased the 53,600 shares of Laclede Gas common stock on or about May 17, 1924, with the funds realized from the foregoing sales of its debentures and preferred stock. Laclede Electric, sometime thereafter, sold about $1,250,000 par value of its prior lien preferred stock and with the proceeds of that sale constructed a pipe line, which it used to transport refining gas from Wood River, Illinois, to St. Louis, Missouri. The refinery gas so transported was used to enrich the carbureted water gas manufactured by Laclede Gas. 756 This operation effected a saving to Laclede Gas of about 5 cents per thousand cubic feet in the manufacture of its gas, with the result that the earnings of both Laclede Gas and Laclede Electric were materially increased. 1162 The Utilities Power & Light Co. entered into negotiations with the petitioner and Munroe sometime in April or early May 1927 for the purchase of the major portion of the Laclede Electric stock owned by the petitioner. The price at which the stock was to be sold represented a substantial profit to the petitioner. A plan was thereupon devised whereby the petitioner expected to spread its profit for tax purposes over a ten-year period. The petitioner, according to the plan, was to sell the Laclede Electric stock to Munroe for his personal interest-bearing notes, payable one-tenth annually during the period 1928 to 1937, inclusive, and then Munroe was to immediately sell the stock to the Utilities Power & Light Co. for cash in an amount equal to the face value of his notes to the petitioner. This plan was carried out. The petitioner sold to Munroe on May 6, 1927, 120,000 shares of the common stock of Laclede Electric and 10,100 of its 12,600 shares757 of preferred stock of the same company, at prices of $70 per share for the common and $100 per share for the preferred. The petitioner received as consideration for the sale Munroe's unsecured notes - 10 notes of $101,000, each bearing interest semiannually at 7 percent, representing payment for the preferred stock and 10 notes of $840,000, each bearing interest semiannually at 6 percent, representing payment for the common stock. One 7 percent note and one 6 percent note became due and payable on May 6 of each year thereafter for a period of 10 years. Munroe, on May 8, 1927, gave the Utilities Power & Light Co. a 60-day option to purchase the Electric stock acquired from the petitioner at the same price he paid for the stock. Utilities Power & Light exercised the option within the 60-day period. It paid Munroe $8,400,000 for the common stock and $1,010,000 for the preferred stock, or a total of $9,410,000 in cash. Munroe received most of the cash payment at the time the option was exercised. The remainder, representing part of the consideration for the preferred stock, was paid within the following year. The petitioner purchased other corporate securities from time to time, 758 some from Munroe, some from others. It also received some securities from Munroe in payment of interest. Munroe sustained losses on the disposition of some of the securities referred to in this paragraph as transferred to the petitioner and was allowed deductions therefor. The petitioner sold 100 shares of stock in 1928 and made numerous sales in 1929 for a total consideration of $1,905,843.01. It claimed a deduction of $224,262.53 on its return for 1929 on account of losses from the disposition of securities owned, including loss on the two securities distributed to Munroe as a dividend. The Commissioner, at some time in 1932, reduced the loss to $162,011.01 1163 and the petitioner paid the resulting tax. The principal adjustment made was to allocate a part of the cost of some stock to additional stock acquired under stock-purchasing rights and, thus, to increase the profit upon the shares sold by $55,261.76. The sale of the 120,000 shares of common and 10,100 shares of preferred stock of Laclede Electric to Munroe in 1927 resulted in a profit to the petitioner of $8,448,096.20. It recorded and reported that transaction as an installment sale. This method was questioned759 by the Government on November 15, 1928, and thereafter the Government and the petitioner discussed the question of whether the gain could be reported upon the installment method or whether it should all be reported as income of 1927. Munroe and the petitioner during these discussions first became aware of section 104 and the possible application of that section and its antecedents to the petitioner. The petitioner in November 1929 agreed to pay the tax for 1927 on the entire profit from the Laclede Electric sale provided that its tax liabilities and those of Munroe up to 1929 be finally closed by agreements under section 606 of the Revenue Act of 1928. The Government representative then expressed his approval of such a plan. The proposal was immediately submitted by the petitioner in writing as follows: As suggested at our informal conference of November 19, 1929, and in accordance with Mr. Shaw's conference with you on November 22, 1929: I am herewith submitting to you, in writing, the tentative proposal I made at that time. The proposal is that closing agreements, as authorized by Section 606 of the Revenue Act of 1928, be entered into with the Corporate Investment Company760 and also D. A. Munroe, for the taxable years (calendar) 1926, 1927 and 1928. The 1926 colsing agreements will show no deficiency or refund for either Mr. Munroe or the Corporate Investment Company. The 1927 closing agreement for the Corporate Investment Company will include the deficiency now in controversy for that year, namely, $1,140,411.99. The 1927 closing agreement for C. A. Munroe will show no deficiency or refund. The 1928 closing agreement of Corporate Investment Company will show a refund of the taxes paid by the Corporate Investment Company on the proportion of profit from the sale of the preferred and common stock of the Laclede Gas and Light Company, which was allocated by the Corporate Investment Company on the installment plan basis in the year 1928, which tax amounted to $101,377.14. The closing agreement for 1928 of C. A. Munroe will show no deficiency or refund. As I told you at the conference this proposal is made for the purpose of settling all matters for the years in question and is not to be construed as an admission on the part of our clients: That the 1927 transaction in controversy was not just what we have contended it to be, namely, a casual761 sale of personal property for a price exceeding $1,000.00, where the initial payment was less than $25%, and therefore, taxable at the election of the taxpayer on the installment plan basis. 1164 You stated at the conference that before such closing agreements could be made there would have to be an examination of the books of C. A. Munroe and Corporate Investment Company for the years that have not alredy been examined. I have been advised that the books of C. A. Munroe and the Corporate Investment Company have been examined for the years 1926 and 1927. There will remain, therefore, only the necessity of an examination of the books for the year 1928. If this proposal is accepted, an examination may be made at once in New York where the books of Mr. Munroe and the Corporate Investment Company are at present located. While I appreciate that matters of settlement take time and can not be unduly pushed, it seems only fair that the Corporate Investment Company should know the position of the Government as early as possible, in order that it may know how to treat the third installment of the contract in controversy in its 1929 return. The Commissioner examined the books762 in 1930 and executed closing agreements in April 1930 as to Munroe and on July 23, 1930, as to the petitioner. The petitioner, however, had paid the tax in full on July 10, 1930. The amount paid, $1,183,502.94, included the tax and interest for 1927 less an overpayment of $101,522.65 for 1928. The petitioner and Munroe gave consideration in 1929 to the question of the possible application of section 104 to the year 1929. They decided to avoid any possibility of the application of the section by distributing all of the gains and profits for the year as dividends. They had a survey of the books made at some time prior to December 26, 1929, for the purpose of estimating the maximum amount available for distribution. All profit from the Laclede sale was excluded from 1929 income because the Commissioner had determined to tax it as income for 1927. Five hundred sixty thousand dollars was estimated to be the approximate amount of gains and profits for 1929. The following charges against those earnings were anticipated although not entered on the books: (1) Depreciation in securities$89,935.89(2) Interest on the proposed 1927 deficiency120,000.00(3) Federal income taxes for 192961,000.00(4) Lawyers' fees16,666.00287,601.89763 Consideration was also given to the possibility of an early demand by the Commissioner for the tax proposed for 1927 to exceed $1,000,000. The petitioner decided to distribute $350,000, believing that its gains and profits for 1929 would not exceed that amount. It also decided to make an additional distribution early in 1930 if the annual audit showed a larger amount of gains and profits available. The petitioner did not have sufficient funds on hand to make a distribution entirely in cash and decided to distribute the $350,000 partly in cash and the remainder in stocks of other corporations. The board 1165 of directors of the petitioner held a special meeting on December 26, 1929, at which the following minutes were recorded and the following resolution upon motion duly made and seconded, was adopted: The Vice President stated that the Company's indicated earnings for the year 1929 would be $560,000, over and above $844,809.50 being 10% of the profit on the sale of Laclede Gas & Electric Company preferred and common stocks which the Government is now contending accrued in 1927 and not in 1929; that the Company holds at the present time securities, (exclusive of securities764 under agreement) of a cost value of $2,781,952.14; that these securities as of the 26th of December, 1929, showed a market value of $89,935.89 less than the purchase price of the same; that after setting up a reserve adequate to take care of this depreciation in securities the Company could safely pay out the sum of $350,000 and suggested the Company pay this dividend as follows: 2,300 shares of Loews, Inc., 6 1/2% Preferred Stock taken at today's price, i.e., $85 per share, and 1,000 shares of Chase National Bank stock taken at today's price $151 a share, and the balance of the $350,000 to be paid in cash. THEREUPON, on motion of Mr. Blind, and seconded by Mr. McIntire, the following resolution was adopted by vote of all the directors present: RESOLVED, that a dividend of $350,000 be paid on the 600 shares of outstanding capital stock, as of close of business December 26th, 1929, payable that date; said dividend to be paid as follows: 2,300 shares of Loews, Inc., 6 1/2% Preferred Stock at $85 per share, and 1,000 shares of Chase National Bank stock at $151 a share, and the balance of the $350,000 to be paid in cash. The dividend declared in the foregoing resolution was paid765 to Munroe on December 26, 1929. Munroe reported the $350,000 dividend as income in his return for 1929. Three thousand five hundred dollars of the dividend was paid in cash. The fair market value of the 2,300 shares of Loew's Inc. stock was $195,500 and that of the 1,000 shares of Chase National Bank stock was $151,000 on December 26, 1929. The cost of the stock exceeded the fair market value at the time of the distribution by $37,662.50 in the case of Loew's Inc. stock and by $25,750 in the case of the Chase National Bank stock. The petitioner claimed the two latter amounts as deductions for losses in its income tax return for 1929. The deductions claimed were allowed by the respondent. The annual audit of the books in 1930 disclosed no additional gains and profits, after allowing for the nonbook items and the Laclede profit already mentioned, and no additional distribution was made of 1929 gains and profits. The securities owned by the petitioner at the close of 1929 had a basis for gain or loss of $3,370,919.30, but were then worth only $3,256,121.50. They were carried on the books at that time at $3,308,779.58. 1166 The opening and closing balance sheets766 of the petitioner for 1929 as shown by its books are as follows: Dec. 31, 1928Dec. 31, 1929ASSETSCash in banks$258,878.61$24,486.87Bankers acceptances2,208,870.86Accrued interest receivable:C. A. Munroe notes111,898.25117,513.69G. H. Ennis notes3,675.006,825.00Other interest320.35Accrued bond interest receivable12,051.254,741.00Notes receivable:C. A. Munroe8,599,000.008,931,668.42G. H. Ennis210,000.00210,000.00New York Oil Co909.15Securities owned:Stocks982,140.302,721,666.18Bonds241,339.50632,361.00Less: Reserve for loss89,935.89Securities held under agreement:Stocks267,570.00115,220.00Bonds127,000.00127,000.00Furniture and fixtures2,145.841,907.41Securities held in trust40,000.00122,306.30Total12,864,889.9612,962,669.13LIABILITIESNote payable, C. A. Munroe$416,500.00$20,000.00Subscriptions payable2,397.50Liability under agreement:Securities held394,570.00242,220.00Less: Capital stock subscribed-6,000.00-6,000.00Proceeds from sale of securities1,682,259.301,959,068.33Income from securities under agreement157,663.83168,248.85Interest accrued on income from securities under agreement167,963.98213,070.96Interest on proceeds from sales of securities under agreement548,735.14673,126.70Deferred profit - Laclede Gas & Electric stock7,603,286.506,758,477.00Deferred income109.05Securities held in trust40,000.00122,306.30Capital stock6,000.006,000.00Surplus1,851,513.712,770,041.94Total12,864.889.9612,962,669.13767 The distribution of December 26, 1929, was the first ever made by the petitioner. Its surplus shown upon its books was as follows: YearSurplus at end of year19221 -$502.16192310,869.5419241 -53,590.09192518,175.301926$116,118.861927482,154.0319281,851,513.7119292,770,041.941167 The petitioner received dividends and interest from the securities held under the agreements of September 13, 1922, and March 5, 1923, and dividends from other securities, as follows: Securities under agreementsYearDividendsInterestDividends from other securities1922$8,459.00$20,083.33None192324,436.0920,089.29$6,106.75192428,814.891,583.8459,151.00192517,945.41600.0092,727.73192612,068.00600.00169,911.92192712,155.50600.00207,140.34192816,628.48600.0030,632.3119299,985.02600.0071,013.7319302,197.72761.6769,128.15The petitioner accrued on its books and claimed and was allowed a deduction of $45,106.98 for 1929 representing interest and fees due Munroe under the contracts of September 13, 1922, and March 5, 1923. 768 The total income tax of the petitioner as finally determined for all years other than 1927 and 1929 was about $62,000, for the period up to 1930. The total income tax paid by Munroe for the period 1922 to 1928, inclusive, was about $30,000. Munroe owned securities at the end of 1929 which had cost at least $1,000,000 more than their then market value. He claimed and was allowed for 1929 losses of $237,556.07 on securities, most of which he had transferred to the petitioner in payment of loans or interest. He reported on his 1929 return an excess of deductions over income in the amount of $53,730.91. Included among the deductions claimed was an item of $234,988.42 representing a note give to the petitioner in payment of interest. The Commissioner, several years later, disallowed that item, as not a proper deduction for one on a cash basis, and determined a deficiency of $61,789.62. The petitioner filed its income tax return for 1929 with the collector of internal revenue for the first district of Illinois. In reported net income of $538,872 and income tax liability of $59,276.01. The Commissioner in 1932 made the adjustments already described, increasing net income to $600,804.05, 769 and assessed additional tax of $6,812.44, which was paid. The net income for the purpose of section 104 as determined in the notice of deficiency is the same amount of net income plus dividends of $71,013.73. The only explanation given in the notice as to the applicability of section 104 is that "the Bureau holds that your corporation is subject to taxation under the provisions of section 104 of the Revenue Act of 1928." The petitioner ceased activities after October 7, 1930, when the transactions occurred whereby it transferred all of its assets and 1168 liabilities in a reorganization, as more fully described in the report of C. A. Munroe,39 B.T.A. 685">39 B.T.A. 685. One of the purposes of the foregoing reorganization of the petitioner was to avoid certain Illinois tax risks by having the petitioner, an Illinois corporation, transfer its assets to a Delaware corporation. Another purpose was to postpone taxation on the amount payable to Munroe under the provisions of the agreements of September 13, 1922, and March 5, 1923. The reorganization of the petitioner was first considered sometime in 1929, although the final plan of reorganization was not worked out until770 the fall of 1930. The cancellation of the agreements of September 13, 1922, and March 5, 1923, as part of the plan of reorganization was not considered until 1930. The petitioner was not formed or availed of in 1929 for the purpose of preventing the imposition of the surtax upon its shareholder through the medium of permitting its gains and profits to accumulate instead of being divided or distributed. The Commissioner erred in allowing as a deduction from the petitioner's income for 1929 losses of $37,662.50 and $25,740 claimed on the distribution of 2,300 shares of Loew's Inc. 6 1/2 percent preferred stock and 1,000 shares of Chase National Bank common stock. The Commissioner did not err in allowing the deduction of $45,106.98 claimed by the petitioner as accrued interest and fees payable to Munroe on the income from the securities transferred under the agreements of September 13, 1922, and March 5, 1923. OPINION. MURDOCK: The two issues raised by the respondent will be discussed first, since they may have some bearing upon the main issue. The case of 771 General Utilities & Operating Co. v. Helvering,296 U.S. 200">296 U.S. 200, is controlling on the question of whether the distribution of the Loew and Chase stocks resulted in deductible losses. The dividend resolution in that case provided for a dividend of a certain amount payable in a named stock at a declared valuation. The Court held that no sale of the stock resulted and the stock was not used to discharge an indebtedness. Here the dividend resolution was strikingly similar and no deductible losses resulted. The Commissioner erred in allowing the deductions claimed on the return for losses on the two stocks distributed. Cf. First Savings Bank of Ogden v. Burnet, 53 Fed.(2d) 919; Commissioner v. Columbia Pacific Shipping Co., 77 Fed.(2d) 759. The respondent has failed to show error in his allowance of the deduction of $45,106.98 claimed by the petitioner as accrued interest and a charge of one-fifth on income due to Munroe under the contracts of September 13, 1922, and March 5, 1923. The respondent 1169 concedes that an accrual and a charge in accordance with the terms of the agreements are proper deductions for 1929, 772 but argues that the correct figure is $14,010.79, not $45,106.98. The amount accrued and deducted for 1929 was computed in the same way that similar amounts were computed for all prior years. The evidence fails to show that the computation of the accrual for 1929 was not made in accordance with the intent of the contracting parties as expressed in their contracts. The contention of the respondent seems to be that no interest and no charge of one-fifth is properly accruable on income of prior years. The contract itself and the consistent interpretation of it by the parties are to the contrary. The deduction was properly allowed. The most important issue for decision is whether the petitioner is subject to tax under section 104 as a corporation "formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its gains and profits to accumulate instead of being divided or distributed." The decision of that issue must depend, in the final analysis, upon the facts in this particular case. It is, therefore, not surprising that the cases cited by the parties are only of general interest and require no detailed773 discussion. Both parties seem satisfied that all relevant facts are contained in the rather lengthy record. We have carefully considered all of that record, although not all of it has been set forth in detail in the findings of fact. The test of "purpose" necessarily depends upon the state of mind of the person or persons responsible for the formation and operation of the corporation. United Business Corporation of America,19 B.T.A. 809">19 B.T.A. 809; affd., 62 Fed.(2d) 754; certiorari denied, 290 U.S. 635">290 U.S. 635. Even though the effect of the formation and operation of a corporation may have been to avoid surtax upon the stockholders, still section 104 does not apply unless the parties in control had the intent and purpose described in that section. Cecil B. deMille Productions, Inc.,31 B.T.A. 1161">31 B.T.A. 1161; affd., 90 Fed.(2d) 12; certiorari denied, 302 U.S. 713">302 U.S. 713; C. H. Spitzner & Son, Inc.,37 B.T.A. 511">37 B.T.A. 511; R. L. Blaffer & Co.,37 B.T.A. 851">37 B.T.A. 851; affd., 774 103 Fed.(2d) 487; Mellbank Corporation,38 B.T.A. 1108">38 B.T.A. 1108. Here Munroe created the corporation and completely dominated its operation, so that the real question is, What was his purpose in the formation and operation of the petitioner? He has testified that he did not have the purpose described in section 104, either in the formation or the operation of the petitioner. However, he is an interested witness and we have considered, not only his categorical denial of the existence of the proscribed purpose, but also all other evidence which might show that his purpose was, in truth, different from what he says it was. 1170 There is a clear preponderance of evidence to show that the petitioner was not "formed" to avoid surtaxes upon Munroe through the means described in section 104. His primary purpose in forming the petitioner was to profit from the purchase of installment paper. Although he might have had additional purposes, and although some surtaxes may have been avoided eventually, nevertheless, this record indicates no purpose in the formation of the corporation which would bring it within section 104. The only argument made by the respondent775 upon this point is that Munroe, a very astute and active man in avoiding taxes, obviously intended from the very beginning to utilize the two contracts, dated September 13, 1922, and March 5, 1923, to avoid tax not only upon himself (since he was on the cash basis and was to receive nothing for ten years, he reported no income) but also upon the corporation, which was using an accrual method whereby it could currently accrue and deduct items eventually payable to Munroe. He does not contend that the agreements were invalid, that Munroe was required by statute to report any items due him under the contracts, 1 or that the petitioner was not entitled under the statutes to accrue and deduct amounts in accordance with the agreements. Yet he attempts to find, in the fact that the contracts were so effective in saving and delaying tax, a purpose to avoid surtax upon Munroe through the medium of having the corporation accumulate its gains and profits instead of distributing them. 776 On sufficient answer to his argument it at once apparent. The moment the petitioner received anything under the contracts, it became indebted in a like amount to Munroe. It also had to accrue fees and charges on the receipts as amounts due Munroe. The Commissioner recognizes the propriety of these accounts. Thus the amounts due Munroe always were increasing more rapidly than the receipts under the contracts were being accumulated, and those receipts were not increasing the accumulated "gains and profits" of the petitioner or any fund from which dividends of the petitioner could come. The petitioner was permitted to use funds accumulated under the contracts to transact other business from which it might derive gains and profits of its own. But if it had had no business 1171 transactions, aside from receipts under the contracts, it would have had no accumulation of gains and profits to distribute as dividends and no surtaxes upon its shareholder could have been avoided. The large surplus which it accumulated was not the result of receipts under the contracts, but came from wholly different transactions. Although the contracts may have avoided or delayed tax on Munroe, 777 they do not bring section 104 into play, since their use did not serve to avoid surtax on Munroe through the medium of permitting the gains and profits of this petitioner to accumulate instead of being distributed as taxable dividends to Munroe. Munroe may have been tax conscious and his contracts may have been cleverly drawn to save him from tax, but still this petitioner is not subject to tax under section 104 unless the facts are within the provisions of that section, which Congress has made so definite and specific. Although the foregoing discussion disposes of the only argument presented by the respondent on the purpose of formation, nevertheless we have considered the evidence from other angles. The history of the corporation during a reasonable period immediately following its incorporation shows that it was using large amounts in the purchase of installment paper but was not successful in accumulating sufficient working capital of its own. It had a paid-in capital of only $6,000 and, at the beginning of 1926, it had accumulated a surplus of only $18,175.30. It began to have greater financial success in 1926, about the time that it ceased purchasing installment notes. 778 But Munroe did not foresee that situation when he formed the petitioner. The evidence does not supply any sound basis for a finding that the purpose in forming this petitioner was such as to bring it within section 104. The respondent next argues that the petitioner was "availed of" during the period 1922 to 1928, inclusive, for the purpose described in section 104 and the section applies, since Munroe did not include in his gross income for 1929 all of the net income of the corporation. He does not argue that the failure of the petitioner to distribute in 1929 the surplus accumulated in prior years is important. The words of the statute, the legislative history of section 104 and its antecedents, and the general scheme of the revenue acts taxing income upon an annual basis show that Congress intended to apply section 104 in case a corporation was "availed of" within the taxable year through the medium of permitting its gains and profits of that year to accumulate, but did not intend to tax a corporation under section 104 merely because it had been availed of in other years or because it did not distribute a surplus accumulated in prior years. the income tax acts have779 always taxed income upon an annual basis and many terms which could refer to a different period 1172 are generally understood to refer to an annual period without any express statement to that effect appearing in the acts. Income, gross income, net income, and dividends are examples. Although some terms, particularly those relating to deductions, are expressly qualified so that they can refer only to the taxable year, nevertheless, where a term is used and is not expressly defined as relating to the taxable year, it is generally so understood. Thus the natural meaning to ascribe to the words "gains and profits" in section 104 is the gains and profits of the taxable year. Furthermore, the use of the words "to accumulate" instead of some such phrase as "to remain accumulated" 2 is significant. Earnings of prior years may remain accumulated during the year but are not permitted "to accumulate" during that year. If Congress had intended to penalize the corporation for accumulating a surplus in prior years or for failing to distribute such a surplus in the taxable year, it would hardly have measured the penalty by the earnings of the current year or relieved the corporation780 from the penalty upon condition that the earnings of the current year were distributed to or reported by the stockholders. See subsection (d), which permits the corporation to escape the tax if the stockholders report the net income of the corporation for the particular year as a part of their gross income. The thought back of this "escape clause" was that the penalty should not be imposed upon the corporation if the stockholders, like partners, reported the earnings of that particular year. See Committee Reports on section 220, of the Revenue Act of 1921. The Senate Finance Committee said, when it approved of the counterpart of (d) as section 220(e) of the Revenue Act of 1926, that there could be no avoidance of surtax on earnings if the stockholders reported their shares of the net income "and the reason for the imposition of the 50 per cent tax on the corporation no longer exists." S. Rept. 52, p. 22, 69th Cong., 1st sess. Thus it appears that Congress was thinking in terms of current income and current gains and profits when it enacted the provisions of section 104. The Bureau has always interpreted similar provisions as referring to "gains and profits" of and "availed of" 781 in the current taxable year. O.D. 188, 1 C.B. 182; I.T. 1572, C.B.II - 1, 139. The decisions of the Board are to the same effect. United Business Corporation of America,33 B.T.A. 83">33 B.T.A. 83; remanded, C.C.A., 2d Cir., Aug. 31, 1936; Almours Securities, Inc.,35 B.T.A. 61">35 B.T.A. 61; affd., 91 Fed.(2d) 427 (C.C.A., 5th Cir.); certiorari denied, 302 U.S. 765">302 U.S. 765; Dill Manufacturing Co.,39 B.T.A. 1023">39 B.T.A. 1023. Consequently, a detailed discussion of events of prior years is not necessary here, even though those 1173 events might show that the corporation was or was not availed of prior to 1928 for the proscribed purpose. They are important only in so far as they may tend to show a purpose, or lack of purpose, in 1929. The argument of the respondent on the question of whether the petitioner was "availed of" in 1929 is relatively short. He attempts to show that the "gains and profits" for the purpose of section 104 were $977,909.35; the distributions782 were limited to $350,000 so that Munroe would escape tax; no liability for the 1927 tax or interest thereon was accrued or accruable in 1929; and the contracts of 1922 and 1923 with Munroe, the losses realized by him upon stock transfers to the petitioner in 1929, and the loans to Munroe, show a purpose to avoid tax, as does the "repeat" attempt to avoid tax through the reorganization of 1930 contemplated in 1929. The claim of the Commissioner, made in his brief, that the correct amount of "gains and profits" for 1929 was $977,909.35 is not supported by the pleadings or the proof but, on the contrary, is shown by the proof to be erroneous. He includes in that total the amount received during the year under the contracts of 1922 and 1923, contrary to his action in determining the deficiency, and he disregards the increase in the amounts due Munroe which he has heretofore allowed to offset those receipts in computing the deficiency. The words "gains and profits" are not defined in the statute. However, it is obvious that in this case they are not greater than the net income as defined in section 104(c). The later amount, as determined by the Commissioner in the notice of deficiency, 783 was $671,817.78. The pleadings and proof show that the only proper increase in that figure is $63,402.50, the amount disallowed as loss on the Loew and Chase stocks. Thus the correct amount of net income as defined in section 104(c) is $735,220.28. The petitioner contends that this figure must be reduced by several items in order to arrive at "gains and profits" within the meaning of those words as used in section 104. The first item is the income taxes for the year 1929 under section 13 as finally determined, and the Commissioner agrees that those taxes are a proper adjustment in arriving at "gains and profits." The correct amount of those taxes under this opinion will be about $73,700. The petitioner also contends that the shrinkage in value of its securities should be deducted from "net income." The Board, however, has held to the contrary. Rands, Inc.,34 B.T.A. 1094">34 B.T.A. 1094. The other two items which the petitioner would use to reduce "net income" in arriving at "gains and profits" are interest of about $120,000 and lawyers' fees in the amount of $16,666.66. The interest is the amount which accrued during 1929 on the large deficiency for 1927. 784 The lawyers' fees were incurred in 1929 in connection with the 1927 tax 1174 controversy. Both of those items, although not entered on the books as expenses of 1929, were actually incurred as expenses in that year and were later paid. Perhaps they should have been accrued on the books as expenses of 1929. Lucas v. American Code Co.,280 U.S. 445">280 U.S. 445. The petitioner contends only that they are items which must be considered in determining how much of the earnings of 1929 were permitted to accumulate instead of being distributed. It may be argued that there is as much justification for reducing "net income" by those two items in order to arrive at "gains and profits" as there is for reducing "net income" by the income taxes for 1929. The taxes for 1929 under section 13 have a direct relation to the year 1929 and will have to be paid. The Commissioner apparently recognizes that earnings, to the extent of the taxes, will not be permitted to accumulate, but will be used to pay the taxes, even though they may serve to swell the book surplus at the end of the year. The situation is exactly the same in relation to the interest on the deficiency for 1927 and785 the attorneys' fees. All three of the items were incurred during 1929 but not accrued on the books. The interest and attorneys' fees were actually paid in 1930, whereas the taxes have not been fully paid at this time. The amounts necessary to pay those items were accumulated only temporarily. It is difficult to see any distinction unfavorable to this petitioner between the taxes for 1929 and the interest for 1929 on the unpaid deficiency for 1927. The "gains and profits" for 1929 were either $524,853.62, or $661,520.28, depending upon whether or not the interest and attorneys' fees are proper adjustments to "net income" in order to arrive at "gains and profits." It may be pertinent to determine the amount of the "gains and profits" actually permitted "to accumulate" during 1929. The distribution of the dividend eliminated $413,402.50 from surplus and that amount of the "gains and profits" for the year was not permitted "to accumulate." The basis and book value of the Loew and Chase stocks was $409,902.50, and the distribution of those stocks eliminated that amount from the assets of the petitioner, despite the fact that the distribution was described as a dividend of $350,000, 786 and the petitioner is not entitled to deduct any loss under section 23. But not all of the "gains and profits" for the year were distributed. The amount permitted to accumulate was either $111,451.12, or $248,117.78, depending upon the treatment to be accorded the interest and attorneys' fees above described. The fact that these "gains and profits" were permitted to accumulate raises the issue but is not determinative of that issue. The important question is, Was there any intention on the part of the corporation and its controlling stockholder, Munroe, to avail of the corporation in 1929 for the purpose of preventing the imposition of the surtax upon Munroe through the 1175 medium of permitting those "gains and profits" of the corporation to accumulate instead of being divided or distributed? It is appropriate, in order to answer that question, to consider the amount of "gains and profits" which Munroe thought the petitioner had towards the close of 1929 and what he proposed to do with theses "gains and the close of 1929 and what he proposed to do with these "gains and Munroe had an estimate made at that time to determine what amount would be available for distribution787 and would not be needed to pay expenses incurred during the year. The estimate was honestly made and convinced Munroe that about $350,000 would be accumulated unless it was distributed. This figure was arrived at by eliminating one-tenth of the gain from the Laclede sale, which the Commissioner had insisted was income of 1927 rather than income of 1929 as shown on the books. That left earnings of about $560,000. It was known that the petitioner had agreed to pay the large deficiency for 1927, interest would have to be paid on that deficiency, and the interest accruing during 1929 would amount to about $120,000. It was also known that lawyers' fees in the amount of $16,666.66 had been incurred in 1929 in connection with the tax controversy and would have to be paid. The taxes for 1929 were estimated at about $61,000. Munroe believed that all of those obligations were proper charges against 1929 earnings in determining the amount of those earnings available for distribution. It was estimated that the securities of the petitioner had depreciated in value to the extent of about $90,000. Munroe thought that allowance would have to be made for that shrinkage in determining the amount788 of 1929 earnings available for distribution as a dividend. He concluded that a distribution of $350,000 would be proper, would represent a complete distribution of the "gains and profits" for the year, would permit none of those "gains and profits" to accumulate, and, therefore, would relieve the corporation from all possibility of tax liability under section 104. It now appears, as shown in the preceding paragraph, that the correct amount of "gains and profits" was somewhat in excess of his estimate. The fact that his estimate later turned out to be erroneous is not so important as the fact that it was honestly made in an effort to distribute the earnings of the petitioner as Munroe saw them. The errors which were made were not inexcusable ones. The evidence as a whole indicates that Munroe did not want to take any chances on the application of section 104, but intended to distribute all of the available "gains and profits" of the petitioner for 1929 and to permit none of those "gains and profits" to accumulate. Such an intent is inconsistent with a purpose to avail of the petitioner to avoid surtax upon Munroe through the medium of permitting its "gains and profits" to accumulate. 789 1176 Munroe filed a return for himself showing a loss and if he had had the matter in mind, he would have thought that his return could absorb tax-free even larger distributions from the petitioner. But apparently he was not thinking so much of the tax significance of the distribution to himself as he was of its importance to the corporation. The record does not support the respondent's claim that the amount of the dividend was fixed so that Munroe would not have any tax to pay. The figures used in the estimate, as well as other evidence in the record, corroborate Munroe's testimony that he had no purpose to avail of the petitioner in 1929 to avoid surtaxes upon himself through the medium of permitting its gains and profits to accumulate instead of being distributed. Furthermore, a "large portion of its earnings for the year in question" were distributed, a fact which also negatives intent to avoid surtaxes and brings the petitioner within Article 542 of Regulations 74, to the effect that the presumption of section 104(c) is thus overcome. The importance of the 1922 and 1923 contracts has been discussed already and merits no further mention. 790 The fact that Munroe in 1929 discharged indebtedness to the petitioner by transfer of securities and thereby sustained deductible losses seems to have little or no significance for present purposes. The reorganization, which occurred in 1930, does not have any bearing whatsoever upon the present question, even though the Board has held that it was a nontaxable reorganization. C. A. Munroe, supra.The loans to Munroe in 1929 and those made in prior years do not show a purpose within section 104. They did not weaken the financial position of the petitioner and they were not disguised dividends of the earnings of the corporation. Cf. Helvering v. National Grocery Co.,304 U.S. 282">304 U.S. 282; United Business Corporation, supra; William C. deMille Productions, Inc.,30 B.T.A. 826">30 B.T.A. 826; A. D. Saenger, Inc.,33 B.T.A. 135">33 B.T.A. 135; affd., 84 Fed.(2d) 23; certiorari denied, 299 U.S. 577">299 U.S. 577. Munroe gave his notes for the amount of the loans, paid the interest in full, and paid the principal. There is every indication that he at all times intended to pay them. Cf. 791 Charleston Lumber Co. v. United States,20 Fed.Supp. 83; United States v. Tway Coal Sales Co., 75 Fed.(2d) 336. The petitioner had substantial income from the loans to Munroe, particularly in the year 1929. Furthermore, Munroe made loans to the petitioner and the latter was indebted to him for a large amount under the contracts. We can not find in the loan situation any purpose to avoid surtax upon Munroe by permitting the gains and profits of 1929 to accumulate. The petitioner made its greatest profit from the sale of the Laclede stock in 1927. It attempted to spread the tax from that transaction over a period of ten years by taking Munroe's notes for the purchase price. It was not, however, a scheme to avoid taxes. Neither does 1177 it demonstrate any purpose within section 104 applicable to the year 1929. The Commissioner has refused to consider any of that gain as gain for 1929. Both parties gave considerable time and thought to the trial and briefing of this case. All of the evidence and all arguments presented have been carefully considered in an effort to determine correctly whether section 104 applies. This opinion792 would be entirely too long were it to contain a detailed discussion of all of the many points argued. We have concluded upon the entire record that section 104 does not apply. Reviewed by the Board. Decision will be entered under Rule 50.OPPEROPPER, dissenting: While the section which is being resisted is penal in its nature, 1 the evil Congress intended to restrict by its enactment is clearly recognizable, 2 and one may assume that the application of the statute was intended so that it would be effective for the purposes for which it was designed. See Foster v. United States,303 U.S. 118">303 U.S. 118. What was within the manifest intention of the legislative body should be considered as much a part of legislation as what is included in its express terms. Helvering v. New York Trust Co.,292 U.S. 455">292 U.S. 455. And this rule does not yield to any effort to make the statute bear less heavily upon those subject to its operation. Helvering v. Stockholms Enskilda Bank,293 U.S. 84">293 U.S. 84. 793 This is not to say that a technical construction of the section will fail to sustain respondent's position in this case, but merely that overlooking the main purpose of the provision so that we permit ourselves to be lost in a maze of detail will more easily result in an erroneous conclusion. The purpose of section 104 clearly was to penalize the intentional avoidance of surtaxes upon individuals by the intervention of corporations. Congressional Record, vol. 50, part VI, p. 5319. That precise result has been accomplished by the use of this petitioner. Since the conclusion that the section does not reach this case is at war with its evident purpose, only an unmistakable prohibition in the language of the act itself should preclude its application. Petitioner's sole stockholder succeeded from 1922 to 1929 in escaping all individual income tax on the earnings of the securities he transferred to petitioner.3 This was the direct result of the plan disclosed by the present facts. It is not unreasonable to assume that 1178 a result so clear and inevitable was also a purpose, at least in the absence of countervailing proof. 794 R. L. Blaffer & Co.,37 B.T.A. 851">37 B.T.A. 851; affd., 103 Fed.(2d) 487 (C.C.A., 5th Cir.); certiorari denied, 308 U.S. 576">308 U.S. 576. He was enabled to accomplish this purpose by three elements in the plan: First, the creation of petitioner; second, the terms of the security transfers; and third, the failure to mesh the corporation's accrual method with the individual's cash basis. Because all three part of the plan were necessary to enable the shareholder to escape surtax, it does not follow that the corporation was not formed for that inhibited purpose. Itf formation was as much an integral and essential part of the scheme as either of the other elements. And because that was not its only purpose it does not follow that the impact of the section is averted. R. L. Blaffer & Co., supra.795 Petitioner must, therefore, it seems to me, be regarded as having been formed for the purpose of avoiding the imposition of surtax upon its shareholder, a result which so far brings the situation meticulously within the most technical reading of the first portion of the section. The majority opinion does not take a contrary view, but rejects the conclusion that this was to be done by permitting the gains and profits of petitioner to accumulate instead of being divided or distributed. That depends upon how we define the words "gains and profits" as used in section 104. There is no express limitation to "net" gains and profits. 4 Whether the provision must be restricted to such net gains in the ordinary and natural application 1179 of the section need not be considered. Clearly petitioner here had gains and profits before it set off against them the corresponding accrued liabilities to its shareholder. It seems obvious that Congress could not have intended the term "gains and profits", whether net or gross, to mean those resulting from an artificial calculation pursuant to a clever device for frustrating the fundamental purpose of the very provision in which the term796 appears. Cf. Gregory v. Helvering,293 U.S. 465">293 U.S. 465. It requires no more penetration than it did in that case to conclude that the organization of petitioner and its accrual of these "expenses" was a mere "disguise for concealing its real character and the sole object and accomplishment of which was the consummation of a preconceived plan * * . To hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose." (Pp. 469, 470.) But for the ingenious terms of the contracts there would have been no such accrued "expenses." Without the accruals there would clearly have been gains and profits in the strictest sense. The contracts pursuant to which petitioner made book entries purporting to offset these gains and profits with "debts" to the shareholder were an integral part of the very scheme by which the shareholder was to avoid surtax. 797 Moreover, these gains and profits were permitted - in fact, under the plan of petitioner's organization, were required - to be accumulated instead of being divided or distributed. That the ultimate division or distribution - the payment for contributed capital - would be in the bookkeeping form of compensation rather than dividends can not change the actuality of the gains and profits, or the fact of their accumulation. See Foster v. United States, supra.Viewed from the standpoint of reality, this corporation was formed, whether or not it was also availed of, 5 for the very purpose which the intent and a fair construction of the language of section 104 will easily cover. We should not permit a long and roundabout path to lead to a different place from the one to which the straight path would take us. Minnesota Tea Co. v. Helvering,302 U.S. 609">302 U.S. 609. I am of the opinion that respondent properly sought to apply section 104 to this petitioner. SMITH, STERNHAGEN, TURNER, ARNOLD, and HARRON agree with this dissent. Footnotes1. Total interest payments for 1928, 1929, and 1930 are not disclosed by the record. See sec. 10 of the Revenue Act of 1916, as amended by sec. 1206(2) of the Revenue Act of 1917; sec. 104(c) of the House Bill of the Revenue Act of 1928. 2↩ Loans outstanding on October 7, 1930. 1. Deficit. ↩1. He apparently has thought, in determining the tax liability of Munroe, that the case of Fremont C. Peck et al., Executors,31 B.T.A. 87">31 B.T.A. 87; affd., 77 Fed.(2d) 857; certiorari denied, 296 U.S. 625">296 U.S. 625↩, was not in point. There, some securities were loaned to a corporation under a contract somewhat like the one involved in the present case. The corporation had power to sell the securities, but was required to pay to the lender at the end of the period the amount of the dividends which it received on the stock. Although the lender was on the cash basis and did not receive the dividends, nevertheless, she was required to include them in her income for the years in which they were received by the borrower. 1. See Helvering v. Mitchell,303 U.S. 391">303 U.S. 391, 405↩. 2. Mead Corporation,38 B.T.A. 687">38 B.T.A. 687, 700↩. 3. Petitioner is obviously giving expression to a misconception when it says in its brief: "But there is no proof in this case of minimizing taxes. The record shows that with the exception of a small profit in 1923 ($5,264.95) the company had net losses for the first five years of its existence (Exhibit 38). During that same period Munroe's net income was less than the losses sustained by the corporation (Exhibit 39). It follows, therefore, that if he had made the transactions which were made by the corporation and sustained the same losses, all his income for those years would have been wiped out, and he would have had large net losses to carry forward." The "net losses" to which petitioner refers were those taken for income tax purposes. They were evidently arrived at by deducting from gross income the accrued "liabilities" consisting not only of all of the income received on the securities contributed by Munroe, but of 20 per cent thereof in addition, or of 7 per cent interest on the proceeds of sales. Naturally these accruals could not have been deducted by Monroe if he had been receiving the income and reporting it for tax purposes. And of course the larger the income from these securities and the smaller the petitioner's income from other sources, the greater would be its net loss, since the receipt of income from that source required it to accrue as a "liability" a greater amount than the income received. For example, petitioner's tax return for the calendar year 1925 shows a gross income of $179,442.17. Of this $114,346.30 is income from interest and dividends and only $14,554.84 is gross profit from its operations. The balance represents capital gains. Against this, in addition to the offsetting deduction for dividends from domestic corporations, it deducted $141,892.99 as "interest." It was thus enabled to show a "net loss", but its dividend and interest income was eight times as great as its operating income. If the bulk of this came from the securities contributed by Munroe or their proceeds, which seems certain, it is manifest that Munroe's net income for 1925 of $23,024.06 would have been augmented three or four times over for surtax purposes if he had retained the securities instead of transferring them to petitioner. ↩4. See Revenue Act, 1928, section 22(a), where "gains" and "profits" are used in the definition of gross income. Cf. G.B.R. Oil Co.,40 B.T.A. 738">40 B.T.A. 738↩ dealing with the term "earnings and profits." 5. See Reynard Corporation,37 B.T.A. 552">37 B.T.A. 552, 562↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624560/	IVAN N. and BOZENA C. HORVAT, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentHorvat v. CommissionerDocket No. 3103-77.United States Tax CourtT.C. Memo 1978-153; 1978 Tax Ct. Memo LEXIS 364; 37 T.C.M. (CCH) 679; T.C.M. (RIA) 780153; April 19, 1978, Filed Ivan N. and Bozena C. Horvat, pro se. Robert J. Percy,365 for the respondent. DAWSONMEMORANDUM FINDINGS OF FACT AND OPINION DAWSON, Judge: This case was assigned to and heard by Special Trial Judge Edna G. Parker pursuant to the provisions of section 7456(c) of the Code. 1 The Court agrees with and adopts the Special Trial Judge's opinion which is set forth below. OPINION OF THE SPECIAL TRIAL JUDGE PARKER, Special Trial Judge: Respondent determined a deficiency of $2,137.99366 in petitioners' Federal income tax for 1973. The four issues are (1) the proper computation of the sick pay exclusion for each spouse, (2) the deductibility of certain items as medical expenses, (3) the amount deductible for an office or offices in the home, and (4) the deductibility of automobile expenses as business expense. FINDINGS OF FACT Petitioners Ivan N. Horvat and Bozena C. Horvat, husband and wife, resided in Monroeville, Pennsylvania, at the time of filing the petition in this case. They filed a timely joint Federal income tax return for 1973. Sick Pay ExclusionBoth petitioners were employed full-time by Westinghouse Electric Corporation, the husband as an engineer and the wife as a draftsperson. On their 1973 joint return they excluded from their gross income an amount of $4,700 as sick pay. Mrs. Horvat was absent from her employment because of illness from March 23, 1973 through August 26, 1973. From March 23, 1973 through April 30, 1973, she continued to receive her full regular salary, but thereafter she was placed on the disability roll and received $87 per week under Westinghouse's insurance benefit plan. She returned to work on August 27, 1973. 367 Respondent excluded the first 30 days (March 23, 1973 to April 21, 1973), during which Mrs. Horvat continued to receive her full regular salary. Respondent then applied the sick pay exclusion of $20 per day to the remaining six work days that she continued to receive her regular salary, for a total sick pay exclusion of $120. Respondent concedes that the $87 per week benefit is excludable as sick pay, but no part of the $87 per week benefit had been included in the wife's W-2 or reported in income. As a result of surgery Mr. Horvat was absent from his job with Westinghouse from August 20, 1973 until October 6, 1973. After his return to work on October 7, 1973, he thereafter missed work intermittently, as follows: Hours Absent 5-day weekWorkedSicknessHolidayTotal10/7/73 to 10/11202004010/14/73 to 10/18251504010/21/73 to 10/25251504010/28/73 to 11/137304011/4/73 to 11/840004011/11/73 to 11/15162404011/18/73 to 11/2204004011/25/73 to 11/29024164012/2/73 to 12/6373040Total20014416360 He continued to receive his full regular salary from Westinghouse368 for all periodsof absence from August through December, 1973. Respondent excluded the first 30 days (from August 20, 1973 through September 18, 1973) in recomputing Mr. Horvat's sick pay exclusion. Respondent allowed a sick pay exclusion of $260 (13 working days X $20 per day) for the period of September 19, 1973 through October 6, 1973 when he returned to work, but nothing thereafter. Of the $4,700 claimed by petitioners as sick pay exclusion, respondent allowed $380. Medical DeductionsPetitioners deducted as medical expense $447.10 for a hearing aid, which was disallowed on the ground that the hearing aid was purchased for a relative or some other person who was not a dependent. Petitioners now concede that the item was not a proper medical deduction. Petitioners also deducted $342 as "physical therapy." That amount represented the expenses of lodging, meals, and travel of Mrs. Horvat on a trip she and her husband took to Florida in July of 1973. Mrs. Horvat had certain back problems in 1973, but the record does not show the nature of her back problems or her doctor's diagnoses, treatments, or prescriptions, if any, for that condition. On audit and at trial369 petitioners claimed as medical deductions the expenses of bringing two persons over from Yugoslavia. Mrs. Horvat's absence from work because of illness began on March 23, 1973. On May 16, 1973, she paid the air fare for a Mr. and Mrs. Kos-Tusek for a round-trip flight by JAT charter for the period July 26 through November 8, 1973. Some time in July of 1973 Mr. and Mrs. Horvat took the trip to Florida as indicated above. On or about July 26, Mr. and Mrs. Kos-Tusek arrived in this country. The Kos-Tuseks were related to Mrs. Horvat in some way. Neither Mr. nor Mrs. Kos-Tusek was a doctor, nurse, physical therapist or any other type of qualified medical person. There is a vague suggestion that Mrs. Kos-Tusek may have been some type of practical nurse, but the record does not show her qualifications, if any. Mrs. Horvat returned to her job on August 27, 1973. Shortly before that date, Mr. Horvat entered the hospital and on August 20, 1973, he was operated on, having an internal and external hemorrhoidectomy, ulcerectomy, and sphincterotomy. Mr. Horvat returned to his job on October 7, 1973. Mr. and Mrs. Kos-Tusek returned to Yugoslavia on or about November 8, 1973. During370 their stay with petitioners, Mrs. Kos-Tusek may have given Mrs. Horvat occasional back rubs or massages. The Kos-Tuseks were not qualified to and did not render any medical services or treatments to either Mr. or Mrs. Horvat. There is no proof that the Kos-Tuseks performed any services at all, except possibly household or domestic work. Petitioners claim as medical deductions the following expenses incurred in connection with the Kos-Tuseks: Round-trip air fare fromYugoslavia and return$ 474Mileage in United States117Meals756Salary (12 weeks X 5 days X8 hours X $2.50 per hour)$1,200Total$2,547Offices in the HomePetitioners deducted $1,200 as the expense of maintaining two offices in their home in 1973. Respondent allowed $204.90 of that amount. Petitioners relied on what they claim was the fair rental value of the house, and the computed two-fifths (two of five rooms) of the alleged fair rental value and utilities, plus certain furnishings. Respondent allowed one office (one of seven rooms) and computed one-seventh of the depreciation, utilities and insurance for the house. Depreciation was based on the cost of the house ($37,000) 371 less the value of the land ($12,000) over a 30-year life. There is no evidence in the record as to the fair rental value of petitioners' house in 1973. Petitioners' house contained three bedrooms, a living room, a family room, two and a half baths, a two-car garage and a basement laundry room.The Court finds as a fact that the house contained a kitchen, and that there were seven rooms in the house, rather than five. Mr. Horvat carried on a television and radio repair business from about 1971 to 1973. However, that business had become unprofitable and was completely abandoned sometime in 1973. Petitioners had engaged in some investment activity over the years. However, based on Mr. Horvat's study of the market in 1972 and his conclusion that the market would be very bad in 1973, they stayed out of the market completely in the year 1973. Automobile ExpenseOn their Schedule C for the television and radio repair business for 1973, petitioners reported gross receipts of $853.48. They deducted as business expense both a mileage allowance and certain itemized auto expenses as follows: Mileage (372 miles X $.15 a mile)$ 55Car repairs236Car depreciation$1,260372 Petitioners owned two cars, the one in issue being the Mercedes Benz. The Mercedes was purchased in 1969 at a price of $5,165 (quoted European delivery), plus some $300- $500 more for customs duties and other charges.The car was placed into business use in 1971. Respondent determined the value of the car at the time it was converted to business use to be $3,000. Petitioners claimed a higher value of $7,500, but there is no evidence to support that figure. There is no dispute as to most of the items of actual expense, specifically the items of insurance, repairs and gas as listed in the statutory notice. The only item in dispute is depreciation. Respondent used the value of the car of $3,000. From this, he deducted $800 salvage value, and depreciated the resulting $2,200 over a three-year life. This resulted in a figure of $733.33 for depreciation, which was added to the other items of actual expense, for a total of $887.27. Respondent then determined that five percent of that amount, or $44.35, represented business use of the car. The proper figure for mileage allowance was $.12 per mile, rather than the $.15 used by petitioners. The corrected mileage allowance for373 the 372 business miles driven in 1973 was $44.64. Since the mileage allowance was slightly larger than the actual itemized automobile expenses, respondent allowed the higher mileage allowance figure. OPINION Sick Pay ExclusionAt all times pertinent to this case, the Code allowed certain "sick pay" to be excluded from gross income. 2 Petitioners challenge respondent's imposition of a 30-day waiting period for this sick pay exclusion. They say there is no waiting period at all, and the the sick pay exclusion begins the first day of their respective periods of illness. They also disagree with respondent's imposition of a new 30-day waiting period to Mr. Horvat, after he had returned to work on October 7, 1973, from his first period of illness. Finally, they claim sick pay exclusion for the $87 per week benefits that had not been included in the wife's W-2, nor reported in income for the year. 374 Section 105 provided that gross income did not include amounts received under wage continuation plans when an employee was "absent from work" on account of personal injuries or sickness. There were complex requirements governing computation of the sick pay exclusion. Section 105(d) provided that: (d) Wage Continuation Plans.--Gross income does not include amounts referred to in subsection (a) if such amounts constitute wages or payments in lieu of wages for a period during which the employee is absent from work on account of personal injuries or sickness; but this subsection shall not apply to the extent that such amounts exceed a weekly rate of $100. The preceding sentence shall not apply to amounts attributable to the first 30 calendar days in such period, if such amounts are at a rate which exceeds 75 percent of the regular weekly rate of wages of the employee (as determined under regulations prescribed by the Secretary or his delegate). If amounts attributable to the first 30 calendar days in such period are at a rate which does not exceed 75 percent of the regular weekly rate of wages of the employee, the first sentence of this subsection (1) shall not apply to the extent375 that such amounts exceed a weekly rate of $75, and (2) shall not apply to amounts attributable to the first 7 calendar days in such period unless the employee is hospitalized on account of personal injuries or sickness for at least one day during such period. If such amounts are not paid on the basis of a weekly pay period, the Secretary or his delegate shall by regulations prescribe the method of determining the weekly rate at which such amounts are paid. Thus, the sick pay exclusion was limited to a maximum weekly rate of $100, and there were waiting periods in some instances. Whether or not there was a waiting period before the exclusion applied depended upon two factors: (1) the proportion of salary covered by the wage continuation payments and (2) any hospitalization of the taxpayer. There was no waiting period if (1) the sick pay was 75 percent or less of the regular weekly wage rate and (2) the taxpayer was hospitalized for at least one day during the period. There was a 7-day waiting period if (1) the rate of sick pay was 75 percent or less of the regular weekly wage rate and (2) the taxpayer was not hospitalized during the period. There was a 30-day waiting period376 if the sick pay was more than 75 percent of the regular weekly wage rate, and this was true whether or not the taxpayer was hospitalized during the period. Here both spouses received more than 75 percent of their regular pay, 100 percent in fact, during their first 30 days of absence from work. Thus, respondent properly applied the 30-day waiting period requirement to them. Kellner v. Commissioner,T.C. Memo 1976-72">T.C. Memo. 1976-72, 45 P-H Memo. T.C. par. 76,072, 35 TCM 326, affd. 39 AFTR 2d 893, 77-1 USTC par. 9236 (2d Cir. 1977). The next issue is whether or not Mr. Horvat had to serve a new waiting period once he had returned to work on October 7, 1973. Section 1.105-4(e), Income Tax Regs., expressly provides that: The 7- or 30-day waiting period (whichever is applicable) applies to each period of absence from work because of personal injury or sickness, regardless of the frequency of such absences or the closeness in time to any prior period of absence from work because of personal injury or sickness. * * * Example (1). Employee A is absent from work because of sickness on Tuesday, January 7, 1964, and returns to work on the morning of Thursday, 377 February 13, 1964. He suffers a relapse and again becomes absent from work on the afternoon of Thursday, February 13, 1964. A's return to work on the morning of Thursday, February 13, 1964, terminates the first period of absence from work because of sickness, and a new period of absence from work because of sickness begins on the afternoon of Thursday, February 13, 1964. Mr. Horvat returned to work on October 7, 1973, and that terminated his period of sickness. For any days of intermittent absence from work after his initial return to work, he again received his full regular salary. To be eligible to exclude more sick pay from his gross income, he would have had to have a consecutive absence of over 30 days. He did not have that at any time after October 6, 1973. Therefore, respondent properly applied a new 30-day waiting period. As to the $87 per week benefits that Mrs. Horvat received after she was placed on the disability roll by her employer, those payments are clearly sick pay, and respondent so concedes. However, they were never included in her W-2 wage statements and never reported in income by petitioners. In other words, those amounts had already been excluded from378 her gross income. What petitioners are suggesting would amount to excluding those amounts twice. Such a double benefit is clearly improper. There is no error in respondent's determination. Medical DeductionsMrs. Horvat had certain back problems in 1973. Petitioners deducted $342 as "physical therapy." That represented her meals, lodging, and travel on a trip she and her husband took to Florida in July of 1973. Mr. Horvat testified that the trip was taken on the "strong suggestion" of the physician who was treating his wife's back condition, and that the doctor "prescribed" a warm climate and swimming in salt water. The record does not establish that the trip to Florida was anything other than a vacation trip, and, as such, a purely personal nondeductible expense under section 262.See Commissioner v. Bilder,369 U.S. 499">369 U.S. 499 (1962). Petitioners now claim as a medical deduction some $2,547 in expenses for bringing two individuals, a Mr. and Mrs. Kos-Tusek, over from Yugoslavia, allegedly to care for Mrs. Horvat and possibly Mr. Horvat during their illnesses in 1973. These individuals were related to Mrs. Horvat in some way. They were not trained medical379 personnel, and did not render any medical services or treatments to either Mr. or Mrs. Horvat.Petitioners' testimony about these individuals was vague, evasive, and wholly unconvincing. The nature of the family relationship was never satisfactorily explained. The timing of the Kos-Tuseks' trip did not coincide with the periods of illness of either taxpayer. They didn't arrive until about the end of Mrs. Horvat's convalescence and they stayed on for a month after Mr. Horvat returned to work. The dates of their charter flight bore no relationship to the alleged purpose of their visit. On this record, the Court can only conclude that the Kos-Tuseks were relatives who simply came to visit the Horvats or to help out with the housework during their illnesses. Any expenses petitioners incurred in connection with these individuals were nondeductible personal expenses, not medical expenses. Offices in the HomePetitioners say they maintained two offices in their home in 1973.The two offices were not claimed in connection with petitioners' employment at Westing-house Electric Corporation, but in connection with their investment activity and a television and radio repair business380 the husband conducted in the home. At the outset there is a dispute as to the number of rooms in petitioners' house. It would seem that this would be a simple matter to prove. The number of rooms and floor plan of the house are readily susceptible of documentary proof, and are matters peculiarly within the knowledge of petitioners themselves. Respondent subpoenaed the architectural drawings of the house, but petitioners did not produce them.Nor did petitioners present any photographs, drawings, sketches, or anything else to show the floor plan. The record contains only the vague and confusing testimony of Mr. Horvat. He admitted that the house contains three bedrooms, a living room, a family room, two and a half baths, a two-car garage, and a basement laundry room. That would seem to be six rooms right there, not the five petitioners claim.3 But the glaring omission would seem to be a dining room and kitchen, or at least a kitchen. When questioned about this, Mr. Horvat testified that the kitchen was a mere "niche," a part of the living room. The Court found the witness to be evasive and his testimony wholly unconvincing. Petitioners have failed to sustain their burden of381 proof on this factual issue. The Court finds as a fact that the house has seven rooms. The next issue is whether one or two rooms were used as offices. In view of the fact that petitioners completely withdrew from the stock market in 1973 and that the television and radio repair business had become unprofitable and was finally completely abandoned sometime during that year, the Court is not persuaded that two rooms in the house were used as offices. Both petitioners had full-time jobs with Westinghouse when they were able to work, and both petitioners had long periods of absence from work because of illness that year. Also from about July 26 through November 8, 1973, there were two more individuals, Mr. and Mrs. Kos-Tusek, living in the house with petitioners. On this record we conclude that at most only one room was used as an office. As to petitioners' computations of the fair rental value of their382 home, there is no evidence in the record to support their figures. Petitioners have not met their burden of proof, and there is no basis to change respondent's determination in regard to the office-in-the-home issue. Automobile ExpensesPetitioners deducted automobile expenses in connection with the television and radio repair business. They apparently no longer contend that they are entitled to both a mileage allowance and itemized actual automobile expenses. As to the itemized actual expenses, the only item still in dispute is depreciation. Petitioners have not presented any evidence to support a higher figure than respondent used for the value of the Mercedes Benz at the time it was converted to business use in 1971. Petitioners' principal objection to respondent's computation seems to be the five percent business use, petitioners contending that it should be 50 percent business use.Mr. Horvat's testimony on this matter was lacking in factual detail.He merely argued that it was somehow "unfair" to allow only a five percent business usage. Since the business miles actually driven in 1973, as reported by petitioners themselves, amounted to only 372 miles, the business*383 use of the car would appear to be minimal. That minimal usage is consistent with the fact that the business itself was failing and was actually abandoned some time during 1973. On this record, the Court has no basis to change respondent's determination. Since the figure for mileage allowance was slightly higher than that for itemized actual expense, respondent properly allowed petitioners the higher figure. Decision will be entered for the respondent. Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and as in effect during the pertinent tax year, unless otherwise indicated. This case was originally heard pursuant to the provisions of section 7463 as a small tax case, because the items placed in dispute did not exceed $1,500. However, in the course of the trial it became evident that the deficiency in dispute exceeded $1,500. The Court deleted the letter "S" from the docket number and assigned the case to Special Trial Judge Edna G. Parker for disposition pursuant to the provisions of section 7456(c) and Rules 180 and 181, Tax Court Rules of Practice and Procedure.↩ That order further provided that the provisions of Rule 182 shall not apply to the case.2. Section 505 of the Tax Reform Act of 1976 repealed the sick pay provision and substituted a new disability income exclusion of $100 per week available only to taxpayers under 65 who have retired on disability as permanently and totally disabled. Pub. L. 94-455, 90 Stat. 1525, 1566.↩3. In a written statement made during the audit, Mr. Horvat stated that the house had six rooms. When cross-examined about this letter at trial, he explained that he had used that figure strictly "for settlement purposes," an explanation the Court found unconvincing.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624561/	MYONG H. AND MI S. KIM, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentKim v. CommissionerDocket No. 23175-92United States Tax CourtT.C. Memo 1994-561; 1994 Tax Ct. Memo LEXIS 569; 68 T.C.M. (CCH) 1181; November 7, 1994, Filed 569 Decision will be entered under Rule 155. For petitioners: Leon Michael Rudloff. For respondent: Linda A. Neal. COHENCOHENMEMORANDUM FINDINGS OF FACT AND OPINION COHEN, Judge: Respondent determined a deficiency of $ 18,027 in petitioners' Federal income taxes for 1988 and additions to tax of $ 4,053 under section 6651(a)(1) and $ 4,507 under section 6661. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. The issues for decision are whether petitioners are entitled to additional Schedule A deductions; whether petitioners are entitled to reduced gross receipts and increased expenses in relation to a Schedule C janitorial service operated by petitioner Myong H. Kim (Mr. Kim); and whether petitioners are entitled to additional Schedule C deductions relating to an insurance agency operated by petitioner Mi S. Kim (Mrs. Kim). FINDINGS OF FACT Some of the facts have been stipulated, and the stipulated facts are incorporated in our findings by this reference. Petitioners resided in Arizona during 1988 and at the time they filed their petition. 570 From January 1, 1988, to August 15, 1988, Mr. Kim was an employee of Edifice Janitorial Company. On or about August 15, 1988, Mr. Kim and Edifice Janitorial Company entered into an Act of Sale of Equipment and Assignment of Contracts (the agreement). Under the agreement, Mr. Kim purchased seven specified building cleaning service contracts and certain cleaning equipment described in an attachment to the agreement. The agreement provided that Edifice Janitorial Company would not conduct the business of janitorial services within the State of Arizona for a period of 10 years from the date of the agreement and that Edifice Janitorial Company licensed to Mr. Kim the use of the name Edifice Janitorial Company in the State of Arizona during the noncompete period of 10 years. The consideration for the agreement was $ 6,387. Thereafter, Mr. Kim operated the janitorial business under the name Edifice Janitorial Service. Expenses relating to the janitorial business were sometimes paid from petitioners' personal checking account and were sometimes paid out of the business account that was maintained for the janitorial service. Some business expenses were charged on petitioners' American571 Express card, which was also used for personal expenses of petitioners. Petitioners did not maintain a cash receipts or cash disbursements journal or otherwise segregate in an organized manner their disbursements for business expenses from their disbursements for personal expenses. Mrs. Kim was employed by Prudential Insurance as an insurance agent from June through December 1988. Her wages earned during 1988 from Prudential Insurance totaled $ 12,009.25. She was also self-employed as an agent for other insurance companies from June through December 1988. In 1984, petitioners purchased a 1985 Buick Electra, agreeing to make 48 monthly payments commencing September 29, 1984. In 1988, petitioners purchased a 1988 Honda. In November or December 1988, they agreed to purchase a 1989 Ford Taurus station wagon. A $ 500 deposit was paid to the seller of the station wagon in November 1988. A contract of purchase for the station wagon was entered into December 22, 1988, and provided for payments beginning January 21, 1989. Petitioners did not keep any contemporaneous records of business mileage or the percentage of business use in comparison to personal use of the vehicles during 572 1988. On Schedule A attached to their U.S. Individual Income Tax Return for 1988 (Form 1040), petitioners claimed unreimbursed employee expenses of $ 4,625 relating to Mr. Kim's employment prior to August 15, 1988. The employee business expenses claimed included $ 750 in meals and entertainment expenses and $ 3,875 for 17,500 business miles on the 1985 Buick. Respondent concedes that $ 3,473 is deductible on petitioners' Schedule A as an employee business expense for 1988. On Schedule C attached to their 1988 return for Mr. Kim's janitorial service, petitioners reported gross receipts of $ 47,108 and claimed deductions of $ 46,175. On Schedule C attached to petitioners' 1988 return relating to Mrs. Kim's insurance sales, petitioners reported gross receipts of $ 1,871 and expenses of $ 7,734. The expenses claimed and the amounts now conceded by respondent in relation to petitioners' Schedule C businesses are as follows: JanitorialRespondentInsuranceRespondentExpensesConcedesExpenses ConcedesAdvertising$ 200 $ 0 $ 260 $ 0 Car and truck34408531,158Depreciation7,7414,7901,3030Insurance2,6966376780Interest008040Office expenses1,0509886030Rent2,00001,0000Supplies1,8732,39200Repairs003000Travel1,69301370Meals andentertainment 76906760Utilities andtelephone 1,2751,4707700Marketing003500Subcontract labor26,00723,45800Christmas party527000Total$ 46,175$ 33,735$ 7,734$ 1,158573 The rent deducted on the two Schedules C consisted of one-half of the rent paid by petitioners for their home during 1988. On a supporting schedule attached to the return, petitioners reported that the Honda was acquired in June 1988 and the 1989 Ford Taurus was acquired in October 1988. The automobile expenses claimed on Schedule C for the janitorial business included 7,200 business miles on the Ford Taurus. Petitioners claimed 23,200 business miles on Schedule C for the use of the Honda in the insurance business in 1988. The dollar amount deducted represented 90 percent of claimed actual expenses. Respondent's concessions are based on mileage allowances and include allowable depreciation on the automobiles. The Schedule C for the janitorial service claimed depreciation in the amount of $ 7,741, including $ 1,503 on the Ford Taurus, $ 5,000 pursuant to section 179, and $ 1,238 on cleaning equipment purchased in 1988. Respondent concedes that 75 percent of $ 6,387 (the consideration in the agreement for purchase of the janitorial service) is an expense for the purchase of the cleaning equipment deductible under section 179. Respondent determined that 25 percent of the purchase574 price was attributable to nondepreciable goodwill, cleaning contracts, and the covenant not to compete. Petitioners secured an extension to August 15, 1989, for filing their 1988 tax return. The return was not filed until May 25, 1990. The return was signed by a certified public accountant as preparer. In the statutory notice of deficiency sent July 15, 1992, respondent disallowed amounts claimed on Schedule A for reasons including failure to show that the amounts claimed were paid or were deductible in the category shown. The miscellaneous deductions were disallowed because they did not exceed 2 percent of the adjusted gross income determined by respondent. The standard deduction was allowed because it exceeded the allowed itemized deductions. Respondent disallowed the expenses claimed on Schedule C for the janitorial and insurance businesses. The stated reason was that: "you did not establish that the business expense shown on your tax return was paid or incurred during the taxable year and that the expense was ordinary and necessary to your business." The amounts disallowed in the statutory notice coincided with items claimed on the tax return. OPINION Petitioners bear575 the burden of proving that the determinations in respondent's notice of deficiency are incorrect. Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. , 112 S. Ct. 1039 (1992); Rockwell v. Commissioner, 512 F.2d 882">512 F.2d 882 (9th Cir. 1975), affg. T.C. Memo. 1972-133. Citing Zuhone v. Commissioner, 883 F.2d 1317 (7th Cir. 1989), affg. T.C. Memo. 1988-142, petitioners acknowledge that the statutory notice is presumed correct unless the taxpayer shows that the proposed assessment is arbitrary and excessive or without factual foundation. As in Zuhone, however, and the cases there cited at 1325-1326, petitioners have not shown here that the statutory notice is arbitrary, excessive, without factual foundation, or otherwise deficient. Petitioners rely solely on the difference between the deductions disallowed in the statutory notice and the deductions conceded by respondent prior to trial as evidence of arbitrariness. Petitioners complain that counsel for respondent asserted, in her opening statement, that petitioners did not respond to576 audit inquiries and did not substantiate any deductions until after the statutory notice was sent. Petitioners assert: "the arbitrary and capricious exception does not apply where the taxpayer refused to make his books and records available. Lysek, Edward, TC Memo 1975-293, aff'd 583 F.2d 1088">583 F.2d 1088 (CA 9 1978). Herein, there was no evidence presented that petitioners ever refused to make books and records available." Petitioners, however, bear the burden of proving the arbitrariness of the statutory notice and did not present any evidence that they responded in any way to audit notices or presented records prior to the time of the statutory notice. As appears in our findings of fact, the statutory notice specifically disallowed the expenses because of petitioners' failure to substantiate them. In analogous circumstances, the Court of Appeals for the Ninth Circuit in Clapp v. Commissioner, 875 F.2d 1396">875 F.2d 1396, 1402-1403 (9th Cir. 1989), stated: While appellants place great weight on the disparity between the amounts of the notices of deficiency and the amounts of deficiency in the stipulated judgments, 577 much of the disparity was the result of attributing income to both the individuals and the trusts in the alternative, an acceptable practice. As for the remaining disparity, the notices of deficiency are perfectly clear: the taxpayers refused to provide information substantiating their deductions at the time of audit, and the deductions were therefore disallowed. During the Tax Court proceedings, appellants substantiated their deductions and the Commissioner thereafter willingly stipulated to deficiencies of far lower amounts. [Id. at 1402.]The Court of Appeals in Clapp declined to invalidate the statutory notice, as requested by the taxpayers, refusing to place on the Commissioner the burden to verify deductions through third-party records -- when faced with taxpayers who refuse to cooperate or provide the necessary information at their audit examinations. The Commissioner points out that it was taxpayers' duty to substantiate their deductions at the time of the audit examination and that the taxpayers failed to do so. [Id. at 1403]Although the Court of Appeals discussed alternative means of578 dealing with arbitrary notices, it did not suggest that a notice sent under the circumstances present in Clapp and present here is arbitrary or otherwise a justification for shifting the burden of proof, as demanded by petitioners here. None of the cases cited by petitioners supports their position. They continue to bear both the burden of presenting evidence and the burden of persuasion with respect to all items in dispute. The first item in dispute relates to gross receipts reported on Schedule C for the janitorial service. Although $ 47,108 was reported on the return, petitioners now contend that the correct amount of gross receipts is $ 38,112.64, based on an undated, handwritten schedule presented at trial. The author of the schedule was not identified. Mr. Kim testified, in response to the leading question of his counsel, only as follows: Q And that is all the income that you got out of the janitorial services during the period that you owned them? A In that year. Yes.The preparer of the tax return did not testify, and there is no evidence as to how the reported amount of gross income was calculated. In their reply brief, petitioners attempt to reconstruct579 the computation, not completely reconciling the numbers; these figures are based on conjecture not justified on this record. Under these circumstances, petitioners have failed to present cogent evidence sufficient to overcome the admissions on the tax return. Cf. Estate of Hall v. Commissioner, 92 T.C. 312">92 T.C. 312, 337-338 (1989). Petitioners also now contend that they are entitled to reduce their Schedule C income from the janitorial service by a $ 2,095.09 balance in the janitorial business bank account on December 31, 1988. Petitioners' contention in this regard is somewhat unintelligible. It seems to arise from the erroneous assumption that amounts received by petitioners' Schedule C business but "not distributed" to petitioners are not taxable to petitioners during the year in which they were deposited in the business bank account. Petitioners' position is unsupported by evidence, law, or logic. Similarly, petitioners' newly claimed deduction for repayments of "business loans" has no apparent basis in law or fact. The loans appear from the evidence to be, at most, the source of funds used for expenditures otherwise claimed as deductions. Petitioners580 fare no better with respect to their attempts to prove deductions beyond those conceded by respondent. The records produced at trial by petitioners consisted of disorganized copies of receipts, including receipts for personal expenses such as birthday gifts; one is marked "fragrance". Several exhibits contain different documents, such as canceled checks and receipts, relating to the same expenditures, suggesting duplication of amounts claimed as deductions. The expenses shown on the exhibits presented by petitioners do not coincide and cannot be reconciled on the record with the amounts reported on petitioners' tax return or the amounts conceded by respondent. The documentary evidence presented by petitioners is simply too unreliable to establish their entitlement to any deductions beyond those conceded by respondent. The testimonial evidence similarly was lacking. Mrs. Kim did not testify at all about the alleged insurance business expenses, notably 23,200 business miles claimed on the Honda from June through December. His counsel's attempt to secure Mr. Kim's testimony about the nature of automobile expenses, bank charges, and the annual fee for the American Express card 581 was contradicted by the documentary evidence or was negated by Mr. Kim's testimony or his admitted lack of knowledge. There was no testimony about when the Ford station wagon was placed in service, and the documents suggest that it was not before December 22, 1988. Thus, the claims on the tax return of depreciation from October and 7,200 business miles in 1988 are not credible. Moreover, the evidence as to certain expenses, such as travel and entertainment expenses and claimed home office expenses, failed to establish satisfaction of the statutory requirements of sections 274(d) and 280A. Petitioners also failed to present evidence relevant under Commissioner v. Soliman, 506 U.S. , 113 S. Ct. 701 (1993), with respect to the home office expense. Rent was apparently claimed on an annual basis for businesses operated only part of the year. With respect to the additions to tax, petitioners merely claim in their briefs that there are no additions to tax because there is no deficiency. They offered no reasonable cause that would negate the additions to tax under section 6651(a) for failure to file a timely return. Mr. Kim merely testified that582 he did not remember whether he requested an extension beyond August 15, 1989, and that he was too busy because of business to file his return on time. The addition to tax under section 6661 applies where there is a substantial understatement of income tax liability. An understatement is substantial if it exceeds the greater of $ 5,000 or 10 percent of the tax required to be shown on the return. Petitioners do not come within any of the exceptions set forth in that statute. If the recomputed deficiency determined under Rule 155 satisfies the statutory percentage or amount, petitioners will be liable for that addition to tax. To reflect respondent's concessions, Decision will be entered under Rule 155.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624562/	L. R. and Lulu McKee, Petitioners, v. Commissioner of Internal Revenue, RespondentMcKee v. CommissionerDocket No. 28650United States Tax Court18 T.C. 512; 1952 U.S. Tax Ct. LEXIS 168; June 12, 1952, Promulgated 168 Decision will be entered for the respondent. Respondent disallowed under section 24 (c) of the Internal Revenue Code additional salaries for petitioners' sons. Petitioner reported his income on the accrual basis, while his sons were on the cash basis. Petitioner's contention is that the contested salaries were constructively paid or constructively received to nullify condition 24 (c) (1) or (2), respectively. Held, that constructive payment does not constitute payment under section 24 (c) (1). Held, further, that under the facts there was no constructive receipt during the taxable years as required by section 24 (c) (2). Therefore, all conditions of section 24 (c) are present and the deduction is not allowed. Carl H. Lambach, Esq., for the petitioners.Marvin E. Hagen, Esq., for the respondent. Black, Judge. BLACK 512 The respondent has determined deficiencies in income taxes against petitioners as follows:YearDeficiency1946$ 43,656.28194797,050.65194849,643.14The explanation of the principal adjustment for 1946 is made in the deficiency notice as follows:(a) It is held that the deduction of $ 59,708.39 claimed on 170 your return for accrued but unpaid salaries to your two sons, Mr. Harry G. McKee and Mr. Clifford R. McKee, is not allowable for the reason that the prohibitions contained in Section 24 (c) of the Internal Revenue Code have not been overcome. Also it is held that the deduction for compensation for your sons' services is excessive to the extent of the accrued but unpaid salaries and that for this further reason the deduction of $ 59,708.39 is not allowable under the provisions of the Internal Revenue Code. * A similar adjustment and explanation was made for each of the taxable years 1947 and 1948. By appropriate assignments of error, petitioner contests the adjustment explained above for each year involved here. The other adjustments are not contested.In the event that the Court shall hold that petitioner is entitled to deduct the additional salaries in question, the parties have stipulated that additional salaries in amounts only as set forth below are considered reasonable compensation for services rendered by the two sons:Clifford R. McKee$ 25,0001946Harry G. McKee30,000Clifford R. McKee38,0001947Harry G. McKee48,000Clifford R. McKee30,0001948Harry G. McKee35,000171 513 The only issue remaining before the Court is whether petitioners' deductions for the additional salaries are not allowable under section 24 (c) of the Internal Revenue Code.FINDINGS OF FACT.Some of the facts have been stipulated and are found accordingly.The petitioners are husband and wife and reside in Muscatine, Iowa. Petitioners filed their joint individual income tax returns on the calendar year basis for the years 1946, 1947, and 1948 with the collector of internal revenue for the district of Iowa at Des Moines, Iowa.During the taxable years involved and for many years prior thereto, L. R. McKee, hereinafter referred to as petitioner, was engaged in the wholesale and retail feed and grain business. He conducted his business as a sole proprietorship under the names of McKee Feed and Grain Co., Hawkeye Soy Products Co., and Ladora Feed and Grain Co. Petitioner's sons Harry G. McKee and Clifford R. McKee worked in his business.Petitioner kept his books and filed his income tax returns on the accrual basis for the calendar years 1946, 1947, and 1948. However, both sons filed their returns for the calendar years 1946 through 1949 on the cash basis.Petitioner's172 son Harry came into the business about 1927 or 1928 and Clifford about 1939. At the end of World War II, in 1945, the sons came out of military service and a contract bearing the date February 1, 1946, was drawn up. This contract was not formally executed. Under the agreement the sons were to be paid compensation in addition to regular salaries, rather nominal in amount. The additional compensation was to be a percentage of the profits, after payment of petitioner's percentage of profit and petitioner's income tax. This contract was motivated by petitioner's desire to reduce his duties and impose upon the sons responsibilities of managing the business. During the taxable years involved, Harry was the general manager of the whole business and Clifford was the superintendent of the grain elevator and soy bean plant.During the taxable years involved petitioner paid his sons a regular salary as follows:194619471948Harry G. McKee$ 3,922.80$ 5,974.80$ 6,089.70Clifford R. McKee1,945.833,931.204,006.80Petitioner claimed these regular salaries as deductions on his income tax returns for 1946, 1947, and 1948, and respondent, in his notice of deficiency, 173 allowed these regular salaries as deductions.514 In his income tax returns for the years 1946, 1947, and 1948 petitioner claimed as deductions additional salaries to his sons as follows:194619471948$ 59,708.59$ 108,700.99$ 69,096.89Respondent in his notice of deficiency disallowed these additional salary deductions. The parties have stipulated that the reasonable additional salaries are as follows:194619471948Clifford R. McKee$ 25,000$ 38,000$ 30,000Harry G. McKee30,00048,00035,000Total$ 55,000$ 86,000$ 65,000Additional compensation for the sons was to depend upon the annual net profits. Petitioner determined the net profits at the end of the calendar years involved. The additional compensation due the sons was computed between January 15 and 20 for the preceding calendar year, and credited between those dates to various ledger accounts on petitioner's records in the names of the sons. The additional compensation was recorded as of December 31 of the year in which the compensation was accrued.The net worth of petitioner's business on December 31, 1946, was $ 223,893.99; on December 31, 1947, $ 278,008.71; 174 on December 31, 1948, $ 277,111.50; and on December 31, 1949, $ 306,187.77.All of petitioner's gross receipts from his business were deposited in his bank accounts and all business expenses were paid by check. The bank balances of petitioner varied during the periods from January 1 to March 16 in each of the years 1947 to 1949, inclusive. The largest bank balance and the smallest bank balance during those periods were as follows:1947Largest balanceSmallest balanceJan. 4$ 80,340.32March 14$ 5,931.811948Jan. 1200,871.05Jan. 2858,303.871949Jan. 3125,417.47March 145,297.13During the years 1946 to 1949, inclusive, petitioner, his son Harry, and the bookkeeper Anna Kent were authorized to draw checks on petitioner's bank accounts for McKee Feed and Grain Co. and Hawkeye Soy Products Co. Petitioner, his son Harry, and Ithel Gillespie were authorized to draw checks on petitioner's bank account for 515 Ladora Feed and Grain Co. The salary checks for the sons were drawn by petitioner, Harry, or Anna Kent.Clifford R. McKee was not authorized to draw checks on petitioner's bank accounts. Petitioner orally instructed Harry G. McKee, 175 Anna Kent, and Ithel Gillespie to draw checks for Clifford R. McKee's salary at his request.During the years 1946 to 1949, inclusive, petitioner had a line of credit with the Muscatine Bank & Trust Co. of Muscatine, Iowa, in the amount of $ 125,000. Additionally petitioner had an open line of credit from the MississippiValley Trust Company of St. Louis of a half million dollars and an open line of credit at Jefferson Bank and Trust Co. of St. Louis of not less than $ 100,000. Harry G. McKee and Clifford R. McKee had full authority to use such credit or to cause it to be used.Reference to the ledger accounts of the salaries accrued in the individual credit of the two sons, Harry and Clifford, will show that the amounts due them were actually withdrawn after the 15th of March in each of the years succeeding their accrual, but during the year. The individual tax returns of Harry G. McKee and Clifford R. McKee introduced in evidence by respondent as exhibits for the years 1947, 1948, and 1949, show that each of the sons included in his return of income for the years succeeding the years of accrual the additional salary so accrued to his individual credit upon the books and paid the176 tax thereon. L. R. McKee testified that he had no knowledge of any provision of law requiring his sons to actually reduce to possession salaries so accrued to their credit upon the books, nor to his knowledge did anyone else in the business know of such provision.Petitioner could and would have paid the additional salaries here in question prior to March 15 of each of the years following the earning of such additional salaries by his two sons, Harry G. and Clifford R., if he had known about the provisions contained in section 24 (c) of the Internal Revenue Code.OPINION.The single question presented here is whether respondent erred in disallowing deductions under section 24 (c) of the Code of additional compensation payable to petitioners' two sons. The applicable statute provides:SEC. 24. ITEMS NOT DEDUCTIBLE* * * (c) Unpaid Expenses and Interest. -- In computing net income no deduction shall be allowed under section 23 (a), relating to expenses incurred, or under section 23 (b), relating to interest accrued -- 516 (1) If such expenses or interest are not paid within the taxable year or within two and one half months after the close thereof; and(2) If, by reason177 of the method of accounting of the person to whom the payment is to be made, the amount thereof is not, unless paid, includible in the gross income of such person for the taxable year in which or with which the taxable year of the taxpayer ends; and(3) If, at the close of the taxable year of the taxpayer or at any time within two and one half months thereafter, both the taxpayer and the person to whom the payment is to be made are persons between whom losses would be disallowed under section 24 (b).It is well established that all three conditions set forth in section 24 (c) of the Code must coexist to prevent the deductions. Akron Welding & Spring Co., 10 T. C. 715; Michael Flynn Manufacturing Co., 3 T. C. 932, 936. The relationship of father and sons satisfies condition 24 (c) (3), which is conceded by petitioner.Petitioner argues that condition 24 (c) (1) is not met because of constructive payment. The salaries were not paid by petitioner within two and one-half months after the close of the taxable years involved here in cash, notes, or in any other form whatsoever. Constructive payment does not constitute payment178 under section 24 (c) (1). P. G. Lake, Inc., 4 T.C. 1">4 T. C. 1, affd. 148 F. 2d 898, certiorari denied 326 U.S. 732">326 U.S. 732; Ashe Electric Co. v. Commissioner, 153 F. 2d 295, affirming a Memorandum Opinion of this Court, August 11, 1944; Granberg Equipment, Inc., 11 T. C. 704, 717. Petitioner relies on Musselman Hub-Brake Co. v. Commissioner, 139 F. 2d 65, reversing on this point a Memorandum Opinion of this Court, November 10, 1942, which we distinguish because there the creditor received demand promissory notes which were worth their face value and constituted payment. We hold that condition 24 (c) (1) is present here.Petitioner argues that condition 24 (c) (2) is not met because the additional compensation was "includible in the gross income" of his sons, even though the sons were on the cash basis, under the theory of constructive receipt. For purposes of section 24 (c) (2), sums are includible in the gross income of a cash basis taxpayer if the doctrine of constructive receipt is applicable. Ohio Battery & Ignition Co., 5 T. C. 283;179 Michael Flynn Manufacturing Co., supra.In this case the additional salaries were not accrued on petitioner's books during the taxable years in which he claimed deductions. The additional salary due each son was computed annually, after making an allowance for paying petitioner's percentage of annual profit plus petitioner's income tax. The sons were not entitled to the additional salaries until the end of the respective calendar years. The salaries were computed and placed on the books between January 15 and 20 of each subsequent year. Both petitioner and his sons filed their returns 517 on the calendar year basis. Petitioner contends that the book entries plus the sons' unrestricted right and ability to obtain cash constitute constructive receipt.The above facts place the instant case within the ambit of McDuff Turner, 5 T. C. 1261, which held that condition 24 (c) (2) is applicable as follows:* * * The credits were included on the books only upon the completion of the audit of petitioner's books on or about May 15, 1942. Moreover, until the audit was completed the amount of the bonuses to be paid was not180 ascertained. Under the agreement the bonuses were not due until after the end of the taxable year and only then could the profits of the business be computed.During the taxable year there was no affirmative action on the part of petitioner or on the part of his daughters which can serve as a basis for constructive receipt of the money by the daughters. Neither of the daughters was authorized to withdraw against the bonus under any circumstances. The money was not available to them by the mere taking at any time prior to the completion of the audit. Though it may be, as the petitioner now says, that they could have drawn the money at any time they had need for it or asked for it, that, with nothing more, may not be construed as placing the payees in the position of having constructively received their money.Section 24 (c) (2) provides expressly that to allow the salary deduction, the salaries must be includible in the sons' incomes "for the taxable year in which or with which the taxable year of the taxpayer ends."In both the instant case and McDuff Turner, supra, the taxpayer's adult children had been employed for several years and were entitled181 to receive stipulated percentages of the net profit. Similarly sufficient funds were available, in either cash or potential credit, to pay those bonuses. In both cases, the credits to the children were recorded on the books as of December 31 of the taxable year. Had the children requested the additional salaries in advance in McDuff Turner, they could have received advances. In the instant case petitioner's son Harry could have written checks and petitioner's son Clifford could authorize checks drawn to him, after the credits were on the books. However, we do not think that these latter circumstances would serve to distinguish the instant case from McDuff Turner, supra.We hold that the additional salary expense is not includible in the gross income of the sons for the taxable year in which or with which the respective taxable year of petitioner ends. Therefore, condition 24 (c) (2) is also satisfied and the contested salary deductions are not allowed.Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624563/	JAMES J. FREELAND AND MAXINE FREELAND, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentFreeland v. CommissionerDocket No. 18708-82.United States Tax CourtT.C. Memo 1986-10; 1986 Tax Ct. Memo LEXIS 598; 51 T.C.M. (CCH) 253; T.C.M. (RIA) 86010; January 9, 1986. W. Gerald Thornton and David D. Dahl, for the petitioners. Edwina L. Wilson, for the respondent. SHIELDSMEMORANDUM FINDINGS OF FACT AND OPINION SHIELDS, Judge: Respondent determined that deficiencies in income tax and additions to tax are599 due from petitioners for the years 1977 and 1978 as set forth below: Additions to TaxYearDeficiencySec. 6651(a)(1) 1Sec. 6653(a)(1)1977$17,378.14$6,287.47$1,307.4919783,293.62164.68Due to concessions, the issues remaining for decision are: (1) whether certain litigation expenses incurred by petitioners in the defense of a foreclosure action constitute deductibel expenses or nondeductible capital expenditures; (2) whether litigation expenses incurred by petitioners in a separate corollary action in which they were named defendants and counter claimed for damages for slander of title constitute deductible expenses or nondeductible capital expenditures; (3) whether petitioners' failure to timely file their 1977 return was due to reasonable cause within the meaning of section 6651(a)(1); and (4) whether the underpayment, if any, in petitioners' income tax for 1977 or 1978 is due to negligence600 or intentional disregard of rules and regulations under section 6653(a)(1). 2FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulations and exhibits attached thereto are incorporated herein. At the time their petition was filed, petitioners resided in Hillsborough, North Carolina. They filed joint income tax returns for the years 1977 and 1978 with the Internal Revenue Service Center at Memphis, Tennessee. In 1941, petitioner, James J. Freeland, whose education ended in the sixth grade, started constructing houses and commercial buildings such as restaurants and motels. Some of his construction was done under contracts with other parties while some of it was done on land owned by petitioners.He continued to do such construction601 up through 1977 and 1978, the years under consideration. In 1964 he and Mrs. Freeland bought a tract of land containing 83 acres at an exit from Interstate 85 near Hillsborough. At that time, the tract was improved with three barns and an old house. Starting in 1965 and continuing through 1971, Mr. Freeland remodeled the barns and the house and personally constructed other buildings and improvements until the tract contained a motel, a campground, an amusement park, a restaurant, several stores and shops, a skating rink and other businesses, all of which were known as the Daniel Bonne Complex ("DBC"). Petitioners operated the motel and skating rink. The other businesses were operated by other parties under leases from petitioners. All of the improvements were of a primitive nature, since they were constructed from old wooden materials salvaged by Mr. Freeland from the demolition of other buildings. The construction stopped about the end of 1971 because of the bad health of both petitioners and they decided at that time to sell the complex. On May 2, 1972, petitioners entered into a contract to sell the DBC to Matthew N. and Genevieve D. Mezzanotte ("Mezzanottes") or their602 assignees. Shortly after entering into the purchase and sale agreement, the Mezzanottes assigned their rights therein to Daniel Boone Complex, Inc. ("DBC, Inc."), a new North Carolina corporation which they had organized. The Mezzanottes then sold all of the outstanding stock in DBC, Inc. to Camilco, Inc. ("Camilco"). All of Camilco's stock was owned by Linda Broyhill McGillan, who permitted DBC, Inc. to remain as a wholly owned subsidiary of Camilco. Under the original contract, the purchase and sale of DBC was to have occurred in 1972, but for several different reasons the sale was delayed until 1974. One of the reasons for the delay was a lawsuit instituted by the Mezzanottes and DBC, Inc. against petitioners in the Superior Court of North Carolina for specific performance on the contract of sale plus damages for the breach thereof. The Superior Court found for the plaintiffs and ordered petitioners to convey DBC to the purchasers in accordance with the sale contract and to pay them damages in the amount of $100,000. The decision of the Superior Court was affirmed by the North Carolina Court of Appeals and in January of 1974 the North Carolina Supreme Court declined to grant603 certiorari. Mezzanotte v. Freeland,20 N.C. App. 11">20 N.C.App. 11, 200 S.E.2d 410">200 S.E.2d 410 (1973), cert. denied 284 N.C. 616">284 N.C. 616, 201 S.E.2d 689">201 S.E.2d 689 (1974). By deed dated March 1, 1974, and recorded on March 15, 1974, petitioners conveyed DBC to DBC, Inc. At the closing of the sale, petitioners received $200,000 in cash and a promissory note for the balance of the purchase price of $1,085,000. The note was payable in 20 annual installments, commencing on March 1, 1975 and bore interest at the rate of 7 percent per annum, payable annually. The promissory note was secured by a deed of trust on the DBC land, buildings, and other improvements. It was also secured by a chattel mortgage on the furniture, fixtures and other personal property of DBC. Since the buildings and other improvements of DBC were particularly subject to destruction by fire, petitioners caused the following provision to be inserted in the deed of trust: That the said party of the first part [DBC, Inc.] will insure and keep insured the buildings and contents on the premises herein conveyed against loss by fire and wind-storm during the existence of this indebtedness in an amount satisfactory to the holder604 of the Note [petitioners] not to exceed the unpaid balance thereon and will assign said insurance to the holder of the Note as his interest may appear for the security of any and all amounts which may be due him; and, should the party of the first part fail to cause such insurance to be issued and assigned as aforesaid or fail to pay any premium therefore, then the said holder of the Note is authorized to effect such insurance or to make such premium payments as may be due, if he so elects, and such sums so paid shall be a lien against the said premises and immediately due and payable to the holder of the Note and shall be secured hereby to the same extent as the principal amount herein described. The purpose of the above insurance was to protect the security for the note taken by petitioners as part of the purchase price. However, DBC, Inc. failed to furnish petitioners at the closing with evidence of the insurance as required under the deed of trust. Consequently, after the closing of the purchase and sale, petitioners obtained the necessary fire and casualty insurance on the DBC property at a cost of $27,005 and demanded reimbursement for the cost of the insurance from DBC, 605 Inc. Subsequent to the closing, petitioners also became aware of the fact that DBC, Inc. had purchased certain building materials, supplies, and construction services on credit, had failed or refused to pay for the same, and had permitted liens to be filed against DBC, Inc. and its property, including DBC. During May, June, and part of July of 1974 petitioners through their attorney, Dalton Hartwell Loftin, who was also the trustee under the deed of trust, made several attempts to obtain reimbursement for the insurance from DBC, Inc. The attempts included letters to the effect that unless the terms of the deed of trust with respect to insurance were complied with foreclosure would be undertaken even though at that time there was no interest or principal due on the note. By letter dated July 2, 1974 DBC, Inc. was informed by petitioner's attorney that DBC, Inc. was in default under the deed of trust and the chattel mortgage because of its failure to reimburse petitioners for the cost of the insurance. On July 22, 1974 petitioners exercised their option to accelerate the total debt secured by the deed of trust and the chattel mortgage and, at their request, the trustee gave notice606 of sale of the realty pursuant to the deed of trust and of the personalty pursuant to the chattel mortgage. This action was recommended to petitioners by their counsel because of the failure of DBC, Inc. to make any response to his demands for reimbursement of the insurance premium and because in his opinion foreclosure was necessary in order to clear the property of the liens filed by creditors of DBC, Inc. The foreclosure sale was originally scheduled for August 23, 1974, but on August 21, 1974, DBC, Inc. and others filed a complaint against petitioners and the trustee under the deed of trust in the Superior Court in which they sought both temporary and permanent injunctive relief from the pending foreclosure sale. Plaintiffs in the lawsuit were granted a temporary restraining order, but on August 28, 1974 the restraining order was dissolved and the foreclosure occurred on August 30, 1974. At the sale, petitioners made the highest bids for the real property under the deed of trust and the personal property under the chattel mortgage. After the foreclosure, sale, DBC, Inc. and the other plaintiffs amended their complaint so as to seek to have the foreclosure set aside with an607 award for damages for the interim loss of profits or, in the alternative, an award for damages for the loss of the property. At the trial, the plaintiffs elected to seek damages only and abandoned their attempt to recover DBC. On July 11, 1975, the Superior Court granted a motion by plaintiffs for partial summary judgment to the effect that the deed of trust and chattel mortgage had been wrongfully foreclosed. On appeal by petitioners, the North Carolina Court of Appeals reversed the partial summary judgment and remanded the matter to the Superior Court for further proceedings. On August 19, 1977, a decision was entered by the Superior Court in which it was held that the foreclosure was valid and that the plaintiffs were not entitled to any damages from petitioners. The plaintiffs appealed the decision to the Court of Appeals but while the appeal was pending petitioners, on December 24, 1977, paid $11,000 to the plaintiffs in full settlement of the matter. At the same time that DBC, Inc. joined in the wrongful foreclosure proceeding against petitioners, DBC, Inc. also joined in a separate corollary action in the Superior Court of Orange County, North Carolina. In this action, 608 petitioners counterclaimed for damages for slander of their title to the DBC property. This action was dismissed on August 12, 1977. 3In connection with the two suits, petitioners incurred and paid litigation expenses in the years 1977 and 1978 in the respective total amounts of $34,650.00 and $11,316.44. The 1977 expenditures consisted of $20,200.00 in attorney fees, the $11,000.00 in settlement of the foreclosure suit, and $3,450.00 in witness fees in the same suit. The 1978 expenditure of $11,316.44 consisted entirely of attorney fees. An exact allocation of the attorney fees as between the foreclosure action and the corollary matter cannot be made from the record. The parties, however, stipulated that only a "minor portion" of the total in attorney fees was incurred in connection with the corollary action. For 35 years prior to 1977, petitioners' income tax returns were prepared by R. C. Neighbors, an accountant, from information furnished by petitioners. Their information for the 1977 return was also turned over to Mr. Neighbors and at his request respondent granted609 an extension of time until June 15, 1978, in which to file the 1977 income tax return. No further extensions were requested. The 1977 return of petitioners was filed on January 25, 1979. OPINION Litigation ExpensesPetitioners contend that all of the legal fees, witness expenses and settlement costs incurred in the wrongful foreclosure action as well as the corollary matter are ordinary and necessary expenses incurred by them in an effort to collect, or protect the ultimate collection, of the interest bearing (income producing) note which they received in the sale of DBC and are deductible under section 212(1) and (2). 4Respondent's first contention is that the legal fees, witness expenses and settlement costs were incurred by petitioners in the defense or610 perfection of title to DBC and are nondeductibel capital expenditures under section 263(a). 5Spangler v. Commissioner,323 F.2d 913">323 F.2d 913, 919 (9th Cir. 1963), affg. T.C. Memo. 1961-341; sections 1.263(a)-2(c) and 1.212-1(k), Income Tax Regs. Secondly, respondent argues that the litigation expenses should be capitalized because the origin of the litigation was in the original sale of a capital asset. Reed v. Commissioner,55 T.C. 32">55 T.C. 32 (1970); Anchor Coupling Company, Inc. v. United States,427 F.2d 429">427 F.2d 429, 433 (7th Cir. 1970), cert. denied 401 U.S. 908">401 U.S. 908 (1971). In determining whether legal fees and other litigation expenses are deductible under section 212 or must be capitalized under section 263(a) the origin of the litigation is the controlling test; and under this test, if the claim has its origin in the acquisition of a capital asset, no ordinary expense deduction611 is allowable. Woodward v. United States,397 U.S. 572">397 U.S. 572 (1970); United States v. Hilton Hotels,397 U.S. 580">397 U.S. 580 (1970). In determining whether the underlying transaction is capital in nature, the search for the origin of the claim is not limited to a simple determination of the first event in a chain which led to the litigation but, instead is "an examination of all the facts * * to [ascertain] the 'kind of transaction' out of which the litigation arose." Boagni v. Commissioner,59 T.C. 708">59 T.C. 708, 713 (1973). In other words, the test includes a consideration of "the nature and objectives of the litigation, the defenses asserted, the purpose for which the claimed deductions were expended, the background of the litigation, and all facts pertaining to the controversy." Boagni v. Commissioner,59 T.C. at 713. Examination of all the facts pertaining to the controversy involved in this case clearly indicates that the wrongful foreclosure action was filed against petitioners by DBC, Inc. after and in direct response to petitioners' declaration of a default on the note, their exercise of the option to accelerate the installment612 payments, and their initiation of foreclosure proceedings. Consequently, all fees and other litigation expenses incurred by petitioners in connection with the issuance of the temporary restraining order, its dissolution by the trial court, the subsequent trial, the appeal and its subsequent settlement were all directly attributable to the foreclosure proceedings. It is apparent, therefore, that in this case the "kind of transaction out of which the litigation arose" was a foreclosure action of which the "nature", "objective" and "purpose" was to remove the title to DBC from DBC, Inc. Since petitioners were the successful bidders at the foreclosure sale, the end result of the transaction was a reacquisition of the title to DBC by petitioners. Therefore, all of their litigation expenses are attributable to the reacquisition of title and are not deductible under section 263(a). Petitioners contend, however, that the foreclosure was instituted solely to collect their note, an income producing asset, and that fees and other expenses incurred in connection with such collection activity even on a note or other evidence of debt received in the sale of a capital asset is deductible under613 Doering v. Commissioner,39 T.C. 647">39 T.C. 647 (1963), affd. 335 F.2d 738">335 F.2d 738 (2d Cir. 1964), and Naylor v. Commissioner,203 F.2d 346">203 F.2d 346 (5th Cir. 1953), revg. 17 T.C. 959">17 T.C. 959 (1951). Their reliance in this case on those opinions is misplaced, however, because in both Doering v. Commissioner,supra, and Naylor v. Commissioner,supra, the litigation in which the disputed expenses were incurred did not result in the acquisition of title by the taxpayers. Here, the end result of the transaction was the acquisition of title. Consequently, all expenses incurred in connection with the transaction are reflected in the cost of the asset or assets acquired. We see no reason why this result would be affected by the fact that at the beginning of the foreclosure petitioners may not have intended to acquire title but only to collect their note. Their motive or purpose at that time is not controlling. Yates Industries, Inc. v. Commissioner,58 T.C. 961">58 T.C. 961 (1972). Neither party has devoted much discussion to the portion of the attorney fees paid by petitioners with respect to the second suit614 in the Superior Court. They did stipulate that it was a "corollary action" to the wrongful foreclosure suit and that only a "minor part" of the total in attorney fees was attributable to it. In any event, we note that petitioners' counterclaim was for slander of title which clearly leads to an inference that their defense to the suit was based upon a claim of title. Consequently, the deduction of this portion of the attorney fees is not allowable because expenditures to defend title or to assert slander of title are also capital in nature. Spangler v. Commissioner,323 F.2d 913">323 F.2d 913 (9th Cir. 1963), affg. T.C. Memo 1961-341">T.C. Memo. 1961-341. Failure to File Timely ReturnRespondent determined that petitioners are liable for the addition to tax provided by section 6651(a)(1) for failing to timely file their 1977 income tax return. Petitioners contend that they are not liable for the addition to tax because they relied in good faith upon their accountant of 35 years to make a timely filing on their behalf with the information which they had provided. Unfortunately for them, the Supreme Court has recently held that the failure to make "a timely filing of a tax return615 is not excused by the taxpayer's reliance on an agent, and such reliance is not 'reasonable cause' for a late filing under section 6651(a)(1)." United States v. Boyle, 469 U.S. (1985). Since petitioners' reliance upon the accountant is their sole defense to the addition to tax under section 6651(a)(1), they have failed to overcome the presumption that respondent's determination with respect to the addition is correct. Therefore, respondent's determination with respect to the addition under section 6651(a)(1) is sustained. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rule 142(a). NegligenceIn the statutory notice, respondent determined that the deficiencies in tax due from petitioners for 1977 and 1978 were due to their negligence or intentional disregard of rules and regulations. Petitioners have the burden of proving this determination to be incorrect. Pritchett v. Commissioner,63 T.C. 149">63 T.C. 149 (1974); Bradley v. Commissioner,57 T.C. 1">57 T.C. 1 (1971). Respondent contends that petitioners' deduction of the litigation expenses constitutes negligence under section 6653(a) because such expenses clearly constituted "nondeductibel616 capital expenditures." Under the circumstances outlined in our findings, we are unable to agree with respondent inasmuch as this particular question has been the subject of a great deal of litigation over a number of years and both lawyers and accountants who are thoroughly familiar with the subject and the numerous cases on the point frequently disagree as to whether an item constitutes a deductible expense or a capital expenditure. Therefore, we are unable to find that the deduction in this case by petitioners constituted negligence or the intentional disregard of rules and regulations. Decision will be entered under Rule 155.Footnotes1. All section references are to the Internal Revenue Code of 1954, as in effect during the years in issue, unless otherwise indicated. All rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise provided.↩2. Petitioners have assigned error to respondent's allowance of additional depreciation deductions in 1977 and 1978 and an additional sales tax deduction in 1977. These adjustments arise from respondent's determination that the litigation expenses in issue must be capitalized instead of expensed. Consequently, the depreciation and sales tax adjustment issues will be resolved by the outcome of the first two issues.↩3. While the record is unclear, the action was apparently dismissed by agreement of the parties.↩4. Section 212 provides: In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year-- (1) for the production or collection of income; (2) for the management, conservation, or maintenance of property held for the production of income; or (3) in connection with the determination, collection, or refund of any tax.↩5. Section 263(a) provides in relevant part: (a) GENERAL RULE.--No deduction shall be allowed for-- (1) Any amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate. * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624564/	Barkley Company of Arizona, Petitioner v. Commissioner of Internal Revenue, RespondentBarkley Co. v. CommissionerDocket No. 6954-85United States Tax Court89 T.C. 66; 1987 U.S. Tax Ct. LEXIS 96; 89 T.C. No. 7; July 9, 1987. July 9, 1987, Filed 96 Respondent received documentary evidence 2 days prior to trial and did not offer it to petitioner for purposes of stipulation in accord with Tax Court Rule 91 and the requirements of an outstanding pretrial order. Respondent, instead, held the document for impeachment purposes, which is an exception to Rule 91 and the pretrial order. At the conclusion of the trial, respondent offered the document to impeach documents in the record and petitioner's entire position. Held, that documentary evidence may not be held or reserved to "impeach" documents or an adversary's position and that the concept of impeachment applies to a specific witness' veracity. Peter C. Guild, Max K. Boyer, and Richard C. Smith, for the petitioner.Patricia Beary, for the respondent. Gerber, Judge. GERBER66 OPINIONPetitioner, following the trial and before submission of briefs, moved to exclude a document that respondent had offered at trial, which the Court had conditionally received, leaving the parties to address the question of admissibility on brief. The parties have presented their legal arguments in the motion and objection to same, and we deem it appropriate to rule upon 97 the admissibility of the document, preliminary to the filing of briefs addressing the substantive issue(s). The substantive issue(s) in this case involves whether petitioner is entitled to a stepped-up basis in realty in connection with a series of transactions in a related corporate group. Upon advice of petitioner's tax advisors, realty was sold in an attempt to raise capital, following a series of corporate transactions. Respondent, in reacting to the form of transaction, disallowed petitioner's use of a stepped-up basis.On March 25, 1985, petitioner filed a petition in this Court and, in part, argues that we should disregard the form and look to the substance of the transaction. 1 On July 67 3, 1985, petitioner and others instituted a suit against their tax advisors in an Arizona State court by means of a complaint sounding in "Contract, Tort and Breach of Fiduciary Duty." At issue here is the admissibility into evidence of the complaint filed in that proceeding, "Exhibit P" (hereinafter referred to as malpractice complaint).98 Respondent argues that: (1) The malpractice complaint constitutes and was properly employed as impeachment evidence regarding Louise Barkley Braden (Louise); and alternatively, that (2) the malpractice complaint may be offered (at the end of a trial) to "impeach" the documentary evidence received at the trial; and (3) that the malpractice complaint otherwise is admissible as an admission by petitioner. Petitioner argues that the malpractice complaint was (1) offered untimely, violating the Court's pretrial order; 299 (2) otherwise irrelevant; and (3) offered in such a manner as to surprise petitioner. 3Respondent first saw and obtained a copy of the malpractice complaint on December 8, 1986, the date of the calendar call involving this case. The trial of this case took place on December 10, 1986, and the parties offered a stipulation of facts consisting of 23 paragraphs with 15 attached exhibits. Respondent chose to reserve the complaint as impeachment evidence, rather than offer it for stipulation or in anticipation of its use.At trial, petitioner called a single witness, Louise, who gave brief testimony. Louise was the wife of the now deceased businessman who was involved with petitioner. Her testimony revealed that her knowledge about the company was limited to some100 involvement after her former husband's death. She mainly confirmed some stipulated 68 facts and stated that she knew of no business purpose for the transactions in dispute.Following Louise's testimony, petitioner rested and respondent called no witnesses. Instead, respondent offered the malpractice complaint as "impeachment evidence." At trial, respondent stated that the malpractice complaint impeached petitioner's entire position in this case. Respondent did not rely upon the malpractice complaint as impeaching Louise's testimony directly.We note at the outset that it is no surprise that the allegations of the malpractice complaint seek to show a tax result which is the exact opposite of that sought in the petition to this Court. In essence, the malpractice proceeding is the petitioner's remedy if it is unsuccessful in this case, and the corollary is also true. There is nothing unusual about pleading or advancing alternative positions, even in the same proceeding, as respondent is many times required to do. Rule 31(c), Tax Court Rules of Practice and Procedure; Doggett v. Commissioner, 66 T.C. 101">66 T.C. 101, 103 (1976). We now consider whether 101 the malpractice complaint was timely offered and is otherwise admissible into evidence.Impeachment QuestionRule 607 of the Federal Rules of Evidence permits impeachment of a witness by any party. One common method of impeachment is by a prior inconsistent statement. 4 Respondent presents the novel argument that the malpractice complaint should be admitted to impeach the documents already stipulated to and to impeach petitioner's position in this case.We turn first to whether Louise's testimony is factually inconsistent with the malpractice complaint. Louise testified that the corporations were deeply in debt and could not service the debt from current earnings. Upon advice of petitioner's tax advisors, a plan was devised to enter into corporate transactions and sell off some real property. Louise also testified102 that she knew of no "pure business justification for the reorganization of Western Arizona69 Development Company to make it a subsidiary of Barkley Company."Respondent contends that the malpractice complaint "alleges that the purpose of contributing the capital stock of Western Arizona Development Co. to Barkley Co. of Arizona was to pay various debts of plaintiffs in that action at the least tax cost to them." Our reading of the malpractice complaint is that it contains allegations that Louise's former husband's estate tax liability created debts and the various plaintiffs (including petitioner) were deeply in debt. These debts generated the need to sell a portion of the corporate real property and certain corporate transactions were entered into, upon advice of the tax advisors, to facilitate that end. In other words, the factual allegations are substantially the same. Accordingly, there is no factual inconsistency, rather only an inconsistency of the conclusion that the facts may support. That conclusion will be one of the determinations that we will be asked to address in the substantive portion of the case.We now consider respondent's proposition that, without petitioner's103 knowledge, respondent may hold a document until the conclusion of a trial, and then offer it to "impeach" any or all of the documentary evidence that had been received in the record. We view respondent's argument as having two fatal flaws.First, by definition "impeachment" is: "To call in question the veracity of a witness, by means of evidence adduced for that purpose, or the adducing of proof that a witness is unworthy of belief." Black's Law Dictionary 886 (4th ed. 1951). Respondent cannot "impeach" documents (inanimate objects) without regard to the source of those documents (the maker or other qualified person). Secondly, respondent offered the malpractice complaint in an untimely fashion, only after petitioner had rested its case and respondent stated that he had no witnesses to testify on his behalf. 5 Accordingly, we find that respondent's offer of the 70 malpractice complaint to "impeach" documentary evidence must be rejected.104 Admission QuestionOur discussion concerning impeachment is somewhat dispositive of the admission question. The problem here is respondent's timing. Respondent failed to comply, to the extent possible, 6 with our pretrial order and Rule 91 of this Court's Rules of Practice and Procedure, which required or ordered the parties to stipulate and exchange documents. 7 Respondent's failure to comply under these circumstances was prejudicial to petitioner and presented the type of surprise that the pretrial order and Rule 91 of this Court's Rules of Practice and Procedure were designed to obviate.*105 In view of the foregoing, petitioner's motion to exclude (Exhibit P from evidence) is granted and,An appropriate order will be entered. Footnotes1. On Aug. 29, 1985, petitioner filed an "Amendment to Petition."↩2. The Court's pretrial order, which was sent to the parties 3 months before trial, ordered the parties (in pertinent part) to stipulate all documentary and written evidence, "unless authenticity is questioned or the evidence is to be used to impeach the credibility of a witness." Additionally, the parties were ordered to exchange documentary evidence, as follows:"Any documents or materials which a party expects to utilize in the event of trial (except for impeachment), but which are not stipulated, shall be identified in writing and exchanged by the parties fifteen (15) days before the call of the calendar [Dec. 8, 1986]. The Court may refuse to receive in evidence any document or material not so stipulated or exchanged, unless otherwise agreed by the parties or allowed by the Court for good cause shown."↩3. Petitioner's attorneys in this case are different from those representing petitioner in the malpractice proceeding. Petitioner's attorneys were unfamiliar with the malpractice complaint and requested and received a recess to read it before they were able to make responses to respondent's offer of this document. Furthermore, respondent's attorney did not advise the Court of her intention to use the malpractice complaint.↩4. The inconsistent statement could be received merely to show the inconsistency, but would not necessarily be received in evidence for the truth of the matters stated therein. Fed. R. Evid. 801(c)↩.5. We do not doubt that respondent could have offered the malpractice complaint for the truth of the matters stated through Louise when she was on the stand. Fed. R. Evid. 801(c) and 801(d)(1)↩. Without the use of a witness, however, the document has hearsay problems and the rules require that Louise have the opportunity to explain any inconsistencies and/or to adopt the document as her own.6. Even though respondent received the malpractice complaint only 2 days prior to the commencement of trial, it could have been offered to petitioner prior to trial.↩7. It is clear that factual allegations contained in pleadings which have been superseded by amended pleadings in the same proceeding may be admissible as an admission by a party. Weinstein on Evidence, par. 801(d), at 801-10, and par. 801(d)(2)(D), at 801-137 (1978); Frank v. Bloom, 634 F.2d 1245">634 F.2d 1245, 1251↩ (10th Cir. 1980). A more difficult question is whether a party's pleading in one case may be used as an evidentiary admission in other litigation, the very situation with which we are confronted. Because of respondent's untimely proffering of the malpractice complaint, we do not have to reach that question here. At the very least, however, the party against whom an admission is being offered should be entitled to an opportunity to explain the alleged admission, analyze the effect of the document on its case, and consider and explore the existence of additional evidence which may contradict or mitigate such an admission.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624567/	B. H. Bickers and Lucille M. Bickers v. Commissioner. B. H. Bickers v. Commissioner.Bickers v. CommissionerDocket Nos. 72575, 73385.United States Tax CourtT.C. Memo 1960-83; 1960 Tax Ct. Memo LEXIS 207; 19 T.C.M. (CCH) 440; T.C.M. (RIA) 60083; April 29, 1960207 Held, petitioners have failed to prove by a preponderance of evidence that they suffered deductible gambling losses in excess of $21,682 for 1953 and $46,219 for 1954. These amounts should be allowed as offsets to the amounts of admitted wagering gains of petitioner B. H. Bickers in the respective taxable years. Held, further, additions to taxes for negligence or intentional disregard of rules and regulations sustained. Henry Klepak, Esq., Texas Bank Building, Dallas, Tex., for the petitioners. David E. Mills, Esq., for the respondent. BLACK Memorandum Findings of Fact and Opinion Respondent has determined deficiencies and additions to taxes of the petitioners as follows: Amount ofAdditionsPetitionersYearDeficiencyto Tax B. H. Bickers andLucille M. Bickers1953$15,740.83$ 787.04B. H. Bickers195446,097.202,304.86The deficiency for 1953 is due to the addition to the net income shown on joint return of "(a) Losses $32,300.00." This adjustment is explained in the deficiency notice as follows: "(a) In your income tax return 208 for the year 1953 you reported $13,200.00 from ventures determined as follows: "Total winnings$45,500.00Total losses32,300.00Net winnings$13,200.00"Since you failed to substantiate any losses the amount of $32,300.00 claimed as such is hereby disallowed and your income for the year 1953 has been increased accordingly." The deficiency for 1954 is due to the same type of adjustment as was made by the Commissioner for 1953 and is explained in the same manner. The only difference is as to amounts. The losses which the Commissioner disallowed for 1954 as offsetting losses were $70,375 in amount. The additions to taxes are for negligence or intentional disregard of rules and regulations. The issues presented are: (1) Whether petitioners have proved that petitioner B. H. Bickers suffered gambling losses in the amounts of $32,300 and $70,375 in 1953 and 1954, respectively, which petitioners are entitled to use as offsets to the undisputed gains which petitioner B. H. Bickers had from wagering transactions in those years, and (2) whether the deficiencies are due to negligence or intentional disregard of rules and regulations. Findings of Fact A stipulation of facts filed by the parties is incorporated 209 herein by this reference. Petitioners B. H. Bickers and Lucille M. Bickers, husband and wife residing in Dallas, Texas, filed a joint income tax return for the taxable year 1953 with the district director of internal revenue at Dallas. B. H. Bickers (hereinafter referred to as petitioner) filed an individual income tax return for the taxable year 1954 with the district director of internal revenue at Dallas. During the years in issue, petitioner owned and operated a private club in Dallas, the income from which is not here in question. Petitioner was also a professional gambler, in which capacity he gained most of his income. He gambled on an individual basis in Texas, Colorado, Nevada, and California. His sporting operations were diversified, extending to participation in poker, dice, and gin rummy games, side bets on the same games, and wagers placed on the outcome of various athletic contests. His gambling occurred in various places, but principally in gambling casinos and country clubs. Most of petitioner's wagering took place in forms which involved a number of other participants, but some of the betting involved only one other person. Petitioner knew some of the people with whom 210 he gambled, but not all of them. Petitioner's only record of his gambling transactions was prepared as follows: At some point on each day that he gambled petitioner counted the money he was carrying prior to gambling. This occurred at any time from the time he arose in the morning until immediately before engaging in wagering. At some point after he finished gambling for the day, he again counted his money. On occasion petitioner engaged in several different forms of gambling between the times he counted his money, losing at one form and winning on others. Petitioner then recorded the increase or decrease in his money as winnings or losings in his gambling on any available slip of paper, such as a matchbook cover, a cocktail napkin, or a piece of golf scorecard. The record bore the date, the amount, and the letters "W" or "L" indicating net winnings or losings for that particular day. Upon return to his office in the club he owned, petitioner placed the slips of paper in a box in his desk. Sometime after the close of each taxable year, petitioner called his secretary and another employee, known as his bookkeeper, to his office. With his secretary's aid he arranged the slips in chronological 211 order and then read them to the bookkeeper who made entries in small notebooks, figuring a running balance. After the entries were completed, they were checked over and changes made. Petitioner threw the slips of paper away after completion of the small notebooks. The small notebooks for each of the taxable years were introduced in evidence as exhibits by petitioner. Neither petitioner's secretary nor his bookkeeper had any knowledge of the correctness of the figures on the slips of paper. They merely assisted in transferring the amounts shown thereon to the notebooks; they endeavored to do this accurately. The entries in the notebook for 1953 are as follows: 1953Jan 1stW 400691463756187Jan 4W 861Feb 12L -115Mar 13W 116Apr 20L 2401261679964915947Jan 9L -532Feb 13L -206Mar 16W 611Apr 23W 1240729659371027187Jan 15W +439Feb 17L 404Mar 21L 501Apr 25W 941Jan 18W +3611529618966018128Jan 20W +961Feb 21W 331Mar 24W 416Apr 30W 5002490652070178628Jan 23L -88Feb 24W 87Mar 26L 787May 4W 9862402660762309614Jan 25W 1647Feb 26W 400Mar 30L 498May 5L 2114049700757329403Jan 27L 1516Feb 28L 1561Apr 3W 1103May 7W 4062533544668359809Jan 29W 721Mar 1stW 1260Apr 7W 100May 8W 20232546706693510011Feb 2W 1629Mar 9W 398Apr 10L 811May 10L 21504883710461247861Feb 4W 1421Mar 11L 225Apr 14L 240May 11W 3806304687958848241Feb 10W 610Mar 12L 504Apr 16W 303May 15W 11106914637561879351935185781265613650May 19W 100July 4W 300Sept 11L 675Nov 7L 305945188781198113345May 20W 240July 6W 1000Sept 13L 546Nov 10L 486969198781143512859May 25L 1824July 10L 650Sept 17W 530Nov 12W 590786792281196513449May 26L 706July 12L 407Sept 19W 45Nov 14W 460716188211201013909May 27L 775July 15W 840Sept 21W 437Nov 18W 300638696611244714209May 29W 335July 20W 260Sept 25L 150Nov 21W 486672199211229714695June 1W 1006July 23W 489Sept 27W 335Nov 26W 2617727104101263214956June 3W 811July 30W 97Sept 28W 262Nov 28W 3868538105071289415342June 6W 336Aug 1W 205Sept 30W 1165Nov 29W 1018874107121405915443June 8L 330Aug 8W 316Oct 1W 297Dec 1W 4808544110281435615923June 10W 600Aug 10W 510Oct 3L 841Dec 3W 6559144115381351516578June 10L 462Aug 13W 255Oct 5L 136Dec 5W 2658682117931337916843June 12L 54Aug 15L 1320Oct 8L 504Dec 7W 1008628104731287516943June 14W 226Aug 18L 415Oct 10W 675Dec 9L 20508854100581355014893June 18W 115Aug 21W 361Oct 13L 285Dec 10L 2418969104191326514652June 20L 1050Aug 24L 350Oct 17W 1010Dec 12W 5407919100691427515192June 21W 401Aug 26W 1120Oct 19W 361Dec 13W 3358320111891463615527June 23W 500Aug 27W 1241Oct 22W 209Dec 16W 2478820124301484515774June 25W 323Aug 30L 890Oct 26L 640Dec 18W 2451601991431154014205Dec 20L 1250June 27L 387Sept 4W 555Oct 28W 2601476987561209514465Dec 22L 705June 29W 210Sept 5W 110Oct 30W 3351406489661220514800Dec 23W 360June 30L 903Sept 7W 406Nov 3L 60014424Dec 28L 90480631261114200July 2W 515Sept 9W 45Nov 5L 55013520Dec 29L 3208578126561365013200212 Many figures and letters in the notebook have been changed, either by partial erasures and insertion of new figures and letters or merely by writing new figures and letters over those originally written. Of the amounts recorded in the notebook as losses for 1953, petitioner sustained losses from gambling during that year in the amount of $21,682. The entries in the notebook for 1954 are as follows: 1954Jan 1stW 35005750117508000Jan 4L 1500Mar 2W 2250May 10W 1250July 24W 50020008000130008500Jan 7W 1250Mar 6W 500May 14L 2500July 28W 1750325085001050010250Jan 10W 1000Mar 10W 250May 18L 2500July 31W 25042508750800010500Jan 12W 2250Mar 15L 1250May 21L 250Aug 2L 25065007500775010250Jan 14L 1500Mar 19L 1000May 25W 1250Aug 6L 17505000650090008500Jan 16L 1000Mar 22W 2500May 28L 500Aug 10L 2504000900085008250Jan 18W 2750Mar 25W 1750June 2W 2750Aug 14W 22506750107501125010500Jan 21L 1750Mar 29W 1250June 5L 250Aug 18W 15005000120001100012000Jan 25W 1250Mar 31W 250June 10L 500Aug 21L 7506250122501050011250Jan 28W 1750Apr 3W 750June 14L 250Aug 25W 27508000130001025014000Jan 31W 1750Apr 6L 1750June 18L 250Aug 30L 12509750112501000012750Feb 2L 750Apr 10L 1250June 21W 1500Sept 3L 17509000100001150011000Feb 5L 1250Apr 14L 2500June 24W 750Sept 6L 150077507500122509500Feb 9L 1750Apr 17W 1250June 28L 1000Sept 10L 122560008750112508275Feb 12W 750Apr 20W 2250July 2W 1250Sept 14W 25006750110001250010775Feb 15W 250Apr 24W 750July 6W 1750Sept 18W 17507000117501425012525Feb 18L 2500Apr 27W 1250July 10W 250Sept 22W 5004500130001450013025Feb 22L 1500Apr 30L 2750July 13L 2500Sept 25W 15753000102501200014600Feb 26W 1000May 3W 250July 16L 1500Sept 29L 19004000105001050012700Feb 28W 1750May 7W 1250July 20L 2500Oct 4L 22505750117508000104501045010500100009500Oct 9L 1750Nov 2L 1500Nov 27W 1000Dec 22W 1500870090001100011000Oct 12W 2800Nov 6L 1500Nov 30W 1500Dec 24W 20001150075001250013000Oct 15L 2500Nov 9W 2500Dec 3L 2000Dec 26L 15009000100001050011500Oct 19L 500Nov 13W 500Dec 7L 1500Dec 28W 2500850010500900014000Oct 23W 500Nov 16L 1750Dec 12W 2000Dec 29L 1500900087501100012500Oct 27W 2750Nov 20L 250Dec 15L 500Dec 30W 5001175085001050013000Oct 30L 1250Nov 23W 1500Dec 18L 100010500100009500213 As was the case with the 1953 notebook, there are many changes and partial erasures in the notebook for 1954. Of the amounts recorded in the notebook as losses for 1954, petitioner sustained losses from gambling during that year in the amount of $46,219. Agents of the internal revenue service examined petitioner's returns several times in the years prior to the years here in question and in the course of such examinations they worked net worth statements on petitioner. On February 18, 1952, a notice was served upon petitioner advising him that he was not maintaining sufficient records for the purpose of determining his correct liability for Federal income taxes; that each taxpayer is required by law to make a return of his correct income; and that he must, therefore, maintain such accounting records as would enable him to do so. The notice contains, among other things, the following: "This is an official notice to you to keep complete records from which your tax liability may be properly determined. Continuing failure to keep such records may subject you to the penalties provided by law. The records you are required to keep include records showing in detail each transaction engaged 214 in by you, including the date thereof, the amount of each item of gross income received, and a description of the nature of the income so received. Detailed records should also be maintained of all payments made by you, including the date of each payment, the name of the payee, address of payee, and a description of the nature of each payment. "Section 29.54-1 of Regulations 111 provides in part as follows: "'The books or records required by this section shall be kept at all times available for inspection by internal-revenue officers, and shall be retained so long as the contents thereof may become material in the administration of any internal-revenue law.'" Petitioner failed either negligently or intentionally to keep and retain such books and records as to enable accurate determination of his liability to income taxes during the years in issue. Opinion BLACK, Judge: Petitioner attacks the respondent's determinations of deficiencies in his income taxes for the years 1953 and 1954 as arbitrary and invalid. For 1953 and 1954, petitioner returned $13,200 and $13,000, respectively, as sums which he claims represent his income from gambling during those years. On his returns he sought 215 no business deductions from those sums. During the course of investigation by an internal revenue agent, petitioner produced two small notebooks in which he had listed $45,500 and $83,375 as winnings from gambling received in those years. He had offset these winnings by claimed losses of $32,300 in 1953 and $70,375 in 1954. Respondent's deficiency notices increase petitioner's income for those years by the amounts shown in the notebooks as losses. It is clear from the record that each amount entered in the notebooks as a winning represented gain from at least one closed gambling transaction and in some instances the net gain on several closed gambling transactions. The yearly totals of the daily winnings were includible in petitioner's annual gross income as defined in section 22(a) of the 1939 Code and section 61(a) of the 1954 Code. 1 Cf. Winkler v. United States, 230 F.2d 766">230 F. 2d 766. But petitioner is entitled to offset his wagering gains by his wagering losses. Section 23(h), 1939 Code, reads: "(h) Wagering Losses. - Losses from wagering transactions shall be allowed only to the extent of the gains from such transactions." Section 165(d), 1954 Code, which is applicable to the taxable 216 year 1954, is to the same effect. Respondent, in the deficiency notices, disallowed, as unsubstantiated, deduction of claimed gambling losses as shown in the notebooks in the amounts of $32,300 and $70,375 in 1953 and 1954, respectively. In the year immediately prior to the years in issue petitioner had been served with a notice to maintain and retain 217 records from which his tax liability could accurately be determined. Petitioner's only records of the claimed losses are, at best admittedly secondary evidence, prepared after the close of each taxable year from various types of memoranda described in our Findings of Fact. Respondent has accepted the winnings as shown in the notebooks compiled by petitioner for the years 1953 and 1954 as being correct but has refused to accept as being substantiated the wagering losses shown on such notebooks. Therefore, in his determination of the deficiencies respondent has included in petitioner's income all of his wagering gains shown in the notebooks and has not allowed any offsetting losses shown in the same notebooks. Respondent called no witnesses in support of his determination, but, as we said in Anthony Delsanter, 28 T.C. 845">28 T.C. 845, at 858: "The burden was on the petitioner to show that the determination was erroneous. If that burden was difficult to meet by reason of their destruction of their records, it is a situation that they created for themselves. But they cannot shift the burden to the Commissioner and then complain that, since he has not put witnesses on the stand justifying his determination, 218 it is arbitrary and must therefore be disapproved. * " Although we have concluded that respondent's disallowance of offsetting losses was erroneous in part, we do not conclude that it is arbitrary and invalid as petitioner contends. Cf. Marx v. Commissioner, 179 F. 2d 938. We must now consider what losses, if any, petitioner has proved that he suffered during the year in issue. "In seeking a deduction the taxpayer has a burden greater than merely proving the Commissioner wrong; he must establish the essential facts from which a correct determination can be made." Mahler v. Commissioner, 119 F. 2d 869, 870. Petitioner asserts that he suffered the losses reflected in the notebooks. After a careful consideration of all the evidence in the record, we are unable to accept petitioner's claim that he incurred the offsetting wagering losses to the extent that he claims. His testimony was to the effect that at some point in the day prior to gambling he counted his money and he counted it again subsequent to gambling, apparently shortly after cessation of daily gambling activities. He further testified that he made personal expenditures while gambling. There is no evidence that he maintained 219 a separate "bankroll" for gambling. The opportunity, under such a system, for including extensive personal expenses in the daily decreases in cash which petitioner recorded as losses is so clear that we are unable to accept the figures in the notebooks as truly portraying his gambling losses. We are satisfied, however, from the whole record, that petitioner suffered substantial gambling losses, as well as gains, during the years in issue, and that loss entries in the notebooks, adjusted to reflect omission of those of which we are unconvinced, are reflective of the wagering losses sustained. We have concluded, therefore, in the exercise of our best judgment and bearing heavily upon petitioner whose inexactitude is of his own making, that petitioner suffered offsetting wagering losses during the years in issue in the amounts set forth in our Findings of Fact. Cf. Cohan v. Commissioner, 39 F.2d 540">39 F. 2d 540. Respondent has determined additions to the taxes here in issue for negligence or intentional disregard of rules and regulations under section 293(a), 1939 Code, and section 6653(a), 1954 Code. Petitioner had been subjected to investigations by internal revenue agents at other times prior 220 to the years in issue. In 1952 he was served, pursuant to section 54(b), 1939 Code, with a notice to maintain and retain adequate records from which his tax liability could be determined. We have already concluded that petitioner's records did not accurately reflect his income, and viewing the facts in their most favorable light, petitioner was, at best, negligent in failing to maintain and retain better records. We sustain, therefore, these additions, modified to reflect reductions in the determined deficiencies. Decisions will be entered under Rule 50. Footnotes. Imposed under section 293(a), Internal Revenue Code of 1939, for taxable year 1953, and under section 6653(a), Internal Revenue Code of 1954↩, for taxable year 1954.1. SEC. 22. GROSS INCOME. (a) General Definition. - "Gross income" includes gains, profits, and income derived from salaries, wages, or compensation for personal service (including personal service as an officer or employee of a State, or any political subdivision thereof, or any agency or instrumentality of any one or more of the foregoing), of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. * * * [For the purposes of this case, section 61(a) of the 1954 Code is to the same effect.]↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624568/	John W. Snow, Jr. v. Commissioner.John W. Snow, Jr. v. CommissionerDocket No. 30121.United States Tax Court1953 Tax Ct. Memo LEXIS 64; 12 T.C.M. (CCH) 1281; T.C.M. (RIA) 53358; November 10, 195364 Respondent reconstructed petitioner's income by the increase in net worth method and determined deficiences and negligence penalties for 1946, 1947, and 1948. Held: 1. Respondent's use of the net worth method was proper and not arbitrary. 2. On the record, a cash sum in excess of $20,000 was earned during 1946, 1947, and 1948 and did not, as petitioner contended, constitute fire insurance proceeds collected by him in 1931 and held in his daughter's safe deposit box. 3. The gain realized on the trade-in of a Ford was nonrecognizable under Sec. 112(b)(1), I.R.C., because derived from exchange of property of like kinds held solely for productive use in petitioner's business. 4. As a result of adjustments in respondent's computations of petitioner's income the deficiency determined for 1946 is excessive, but the deficiencies for 1947 and 1948 are lower than could have been determined. However, greater deficiencies for 1947 and 1948 cannot be adjudged because respondent asserted no claim therefor. 5. Negligence penalties were properly imposed. Eugene E. Gilmer, Esq., 506-7 Frank Nelson Building, Birmingham, Ala., for the petitioner. D. Louis Bergeron, Esq., for the respondent. BLACK 65 Memorandum Findings of Fact and Opinion The Commissioner has computed petitioner's income for the taxable years 1946, 1947, and 1948 by application of the so-called "net worth increase" method. He has determined deficiencies in petitioner's income taxes for those years and has added negligence penalties, as follows: 5% NegligenceYearDeficiencyPenalty1946$ 570.54$28.5319471,381.6769.0819481,628.5081.43Petitioner contends that the Commissioner erred in disregarding petitioner's method of reporting income and arbitrarily determining that income by the net worth method. Petitioner further contends that, even if the Commissioner's utilization of the net worth method was proper in this case, the Commissioner erred in its application in the following particulars: (1) failure to include at least $20,000 in cash in petitioner's assets as of December 31, 1945, which sum increased to at least $21,712 as of December 31, 1947; (2) failure to include $11,250 in United States Government Series E Bonds in petitioner's assets as of December 31, 1945, and $6,750 of said bonds in his assets as of the close of each of the tax years in issue; and (3) commission of numerous minor errors in the determination 66 of petitioner's assets and liabilities for the periods involved. Petitioner also contests the Commissioner's determination of negligence penalties for 1946, 1947, and 1948. Findings of Fact Petitioner is a physician and surgeon presently residing in Graysville, Alabama. During the three tax years in question he resided in Palos, Alabama, and filed returns for those years with the Collector of Internal Revenue for the District of Alabama. Petitioner is married to Florence Snow. They have three children, Florence Snow was regularly employed during the tax years involved and filed separate income tax returns for those years. Petitioner was engaged in the practice of medicine in Palos from 1907 through 1949. He was employed as company doctor by several corporations and, for the years here pertinent, was company doctor for Adams, Rowe & Norman, a coal mining corporation. The corporation deducted from $1.50 to $2.00 per month from the wages of each employee and remitted that amount to petitioner. In return petitioner treated the employees and their families for all except certain types of cases specified in his contract with the corporation. Petitioner himself dispensed the drugs he prescribed 67 for the corporation patients, sometimes on credit, and occasionally loaned money and supplied merchandise to those patients. A tally of these transactions was submitted to the corporation which then deducted the amounts due petitioner from its employees' salaries and paid those amounts to the petitioner. Petitioner conducted a successful private practice in addition to the arrangement he had with Adams, Rowe & Norman. In 1930, petitioner's clinic was destroyed by fire. He recovered on an insurance policy applicable thereto and used the proceeds to construct a combined residence and clinic. This too, however, burned down around 1931. Thereafter he conducted his practice in offices which Republic Steel Co. permitted him to use rent free. Petitioner received insurance proceeds to compensate him for the loss resulting from the second fire. He claims that he did not spend those proceeds until 1949, when he purchased United States Government Series G Bonds therewith. He states that during the tax years involved the money was kept by his daughter, Helen Snow Silver, sometimes hereinafter referred to as Helen, in a safe deposit box maintained in the name of a firm she and her husband own. 68 Therefore, he contends, that money should have been included in respondent's computation of petitioner's assets as of December 31, 1945, and did not represent income received in any of the taxable years. In 1936, petitioner borrowed $3,110 on a life insurance policy in order to make an appeal bond in a suit in which he was then involved. Although friends offered to loan him the money petitioner stated that he obtained it by borrowing on his policy because "that sum was available without disturbing anything or anybody." The loan was subsequently repaid. Between 1941 and 1945, the petitioner expended $11,250 for United States Government Series E Bonds with an aggregate redemption value at maturity of $15,000. On July 9, 1946, internal revenue agent Stephen J. Sullivan interviewed the petitioner at Palos in connection with an investigation of petitioner's returns for the years 1942 through 1945. The interview was discontinued when petitioner complained that he was not feeling well. Sullivan wished to meet the petitioner on July 10 in order to inspect the contents of a safe deposit box petitioner maintained at the First National Bank in Birmingham, Alabama. Petitioner, however, stated 69 that he had another appointment in Birmingham on the 10th, so Sullivan agreed to meet him on July 11. Sullivan discovered, on July 11, that petitioner had opened his safe deposit box in the First National Bank on the preceding day, July 10. Petitioner explained that he had removed two $1,000 bills from the box on July 10 and a closed package, the contents of which were unknown to him since it belonged to his daughter Helen. Petitioner also stated that he frequently held other people's property in his box, as a personal favor, but did not specifically identify any of the alleged depositors. Petitioner asserted that the only bank he dealt with was the main branch of the aforementioned First National Bank and never mentioned that he had $20,000 in cash in Helen's box or elsewhere. As a result of the above investigation deficiencies totaling $5,753.51 were assessed against petitioner which he paid by check dated July 25, 1946. Almost all the funds to cover that check were obtained by cashing in Series E Bonds for which he had paid $4,500 between 1941 and 1945. The redemption value of those bonds at the time he cashed them cannot be determined from the record, particularly since petitioner 70 failed to report his gain thereon as income from interest in his 1946 return. Following that transaction petitioner still possessed Series E Bonds for which he had paid a total of $6,750 between 1941 and 1945, and those bonds were held by him throughout 1946, 1947, and 1948. On April 19, 1946, petitioner loaned $6,000 to Helen and her husband to be used by them toward the purchase of a house. The loan was subsequently repaid. In January 1948, petitioner traded for a new Ford, an old Ford automobile which he used for business purposes but was not held by him as stock in trade or primarily for sale. He had already fully depreciated the old Ford for income tax purposes. The purchase price of the new Ford was $1,690.55. He was allowed $1,045 on his old car and paid, in addition, $645.55 in cash. The $1,045 constitutes a gain to petitioner, but one resulting from exchange of property of like kinds held for productive use in petitioner's business. Petitioner, sometime in 1948, also sold, for $1,000, a 1942 Packard automobile which he owned for over six months and fully depreciated for income tax purposes prior to the sale. He used that car in his business, it was not property of a kind that 71 would properly be includible in his inventory, and it was not held by him primarily for sale to customers in the ordinary course of his business. The $1,000 gain thus realized was, therefore, properly regarded by respondent as derived from the sale of a capital asset held for more than six months. In April 1949, petitioner and Helen each contributed $25,000 toward the purchase of $50,000 Series G Bonds. The bonds were taken out jointly in the names of petitioner and Helen. In November 1949, internal revenue agent Horace W. Weissinger began investigating petitioner's returns for the taxable years 1946 through 1948. Those returns were prepared for petitioner by deputy collectors of internal revenue on the basis of written and oral information supplied them by petitioner. Adjusted gross income was reported in those returns as follows: Adjusted GrossYearIncome1946$6,117.9619474,904.7919484,652.36We find as a fact that petitioner did not keep or maintain adequate records to support the entries made in those tax returns. The only supporting data petitioner gave Weissinger were cancelled checks and bank statements relating to a joint account in the First National Bank of Birmingham. That 72 account, which was active during all the years here involved, was in the name of "Mrs. John W. Snow, Jr., M.D." and either petitioner or his wife could withdraw money therefrom by signing that name. There is no evidence touching on the amount of money, if any, which was contributed to that joint account by petitioner's wife and we, therefore, conclude that all the money deposited therein originated with petitioner. Weissinger also determined the balances in a savings account petitioner maintained at the First National Bank and discovered, in petitioner's safe deposit box at that bank, $2,380 in cash and nine $1,000 (redemption value) Series E Bonds purchased between 1941 and 1943. Petitioner told Weissinger about the $50,000 in Series G Bonds which he and Helen purchased and claimed that he had one other $1,000 Series E Bond. Petitioner further stated that the only safe deposit box he had was in the First National Bank. He failed to state that he had ever used Helen's box. Because of the aforementioned lack of records the correctness of petitioner's returns could not be determined. Weissinger, therefore, reconstructed petitioner's income for the years 1946 through 1948 by use of the 73 net worth method. That method involves arriving at income for a taxable year by finding the difference between the taxpayer's net assets at the beginning and end of the particular year and adding thereto the taxpayer's nondeductible expenditures for that year. Assets and liabilities which remained constant throughout the period were not included in Weissinger's calculations since they would have no effect thereon. Weissinger's calculations upon which the respondent based his deficiency determinations are as follows: 174 As of December 31, ASSETS:1945194619471948Mrs. John W. Snow, Jr., M.D. - checkingaccount$1,203.04$ 650.37$ 1,329.73$ 1,261.72John W. Snow - savings account6,150.546,243.256,274.466,337.35Cash on hand (used to purchase G Bondsin 1949)9,500.0017,000.0025,000.00Ford automobile1,690.55Office refrigerator169.00169.00Total assets2 $7,353.54 $16,393.62$24,773.19 5 $33,458.62 LIABILITIES: 3 Comparative reserve for depreciation 1,790.002,780.003,980.00Net worth$7,353.54$14,603.62$21,993.19$29,478.62Increase$ 7,250.08$ 7,389.57$ 7,485.43PLUS: 4 Personal expenses paid by check 987.381,476.154,896.00Income tax paid in cash1,074.14$ 8,237.46$ 9,939.86$12,381.43LESS: Adjustment for 1/2 gain on sales of Pack-ard and old Ford, and for tax refund1,140.00Corrected adjusted gross income$ 8,237.46$ 9,939.86$11,241.43Adjusted gross income reported by peti-tioner6,117.964,904.794,652.36Additional taxable income$ 2,119.50$ 5,035.07$ 6,589.07 The $25,000 used for the purchase of Series G Bonds in 1949 was allocated as earnings over the three taxable years in proportion to the receipts (exclusive of that $25,000) reported by petitioner in his returns for those years. We find, considering the record as a whole, that that sum was actually earned by petitioner during that period and was not reported as income by him. The money was not, as petitioner claims, in large part insurance proceeds received by him in 1931. Furthermore, the aforementioned method of allocation of those earnings over the three years in issue is, 75 under the circumstances, reasonable and proper and, we think, accurately reflects petitioner's earnings for those years. It was stipulated at the hearing that outstanding checks drawn on the "Mrs. John W. Snow, Jr., M.D." account were not taken into consideration by Weissinger in listing the closing balances in that account. The parties agree, and we so find, that the correct balances in that account, as of December 31, were as follows: YearBalance1945$ 988.171946166.8519471,041.371948997.01The facts indicate that another correction in Weissinger's computation is necessary. In determining petitioner's adjusted gross income for 1948, a $1,140 adjustment was made for one-half the gain on the sales of the Packard and old Ford, and for a tax refund. As mentioned above petitioner's gain on the 1948 trade of his oldford for a new one was $1,045. Weissinger obviously recognized that gain and included half of it, or $522.50, in the adjustment on the theory that the trade involved the sale of a capital asset held for over six months. 6 We find, however, that the trade constituted an exchange of property (the old Ford) held for productive use in petitioner's business (but not as stock in trade 76 or primarily for sale), for property of a like kind (the new Ford) which was put to the same use. Therefore, no portion of the gain realized on the transaction should have been recognized. 7 In view of our holding in this respect, respondent's adjustment for 1948, which reads: "Adjust for 1/2 Auto Sales [Packard and old Ford] & Tax Refund, $1,140.00" should be changed to $1,662.50. This means that no profit is to be included for the exchange of the old Ford. Prior to such an adjustment $522.50 was included. Taking into account the above corrections, and correcting the $1,000 mathematical error in addition of petitioner's assets for 1948, we find that the following is the proper statement of petitioner's net worth and taxable income for the years involved: As of December 31,ASSETS:1945194619471948Mrs. John W. Snow, Jr., M.D. - checkingaccount$ 988.17$ 166.85$ 1,041.37$ 997.01John W. Snow - savings account6,150.546,243.256,274.466,337.35Cash on hand (used to purchase G bondsin 1949)9,500.0017,000.0025,000.00Ford automobile1,690.55Office refrigerator169.00169.00Total assets$7,138.71$15,910.10$24,484.83$34,193.91LIABILITIES: Comparative reserve for depreciation1,790.002,780.003,980.00Net worth$ 7,138.71$14,120.10$21,704.83$30,213.91Increase$ 6,981.39$ 7,584.73$ 8,509.08PLUS: Personal expenses paid by check987.381,476.154,896.00Income tax paid in cash1,074.14$ 7,968.77$10,135.02$13,405.08LESS: Adjustment for 1/2 gain on sale of Pack-ard, full gain on trade of Ford and taxrefund1,662.50Corrected adjusted gross income$ 7,968.77$10,135.02$11,742.58Adjusted gross income reported by peti-tioner6,117.964,904.794,652.36Additional taxable income$ 1,850.81$ 5,230.23$ 7,090.2277 The deficiency determined by respondent for 1946 is based upon income greater than that shown in the preceding statement. The deficiencies determined by respondent for 1947 and 1948 are based upon income lower than that shown in the preceding statement. We find that the petitioner was negligent in reporting his income and intentionally disregarding respondent's regulations requiring him to keep proper records. Subsequent to his receipt of the deficiency notice in the instant case the petitioner paid $4,217.23 of the deficiencies, penalties, and interest determined therein to the Collector of Internal Revenue for the District of Alabama. Opinion BLACK, Judge: When a taxpayer does not regularly employ a method of accounting or if the method of accounting employed by him does not clearly reflect his income, the respondent may resort to the net worth method of computation of such income. 8 As we said in Louis Halle, 7 T.C. 245">7 T.C. 245, 250, affd. 175 Fed. (2d) 500 (C.A. 2), certiorari denied 338 U.S. 949">338 U.S. 949: "The Commissioner need not accept, as complete, correct, and accurate, the returns filed or the sworn statement of the taxpayer that his returns completely and correctly disclose his tax 78 liability. The Commissioner has authority to check the returns against the records of the taxpayer and, if no records have been kept or the records are incomplete, inaccurate, or otherwise unsatisfactory, he may seek information elsewhere to discover, assess, and collect the full tax liability imposed by law." * * See also Bishoff v. Commissioner, 27 Fed. (2d) 91 (C.A. 3). Petitioner here failed to produce, either upon request of the internal revenue agent who examined his returns or at the hearing, any records (other than canceled checks and bank statements) to substantiate his returns. Nor were records shown to support petitioner's statement 79 as to the origin of the $25,000 used to purchase the Series G Bonds in 1949. Respondent, therefore, was justified in resorting to the net worth method to determine petitioner's income and tax liability. Respondent's determination of deficiencies based upon that method is prima facie correct and the burden of proving it erroneous rests upon petitioner. J. V. Moriarty, 18 T.C. 327">18 T.C. 327. Petitioner contends that he has successfully carried his burden of proof by showing respondent's determination to be so incorrect as to be arbitrary and excessive and, therefore, invalid in its entiretly. To support this contention petitioner cites Helvering v. Taylor, 293 U.S. 507">293 U.S. 507, and cases following that decision. In Helvering v. Taylor, the Court said that the taxpayer need go no further to sustain his burden of proof than showing that the Commissioner's determination is incorrect. The taxpayer need not, in addition, prove the correct amount that lawfully might be charged against him. However, continued the Court, the taxpayer may still be held liable for taxes if "his evidence was sufficient also to establish the correct amount that lawfully might be charged against him." The record in the instant 80 case reveals that although petitioner has proved respondent's computation to be incorrect in some respects, the evidence petitioner adduced also establishes the correct figures and the resulting tax liability. Furthermore, since respondent's determinations were in the main based on inferences properly drawn from the facts proved by the evidence they cannot, even though incorrect in some respects, be declared "arbitrary" and as a consequence totally invalid. Hague Estate v. Commissioner, 132 Fed. (2d) 775 (C.A. 2), certiorari denied, 318 U.S. 787">318 U.S. 787. Petitioner's contention, therefore, cannot be sustained. We next consider certain specific items entering into respondent's computation of petitioner's net worth and income for the years involved. The correct balances in petitioner's joint checking account at the end of the years 1945 through 1948, were stipulated at the hearing and we have so found in accordance with that stipulation. Those balances differed from the ones listed in respondent's computation because respondent failed to consider checks drawn on that account which were outstanding at the close of each of the years. Petitioner urges that respondent erred in failing to list 81 the $11,250 in Series E Bonds (purchased between 1941 and 1945) as an asset as of December 31, 1945, and in failing to list $6,750 of those bonds as assets held at the close of 1946, 1947, and 1948. Petitioner redeemed $4,500 (plus accrued interest) of those bonds in 1946 to be used to satisfy most of a $5,753.51 income tax deficiency determined against him following investigation of his returns for the years 1942 through 1945. The $5,753.51 expenditure likewise was not taken into account in respondent's calculations for 1946. These omissions by respondent worked in petitioner's favor and petitioner cannot, therefore, be heard to complain. The reduction in petitioner's net worth in 1946, resulting from the $4,500 decrease in bond holdings, was more than offset by the nondeductible expenditure of $5,753.51 paid to settle his aforementioned income tax liability. Consequently, had both items been taken into account, respondent's statement would show greater income for petitioner in 1946. Moreover, the exclusion of the $6,750 balance of bonds from the asset listings for 1946 through 1948 was merely for convenience sake. Since those bond holdings were constant from the close of 1946 through 82 1948, inclusion in the asset listings for those years would have no effect on computations endeavoring to show changes in net worth for that period. Petitioner next urges that respondent erred in his treatment of the trade of petitioner's old Ford for a new one in January 1948. As stated in our Findings of Fact petitioner realized a $1,045 gain on that transaction resulting from the fact that his old Ford, upon which the vendor allowed him that amount, had already been fully depreciated for tax purposes. Respondent recognized the full $1,045 gain, treated the trading of the old Ford as the sale of a capital asset held for more than six months, and deducted one-half of that gain ($522.50) from petitioner's gross income. 9 However, we have found, as petitioner urges, that the transaction constituted an exchange under section 112 (b) (1) of the Code of property of like kinds "held for productive use in trade or business * * * (not including stock in trade or other property held primarily for sale * * )." 10 Consequently, none of petitioner's $1,045 gain may be recognized. W. H. Hartman Co., 20 B.T.A. 302">20 B.T.A. 302; I.T. 2573, X-1, C.B. 215; see also Thomas Goggan & Bros., 45 B.T.A. 218">45 B.T.A. 218; National Outdoor Advertising Bureau, Inc., v. Helvering, 89 Fed. (2d) 87883 (C.A. 2). See also Treasury Regulations 111, section 29.112 (b)(1)-1. Petitioner maintains that respondent erred in determining that the $25,000 with which petitioner purchased Series G Bonds in April 1949, was earned during the three taxable years in question. Petitioner states that at least $20,000 of that sum was acquired prior to 1946, and that an additional $1,712 was accumulated by the end of 1947. He explains that the money represented insurance proceeds collected when an office and residence built by him burned down in 1931. He states that he first put the money 84 in his sister's custody and then in the custody of his daughter Helen. He claims that he permitted his family (consisting of three children, seven sisters, and four brothers) to borrow it as needed from time to time, without interest. The money was always replaced but he kept no record of the loans and could not testify as to any particular transactions. In 1949, said the petitioner, Helen advised him to put the money into Government bonds in order to get income from it. Helen testified that she kept petitioner's money in a safe deposit box maintained in the name of Silver & Douce Co., a company of which her husband was president and she was vice-president, secretary, and treasurer. Money of Silver & Douce Co. was also kept in that box. The money which petitioner gave her was in envelope and she did not count it when it was given to her nor did she know how much was there until she took it out of the box in 1949 to buy the G bonds. She testified that she did not know what was to happen to petitioner's money in the event petitioner died while it was still in her safe deposit box. We are not required to believe petitioner's and Helen's testimony, even if it be uncontradicted, if it appears 85 inherently improbable or manifestly unreasonable. Carmack v. Commissioner, 183 Fed. (2d) 1 (C.A. 5), certiorari denied 340 U.S. 875">340 U.S. 875; Boyett v. Commissioner, 204 Fed. (2d) 205 (C.A. 5). It does, in fact, appear improbable to us that petitioner would give Helen such a large sum of money merely to be placed in her safe deposit box when he himself maintained such a box. Petitioner, a member of the medical profession and presumably an educated man, apparently would have us believe that for over 17 years, until his daughter advised him, he failed to realize that that large sum of money would be put to better use if invested in bonds which yielded an income. It seems strange to us, moreover, that Helen never counted the money petitioner allegedly entrusted to her until 1949, even though she placed it in a box with funds not belonging to petitioner and the money supposedly was loaned to relatives from time to time; that nothing was said regarding the disposition of the money in the event of petitioner's untimely death; and that no record of loans of the money was kept by petitioner. The above considerations, coupled with the fact that petitioner's credibility is subject to question in 86 view of his income tax derelictions for the years 1942 through 1945, Rogers v. Commissioner, 111 Fed. (2d) 987, (C.A. 6) alone convince us that petitioner's explanation of the source of the over $20,000 is not plausible. However, we wish to point out several other factors which make it impossible to give credence to petitioner's story: (1) In 1936, petitioner borrowed $3,110 against a life insurance policy in order to make an appeal bond in a suit in which he was then involved. He obtained the money that way rather than by borrowing from his friends because, as he stated, "that sum was available without disturbing any thing or anybody." (2) On July 11, 1946, petitioner told the internal revenue agent who was investigating his returns for 1942 through 1945 that he had just removed two $1,000 bills from his safe deposit box and a package which belonged to Helen; that the only bank he dealt with was the one in which that box was located; and that he frequently held other people's property in that box as a personal favor. Petitioner did not mention that he owned any other assets. (3) In order to pay the $5,753.51 income tax deficiency assessed against him for the tax years 1942 through 87 1945, petitioner found it necessary, in 1946, to redeem $4,500 (plus interest) of Series E bonds he had purchased from 1941 through 1945. (4) Petitioner, in 1949, failed to provide the investigating internal revenue agent with any books or records (other than canceled checks and bank statements) to substantiate his returns for 1946 through 1948, stated that he had only one safe deposit box, and never mentioned that he had ever used Helen's box. It is obvious that the above facts are indicative of a course of conduct inconsistent with petitioner's contention. A man who has over $20,000 in cash lying dormant would not ordinarily borrow on insurance policies or redeem Government bonds to meet financial demands that easily could be satisfied from such sum. Nor would he normally keep that cash in another's safe deposit box when he has a box of his own and finds it no inconvenience even to hold other people's property in that box. In addition, there arises a justifiable inference that all the assets he had in 1946 were those revealed to the investigating revenue agent in that year, especially since it would not be to his disadvantage to mention the $20,000 if, as alleged, it constituted 88 fire insurance proceeds collected in 1931. A consideration of the record, therefore, leaves us with no doubt of the correctness of respondent's determination that petitioner earned the entire $25,000 during the period in issue. We have found that as a fact. Respondent allocated the $25,000 as earnings over the taxable years 1946 through 1948, in proportion to the receipts (exclusive of that $25,000) reported by petitioner in his returns for those years. This appears to us a reasonable and proper method of allocation where, as here, petitioner had produced no records indicating otherwise and has provided no reliable guides. Cf. Andrew P. Solt, 19 T.C. 183">19 T.C. 183, 188; Cohan v. Commissioner, 39 Fed. (2d) 540, 544. The burden of proving that respondent's allocation was erroneous or arbitrary and without basis is upon petitioner. He has here made no showing to that effect. Respondent determined that petitioner's adjusted gross income for each of the years involved (upon which respondent based his deficiency determination) was as follows: YearIncome1946$ 8,237.4619479,939.86194811,241.43We have found, however, that petitioner's correct adjusted gross income for each of those years was as follows: 89 YearIncome1946$ 7,968.77194710,135.02194811,742.58The corrected income figure for 1947 is higher despite the reduction in petitioner's checking account balances because the balances for 1947 was not reduced as much as the 1946 balance. The corrected 1948 income figure is higher even though we treated all the gain on the trade of petitioner's Ford as nonrecognizable because respondent made a mathematical error of $1,000 in adding petitioner's assets, which we have corrected. We may recognize this mathematical error as offsetting the reductions adjudged in respondent's calculations for 1948, even though no mention of it was made in the pleadings or at the hearing. Houston Lighting & Power Co. v. Commissioner, 34 B.T.A. 745">34 B.T.A. 745, appeal dismissed (App. D.C.) June 16, 1937; Standard Oil Co. v. Commissioner, 43 B.T.A. 973">43 B.T.A. 973, affd. 129 Fed. (2d) 363 (C.A. 7), certiorari denied 317 U.S. 688">317 U.S. 688; John I. Chipley, 25 B.T.A. 1103">25 B.T.A. 1103. However, despite our finding that petitioner's income for 1947 and 1948 was greater than that upon which respondent based his deficiency determinations, we may not in this decision adjudge deficiencies greater than those asserted in respondent's deficiency notice since 90 no claim therefor was made by respondent in a proper pleading. Section 272 (e), Internal Revenue Code; Moise v. Burnet, 52 Fed. (2d) 1071 (C.A. 9); Lucinda Pitman, 24 B.T.A. 244">24 B.T.A. 244, reversed on other grounds, 64 Fed. (2d) 740 (C.A. 10); see also Davison v. Commissioner, 60 Fed. (2d) 50 (C.A. 2); and compare Helvering v. Edison Securities Corp., 78 Fed. (2d) 85 (C.A. 4). Petitioner argues in his brief that he maintained adequate records to substantiate his returns for 1946, 1947, and 1948 and stood ready to produce them at the hearing had he thought it necessary. We have heretofore found as a fact that adequate records were not maintained. Even were we to believe petitioner's allegation it would not change our decision on the above matters since, whatever the reason, the nonappearance of those records in evidence constitutes a failure of proof regarding the contents thereof and the facts such contents would tend to prove. Pennant Cafeteria Co., 5 B.T.A. 293">5 B.T.A. 293; Aaron Samuelson, Exr., 10 B.T.A. 860">10 B.T.A. 860; Burnet v. Houston, 283 U.S. 223">283 U.S. 223, 228. The remaining question for consideration is whether respondent's determination of negligence penalties for 1946, 1947, and 1948 was proper. The burden 91 of proving that the imposition of those penalties is erroneous rests upon petitioner. J.T.S. Brown's Son Co., 10 T.C. 840">10 T.C. 840; Gibbs & Hudson, Inc., 35 B.T.A. 205">35 B.T.A. 205. Section 293 (a) of the Code provides for the assessing of a negligence penalty totaling five per cent of a deficiency if any part of the deficiency "is due to negligence, or intentional disregard of rules and regulations but without intent to defraud." We have found, as aforementioned, that petitioner failed to keep books and records adequate to substantiate his returns. That action was in "disregard" of Regulations 111, section 29.54-1, 11 and petitioner failed to introduce evidence indicating that the disregard was other than "intentional." Moreover it has been held that the negligence penalty is justified where items of obviously taxable income are excluded from a return without satisfactory explanation. Edmond A. Hughes, 27 B.T.A. 1022">27 B.T.A. 1022, affd. sub nom. Little v. Helvering, 75 Fed. (2d) 436 (C.A. 8); Thomas J. Avery, 11 B.T.A. 958">11 B.T.A. 958; Louis Wald, 8 B.T.A. 1003">8 B.T.A. 1003. Petitioner here failed to include items of income totaling $25,000 in his returns for the years involved and, as we have found, gave no satisfactory or tenable 92 explanation therefor. Consequently, it is clear that respondent properly imposed the negligence penalties. We have found, as above stated, that respondent's deficiency determinations for 1947 and 1948, and the negligence penalties for those years are sustainable. However, the deficiency determination 93 for 1946 is excessive to the extent that it is based upon adjusted gross income greater than $7,968.77. Therefore, that deficiency, as well as the negligence penalty for 1946, must be recomputed. Decision will be entered under Rule 50. Footnotes1. Includes only items subjected to change. 2. This is a mathematical error. The correct figure is $7,353.58. ↩ 5. This is a mathematical error. The correct figure is $34,458.62; the "Corrected adjusted gross income" should be $12,241.43; and the "Additional taxable income" should be $7,589.07.↩3. Contains only the additions credited to the reserve since December 31, 1945. Those additions were for depreciation of automobiles and office equipment. ↩4. Includes certain nondeductible expenditures for assets, such as real estate. Nondeductible expenditures paid in cash are not included because of inability to reasonably approximate them. ↩6. I.R.C., section 117(a), (b), (j)↩. 7. I.R.C., section 112(b)(1)↩.8. Internal Revenue Code. SEC. 41. GENERAL RULE. The net income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income. * * ↩9. I.R.C., section 117 (a), (b), (j)↩. 10. SEC. 112. RECOGNITION OF GAIN OR LOSS. * (b) Exchanges Solely in Kind. - (1) Property held for productive use or investment. - No gain or loss shall be recognized if property held for productive use in trade or business or for investment (not including stock in trade or other property held primarily for sale, nor stocks, bonds, notes, choses in action, certificates of trust or beneficial interest, or other securities or evidences of indebtedness or interest) is exchanged solely for property of a like kind to be held either for productive use in trade or business or for investment.↩11. Sec. 29.54-1. Records and Income Tax Forms. - Every person subject to the tax, except persons whose gross income (1) consists solely of salary, wages, or similar compensation for personal services rendered, or (2) arises solely from the business of growing and selling products of the soil, shall, for the purpose of enabling the Commissioner to determine the correct amount of income subject to the tax, keep such permanent books of account or records, including inventories, as are sufficient to establish the amount of the gross income and the deductions, credits, and other matters required to be shown in any return under chapter 1. * * The books or records required by this section shall be kept at all times available for inspection by internal-revenue officers, and shall be retained so long as the contents thereof may become material in the administration of any internal-revenue law.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624569/	GRAND RAPIDS NATIONAL BANK, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Grand Rapids Nat'l Bank v. CommissionerDocket No. 21116.United States Board of Tax Appeals9 B.T.A. 1119; 1928 BTA LEXIS 4297; January 9, 1928, Promulgated 4297 Two banks were affiliated for the period January 1, 1922, to March 14, 1922, and on the latter date they merged under the National Bank Act and continued as one bank throughout the remainder of the year. Held that but one return was required. Frank E. Seidman, C.P.A., for the petitioner. Alva C. Baird, Esq., for the respondent. SIEFKIN1119 This is a proceeding for the redetermination of a deficiency in income taxes for the period March 15, 1922, to December 31, 1922, in the amount of $1,242.28. At the hearing, an issue relating to the deduction of an alleged loss was withdrawn, and the only issue is whether the respondent properly divided the net income for the calendar year 1922 into two separate taxable periods. Except for 1120 the introduction of the deficiency letter upon which the deficiency is based, all of the facts were admitted by answer of the respondent and by stipulation. FINDINGS OF FACT. The petitioner is a national bank with its headquarters at Grand Rapids, Mich., and has been operating as a national bank for many years. The City Trust & Savings Bank was, from the date of its organization on December 23, 1910, to4298 and including the date of its absorption by the Grand Rapids National Bank, a state bank operating in Grand Rapids, Mich.The City Trust & Savings Bank and the Grand Rapids National Bank were affiliated during the period January 1, 1922, to March 14, 1922, the stockholders of both banks being identical. The stockholdings of the City Trust & Savings Bank were never, since the date of its organization, evidenced by separate stock certificates, such stockholdings appearing as an endorsement on the back of the stock certificates of the Grand Rapids National Bank. The owner of stock in the Grand Rapids National Bank was automatically the owner in exactly the same proportion of stock in the City Trust & Savings Bank, the following endorsement appearing on the reverse side of the stock certificates of the Grand Rapids National Bank: This is to certify that the owner of the within shares of stock in the Grand Rapids National City Bank also owns 100 shares of stock in the City Trust & Savings Bank of Grand Rapids, and in order to associate said banks for mutual benefit it is agreed that such ownership, however, is subject to the accepted condition and proviso that the same shall not4299 be separated from the title and ownership of said shares of stock in the Grand Rapids National City Bank. The Commissioner has properly held that the Grand Rapids National Bank and the City Trust & Savings Bank were affiliated corporations. The Commissioner has properly held that Grand Rapids National Bank and the City Trust & Savings Bank were affiliated corporations during the period January 1, 1922, to March 14, 1922, and during the years prior thereto. In the early part of 1922 it was decided to consolidate both banks. For this purpose it was necessary to first change the City Trust & Savings Bank to a national bank because, under the National Bank Act, one national bank can not consolidate with other than another national bank. Action was, therefore, taken for the purpose of such change, which was duly granted by the Comptroller of the Currency in the latter part of February, 1922. 1121 Accordingly, on March 14, 1922, the Grand Rapids National Bank absorbed all the assets and assumed all of the liabilities of the City Trust & Savings Bank, and the latter bank went out of existence. Subsequent to March 14, 1922, the Grand Rapids National Bank continued4300 the business of the City Trust & Savings Bank under its own name. The Grand Rapids National Bank and the City Trust & Savings Bank filed a consolidated return for the entire calendar year 1922. The Commissioner ruled that separate returns should be filed for the period January 1, 1922, to March 14, 1922, and for the period March 15, 1922, to December 31, 1922. OPINION. SIEFKIN: The question presented for our consideration is whether two affiliated corporations, which merged during the year 1922, must file two returns, one for the period of affiliation and one for the period of merger or, whether one return for the entire period is proper. The position of the petitioner is that the merger did not create a new corporate entity; that since no new corporate entity was created, no new taxable entity would result, since the two corporations which were the basis of the merger were affiliated prior to the merger and that, therefore, only one taxable entity existed throughout the year 1922 and only one return is required. We have heretofore held in a number of cases that the theory of affiliation is to tax, as a business unit, what really is a business unit. 4301 . In , we stated: From July 1, 1919, however, Congress has said that the generally recognized principle of corporate identity was to be overridden for the purpose of the income and profits tax and that a consolidated return should be filed "if substantially all the stock of two or more corporations is owned or controlled by the same interests," which is the situation here. From July 1, in other words, the separate existence ceased for tax purposes just as effectually as if under State statute the corporations had been consolidated for all corporate purposes. Likewise, we said in : It is our conception of the law that, for purposes of taxation, the affiliated group must be considered as a single economic unit. The requirement with respect to computing the taxes of an affiliated group upon the basis of a consolidated return was first introduced into the law to prevent avoidance and resulting injustice, either to the Government or to the taxpayer, as the case might be, and not to create4302 that situation. The normal treatment in the case of an affiliated group as a single economic unit, therefore, is to disregard the internal structure, to break down the separate legal existence of subsidiaries, and to treat them in all respects, so far as taxation is concerned, as if they were unincorporated branches. 1122 And again, at page 541, it was said: The effect of consolidation, in the language of congressional committees quoted in other decisions of the Board relating to affiliations, is to treat that as an economic unit which really is an economic unit. The statute should be so interpreted that consolidation can not be so carried out as to make evasion possible, or so carried out as to make accidental differences result in tax. This can only be done by disregarding corporate lines in computing the income and treating the affiliated group as one corporation. When this is done it is clear that a transaction such as we have here results in no profit or loss to the affiliated group, being a change in form of a profit or loss previously realized and reflected in the assets or liabilities of one of the group. Under the reasoning of these decisions, it appears4303 that from January 1, 1922, to March 14, 1922, but one return was required. An Act entitled "An Act to provide for the consolidation of national banking associations" (40 Stat. 1043, 1044), and which was approved November 7, 1918, stated: Any two or more national banking associations located within the same county, city, town or village, may, with the approval of the Comptroller of the Currency, consolidate into one association under the charter of either existing banks, on such terms and conditions as may be lawfully agreed upon by a majority of the board of directors of each association proposing to consolidate, and be ratified and confirmed by the affirmative vote of the shareholders of each such association owning at least two-thirds of its capital stock outstanding. This Act contemplates a merger in that the associations shall continue under the charter of one of them. There is, therefore, created no new entity. In , the first paragraph of the syllabus reads: Under the 1918 amendment to the National Banking Act, three banking associations agreed to unite their business and assets and to continue the business4304 under the charter of one of such associations, in accordance with the provisions of the statute. Held, that no new corporate entity was created, the effect of the statute being to merge the identity of two of such associations in the third, whose corporate existence continued. The Revenue Act of 1921, section 239(a) provided: That every corporation subject to taxation * * * shall make a return, * * . Section 240 of the same Act permitted two or more affiliated corporations to make a consolidated return, thus showing that section 239 does not strictly require that "every corporation" shall file a separate return. We think that filing a return for the year 1922 meets the requirements of the statute and that "every corporation" involved has filed "a return." 1123 Based on the foregoing, we agree with petitioner's contention that but one return was required for the entire year 1922. Reviewed by the Board. Judgment will be entered on 15 days' notice, under Rule 50.TRAMMELL and GREEN dissent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624571/	Pacific Mills, Petitioner, v. Commissioner of Internal Revenue, RespondentPacific Mills v. CommissionerDocket No. 20888United States Tax Court17 T.C. 705; 1951 U.S. Tax Ct. LEXIS 52; October 26, 1951, Promulgated 52 Decision will be entered under Rule 50. On November 22, 1944, petitioner paid $ 2,065,842.02 to the United States in an agreed settlement of a claim by the O. P. A. that petitioner had made overcharges on the sale of some of its woolen and worsted fabrics covering the period June 22, 1942 to October 16, 1944. Petitioner, in calculating its ceiling prices under Maximum Price Regulation 163, took practicable precautions and its actions were in good faith and not the result of an unreasonable lack of care. Held, the payment of $ 2,065,842.02 is deductible under section 23 (a) (1) (A) of the Internal Revenue Code. Randolph E. Paul,53 Esq., Louis Eisenstein, Esq., and Louis F. Oberdorfer, Esq., for the petitioner.M. L. Sears, Esq., and Joseph Landis, Esq., for the respondent. Black, Judge. BLACK 705 The Commissioner determined deficiencies in petitioner's excess profits tax for the calendar years 1944 and 1945 in the amounts of $ 1,478,587.99 and $ 26,422.29, respectively. The deficiencies resulted from several adjustments made in the income as reported by petitioner. Assignments of error were originally made as to all of these adjustments. However, at the hearing petitioner filed an amended petition in which all of these assignments of error were abandoned except as to one main adjustment which the Commissioner had made for 1944. In its amended petition, petitioner contests only the deficiency for the year 1944 and assigns errors as follows:(a) The Commissioner erred in overstating the petitioner's excess-profits net income for the taxable year 1944 by disallowing as a deduction, under section 23 (a) or (f) of the Internal Revenue Code, the amount of $ 2,065,842.02 paid by the petitioner to the Office of Price Administration in 1944.(b) If it be determined that the Commissioner did54 not err as stated above, then the Commissioner erred in including in the petitioner's gross income for the taxable year 1944 the amount of $ 1,287,322.11, which was attributable to sales made by the petitioner in the taxable year 1944 and which was paid to the Office of Price Administration in said taxable year.(c) The Commissioner erred in determining that the petitioner underpaid its taxes and in determining the deficiency complained of.The $ 2,065,842.02 was paid by petitioner to the Office of Price Administration in settlement of a claim resulting from alleged overcharges 706 made by petitioner on the sale of worsted and woolen civilian fabrics. The overcharges resulted from the fact that petitioner in computing its ceiling prices used foreign top as its raw material and applied to the calculated cost of its fabrics a profit ratio which involved the cost of goods sold in 1941, whereas the Office of Price Administration determined that under the applicable regulation petitioner was required to use the cost of foreign raw or grease wool as its raw material and a profit ratio involving the cost of goods manufactured in 1941.FINDINGS OF FACT.Many of the facts have been 55 stipulated and they are found accordingly. Other facts are found from the evidence.Petitioner is a corporation organized in 1850 under the laws of Massachusetts with principal offices in Boston, Massachusetts. It filed its excess profits tax and income tax returns for the calendar year 1944 with the collector of internal revenue for the district of Massachusetts. It keeps its books and files its returns on the accrual basis of accounting.Petitioner is, and since 1850 has been, engaged in the textile business. It manufactures and sells woolen, worsted, cotton, and rayon fabrics. Since 1850, petitioner has been operating its woolen and worsted division at Lawrence, Massachusetts. In 1942, 1943, and 1944, this division manufactured women's dress goods, coatings, men's wear, linings, automobile fabrics, and Government fabrics.Prior to the early 1930's petitioner purchased raw or grease wool, either foreign or domestic, which it sorted, cleaned, and combed to manufacture what is known as top. Petitioner then spun the top into worsted yarn which was woven into worsted fabrics. In the early 1930's petitioner shifted to a policy of purchasing top instead of raw wool. Petitioner56 bought 4,643,900 pounds of top in 1939, 6,839,700 pounds in 1940, 5,302,000 pounds in 1941, and 484,000 pounds in 1942. By 1939, petitioner had also resumed the purchase of raw wool. It bought 16,000 pounds of raw wool in 1939, 296,700 pounds in 1940, 1,603,600 pounds in 1941, and 5,847,710 pounds in 1942.In the manufacture of its fabrics petitioner does not distinguish between foreign and domestic wools as wool of the same grade is interchangeable in so far as the fabric is concerned. There are, however, price differentials between foreign and domestic wool of the same grade. Before 1939, the price of domestic top was lower; in late 1939 and early 1940, it was higher; in mid-1940 it was lower; in late 1940 it was higher and remained higher throughout the war. In Revised Price Schedule 58, as amended March 27, 1942, appendix B, 7 F. R. 2397, the Office of Price Administration (hereinafter called O. P. A.) established different maximum prices for foreign and domestic 707 top. Before 1941, petitioner generally used domestic wool for apparel fabrics; in 1941, petitioner used more foreign wool than domestic.As far back as its records are available57 petitioner has always considered top as its raw material in estimating costs and setting its prices. Grease wool is not regarded as the raw material because the cost of grease wool cannot be determined until after it is made into top.Before 1942, petitioner, in pricing its contemplated fabrics, consistently used the lowest cost of top, whether domestic or foreign, which it believed would hold for the particular season. A fabric priced on the basis of foreign top might be finally made from domestic top, or vice versa. Petitioner never revised the price of a fabric because of such changes. Before 1941 and early in 1941, petitioner used the estimated cost of domestic top in setting its prices; later in 1941 petitioner used the estimated cost of foreign top.In February 1942, petitioner shifted its cost estimates and price calculations from a foreign top basis to a domestic top basis. The basis for this shift to domestic top was that petitioner believed that domestic top would very likely be its only source of supply. In early 1942, petitioner revised its cost estimates of nine fabrics previously based on the cost of foreign top to reflect the cost or ceiling price of domestic 58 top. In the same period the costs of about 50 additional fabrics were directly computed on the basis of the ceiling price of domestic top. Thereafter all of petitioner's cost estimates of its civilian fabrics were based upon the ceiling price of domestic top.On June 16, 1942, the Administrator of O. P. A. issued Maximum Price Regulation 163, which became effective on June 22, 1942. Maximum Price Regulation 163 (hereinafter referred to as MPR 163) fixed the maximum prices which could be charged by manufacturers of woolen and worsted civilian apparel fabrics. The Administrator also issued a Statement of the Considerations and a press release interpreting the scope and meaning of MPR 163 to the industry.The ultimate conflict between petitioner and O. P. A. related to overcharges made by petitioner on sales of "new" 1 woolen and worsted civilian apparel fabrics, none of which sales were made for use or consumption other than in the course of trade or business. The alleged 708 overcharges were a result of petitioner's determination that its raw material was purchased foreign top and its profit ratio for 1941 was to be computed using the cost of goods sold in 1941, whereas 59 the O. P. A. determined that petitioner's raw material was foreign grease wool and its profit ratio for 1941 was to be computed on the basis of cost of goods manufactured in 1941.Section 1410.102 (d) of MPR 163 relating to the60 maximum price of a new or worsted apparel fabric is as follows:(d) New woolen or worsted apparel fabrics. The maximum price for a woolen or worsted apparel fabric for which a maximum price cannot be determined pursuant to paragraphs (a), (b) or (c) of this section, shall be computed by multiplying the sum of (1) the cost of the raw materials used in the fabric and (2) the manufacturing cost thereof, by the 1941 ratio of the manufacturer's weighted average selling price to his weighted average manufacturing cost of all woolen or worsted apparel fabrics. For the purpose of this paragraph (d):The cost of raw materials and the manufacturing cost shall not exceed such costs, determined in accordance with the customary accounting practice of the manufacturer, which would have been incurred had the raw materials been delivered to the manufacturer and the fabric manufactured during March 1942;The weighted average selling price shall be determined by dividing the total amount received during 1941 from the sale of all woolen and worsted apparel fabrics by the total number of yards thereof sold during 1941;The weighted average manufacturing cost shall be determined by dividing the 61 total manufacturing costs of all woolen and worsted apparel fabrics manufactured during 1941 by the number of yards thereof so manufactured.The Statement of the Considerations involved in the issuance of MPR 163 which considerations relate to new fabrics is as follows:4. New fabrics. The formula to be used for determining the maximum price which a manufacturer may charge for a new fabric, which is not comparable to any fabric produced by him during an applicable selling period, is to multiply the cost of production of such new fabric, as determined by production costs during March 1942, by the ratio of the weighted average selling price to weighted average cost of all woolen or worsted fabrics produced and sold by him from January 1 to December 31, 1941. Thus, in determining maxima for new fabrics a manufacturer is limited to his production costs prevailing in March 1942. By this restriction prices for new fabrics will not be at levels higher than those provided for in the General Maximum Price Regulation.The Press Release dated June 17, 1942, in connection with MPR 163, in so far as it relates to new fabrics, provides as follows:For "new fabrics" not comparable to any fabrics62 previously produced by a manufacturer, a simple formula to establish his selling price is provided. The manufacturer determines the raw material and manufacturing cost on the basis of March 1942 levels. He then multiplies this by the ratio of his 1941 weighted average selling price of all civilian woolen or worsted apparel fabrics he produced to his weighted average manufacturing cost of these same fabrics. The regulation provides the method for obtaining these weighted average cost and selling price items.709 The following is an example of how the selling price is established for a new fabric:Assume raw materials cost in March, 1942$ 2.00Assume manufacturing cost in March, 1942.85Total cost$ 2.85Total weighted selling price of all civilian fabrics made and soldduring 1941 by the manufacturer$ 2.00Total weighted costs of all civilian fabrics made and sold during1941 by the manufacturer1.90$ 2.85 x $ 2.00/$ 1.90 = $ 3.00 per yard selling price of thenew fabric.Upon the issuance of MPR 163, petitioner's president, Henry W Bliss, instructed E. Dean Walen, vice-president in charge of the worsted division, to supervise compliance with the63 regulation. In order to comply with MPR 163, Walen carefully studied the regulation, the Statement of the Considerations, and the accompanying press release. About 12 other officers and employees assisted him in the interpretation of the regulation, including the comptroller, the general manager of the woolen and worsted division, the head of the division's cost and accounting department, and two of the latter's top assistants. Under MPR 163 the maximum price of a new fabric was computed by applying a stated profit ratio against specified costs. The profit ratio called for an analysis of accounting records of 1941 operations which were at the Boston office under the supervision of the comptroller and assistant treasurer, Dwight B. Billings. The cost factors involved considerations and calculations resembling the cost estimating system employed by the woolen and worsted division at Lawrence. Walen and his assistants, therefore, calculated the cost factors, and Billings worked out the profit ratio.After studying MPR 163, the Statement of the Considerations, and the press release, Walen and his assistants concluded that the raw material costs and manufacturing costs were to be64 computed as of March 1942. Since, under the petitioner's customary accounting practice, the cost of top was the cost of the petitioner's raw material for pricing purposes, Walen and his assistants construed the regulation as authorizing the petitioner to use the highest cost of top which the petitioner would have incurred in March 1942. The highest March 1942 cost of top was the ceiling price of domestic top as established by Price Schedule 58.After studying MPR 163, the Statement of the Considerations, and the press release, Billings concluded that a narrow literal interpretation of MPR 163 would not adequately reflect the underlying meaning and intention of the regulation. For example, as regards the numerator of the 1941 profit ratio, MPR 163 required a determination of the "total amount received during 1941 from the sale of all 710 woolen and worsted apparel fabrics." In a strictly literal sense this language meant to Billings that the numerator of the ratio was the total cash received in 1941 from sales made by petitioner. However, since petitioner's books were kept on an accrual basis, Billings decided that MPR 163 required him to compute the profit ratio on the basis65 of sales accrued in 1941, rather than amounts received in that year. The O. P. A. never questioned this interpretation of MPR 163.On the basis of MPR 163, as construed by the Statement of the Considerations and the press release, Billings decided that the denominator of the profit ratio was the cost of goods sold in 1941 and computed a 1941 profit ratio of 1.1539.In the computation of the 1941 profit ratio, Billings used the actual cost of the actual raw materials used which included grease wool to the extent that grease wool was used. Billings discussed his conclusions with Walen and the latter's assistants. He also checked his conclusions with petitioner's legal counsel and accountants, who confirmed his views.On and after July 17, 1942, petitioner filed 90 reports of new fabrics with O. P. A. Each report indicated the cost of the grade of top which petitioner intended to use in the respective fabric. The cost shown for the particular grade was the ceiling price of domestic top as established by Price Schedule 58, effective in March 1942. The manufacturing cost shown on each form was petitioner's manufacturing cost per yard in March 1942. The profit ratio was based on 66 the ratio of petitioner's weighted selling price of goods sold in 1941 to its weighted cost of goods sold in 1941.On or about September 24, 1942, O. P. A. issued printed forms on which manufacturers were to report the ceiling prices of new fabrics. The forms contained a list of instructions which stated, among other things, that "The cost of raw materials for the new fabric shall be calculated at the highest cost which the manufacturer would have incurred for such raw material if purchased from his customary source of supply for delivery during March 1942." Walen concluded that this official interpretation further confirmed his view that the applicable raw material cost was the March 1942 ceiling price of domestic top. These instructions also contained the following:17. The weighted average manufacturing cost shall be determined by dividing the total manufacturing costs, including the cost of raw materials, of all woolen and worsted apparel fabrics manufactured during 1941 by the number of yards thereof so manufactured.In December 1942, two O. P. A. representatives reviewed petitioner's computation of ceiling prices under MPR 163. In addition to checking petitioner's calculation67 of raw material and manufacturing costs, the O. P. A. representatives examined petitioner's method of computing its 1941 profit ratio. In reviewing the profit ratio, they 711 discovered that certain nonapparel fabrics which were low profit goods had been erroneously included in the computation. Accordingly, these fabrics were eliminated from the calculation, thereby increasing petitioner's profit ratio from 1.1539 to 1.1560. The O. P. A. representatives checked the calculation of the revised profit ratio. Apart from the error in profit ratio, they found nothing wrong with petitioner's calculation of ceiling prices for its new fabrics.During the latter part of September 1944, O. P. A. inquired whether petitioner was using foreign or domestic top in manufacturing new apparel. Petitioner stated that it had been using foreign top for some time. About October 1, 1944, Carter Lee, the regional enforcement attorney in the Boston office of O. P. A., caused an investigation of petitioner's pricing methods. Petitioner's representatives met with O. P. A. officials approximately 25 times between late September and November 22, 1944, to discuss the ceiling prices of petitioner's 68 new civilian fabrics. The early discussions between O. P. A. and petitioner involved the following contentions by O. P. A. concerning the interpretation of MPR 163: (1) petitioner should have considered the cost of foreign raw wool as the cost of its raw material rather than domestic top; and (2) petitioner should have considered its actual cost of raw wool and its actual manufacturing cost rather than its highest March 1942 costs.Petitioner contended that the method it had used in computing its ceiling prices was in accord with MPR 163, and the Statement of the Considerations and the press release accompanying it. The issue raised by Lee of O. P. A. regarding the use of actual current raw material and manufacturing costs as compared with its highest March 1942 costs was abandoned at an early stage of the negotiations upon advice given Lee by the O. P. A. price division.On October 16, 1944, petitioner stopped billing its customers pending a resolution of its controversy with O. P. A. over its pricing policy. At a conference on or about October 20, 1944, which was attended by Walen and other representatives of petitioner, Lee, who had discussed the matter with his price division, 69 advised petitioner that O. P. A. regarded as a violation the use of top as a raw material rather than raw wool when raw wool was the actual raw material. Petitioner agreed to make a calculation of overcharges on that basis. Lee asked petitioner's representatives what efforts they had made to get an interpretation from O. P. A. and petitioner's representatives said they believed they had a right to do what they had been doing and had not asked for any interpretation from anyone.At the conference of about October 20, 1944, Lee advised petitioner that it appeared to him that petitioner had not taken all practicable precautions and that O. P. A. policy required him to insist upon a settlement in excess of single damages for the statutory period (one 712 year) and as a part of that settlement that it must agree to complete compliance with the regulation as interpreted by O. P. A., such agreement to be by some sort of order entered in court. Walen agreed to go along with a settlement on that basis.During their audit, O. P. A. accountants raised the further question whether petitioner, in computing its profit ratio, should have used the cost of goods manufactured in 1941, rather70 than the cost of goods sold in 1941. Petitioner's representatives pointed out that the Administrator's Statement of the Considerations and his press release expressly interpreted the regulation as requiring the manufacturer to use the cost of goods sold. They further explained that it was not sensible to use the cost of goods manufactured in the denominator of the ratio. O. P. A. agreed that the Statement of the Considerations and the press release supported petitioner's views; however, the O. P. A. insisted that the strict language of the regulation controlled, regardless of the Administrator's Statement of the Considerations and his press release. Therefore, the profit ratio was recomputed as 1.1377, based on the cost of goods manufactured in 1941.At a conference between O. P. A. and petitioner early in November 1944, Lee again asked petitioner if it was prepared to settle the case on the basis of O. P. A.'s interpretations, consenting to an injunction against future violations and a money payment of an amount equal to all the overcharges from the time of first figuring the ceiling prices of fabrics which, by definition, would be in excess of the overcharges for the statutory71 year. It appeared from the tabulation O. P. A. had at that time, either on the basis of using foreign top in calculating ceiling prices until December 15, 1943, and foreign grease wool thereafter, or on the basis of foreign grease wool for the entire period, the money payment would exceed the overcharges for the statutory period of one year.At O. P. A.'s request, petitioner prepared a schedule dated November 15, 1944, showing alleged overcharges of $ 2,065,842.02 for the period between June 22, 1942, and October 16, 1944. This schedule was computed by using (1) the March 1942 cost of foreign top as the raw material cost for fabrics filed with O. P. A. on or before December 15, 1943, (2) the March 1942 cost of foreign grease wool as the raw material cost for fabrics filed after December 15, 1943, and (3) a profit ratio of 1.1377. The alleged overcharges for the same period, previously computed on the basis of the same raw material costs and petitioner's profit ratio of 1.1560, came to $ 1,399,157.48, or a difference of $ 666,684.54. Of the $ 2,065,842.02, the amount of $ 1,287,579.40 represented alleged overcharges attributable to new fabrics sold and invoiced during the calendar72 year 1944.For a number of reasons the petitioner finally agreed to compromise the O. P. A. claims by paying $ 2,065,842.02. Government contracts 713 were then being cancelled and petitioner had to expand its civilian production. As long as the controversy continued, petitioner was unable to quote prices and do business in a competitive market. Petitioner's financial position was seriously jeopardized because of the controversy. About $ 2,100,000 in uncollected accounts had accumulated after the petitioner had suspended billing on October 16, 1944. At the same time, petitioner had undertaken heavy obligations for a new plant and machinery. On September 18, 1944, petitioner's board of directors had authorized the expenditure of $ 5,000,000 for a new plant. By November 1944, petitioner had entered into commitments involving about $ 1,250,000 of the $ 5,000,000 to be spent. Petitioner was facing the renegotiation of large Government contracts which eventually entailed a repayment of about $ 1,700,000, before taxes. In view of these facts, petitioner's officers decided that litigation with O. P. A. should be avoided, if possible.Before the settlement was completed, Billings73 proposed that the alleged overcharges, as finally computed, should be returned to petitioner's customers. But O. P. A. officials insisted that the money had to be paid to the Administrator, and the money was so paid.Petitioner agreed that settlement would be accomplished along the lines of computing overcharges on the basis of O. P. A. interpretations throughout the entire period during which new fabrics had been priced under MPR 163, and a computation would also be made on the basis of the December 15, 1943, cutoff with a view to considering the amount so determined for settlement and agreed the case would be entered in court.The following table shows the amounts of overcharges calculated for various periods determined by using raw materials and a profit ratio as indicated:PeriodRaw materialJune 22, 1942 to Oct. 16, 1944Foreign top for styles filed on or beforeDec. 15, 1943.Foreign grease wool for styles filed afterDec. 15, 1943.June 22, 1942 to Oct. 16, 1944Foreign top for styles filed on or beforeDec. 15, 1943.Foreign grease wool for styles filed afterDec. 15, 1943.Calendar year 1944Foreign top for styles filed on or beforeDec. 15, 1943.Foreign grease wool for styles filed afterDec. 15, 1943.June 22, 1942 to Oct. 16, 1944Foreign grease woolAug. 30, 1943 to Sept. 1, 1944Purchased foreign topOct. 13, 1943 thru Oct. 12, 1944Foreign grease woolOct. 13, 1943 thru Oct. 12, 1944All grease woolOct. 13, 1943 thru Oct. 12, 1944Foreign topOct. 13, 1943 thru Oct. 12, 1944Foreign top on fabrics filed up to andincluding Dec. 15, 1943.Oct. 13, 1943 thru Oct. 12, 1944Grease wool on fabrics filed subsequent toDec. 15, 194374 PeriodRatioOverchargeJune 22, 1942 to Oct. 16, 19441.1560$ 1,399,157.48June 22, 1942 to Oct. 16, 19441.13772,065,842.02Calendar year 19441.13771,287,579.40June 22, 1942 to Oct. 16, 19441.13772,417,592.43Aug. 30, 1943 to Sept. 1, 19441.15601,006,857.71Oct. 13, 1943 thru Oct. 12, 19441.13771,957,949.53Oct. 13, 1943 thru Oct. 12, 19441.15601,460,831.48Oct. 13, 1943 thru Oct. 12, 19441.13771,625,358.30Oct. 13, 1943 thru Oct. 12, 19441.13771,498,848.87Oct. 13, 1943 thru Oct. 12, 19441.1377170,323.97714 Lee was seeking to make an estimate of the overcharges for the statutory period that would be sufficiently accurate to furnish a fair basis upon which the court might act in the matter. Based on eleven-twelfths of the overcharges for the 1-year period, October 13, 1943, to October 12, 1944, Lee estimated the approximate overcharges for the 1 year preceding the entry of the action at a little less than $ 1,800,000.On November 22, 1944, O. P. A. officials and petitioner's counsel appeared before Federal District Judge Wyzanski in the Federal Courthouse at Boston. Judge Wyzanski was presented with the complaint, 75 the answer, the stipulation for judgment, and the judgment. He was informed that there had been a controversy between the petitioner and O. P. A., that the parties had agreed upon a settlement requiring the payment of a sum of money to the O. P. A., that a bill of complaint was to be filed so that an injunction might be issued by consent, and that upon payment of the agreed amount a court order was to be entered. The parties did not discuss the issues of the controversy with Judge Wyzanski. After about 15 minutes, petitioner's counsel gave the O. P. A. officials a check for $ 2,065,842.02 in settlement of the controversy, and Judge Wyzanski signed the judgment. None of the $ 2,065,842.02 has been repaid to the petitioner.The complaint as filed alleged as follows:1. In the judgment of the Administrator, the defendant has engaged in acts and practices which constitute a violation of Section 4 (a) of the Emergency Price Control Act of 1942 (Public L. No. 421, 77th Cong., 2nd Sess., 56 Stat. 23), as amended, hereinafter called the Act in that the defendant has violated Maximum Price Regulation No. 163 (7 Fr. 4513), as amended, hereinafter called the Regulation, 76 effective in accordance with the provisions of the Act; and, therefore, pursuant to Section 205 (a) and Section 205 (e) of the Act, the Administrator brings this action to enforce compliance with said Regulation and for such damages in behalf of the United States as under the terms of the Act the Administrator is entitled to recover in behalf of the United States.2. Jurisdiction of this action is conferred upon this Court by Section 205 (c) of the Act.3. Since the issuance of the Regulation, the defendant at its place of business at Lawrence, Massachusetts, has sold and delivered woolen and worsted civilian apparel fabrics at prices in excess of those prices permitted by the Regulation. There is annexed hereto and made part hereof a schedule marked Exhibit A showing each fabric sold, the maximum permissible price and the amount of the overcharge. None of said sales were made for use or consumption other than in the course of trade or business. The amount of the overcharges during the year next preceding the commencement of this action is in excess of $ 1,800,000.00.WHEREFORE, the Administrator demands:A. a preliminary and final injunction (1) enjoining the defendant from77 selling or delivering any woolen or worsted civilian apparel fabrics at prices in excess of the maximum prices established by Maximum Price Regulation No. 163 (7 FR 4513) as amended, issued pursuant to the Emergency Price Control Act of 1942, as amended:(2) enjoining the defendant from performing any act prohibited or failing 715 to perform any act required by the provisions of said Maximum Price Regulation No. 163, as amended.B. judgment in behalf of the United States against the defendant in the sum of $ 1,800,000 or such other amount as the Administrator may be entitled to recover under the Act.A schedule annexed to the complaint as "Exhibit A" recited alleged overcharges of $ 2,417,592.43 for the period between June 22, 1942, and October 16, 1944. This schedule was based on the March 1942 cost of foreign grease wool and a profit ratio of 1.1377. The petitioner's answer to the O. P. A. complaint declared:1. The defendant is without knowledge or information sufficient to form a velief [sic] as to the truth of the amerment [sic] in Paragraph 1 of the complaint as to the judgment of the Administrator, but denies that it has engaged78 in any acts or practices in violation of the Emergency Price Control Act of 1942, as amended, or of any maximum price regulation issued pursuant to said Act.2. Further answering, the defendant hereby specifically denies all other averments in the complaint.WHEREFORE the defendant prays that the complaint be dismissed and for its costs.The stipulation for final judgment filed with the court read:It is hereby stipulated and agreed by and between the plaintiff, Chester Bowles, Administrator of the Office of Price Administration, by counsel, and the defendant, by counsel, that1. The plaintiff's claim for damages with respect to the alleged violations as set forth in the Complaint having been adjusted by the parties, the same is to be dismissed with prejudice but without costs. However, it is understood between the parties and made part of this stipulation that such adjustment does not extend to or cover any other violations of said Act than those aris- [sic] from the sales specified in the Complaint filed in this action even though such other violations may have occurred in sales to the same purchasers as were involved in the specified transactions set forth in the Complaint; 79 and2. Final judgment in the form hereto annexed may be entered against said defendant without notice at any time hereafter.Signed at Boston this 22nd day of November, 1944.The final judgment dismissed the O. P. A. claim for damages and enjoined any violations of MPR 163 in the following language:The plaintiff and the defendant having through counsel entered into a stipulation on the 22 day of November, 1944, which stipulation is filed in the Office of the Clerk of the Court and the plaintiff's claim for damages having been adjusted and the parties consenting to the entry of final judgment in the form below and sufficient reasons therefore appearing: NOW, IT IS ORDERED, ADJUDGED AND DECREED THAT(1) the plaintiff's claim for damages is dismissed with prejudice but without costs(2) the defendant is enjoined from selling or delivering any woolen and worsted civilian apparel fabrics at prices in excess of the maximum prices established by Maximum Price Regulation No. 163, as amended, issued pursuant to the Evergency [sic] Price Control Act of 1942, as amended;716 (3) the defendant is enjoined from performing any act prohibited or failing to perform any act required 80 by the provisions of Maximum Price Regulation No. 163, as heretofore or hereafter amended.The release delivered to the petitioner by O. P. A. stated:In consideration of $ 2,065,842.02 received by me on behalf of the United States of America, I, Chester Bowles, as Price Administrator of the Office of Price Administration, hereby release and discharge Pacific Mills from any and all claims which the Price Administrator has arising under Section 205 (e) of the Emergency Price Control Act of 1942, as amended, by reason of the sales described in the Bill of Complaint and particularly Exhibit A annexed thereto, filed in the United States District Court for the District of Massachusetts in the case of Bowles, Administrator vs. Pacific Mills, Civil Action No. 3150.This release does not extend to or cover any other violations of said Act than those specified above even though such other violations may have occurred in sales to the same purchasers as were involved in the above specified transactions.Except as expressly stated herein, nothing herein shall be construed in any way to limit, impair, prejudice, or bar in any manner whatsoever the right or duty of the United States of America, 81 or any officer or agency thereof, to bring or cause to be brought any action or proceeding pursuant to the said Act or any law of the United States for and concerning the said overcharges and periods of time hereinabove mentioned.In its tax returns for the year 1944, petitioner deducted from its gross income under "Schedule K -- Item 29 -- Other Deductions: Settlement with Office of Price Administration $ 2,065,842.02." The Commissioner has disallowed this deduction without stating in the deficiency notice the reason for his disallowance.During the course of the negotiations between petitioner and O. P. A. petitioner pointed out that the profit ratio for 1941 worked a hardship on petitioner as that profit ratio was computed on the basis of the cost of top to the extent top was used in 1941. Petitioner from 1942 on expanded its own production facilities and bought increasing quantities of raw wool and, therefore, petitioner contended that the pricing formula under MPR 163 was distorted by applying a profit ratio based on relatively higher costs of raw materials against a relatively lower cost of raw materials. Therefore, the petitioner contended, if its maximum prices were now 82 to be based on grease wool as the raw material, it should also be allowed to use a profit ratio based on grease wool as its raw material. Although O. P. A. was impressed by petitioner's argument, the existing regulation did not provide for any treatment other than determined by O. P. A. Petitioner was advised to file an application to amend the regulation.On October 30, 1945, O. P. A. issued Amendment 17 to MPR 163, which stated that if "since 1941 any manufacturer" had "changed his method of operation" he could increase his 1941 profit ratio by 50 per cent of the difference between his existing ratio and a ratio computed as if his "changed method of operation" had "been in effect in 1941." 717 A "changed method of operation" included "a change from the use of purchased top to purchased raw wool." Under Amendment 17 the petitioner's profit ratio which O. P. A. had reduced from 1.1560 to 1.1377 increased to 1.1507.On March 26, 1946, the O. P. A. Administrator issued Amendment 19 to MPR 163. In regard to the cost of raw material, Amendment 19 authorized a manufacturer of new worsted fabrics to calculate its cost "at the highest cost which the manufacturer incurred for raw 83 material purchased during March 1942." A footnote added that "if a mill did not buy in March 1942 the type of raw material it intends to use at present, it shall use March 1942 ceilings for such raw material." With respect to manufacturing costs, Amendment 19 authorized a manufacturer of new worsted fabrics to use the manufacturing costs "determined in accordance with the customary accounting practice of the manufacturer, incurred (or which he would have incurred) in the manufacture of the fabric during" March 1942. In addition, Amendment 19 added a definition of "raw material" for the purpose of determining the raw material cost. "Raw material" was defined as "whatever materials the mill purchases for processing." Amendment 19 also permitted the 1941 profit ratio to be computed either on the basis of the cost of goods manufactured or invoiced in 1941, provided that a manufacturer who prior to March 26, 1946, reported to the O. P. A. his profit ratio by one of these methods was not now entitled to change. In view of Amendment 19, the petitioner recomputed its 1941 profit ratio for future use in determining the proper ceiling price to charge for its products on the basis of the cost84 of goods sold in 1941, instead of the cost of goods manufactured in that year. On June 3, 1946, O. P. A. approved the petitioner's use of the cost of goods sold.The petitioner's profit ratio as recomputed under Amendments 17 and 19 was 1.1641, as compared with its earlier ratio of 1.1560 which O. P. A. had reduced to 1.1377 in 1944.In calculating its ceiling price of new woolen and worsted fabrics during the period here in question petitioner did not fail to take practicable precautions in applying the provisions of MPR 163, and petitioner's actions were in good faith and not the result of an unreasonable lack of care.OPINION.The sole question in this proceeding relates to the payment of $ 2,065,842.02 made by petitioner on November 22, 1944, to O. P. A. in settlement of a claim arising under section 205 (e) of the Emergency Price Control Act of 1942, as amended.Petitioner's primary contention is that the $ 2,065,842.02 which it paid in 1944 in settlement with O. P. A. for alleged violation of the 718 price control law and O. P. A. regulations is deductible as an ordinary and necessary business expense under section 23 (a) (1) (A), I. R. C., but that if the amount is not85 deductible as a business expense, it is deductible as a loss under section 23 (f) of the Code. These contentions are made under petitioner's assignment of error (a) in its amended petition. In the alternative, petitioner contends that $ 1,287,579.40, the amount of the payment to O. P. A. attributable to sales made and invoiced in 1944, was not includible at all in petitioner's gross income for 1944. This alternative contention is made in petitioner's assignment of error (b) in its amended petition.Respondent contends that the $ 2,065,842.02 is neither deductible as an ordinary and necessary business expense nor as a loss, and that petitioner may not exclude from gross income for 1944 any part of the amount paid to the O. P. A. on behalf of the United States.Where the O. P. A. has received payment from a taxpayer as a result of a claim under section 205 (e) of the Emergency Price Control Act of 1942, as amended, the payment is allowed as a deduction under section 23 (a) (1) (A) of the Code if the violation of the price regulation, order or schedule was neither wilful nor the result of failure to take practicable precautions against the occurrence of the violation ( Jerry Rossman Corp. v. Commissioner, 175 F.2d 711">175 F. 2d 711,86 reversing 10 T.C. 468">10 T. C. 468), or if "The violation was inadvertent and unintentional rather than in deliberate or careless disregard of the law." Farmers Creamery Co. of Fredericksburg, Va., 14 T. C. 879. The deduction has not been allowed, however, where the taxpayer has failed to show the violation was neither wilful nor the result of failure to take practicable precautions where the violation is not innocent and unintentional and made without the exercise of reasonable care. National Brass Works, Inc. v. Commissioner, 182 F.2d 526">182 F. 2d 526; National Brass Works, Inc., 16 T. C. 1051; Henry Watterson Hotel Co., 15 T.C. 902">15 T. C. 902; Garibaldi & Cuneo, 9 T.C. 446">9 T. C. 446.The cases involving claimed deductions for payments made to O. P. A. under section 205 (e) of the Emergency Price Control Act of 1942, as amended, and which have allowed such payments as deductions rely on Commissioner v. Heininger, 320 U.S. 467">320 U.S. 467, where the Supreme Court held that the legal expenses incurred in the unsuccessful87 defense of a postal fraud order were deductible. The Court said: "If the respondent's litigation expenses are to be denied deduction, it must be because the allowance of the deduction would frustrate the sharply defined policies * * * which authorize the Postmaster General to issue fraud orders." The Heininger case, supra, has been interpreted as applying not only to the deduction of legal expenses, but also to the deduction of payments to O. P. A.Jerry Rossman Corp. v. Commissioner; National Brass Works, Inc. 719 v. Commissioner; Henry Watterson Hotel Co., all supra. The test is whether the allowance of the deduction will frustrate the sharply defined policies of the Emergency Price Control Act of 1942, as amended. In the Jerry Rossman case, Judge L. Hand, speaking for the court, said: * * One may indeed argue, as the Commissioner does, that the more unsparing and relentless was the pursuit of offenders, however innocent they may have been of any wilful violation of the regulations, the more solicitous would they become to comply, and the more effective would be the enforcement of the Act. That has been a school of penology since the time 88 of Draco; but it has not been the only school, and, as we read Commissioner v. Heininger, supra, the Supreme Court did not accept it. The Administrator did not believe that such a rigid and uncomprising [sic] policy was the best way to realize the purposes of the Act. When the amendment to § 205 (e) was being considered in 1944, he declared in a letter to the Senate Committee "that the protection of innocent violators from excessive damages" was "obviously desirable"; and that it had been his "policy to adjust cases involving innocent violations by payment of merely the amount of the overcharge." He thought that Congress had given him discretion not to sue for "treble damages" in some instances, and he had exercised that discretion so as "to avoid undue hardship in deserving cases." [It may be noted in the instant case that O. P. A. Director did not ask for treble damages and none have been paid.] In short, he did not believe that it paid to sweep into the same pool with wilful or careless violators, violators for whom the daedalian mazes of the regulations had proved too much. Moreover Congress showed in 1944 by the amendment of § 205 (e) that it 89 agreed with the Administrator. It seems to us that we should accept these expressions as evidence that in cases where the Administrator accepted the overcharge as sufficient, it did not "frustrate" any "sharply defined" policies of the Emergency Price Control Act of 1942.Since under the provisions of section 205 (e) of the Emergency Price Control Act of 1942, as amended, "if the defendant proves that the violation of the regulation, order, or price schedule in question was neither willful nor the result of failure to take practicable precautions against the occurrence of the violation" the amount recoverable shall be the amount of the overcharge or $ 25, whichever is greater, the allowance as a deduction of payments to O. P. A., where this defense is shown, would not frustrate the policy of the act. Jerry Rossman Corp. v. Commissioner; National Brass Works, Inc. v. Commissioner, both supra. The purpose of the amendment to section 205 (e) whereby the treble damage provision could not be enforced against innocent violators was to reduce the possible severe "penalty" imposed upon those who could show their actions and mistakes were honest and without the intent to 90 commit a violation -- where practicable precautions had been taken and there was no wilful violation. 90 Cong. Rec. 5375-5384, 5435-5451, 5886-5887 (1944).In Garibaldi & Cuneo, supra, we held that the taxpayer could not deduct as an ordinary and necessary expense the payment to O. P. A.720 of one and one-half times the amount of the overcharges in settlement of an action for treble damages. In Garibaldi & Cuneo we found that:The petitioner has failed to show that it could not have made correct computations of the maximum price on bananas under the applicable OPA regulation during the taxable year if it had exercised ordinary diligence and reasonable intelligence in attempting to make such computations.In Henry Watterson Hotel Co., supra, the taxpayer was not allowed to deduct the payments to O. P. A. where taxpayer "offered no explanation whatsoever as to the reasons for the overcharge," and in National Brass Works, Inc., supra, we held that the taxpayer was not entitled to deduct a payment to O. P. A. where the taxpayer deliberately and knowlingly failed to comply with the 91 price regulation and where it was not shown that the overcharge was innocently and unintentionally made. In National Brass Works, Inc., supra, we commented upon the rule that we considered had been followed in cases involving these O. P. A. overcharges in the following language: * * But it appears from the Rossman case that "adequate care" means care to avoid the making of any overcharges knowingly. That is, if the overcharges were unwittingly and innocently made, as in the Rossman case, allowing a reduction of the overpayment of such overcharge would not "frustrate" the Price Control Act. As we read the Rossman case and the opinion of the Ninth Circuit in the present case on appeal, the opposite result should follow where the record shows the overcharge was deliberately or "intentionally made."After a careful consideration of all the evidence we have found that in the instant proceeding petitioner, in good faith and with the exercise of reasonable care, calculated its ceiling prices which it believed were in accordance with MPR 163. The overcharges which it made were not deliberately nor intentionally made.In the instant proceeding92 the payment of O. P. A. was, as we have found in our Findings of Fact, in excess of the amount of the alleged overcharges for the statutory period of 1 year and respondent argues that because the total amount paid to O. P. A. was more than the amount of the overcharge for the statutory period this precludes any finding that the alleged violation was neither wilful nor the result of failure to exercise practicable precautions. Section 205 (e), Emergency Price Control Act of 1942, as amended. We think this contention is without any merit when the facts in evidence are considered. The payment here was a settlement and the district court proceeding and the judgment and injunction issued out of that proceeding were all by consent and without a decision on the merits. There is no finding by any court, as we found in the National Brass Works, Inc., case, supra, that the taxpayer "deliberately and knowingly failed to comply with the price regulations and had not shown that the overcharges 721 were innocently and unintentionally made." The whole purpose of the payment to O. P. A. in the instant case was to settle a claim for an alleged violation of MPR 163 which petitioner93 believed it did not violate, but, that if it did violate, it did so without any wilful intent. While petitioner paid $ 2,065,842.02 to O. P. A., its liability for treble damages for the statutory 1-year period might have been approximately $ 5,400,000. Although the payment to O. P. A. exceeded the statutory 1-year overcharges, the excess over this amount was not an arbitrary figure for the purpose of making the payment punitive, but rather the entire amount was carefully calculated to reflect the overcharges for the entire period from June 22, 1942, to the date of settlement in such a way as to remove petitioner's profit from past overcharges.The administrative determination, if any, is not final on the question of adequate care ( Jerry Rossman Corp. v. Commissioner, supra) as that question is to be judicially determined on the merits. National Brass Works, Inc. v. Commissioner, supra. See also Utica Knitting Co.v. Shaughnessy in the United States District Court for the Northern District of New York, decided September 4, 1951. In that case it was held that the amounts paid to the Government in 1946 94 in settlement of damages for O. P. A. violations were deductible in that year on the accrual basis since there was a binding adjudication in that year as to taxpayer's liability and neither wilfulness nor carelessness was involved in the violations. In rendering summary judgment for the plaintiff taxpayer, the court said:The decisions in the Jerry Rossman and National Brass Works cases, supra, eliminate the necessity of discussing and deciding several contentions made before this Court. They plainly hold that a deductible expense is not determined by the label placed thereon, and the question as to whether or not the payments made by the plaintiff here may be termed penalties is not decisive. Neither is the fact that a violation of law is directly involved. Each case must be decided upon its own facts. ( Commissioner v. Heininger, 320 U.S. 467">320 U.S. 467.) The decision follows, based upon the circumstances of the violation and the effect of the allowance of the deduction upon the enforcement of the law violated.Because we have found as a fact that the alleged violation of MPR 163 was neither wilful nor a result of failure to take practicable*95 precautions and was not a result of unreasonable lack of care, the payment of $ 2,065,842.02 which petitioner paid O. P. A. in 1944 was properly deducted by petitioner under section 23 (a) (1) (A) of the Internal Revenue Code in determining its net income. As a result of this holding, it is unnecessary for us to decide petitioner's alternative contentions.Decision will be entered under Rule 50. Footnotes1. Sections 1410.102 and 1410.115 of MPR 163 originally described three principal types of woolen and worsted civilian fabrics: base period fabrics, comparable fabrics, and new fabrics. A base period fabric was a fabric which the manufacturer had sold before the issuance of MPR 163. A comparable fabric was a fabric not previously sold by him but substantially similar to a base period fabric sold by him. Generally speaking, comparable fabrics were like base period fabrics except that comparables were manufactured from different blends of raw material. A new fabric was a fabric which did not fall within the definitions of base period and comparable fabrics. Later, on September 8, 1942, Amendment 4↩ to MPR 163 added the category of similar fabrics, as defined in section 1410.102 (i) of MPR 163.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624572/	James G. Maxcy and Louise C. Maxcy, Petitioners v. Commissioner of Internal Revenue, RespondentMaxcy v. CommissionerDocket No. 870-71United States Tax Court59 T.C. 716; 1973 U.S. Tax Ct. LEXIS 167; 59 T.C. No. 71; March 1, 1973, Filed 167 Decision for all years will be entered under Rule 50. 15Petitioner James G. Maxcy, his brother, Von, and sister, Elizabeth, were partners in certain businesses. The partnerships168 in question had taxable years ending July 31. Von died on Oct. 3, 1966. The final agreement relating to the acquisition by James of Von's and Elizabeth's interests was executed on Feb. 26, 1968. Petitioners claimed the partnerships terminated on the death of Von and were thereafter operated as sole proprietorships by James. Held, the partnerships did not terminate until Feb. 26, 1968, and petitioners are entitled to deduct only James' pro rata share of the losses of the partnerships for the period Oct. 3, 1966, to Feb. 26, 1968. Held, further, James did not acquire the partnership interests of Von and Elizabeth until Feb. 26, 1968, and is entitled to depreciation in respect of the assets representing those interests only from that date. Held, further, petitioners are entitled to the benefit of an unused investment credit for fiscal 1964 to the extent of, but not in excess of, the amount of the deficiency for that year based upon an excessive carryback of a net operating loss for fiscal 1967 even though a claim for refund or credit for fiscal 1964 is otherwise barred by the period of limitations under secs. 6511(a) and (b) and 6512(b)(2), I.R.C. 1954. Thomas D. Aitken173 and James W. Ault, for the petitioners.Donald W. Williamson, Jr., for the respondent. Tannenwald, Judge. TANNENWALD716 OPINIONRespondent determined the following deficiencies in petitioners' income tax:FYE July 31 --Deficiency1964$ 1,898.17196512,871.98196621,142.36The parties have stipulated that the issues which remain for decision are as follows:(a) Whether petitioners are entitled to the investment credit in the amount of $ 3,500.00 for the fiscal year ended 7/31/64, to the extent needed to offset any deficiency for that period otherwise determined by this Court.(b) The date of termination of the Maxcy & Maxcy partnership.(c) The date of termination of the Maxcy Groves partnership.(d) The date of termination of the Arcadia partnership.(e) Whether petitioner is entitled to deduct depreciation on assets acquired from [Charles Von Maxcy's] estate and from [Laura Elizabeth Maxcy] using the declining balance method at a rate not exceeding 150% of the straight line rate. 1174 717 (f) At what date is the petitioner entitled to claim depreciation on the assets acquired from [Charles Von Maxcy's] estate and from [Laura Elizabeth Maxcy].All of the facts have been stipulated and are found accordingly. The stipulation of facts and exhibits are incorporated herein by this reference.James G. Maxcy (hereinafter referred to as the petitioner) and Louise C. Maxcy, husband and wife, resided in Sebring, Fla., at the time of the filing of the petition herein. Joint income tax returns for the years in question as well as for the fiscal years ended July 31, 1967, July 31, 1968, and July 31, 1969, were filed with the district director of internal revenue, Jacksonville, Fla. Amended returns were filed for fiscal years 1964, 1965, and 1969. Louise C. Maxcy is a party to this action solely because she filed joint returns with petitioner for the years in question.Petitioner, as of October 3, 1966, was a member of three family partnerships:(a) Maxcy Groves, in which petitioner, his brother, Charles Von Maxcy (hereinafter referred to as Von), and their sister, Laura Elizabeth Maxcy (hereinafter referred to as Elizabeth), were equal partners and equal coowners of175 the citrus groves and land. The business of the Maxcy Groves partnership consisted of growing and selling citrus fruit.(b) Maxcy Groves and C. Von Maxcy (a/k/a and hereinafter referred to as the Arcadia partnership), which consisted of Von, who owned a 65-percent interest in the partnership, and the Maxcy Groves partnership, which owned the other 35-percent interest. The principal business of the Arcadia partnership was the growing and selling of citrus fruit.(c) Maxcy & Maxcy (a/k/a C. V. and J. G. Maxcy Groves), which was owned equally by Von and petitioner at all times pertinent hereto, except that prior to August 1, 1965, Von owned a 60-percent interest therein and petitioner owned the other 40 percent. The principal business of this partnership was also the growing and selling of citrus fruit.Von was killed on October 3, 1966. At the time of Von's death, there existed no written partnership agreement between or among the partners in any of the three partnerships. Neither was there any agreement, written or otherwise, as to the disposition of a deceased partner's interests in the event of the death of a partner.Irene H. Maxcy (Von's widow) and the Citizens National Bank176 of Orlando were appointed coexecutors of Von's estate.718 On or about November 8, 1966, Von's executors filed a petition with the County Judge's Court of Highlands County, Fla., which read, in pertinent part, as follows:2. That your petitioners have not as yet had sufficient time to assemble the information required for an inventory to be filed in said estate, but are aware of the fact that among the assets of the estate are certain partnerships in which decedent was a partner to wit:(a) C. V. and J. G. Maxcy Groves (1/2 interest)(b) Maxcy Groves (1/3 interest)(c) Arcadia (2/3 interest)3. In addition to said partnerships decedent owned certain groves and certain equipment pertaining to caretaking and grove operation and marketing.4. That petitioners are aware of Florida Statutes 733.37 requiring that in the absence of an agreement to the contrary, partnerships will be liquidated upon the death of a partner.5. That the immediate liquidation of said partnership is not practical now [sic] would it be in the best interests of the estate.6. That pending an orderly liquidation of said partnerships numerous decisions relating to caretaking, marketing and other matters 177 are necessary to conserve said assets of the estate.7. That petitioners desire a court order authorizing them to continue the business of the decedent and to participate in the decisions relating to the partnership businesses of decedent.Wherefore, petitioners pray that this Honorable Court authorize them as Executors to continue in behalf of the estate the businesses of decedent and to participate in the business affairs of said interests owned in partnership pending orderly liquidation of said partnerships and disposition thereof in the best interests of the estate.The parties have stipulated that, in seeking the aforementioned relief, Von's executors were primarily interested in continuing certain businesses other than the partnerships in question and in assuring their participation in any decisions regarding the liquidation of the partnerships and the disposition thereof.By order dated November 8, 1966, the relief prayed for in the petition was granted and the coexecutors were "ordered, to participate in the business affairs of said interests owned in partnership pending orderly liquidation of said partnerships and disposition thereof, all in the best interests of the estate." 178 Following Von's death, the business of each of the three partnerships was continued essentially the same as before Von's death. Each of the businesses was managed by petitioner. The coexecutors of Von's estate did not actively participate in the management of any of these business operations, and they advised petitioner almost immediately after Von's death that petitioner was to be responsible for such management. The Citizens National Bank was kept apprised of the operations of the businesses through monthly financial statements furnished by petitioner. In accordance with the advice of petitioner's 719 counsel, the books of account of each of the three partnerships were, until February 26, 1968, maintained in the same manner as they had been prior to Von's death.Following Von's death, petitioner made additional contributions to the operating capital of the three businesses. The coexecutors of Von's estate refused to make any such contributions, although the petitioner requested them to do so.The first meeting at which the liquidation and termination of the three partnerships was discussed by the interested parties was held on February 22, 1967. Among those present at179 this meeting were the petitioner, Elizabeth, and the coexecutors of Von's estate. At this meeting, among other things, the parties considered liquidating the partnerships as of July 31, 1967. Consideration was also given at this meeting to having either Von's estate or the petitioner purchase the other's interests in the partnerships, but no offer or offers were made by either party at that time.The next meeting was held on August 22, 1967. At this meeting, an oral offer was made by petitioner to purchase Von's interests in the three partnerships. The offer price was computed in the following manner: The value of Von's interests in the three partnerships as of October 3, 1966, as set forth in the appraisal of the estate of Charles Von Maxcy, deceased, made by Alvin R. Schneider, M.A.I., and L. C. Smith, broker, dated August 10, 1967, was reduced by the petitioner's estimate of the appraiser's overevaluation of Von's interests in the three partnerships as of the date of death, and further reduced by petitioner's estimate of the decline in the value of Von's interests in the three partnerships from October 3, 1966, to July 31, 1967, to arrive at a gross purchase price. The offer180 also contemplated the following reductions, credits, and setoffs against the gross purchase price:(a) The estate would pay its pro rata share of the real estate taxes on the partnership properties through July 31, 1967;(b) The estate would share in the losses sustained by the three businesses up to July 31, 1967;(c) The petitioner would receive credit for advances he had made to operating capital of the three businesses since the date of Von's death and up to July 31, 1967; and(d) The estate would pay a share of the proposed salaries of petitioner and Elizabeth for their services to the businesses between the date of Von's death and July 31, 1967.By letter dated August 29, 1967, Von's executors rejected petitioner's proposal. The letter stated that the major assets of the partnerships had not declined in value since Von's death, that petitioner and Elizabeth were not entitled to any salary for their efforts on behalf of the partnerships since Von's death, that expenditures such as discing 720 harrowing, and fertilizing the groves for future use should not be charged to the estate, that the payment of an "open end" fee to petitioner's attorneys was not justified because181 much of their work did not concern itself with partnership businesses, but with matters personal to petitioner and other members of the family, and finally that certain questions existed as to the nature and amount of advances made by petitioner to the partnerships.The interested parties met again on September 21, 1967. At this meeting, the coexecutors of the estate advised the petitioner that Von's interests in the three partnerships must be valued as of the date of Von's death in computing the purchase price. The reason given the petitioner by the coexecutors for reverting back to the date of death was that, in the legal opinion of counsel for the Citizens National Bank of Orlando, the partnerships had to be dissolved as of the date of Von's death under the laws of the State of Florida. The petitioner thought, however, that the coexecutors' reason for insisting on a date-of-death valuation was that it would be a more advantageous valuation date for the estate.Between September 21, 1967, and October 5, 1967, negotiations continued, with the result that, by letter dated October 5, 1967, the coexecutors of the estate made an offer to sell Von's interests in the three partnerships182 to petitioner for $ 295,000 cash (subject to certain adjustments) plus the estate's proportionate share of proceeds "from the partnerships' fruit now in participation for the 1966-67 season." The offer called for petitioner to pay additional consideration in the form of the discharge and satisfaction of all partnership obligations, petitioner's and Elizabeth's release of their claims for compensation for services rendered the partnerships since the date of Von's death, and the complete and full agreement of petitioner and Elizabeth "that the Estate is to bear no share of the expenses and losses of the partnerships subsequent to October 3, 1966." This offer was followed by further negotiations, as a result of which the parties reached an oral agreement, which was reduced to writing in the form of a letter from petitioner to the coexecutors and signed by them, dated October 19, 1967. In that letter, petitioner agreed to purchase the estate's interests in the partnerships for $ 286,000 cash "less the Estate's share of any principal and interest due as of closing on the Florida Citrus Production Credit Association obligations, plus the Estate's proportionate part of the 1966-1967 participation183 fruit proceeds as said monies are received." 2721 Valuation of the estate's interests was established as of October 3, 1966. Petitioner also agreed to the following:1. Complete and full satisfaction of all claims, including interest, by all partnerships, himself, his wife, his sister Elizabeth, and Mary V. Maxcy, against either Von Maxcy, Inc., 3 or the estate;2. Either pay or assume and agree to pay in full a promissory note for $ 45,000 in favor of The First National Bank of Orlando and signed by Von, petitioner, and Elizabeth;3. Release and satisfaction of any claim petitioner or Elizabeth had for compensation from the partnerships for any post-death services rendered; and4. Complete and full agreement of petitioner and Elizabeth that the estate was to bear no share of the expenses or losses from operations of the partnerships subsequent to October 3, 1966.184 The performance of the October 19, 1967, letter agreement contained the following:Of course you [the coexecutors] understand from our many discussions, that this offer is conditioned upon the successful conclusion of my [petitioner's] negotiations for funds from a lender who tentatively committed them to me quite some time ago. I have no reason to believe that the loan still cannot be consummated. But if the financing arrangements prove impossible, then I will not be bound by this offer to purchase. Similarly, I understand you all have entered this agreement subject to approval by the County Judge for Highlands County, Florida. I presume that you will immediately petition the Court for its approval of this transaction. When you have notified me of the Court's approval, we can schedule a tentative closing date and discuss some satisfactory means to obtain satisfaction of the obligations you hope to have satisfied before October 31, 1967. [Emphasis added.]On October 24, 1967, the coexecutors petitioned the County Judge's Court for an order "allowing them to sell said property." 4 On October 30, 1967, the court issued an order in which the coexecutors were -- authorized, 185 to sell the following described property at private sale to James G. Maxcy:Maxcy & Maxcy50%Maxcy Groves and C. Von Maxcy Estate65%Maxcy33 1/3%the said sale to be made in accordance with the Contract attached to the Petition for this Order.At some point of time following completion of the negotiations with the coexecutors for the purchase of Von's interests in the three partnerships, and prior to February 26, 1968, the petitioner and Elizabeth reached an agreement for the purchase by petitioner of Elizabeth's 722 interests in the partnerships. The basis of valuation for Elizabeth's interests was the same as that utilized in valuing the estate's interests in the partnerships.On February 26, 1968, the date of closing, the acquisition by petitioner of the partnership interests owned by the estate and Elizabeth was finalized186 by the execution of a document entitled "Partnership Termination Agreements" entered into by and between petitioner, Elizabeth, Von's widow, acting individually, and the coexecutors of Von's estate. The letter agreement of October 19, 1967, served as the basis for this document.The preamble to this document recited that Von's death dissolved the partnerships and that the purchase of the estate's and Elizabeth's interests in the partnerships was "in lieu of a liquidation or in-kind distribution of the partnerships' assets and in lieu of a final accounting of the partnerships."This agreement provided, in pertinent part, that, with respect to petitioner's purchase of the estate's interests in the partnerships, petitioner would pay $ 286,000 plus the estate's share of participation fruit proceeds from the 1966-67 season. In addition, petitioner agreed to satisfy any and all claims the partnerships, petitioner, his wife, his sister Elizabeth, or Mary V. Maxcy might have against either the Estate or Von Maxcy, Inc., satisfaction of the estate's liability on obligations to the Gulf-Atlantic Citrus Production Credit Association as of the date of death, and payment in full of a $ 45,000187 note to the Orlando Bank, upon which the signatures of Von, Elizabeth, and petitioner appear.With respect to the purchase of Elizabeth's interests, petitioner agreed to pay $ 14,747 plus Elizabeth's share of the 1966-67 participation fruit proceeds; to execute a $ 15,000 note, with interest at 7 percent, in favor of Elizabeth, payable in three equal installments commencing February 23, 1969; to repay a $ 10,000 loan Elizabeth received from Arcadia; and to convey the "JGM 20 acre grove" to Elizabeth, with taxes thereon to be prorated from October 1, 1966 through 1967.With respect to both purchases, petitioner assumed and agreed to pay all debts, obligations, and liabilities existing on or arising after October 3, 1966, and pay the estate's share of all closing costs involved in the liquidation and termination of the partnerships; Elizabeth paid her share of the closing costs with regard to the termination of Maxcy Groves only. All parcels of realty were transferred to petitioner by way of deeds dated February 23 or 26, 1968, and recorded on February 26, 1968. The three partnerships in question were declared terminated as of October 3, 1966. Except for their share of participation188 fruit proceeds and the payments required thereunder, the document 723 provided that the estate and Elizabeth "are to share in none of the profits and to bear none of the expenses or losses from the operation of the former partnership properties subsequent to October 3, 1966."On the same day that the document was executed (February 26, 1968), Elizabeth, Von's widow, acting individually, and the coexecutors of Von's estate conveyed to petitioner by bill of sale all grove equipment and other personal property, as well as all fruit then growing in the groves, owned by the three partnerships and, in addition, assigned to petitioner all proceeds from sales of fruit for the growing season 1967-68 whether theretofore paid or not.The petitioners, on their joint income tax returns filed for the taxable years July 31, 1967, and thereafter, treated the partnerships as having terminated for Federal income tax purposes on October 3, 1966, with the result that they included all income (except the estate's share of the 1966-67 fruit participation proceeds) and claimed all expenses and losses realized, incurred, or sustained in the partnership operations subsequent to Von's death on October189 3, 1966. Petitioners' return for fiscal 1967 was filed on or about April 18, 1968. The income tax returns filed by Elizabeth (for calendar years 1966 and subsequent) and for Von's estate (for taxable years ended September 30, 1967, and subsequent) similarly reflected such income, expenses, and losses as belonging to petitioner, except that Elizabeth's return for calendar year 1966 showed only her share of income in the Maxcy Groves partnership for the period ending July 31, 1966. The first such return for Von's estate covered the fiscal year October 3, 1966, to September 30, 1967, but was not filed until April 16, 1968, i.e., after the February 26, 1968, agreement had been executed. The record does not contain the final income tax return of Von nor does it indicate when Elizabeth's 1966 return was filed.On Schedule F of the estate tax return filed by the coexecutors of Von's estate between January 16 and April 3, 1968, each of the partnership interests was listed as an asset not disposed of within 1 year following Von's death, with the statement that the "Executors have entered into an agreement for sale" (emphasis added) for a specified amount.On or about April 15, 1968, 190 the petitioners filed a claim for refund in the amount of $ 3,500 for the fiscal year ended July 31, 1964, on the ground that an investment credit in that amount was not claimed on their amended joint return for that year. Respondent has taken no action on this claim, but both parties agree that the claim was untimely filed. Respondent concedes that, had this claim been timely filed by the petitioners under the applicable statute of limitations, the amount of $ 3,500 claimed as a refund therein would have been allowed.724 On or about April 22, 1968, the petitioners filed an Application for Tentative Carryback Adjustment resulting from a net operating loss and unused investment credit claimed for the fiscal year ended July 31, 1967. As a result of this application, tentative refunds were made by respondent to the petitioners for the entire amount of income tax ($ 11,282.39) paid for the fiscal year ended July 31, 1964, the entire amount of income tax ($ 12,498.94) paid for the fiscal year ended July 31, 1965, and $ 1,514.66 of the $ 13,256.34 income tax paid for the fiscal year ended July 31, 1966.On or about November 15, 1968, the petitioners filed another Application for191 Tentative Carryback Adjustment resulting from a net operating loss claimed for the fiscal year ended July 31, 1968, as a result of which a tentative refund was made by respondent in the amount of $ 11,469.14, representing the balance of the $ 13,256.34 income tax paid by the petitioners for the fiscal year ended July 31, 1966, less the $ 1,514.66 tentatively refunded pursuant to the prior application referred to in the above paragraph.Also on or about November 15, 1968, the petitioners filed a claim for refund in the amount of $ 272.54 for the fiscal year ended July 31, 1966, on the ground that the investment credit of $ 1,361.01 claimed on the original July 31, 1965, joint return filed by the petitioners was no longer needed in the fiscal year ended July 31, 1965, due to the net operating loss carryback from the fiscal year ended July 31, 1967, to the fiscal year ended July 31, 1965, pursuant to the application of April 22, 1968, and the $ 1,361.01 investment credit was therefore allowable as a carryforward to the fiscal year ended July 31, 1966. Respondent has taken no action on this claim; he concedes, however, that the claim is allowable as a credit or refund, as the case may192 be.Issue 1. Termination of the Three PartnershipsWe are first asked to determine when the partnerships in question terminated within the meaning of section 708(a) and section 708(b)(1). 5 Respondent contends that they did not terminate before February 26, 1968, the date of the so-called partnership termination agreements. Petitioner contends they terminated on October 3, 1966, the date of Von's death and the date used to value the assets purchased by petitioner from his partners. At stake is the amount of petitioner's share of the losses incurred by the partnership businesses subsequent to Von's death and the point of time from which petitioner may commence depreciating the partnership assets purchased from his partners at the 150-percent rate. Alternatively, petitioner suggests 725 that the agreement of October 19, 1967, retroactively allocated all profits and losses of the partnership for its final 2 years to petitioner.Section193 708(a) provides that an existing partnership shall be considered as continuing unless terminated. Section 708(b)(1) provides that a partnership shall be terminated only if --(A) no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership, or(B) within a 12-month period there is a sale or exchange of 50 percent or more of the total interest in partnership capital and profits.Petitioner's arguments seek to invoke section 708(b)(1)(A), while respondent asserts that section 708(b)(1)(B) is the operative provision under the circumstances herein.Petitioner stresses that only he participated in the managing and financing of the partnership businesses subsequent to Von's death, only he was to account for post-death profits and losses, and, finally, that date-of-death values were used in determining the purchase price of the partnership assets. As a result, he contends that the partnerships terminated on Von's death because from and after that date all activities were carried on solely by himself and not by "any * * partner in a partnership." (Emphasis added.)Petitioner asserts that, in the instant194 case, there was no process of "winding up" or liquidation of the partnership businesses following Von's death in which it could be said that the estate continued to participate as a partner and that the termination of the partnership was postponed until the completion of that process. Cf. Kinney v. United States, 228 F. Supp. 656">228 F. Supp. 656, 663-664 (W.D. La. 1964), affirmed per curiam 358 F.2d 738">358 F.2d 738 (C.A. 5, 1966); David A. Foxman, 41 T.C. 535">41 T.C. 535, 556-557 (1964), affirmed on another issue 352 F.2d 466">352 F.2d 466 (C.A. 3, 1965); Estate of Guy B. Panero, 48 T.C. 147">48 T.C. 147, 155 (1967); Elaine Yagoda, 39 T.C. 170">39 T.C. 170, 183 (1962), affd. 331 F.2d 485">331 F.2d 485, 491 (C.A. 2, 1964). But it does not follow from this assertion, even if true, that there was no "business of the partnership * * carried on by any of the partners in a partnership."Clearly, the coexecutors of Von's estate asked for and received the broadest authority from the Florida County Court to continue "all businesses of the decedent" and "participate in the 195 business affairs of [the partnership] pending orderly liquidation." See also Fla. Stat. Ann. sec. 733.08 (1945). Their continued participation is further confirmed by the fact that petitioner accounted to them monthly in respect of the operations of the businesses. It is equally clear from our findings that there was a lengthy and tortuous process of negotiations before the rights and obligations of petitioner, Von's estate, and Elizabeth were finally defined.726 Petitioners' attempts to counteract these critical factors miss the mark. To be sure, petitioner was responsible for the management of the businesses, but such responsibility is not to be equated with the existence of a sole proprietorship, cf. Austin v. United States, 461 F.2d 733">461 F.2d 733, 737 (C.A. 10, 1972); in this respect, petitioner's status was comparable to that of a managing partner functioning on behalf of himself and his copartners, for which he was obligated to (and, in fact, did) account. Cf. Biers v. Sammons, 2d 158">242 So. 2d 158 (Fla. Dist. Ct. App. 1970), and cases cited therein. Similarly, the fact that the coexecutors refused to make additional196 contributions to the operating capital of the three businesses is not the equivalent of an absence of sharing of profits and losses. Petitioner can draw little, if any, sustenance from the fact that the various parties reported the profits and losses of the three partnerships in a manner consistent with termination on October 3, 1966; most, if not all, the returns were filed subsequent to February 26, 1968, i.e., after the definitive arrangements were finalized, 6 and Elizabeth's 1966 return did not include any item in respect of Maxcy Groves for the period August 1 to October 3, 1966. Finally, the fact that the interests of the estate and Elizabeth were valued as of October 3, 1966, in order to determine the amount to be paid simply reflects their belief that their interests were worth at least that much of the time of the buyouts.197 In short, other than by way of hindsight, the conclusion that the partnership terminated as of October 3, 1966, is belied by the facts herein. We think it clear beyond peradventure that both the estate and Elizabeth retained their respective interests in the partnerships until well after that date. Cf. Frederich v. Commissioner, 145 F.2d 796">145 F.2d 796 (C.A. 5, 1944), reversing on other grounds 2 T.C. 936">2 T.C. 936 (1943); Estate of Guy V. Panero, supra; David A. Foxman, supra. Compare Fla. Stat. Ann. sec. 733.37 (1951). Had the values sharply increased or decreased, we have little doubt that such fluctuations would have been reflected in the ultimate purchase price.The case of Knipp's Estate v. Commissioner, 244 F.2d 436">244 F.2d 436 (C.A. 4, 1957), affirming 25 T.C. 153">25 T.C. 153 (1955), relied on by petitioners, is not in point. In that case, there was a preexisting partnership agreement which provided for a buyout in the event of death and for the immunization of the deceased's estate from sharing in profits or losses. The same condition obtained in Rev. Rul. 54-55, 1 C.B. 153">1954-1 C.B. 153,198 also cited by petitioner.The question remains, however, as to when the three partnerships were in fact terminated. Resolution of this question turns upon when 727 there was a sale of 50 percent or more of the total interest in each of the partnerships within the meaning of section 708(b)(1)(B). Three possible dates suggest themselves, i.e., October 19, 1967, October 30, 1967, and February 26, 1968.As far as the partnership interests of the estate are concerned, the letter agreement of October 19, 1967, embodying petitioner's offer and its acceptance by the coexecutors of Von's estate, was specifically conditioned upon court approval and petitioner's obtaining sufficient financing to consummate the purchase. The court approval was obtained on October 30, 1967, but such approval, by its terms, merely "authorized" the sale; it did not approve a consummated sale or operate by itself to accomplish a sale. Moreover, the estate tax return filed by the coexecutors at some undisclosed date after January 16, 1968, 7 spoke in futuro, i.e., of an "agreement for sale." (Emphasis added.) With respect to the fulfillment of petitioner's requirement of financing, the record contains199 no indication of when this was accomplished and it is clear that the October 19, 1967, agreement was not binding until that substantial condition was satisfied; under the circumstances, the agreement of October 19, 1967, constituted nothing more than an option to purchase in favor of petitioner. Cf. Chapin v. Commissioner, 140">180 F.2d 140 (C.A. 8, 1950); Stiver v. Commissioner, 90 F.2d 505 (C.A. 8, 1937). Compare Teaford v. Commissioner, 246 F.2d 73">246 F.2d 73 (C.A. 7, 1957); LeSage v. Commissioner, 173 F.2d 826">173 F.2d 826 (C.A. 5, 1949), affirming on this issue a Memorandum Opinion of this Court.The only evidence with regard to when agreement upon terms of purchase of Elizabeth's interests was first reached indicates that it occurred at some undetermined date after negotiations200 with the estate were concluded, but no later than February 26, 1968. On the basis of the record before us, the only conclusion to be drawn is that the sale of her interest occurred on February 26, 1968; we would be making a wild guess to set the date earlier.Taking into account all the facts and circumstances, we conclude that sales of the partnership interests in question did not occur until February 26, 1968. Edwin E. McCauslen, 45 T.C. 588 (1966). Our conclusion is in no wise impaired by any rationale based upon the argument that petitioner was in possession and control of the partnership assets. Compare, e.g., Clodfelter v. Commissioner, 426 F.2d 1391">426 F.2d 1391 (C.A. 9, 1970), affirming 48 T.C. 694">48 T.C. 694 (1967); Pacific Coast Music Jobbers, Inc., 55 T.C. 866">55 T.C. 866 (1971), affd. 457 F.2d 1165">457 F.2d 1165 (C.A. 5, 1972); Ted F. Merrill, 40 T.C. 66">40 T.C. 66, 74 (1963), affirmed per curiam 336 F.2d 771">336 F.2d 771 (C.A. 9, 1964). Petitioner's possession and control herein prior to February 26, 1968, was not as a purchaser but201 as a partner.728 Petitioners alternatively contend that if we find that the partnerships did not terminate on October 3, 1966, the partnership agreements were amended prior to November 15, 1967, to provide that only petitioner would be entitled to the profits and would bear the losses of the partnerships after October 3, 1966 (other than certain fruit participation proceeds, see fn. 2 supra), and that this amendment was effective under section 761 (c) 8202 in respect of the partnership fiscal years ended July 31, 1967, which included the October 3, 1966, date. His argument runs as follows: Section 702(a) requires each partner to take into account his distributive share of partnership income or losses in determining his personal income tax; section 704(a) provides that the partnership agreement generally determines each partner's share of income, or loss; and section 761(c) allows an amendment of the partnership agreement to be retroactive under certain circumstances. 9The petition herein, which, according to Rule 7, Tax Court Rules of Practice, must state all assignments of error and the facts upon which error is alleged in a clear and concise manner, is worded only in terms of when did the partnership terminate, the date from which petitioner may take depreciation on the purchased assets, and the availability of an unused investment credit. In addition, the parties stipulated the issues which were submitted to us for consideration. The first time this issue of retroactive allocation appeared was in petitioners' original brief. It is well established that this Court will not consider issues first raised on brief and not appearing in the pleadings. Sidney Messer, 52 T.C. 440">52 T.C. 440 (1969), affd. 438 F. 2d 774 (C.A. 3, 1971); Eleanor Shomaker, 38 T.C. 192">38 T.C. 192, 201 (1962); William Greenberg, 25 T.C. 534">25 T.C. 534 (1955). We think this principle203 is particularly applicable in this case in view of the interrelationship between section 761(c) and the existence of a "principal purpose of * * * avoidance or evasion of tax" in respect of a provision in the partnership agreement as provided in section 704(b)(2). There are potential factual elements involved which might well have resulted in a different focus to the instant case, including the possibility that it would not have been fully stipulated. 10Issue 2. DepreciationOur analysis as to when the partnerships terminated disposes of the issue of the date of acquisition by petitioner of the assets representing 729 the partnership interests of Elizabeth and Von's estate for purposes of 204 determining the point of time from which petitioner may commence depreciating those assets. That date is February 26, 1968. Edwin E. McCauslen, supra.Issue 3. Unused Investment CreditThe deficiency asserted by respondent for fiscal 1964 is predicated upon his determination that petitioner overstated the amount of his fiscal 1967 net operating loss which could properly be carried back to the earlier year and that, consequently, respondent made an erroneous tentative refund of $ 1,698.17 of petitioner's tax for such earlier year. Our disposition of the prior issues herein largely sustains respondent's determination that the claimed fiscal 1967 net operating loss was overstated, with the consequence that there was an erroneous tentative refund in respect of fiscal 1964 which was timely determined to be a deficiency by respondent on November 12, 1970, pursuant to the provisions of section 6501. Petitioners seek to resist the determination of such deficiency by claiming the benefit of such portion of a $ 3,500 investment credit as will reduce respondent's claim for fiscal 1964 to zero. They do not seek a decision by this Court that they are entitled205 to a credit or refund of any excess of such credit over the amount of respondent's claim based upon the smaller 1966 net operating loss carryback. Petitioners did not take advantage of such credit on their fiscal 1964 tax return and they did not file a timely claim for refund in respect thereof. Respondent resists petitioners' effort to reduce the deficiency on the ground that any such reduction is barred by the period of limitations applicable to refunds specified in sections 6511 (a) and (b) and 6512(b)(2).As we see it, the critical problem in resolving the issue thus presented is what elements may we properly take into account in deciding whether a "deficiency" exists for fiscal 1964. If respondent's determination of a deficiency for that year had been made within the normal period of limitations (in this case, within 3 years from the filing of the return), there would be no problem. Clearly, under such circumstances, petitioner would be entitled to resist respondent's determination on any ground, irrespective of whether it had formed the basis of a claim on their tax return or of the determination of a deficiency by respondent. Vincent A. Marco, 25 T.C. 544">25 T.C. 544, 549 (1955);206 Estate of Mary E. Jackman, 2 B.T.A. 515">2 B.T.A. 515 (1925). 11 Prior to 1966, however, the situation with respect to net operating loss carrybacks was more restricted. 207 Respondent could assert deficiencies, after the 730 expiration of the normal period of limitations, in respect of erroneous allowances of refunds made in response to applications for tentative net operating loss carryback adjustments only to the extent that such deficiencies were "attributable" to the carryback. Sec. 6501(h); sec. 6213(b)(2); Ione P. Bouchey, 19 T.C. 1078 (1953); Edward G. Leuthesser, 18 T.C. 1112">18 T.C. 1112 (1952). Cf. Bunn's Auto Sales, Inc., 35 T.C. 861 (1961). 12 Taxpayers were similarly limited in their ability to resist the determination of such deficiencies. Deakman-Wells Co. v. Commissioner, 213 F. 2d 894, 899 (C.A. 3, 1954), reversing on another issue 20 T.C. 610">20 T.C. 610 (1953); United Surgical Steel Co., 54 T.C. 1215">54 T.C. 1215, 1226-1227 (1970).In 1966, Public Law 89-721, 89th Cong., 2d Sess. (80 Stat. 1150 (Part 1)), added section 6501(m) to the Internal Revenue Code, which provides as follows:(m) Tentative Carryback Adjustment Assessment Period. -- In a case where an amount has been applied, credited, or refunded under section 6411 (relating to tentative carryback adjustments) by reason of a net operating loss carryback, or an investment credit carryback, to a prior taxable year, the period described in subsection (a) of this section for assessing a deficiency for such prior taxable year shall be extended to include the period described in subsection (h) or (j), whichever is applicable; except that the amount which may 208 be assessed solely by reason of this subsection shall not exceed the amount so applied, credited, or refunded under section 6411, reduced by an amount which may be assessed solely by reason of subsection (h) or (j), as the case may be.By virtue of that section, deficiencies in respect of erroneous tentative carryback adjustments were permitted on grounds not attributable to the carryback so long as the deficiency determined did not exceed the amount of the refund reduced by any amount that in fact is attributable to the carryback. H. Rept. No. 2161, 89th Cong., 2d Sess., p. 4 (1966); S. Rept. No. 1709, 89th Cong., 2d Sess., p. 4 (1966). Thus, the prior transactional limitations involved in the determination of such deficiencies were eliminated. 13 The section was made applicable to any case where the application for tentative carryback adjustment was filed after November 2, 1966, which is the situation herein.209 The broadening of the grounds upon which such deficiencies could be determined by respondent accomplished a similar expansion of 731 the elements which we may properly take into account in deciding what the amount of the deficiency should, in fact, be, subject to the qualification that we cannot reduce the amount below zero and determine that a taxpayer has made an overpayment of tax for the otherwise barred year. See Springfield Street Railway Co. v. United States, 312 F.2d 754">312 F. 2d 754, 759 (Ct. Cl. 1963). The definition of a deficiency is contained in section 6211. 14 Subsection (b) of section 6211 excludes certain credits against tax from the determination of the amount of a deficiency, but the investment credit is not so excluded and, consequently, may be taken into account.210 In view of the foregoing, we hold that petitioners are entitled to a credit for that portion of the $ 3,500 investment credit for 1964 which does not exceed the amount to which respondent may otherwise be found to be entitled for that year by virtue of the Rule 50 computation.Because of the numerous concessions made by both parties and to reflect our decision herein with respect to the availability to petitioners of the unused investment credit for fiscal 1964,Decision for all years will be entered under Rule 50. 15*211 Footnotes15. The stipulation of the parties makes a passing reference to a possible question as to the availability to petitioner of a net operating loss for fiscal year 1969 as a carryback to fiscal 1966. Petitioners appear to have abandoned any claim in respect thereto on brief. In any event, we have no evidence that such a net operating loss occurred or, if it did, the amount thereof, and we do not read the stipulation as a concession by respondent as to either of these two conditions. Consequently, any such loss cannot be taken into account, assuming, without deciding, that we would be entitled so to do. Cf. Springfield Street Railway Co. v. United States, 312 F. 2d 754 (Ct. Cl. 1963). But compare Yellow Cab Co. v. Commissioner (C.A. 7, 1965, 16 A.F.T.R. 2d 5457, 65-2U.S.T.C. par. 9568), reversing 43 T.C. 125">43 T.C. 125 (1964), with Raymond Spector, 42 T.C. 110">42 T.C. 110, 113↩ (1964).1. This issue has now been conceded by respondent on brief.↩2. Participation fruit proceeds consisted of the proceeds of any fruit picked during a particular season, in this case, the 1966-67 fruit season.↩3. 83.33 percent of the outstanding stock of Von Maxcy, Inc., was owned by Von at the time of his death.↩4. The petition for court approval noted that Von's interests in the partnerships were valued at $ 398,000 on the date of Von's death and that they were being sold for $ 406,000.↩5. All references are to the Internal Revenue Code of 1954, as amended.↩6. The date of the filing of the three partnership returns for the period Aug. 1 to Oct. 3, 1966, does not appear in the record, but the date of signature of the preparer of the returns is Apr. 5, 1968.↩7. By letter of that date, the coexecutors were granted an extension of time to file the estate tax return to Apr. 3, 1968.↩8. SEC. 761. TERMS DEFINED.(c) Partnership Agreement. -- For purposes of this subchapter, a partnership agreement includes any modifications of the partnership agreement made prior to, or at, the time prescribed by law for the filing of the partnership return for the taxable year (not including extensions) which are agreed to by all the partners, or which are adopted in such other manner as may be provided by the partnership agreement.↩9. The partnership agreement and/or any modification thereof may be oral or written. Sec. 1.761-1(c), Income Tax Regs.↩10. Compare Jean Kresser, 54 T.C. 1621">54 T.C. 1621, 1631 fn. 5 (1970), with Smith v. Commissioner, 331 F. 2d 298, 301 (C.A. 7, 1964), affirming a Memorandum Opinion of this Court. Compare also Stanley C. Orrisch, 55 T.C. 395">55 T.C. 395↩ (1970).11. Indeed, petitioner would have been enabled under such circumstances to seek a determination of an overpayment for 1964 by this Court in accordance with the provisions of sec. 6512(b).↩12. Respondent has been afforded a broader scope in defending against suits for refund by a taxpayer based upon a net operating loss carryback to an otherwise barred year. Commissioner v. Van Bergh, 209 F. 2d 23 (C.A. 2, 1954), reversing on another issue 18 T.C. 518">18 T.C. 518 (1952). Compare Lewis v. Reynolds, 284 U.S. 281">284 U.S. 281↩ (1932).13. Such transactional limitations would appear to continue to be applicable to deficiencies asserted under sec. 6501(b) in respect of payments made in response to "regular" (as distinguished from "tentative") claims for refund based upon net operating loss carrybacks. Ione P. Bouchey, 19 T.C. 1078 (1953); Edward G. Leuthesser, 1112">18 T.C. 1112↩ (1952).14. SEC. 6211. DEFINITION OF A DEFICIENCY.(a) In General. -- For purposes of this title in the case of income, estate, gift, and excise taxes, imposed by subtitles A and B, and chapter 42, the term "deficiency" means the amount by which the tax imposed by subtitle A or B or chapter 42 exceeds the excess of -- (1) the sum of (A) the amount shown as the tax by the taxpayer upon his return, if a return was made by the taxpayer and an amount was shown as the tax by the taxpayer thereon, plus(B) the amounts previously assessed (or collected without assessment) as a deficiency, over -- (2) the amount of rebates, as defined in subsection (b) (2), made.(b) Rules for Application of Subsection (a). -- For purposes of this section -- (1) The tax imposed by subtitle A and the tax shown on the return shall both be determined without regard to payments on account of estimated tax, without regard to the credit under section 31, and without regard to so much of the credit under section 32 as exceeds 2 percent of the interest on obligations described in section 1451.(2) The term "rebate" means so much of an abatement, credit, refund, or other repayment, as was made on the ground that the tax imposed by subtitle A or B or chapter 42 was less than the excess of the amount specified in subsection (a) (1) over the rebates previously made.(3) The computation by the Secretary, or his delegate, pursuant to section 6014, of the tax imposed by chapter 1 shall be considered as having been made by the taxpayer and the tax so computed considered as shown by the taxpayer upon his return.(4) The tax imposed by subtitle A and the tax shown on the return shall both be determined without regard to the credit under section 39, unless, without regard to such credit, the tax imposed by subtitle A exceeds the excess of the amount specified in subsection (a) (1) over the amount specified in subsection (a) (2).↩15. The stipulation of the parties makes a passing reference to a possible question as to the availability to petitioner of a net operating loss for fiscal year 1969 as a carryback to fiscal 1966. Petitioners appear to have abandoned any claim in respect thereto on brief. In any event, we have no evidence that such a net operating loss occurred or, if it did, the amount thereof, and we do not read the stipulation as a concession by respondent as to either of these two conditions. Consequently, any such loss cannot be taken into account, assuming, without deciding, that we would be entitled so to do. Cf. Springfield Street Railway Co. v. United States, 312 F. 2d 754 (Ct. Cl. 1963). But compare Yellow Cab Co. v. Commissioner (C.A. 7, 1965, 16 A.F.T.R.2d (RIA) 5457">16 A.F.T.R. 2d 5457, 65-2U.S.T.C. par. 9568), reversing 43 T.C. 125">43 T.C. 125 (1964), with Raymond Spector, 42 T.C. 110">42 T.C. 110, 113↩ (1964).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624573/	Herman E. Londagin and B. Maxine Londagin, Petitioners v. Commissioner of Internal Revenue, RespondentLondagin v. CommissionerDocket No. 8237-71United States Tax Court61 T.C. 117; 1973 U.S. Tax Ct. LEXIS 30; 61 T.C. No. 15; October 30, 1973, Filed 30 Decision will be entered for the respondent. Petitioners on their 1964 Federal income tax return claimed and were allowed a casualty loss deduction because of damage to their home in the "Good Friday" earthquake in Alaska on Mar. 27, 1964. At the time of the earthquake there were mortgages on petitioners' home which were paid off later with proceeds of an increased mortgage loan, the balance of which proceeds was used to partially repair the damage to petitioners' home. Held, a payment in 1968 by the Alaska Mortgage Adjustment Agency made because of the damage to petitioners' home in the earthquake in partial reduction of petitioners' home mortgage constituted income to petitioners to the extent of the amount of the casualty loss deduction in 1964 which resulted in a tax benefit to petitioners. Paul J. Nangle, for the petitioners.Richard S. Shipley, for the respondent. Scott, Judge. SCOTT 118 Respondent determined a deficiency in petitioners' Federal income tax for the calendar year 1968 in the amount of $ 1,679.09. The issue32 for decision is whether a payment in 1968 by the Alaska Mortgage Adjustment Agency to petitioners' mortgagee for the reduction of the mortgage on petitioners' home constitutes income in that year to petitioners to the extent that petitioners had received a tax benefit for an earthquake casualty loss deducted by them in a prior year.FINDINGS OF FACTSome of the facts have been stipulated and are found accordingly. Herman E. and B. Maxine Londagin, husband and wife, who at the time of the filing of their petition in this case resided in Valdez, Alaska, filed a joint Federal income tax return for the year 1968 with the district director of internal revenue at Anchorage, Alaska.On March 27, 1964, a severe earthquake occurred over a large part of Alaska. This earthquake, commonly referred to as the "Good Friday" earthquake, caused substantial damage to petitioners' personal residence in Valdez, Alaska. The damage was so extensive that petitioners were unable to continue to reside in their home. Petitioners on their joint Federal income tax return for the year 1964 claimed a casualty loss deduction from this earthquake damage in the amount of $ 10,050, computed as follows:EARTHQUAKE LOSSESHome appraised and purchased 6/1/63$ 14,900Appraised 5/15/65 [sic] by Urban Renewal4,750Total home loss10,150Less $ 100 limitation100Total loss10,05033 On their joint 1964 income tax return petitioners had reported total adjusted gross income of $ 14,647.78. They claimed total deductions, including the claimed casualty loss, of $ 12,142.77, leaving a remainder 119 of income of $ 2,505.01. They claimed five personal exemptions of $ 600 each, totaling $ 3,000, and as a result showed no tax due for the year 1964. Respondent allowed the claimed casualty loss as shown by petitioners on their return.On March 27, 1964, when the earthquake occurred, petitioners' home was encumbered with a first and second mortgage which together with accrued interest totaled $ 12,850.76. In August 1964 they obtained a loan from the Small Business Administration in the amount of $ 16,051.73, which was used to satisfy the then-existing mortgages on petitioners' home. The amount of the proceeds of the loan in excess of those mortgages was spent for repairs to the home to put it in condition to enable petitioners to move back into it to live. In 1966 the City of Valdez determined to move the entire town 4 miles further down the bay than the area where it was located at the time of the earthquake. In accordance with this determination the Alaska34 State Housing Authority condemned all existing property in Valdez. Under this condemnation the housing authority purchased petitioners' repaired house for $ 4,765 and then, in accordance with its policy in such cases, sold the salvage rights to the house back to petitioners for $ 800, and sold petitioners a lot in the new townsite for $ 660. In 1966 petitioners borrowed an additional $ 7,300 from the Small Business Administration which they spent to move their house to its new site and to do further rehabilitation work on the house.On August 19, 1964, Congress amended the Alaska Omnibus Act by Pub. L. 88-451 (78 Stat. 505) to provide assistance to the State of Alaska for reconstruction of areas damaged by the earthquake. Section 57 of that law contained a provision authorizing grants for the purpose of enabling the State to adjust home mortgage obligations or other real property liens secured by one- to four-family homes which had been severely damaged or destroyed in the "Good Friday" earthquake. On September 7, 1964, a special session of the Alaskan legislature enacted legislation to implement section 57 of the Alaska Omnibus Act (ch. 1, SLA 1964, First Special Session). This35 law stated its purposes to be:Sec. 2. Purpose. (a) It is determined and declared as a matter of legislative finding that(1) A large number of one to four family homes that were severely damaged or destroyed in the March 1964 earthquake and subsequent seismic waves were owned subject to substantial mortgages and other liens;(2) The damage to family homes in many cases exceeded 60 per cent of the pre-earthquake value of the homes;(3) That no federal or state programs exist to relieve the economic hardship suffered by the homeowners although such programs do exist in many cases to assist other individuals and businesses;120 (4) The President of the United States is authorized by Section 57 of the "1964 Amendments to the Alaska Omnibus Act" to make additional grants to the state in an amount up to $ 5,500,000 to match, on a fifty-fifty basis, any funds provided by the state to pay costs of retiring and adjusting such mortgage obligations;(5) The absence of an effective program for relief of said mortgagors threatens to depress a substantial portion of the economy of the state and several municipalities within the state;(6) The absence of an effective program for relief of36 said mortgagors will make it impossible for great numbers of individuals to rebuild their homes which will result in an exodus of solid citizens from the state and decrease the economy and the tax base of the state and certain municipalities at all levels;(7) The absence of an adequate program for relief of mortgagors creates conditions contrary to the public interest which threaten, or may threaten, the health, safety, welfare, comfort, and security of the citizens of the state;(8) An adequate program for relief of mortgagors will permit substantial rebuilding that would otherwise not be done and thus stabilize the economy of the state;(9) An adequate plan for relief will stimulate the economy of the state by making available $ 5,500,000 of federal matching funds on a grant basis and is both necessary and desirable and in the best interests of the public welfare;(10) As a result of the 1964 earthquake and subsequent seismic waves there is an aggravated housing shortage in several areas of the state that were affected by the earthquake and seismic waves and an adequate relief program will greatly contribute to the rebuilding of homes that were severely damaged or destroyed;(11) 37 There is a definite need for relief in the state for mortgagors who have lost their homes but still are burdened by substantial mortgages;(12) A large number of mortgages, on one to four family homes which were severely damaged or destroyed in the March 1964 earthquake and subsequent seismic waves, are owned by banks and lending institutions outside the State of Alaska. These banks and lending institutions are a primary source of development capital for financing home mortgages, industrial development programs, and capital improvement programs within the State of Alaska. Bankruptcy and defaults resulting from the inability of individuals to pay their mortgage obligations may substantially and adversely affect the credit of the State of Alaska and its citizens and damage its reputation in financial circles throughout the United States for meeting its financial commitments. Injury to the state's credit and to its reputation for meeting financial obligations threaten to reduce sources of development capital which are essential to the economic growth and development of the State of Alaska.(b) Therefore, it is the policy of the state to promote the health, safety, and welfare of its38 citizens by the creation of an agency to implement Section 57 of the "1964 Amendments to the Alaska Omnibus Act" by using federal grants and state matching money to relieve mortgagors whose homes were severely damaged or destroyed in the 1964 earthquake and subsequent seismic waves. The implementation of this program will stabilize the population of the state and stimulate and improve the economy and increase the tax base of the state and municipalities affected by the 1964 earthquake. These purposes are considered necessary and are public purposes for which public money may be spent.In accordance with this Act the Governor of the State of Alaska prepared an Alaska Mortgage Adjustment Plan which was approved on behalf of the President of the United States on February 18, 1965. 121 This plan provided that the commissioner of commerce of the State of Alaska would administer a program through an agency to be known as the "Alaska Mortgage Adjustment Agency" which was established within the Department of Commerce of the State of Alaska. In accordance with the regulations issued by the Alaska Mortgage Adjustment Agency, petitioners made application to that agency for relief under39 the program. Petitioners' application was granted and the Alaska Mortgage Adjustment Agency in 1968 made a payment of $ 7,057.76 on the mortgage then outstanding on petitioners' home. This payment was sent by the Alaska Mortgage Adjustment Agency to the Small Business Administration which applied it in reduction of petitioners' home mortgage loan. At the time of the reduction of the mortgage, the term of the mortgage loan was reduced from 30 years to approximately 18 years. The payment made in reduction of petitioners' home mortgage loan by the Alaska Mortgage Adjustment Agency was made with respect to and because of the damage sustained by petitioners' residence during the 1964 "Good Friday" earthquake. The computation of the payment made on petitioners' mortgage was as follows: 1. Preearthquake fair market value$ 15,000.00 2. Physical damage (cost of restoration)10,235.00 3. Computed post-earthquake value (line 1 minus line 2)4,765.00 4. March 27, 1964, aggregate outstanding amounts of purchasemoney and improvements lien obligations:First Fed. Savings and Loan$ 9,657.20Less: 8% interest (3/28/64 to 4/1/64)6.44Philip E. Nickerman3,200.00Total12,850.76Less: Any discounts at which lienors acquiredthe obligations0 5. Aggregate outstanding obligations12,850.76 6. Adjusted outstanding obligations12,850.76 7. Amount by which March 27, 1964, obligations are eligible forreduction (line 6 minus line 3)8,085.76 8. Amount of principal required to be paid by or for lien debtorsubsequent to March 27, 19641,000.00(a) Amount paid to principal since March 27,19641,273.55(b) Excess (over $ 1,000) to be credited bylienor in further reduction ofindebtedness (8(a) minus 8)273.55 9. Amount to be paid by Agency (line 7 minus line 8, but not toexceed $ 30,000)7,085.7610. Amount by which each obligation is to be reduced by Agency payment in accordance with priorities under Alaska law:Small Business Administration$ 7,057.76Title report28.00Total$ 7,085.7640 122 After receiving the reduction in their mortgage by the payment made by the Mortgage Adjustment Agency, petitioners later in 1968 or 1969 obtained a personal loan of approximately $ 4,400 to further improve their home, and in 1973 borrowed an additional $ 3,500 from the First National Bank of Anchorage which they intend to use for additional improvements to their home. Petitioners have recently increased the fire insurance on their home to $ 30,000, but they do not believe they have yet fully restored their home to its preearthquake condition.There was no discretion in the Alaska Mortgage Adjustment Agency with respect to payments on applications filed under the program. The payment was arrived at by a mechanical formula and was not affected in amount or method of computation by the hardship or need of assistance, or lack of such need, of the homeowners. Petitioners on their 1968 joint Federal income tax return made the following statement:Taxpayer acknowledges receipt of Form 1099 from State of Alaska Mortgage Adjustment Agency payment in the amount of $ 7,057.76 was made to the Small Business Administration. In taxpayer's opinion such sum is not taxable income 41 but rather a grant from the U.S. Government and the State of Alaska to bolster the mortgage money market in the State of Alaska.Petitioners did not include any portion of the $ 7,057.76 in their taxable income for 1968. The respondent in his notice of deficiency increased petitioners' income as reported by $ 6,562.77 with the explanation that the amount of $ 7,057.76 paid to the Small Business Administration on petitioners' behalf by the Alaska Mortgage Adjustment Agency constituted gross income to petitioners to the extent that the payment exceeded the recovery exclusion provided by section 111 of the Internal Revenue Code.OPINIONRespondent in his brief takes the position that the $ 7,057.76 paid on petitioners' behalf by the Alaska Mortgage Adjustment Agency in reduction of petitioners' home mortgage was so connected with the loss petitioners sustained from the earthquake casualty as to constitute "compensation" for that casualty loss within the meaning of section 165(a) of the Internal Revenue Code of 1954. 1 Respondent further states that since the payment constituted compensation for a casualty loss which had been deducted by petitioners under the provision of 123 42 section 165(c), the amount is includable in petitioners' income under the provisions of section 1.165-1(d)(2)(iii), Income Tax Regs.2 Respondent contends that there were no elements of a gift in the payments made in reduction of petitioners' home mortgage since the intent of the payment was to benefit the State of Alaska as a whole rather than to aid only those individuals who were in need of financial assistance. Respondent argues that the payment was not from a motive of "detached and disinterested generosity" and was not made "out of affection, respect, admiration, charity or like impulses" as required by the holding in Commissioner v. Duberstein, 363 U.S. 278">363 U.S. 278 (1960), for a payment to constitute a gift.43 Petitioners in their brief do not argue that the payment made on their behalf by the Alaska Mortgage Adjustment Agency constituted a gift and, in effect, concede that it did not. Neither do petitioners question the respondent's computation of the amount includable in their income, if any amount is includable because of the payment made in reduction of their mortgage by the Alaska Mortgage Adjustment Agency. Petitioners' argument is that under the definition of income in Eisner v. Macomber, 252 U.S. 189">252 U.S. 189, 207 (1920), as further defined in the cases of Commissioner v. Glenshaw Glass Co., 348 U.S. 426">348 U.S. 426 (1955); Commissioner v. LoBue, 351 U.S. 243">351 U.S. 243 (1956); and Gen. Investors Co. v. Commissioner, 348 U.S. 434">348 U.S. 434 (1955), they have received from the payment no "gain derived from capital, from labor or from both combined" in the year 1968. Petitioners in support of their conclusion that they received no gain because of the payment in 1968 point out that even though their mortgage was reduced the mortgage payments they made monthly were not reduced or substantially44 reduced since the term of the mortgage was reduced from 30 to 18 years. 3 Although not stated in those terms, petitioners are apparently contending that a cancellation of indebtedness on property does not result in income until the property is disposed of or at least until a final payment has been made on the mortgage. 445 124 Petitioners by this argument do not answer respondent's contention that the payment on their home mortgage is income to them since it compensated them in part for a casualty loss which they had previously claimed as a deduction. Amounts received as reimbursements, or refunds of amounts which were previously deducted from income with a resultant tax benefit, constitute income to a taxpayer in the year received even if the amount might not otherwise be an income item. See Dobson v. Commissioner, 320 U.S. 489 (1943). Furthermore, in our view petitioners have misconstrued the cases on which they rely. Those cases do not relate to whether income may be derived from the recovery of an item previously deducted nor do they deal as petitioners intimate with whether a cancellation of an indebtedness constitutes income. In this case respondent did not determine that petitioners had income from the cancellation of indebtedness, for if he had the amount of additional income determined would have been greater than the amount as determined in the deficiency notice.Since respondent did not determine that petitioners received income from the cancellation46 of indebtedness, we need not decide this issue which petitioners indirectly raised. We do, however, point out that ordinarily where a solvent taxpayer receives a benefit of a reduction in an indebtedness which he owes and the reduction does not constitute a gift, that taxpayer has received taxable income. United States v. Kirby Lumber Co., 284 U.S. 1">284 U.S. 1 (1931). Other taxpayers have argued as do petitioners here that when the indebtedness which is wholly or partially discharged is secured by property which has not been disposed of no income has been received, relying on substantially the same reasoning as petitioners. In connection with a similar argument, we stated in L. D. Coddon & Bros., Inc., 37 B.T.A. 393">37 B.T.A. 393 (1938), that a cancellation of an indebtedness with respect to property which was still retained by the taxpayer was not merely an adjustment of the purchase price, and therefore a capital transaction, but under the decision of the Supreme Court in United States v. Kirby Lumber Co., supra, constituted income to the taxpayer unless excludable for some other reason. In that case47 we stated (pp. 398-399):From an examination of these cases the present state of authority seems to be that where a solvent debtor is under direct obligation to make payments for physical property purchased by him or by his assignor, which is still held by him, and satisfies this obligation by paying less than the amounts called for by the obligation, the property continuing to be of a value sufficient to pay the indebtedness, the transaction will result in taxable income to the debtor in the amount by which the face value of the obligation exceeds the amount paid by him for its satisfaction. Whether income will be realized at the time of the partial forgiveness of the debt even if the property bought has a value less than the remaining obligation, we do not now decide, but it seems clear that realization should not be postponed until disposal of the property.125 Here the record indicates that petitioners' property had value sufficient to pay the indebtedness on it at the time the payment was made on their behalf by the Alaska Mortgage Adjustment Agency. Shortly after the payment they borrowed additional sums to further improve the property and thereafter increased the48 insurance on their home to $ 30,000. At least there is nothing here to indicate that petitioners' property did not have a value in 1968 in excess of the mortgage on the home. In Reliable Incubator & Brooder Co., 6 T.C. 919">6 T.C. 919 (1946), we applied the same rule applied in L. D. Coddon & Bros., Inc., supra, to a partial reduction of an indebtedness of a taxpayer who continued to hold mortgaged property subject to the balance of the indebtedness. In our view, there is no distinction in petitioners' arguments here and the arguments we refused to follow in the Coddon and Reliable Incubator cases. The contention made by petitioners that they can receive no income from a transaction which is in some way related to property until the property is disposed of is not valid even in those cases which involved cancellation of indebtedness. Their contention certainly is not persuasive in this case which involves compensation in the year in issue for a casualty loss previously deducted.We conclude that petitioners' position that they received no income from the payment in reduction of their home mortgage in the year the payment*49 was made is not well taken. 5Decision will be entered for the respondent. Footnotes1. All references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩2. Sec. 1.165-1(d)(2)(iii), Income Tax Regs., provides as follows:(iii) If the taxpayer deducted a loss in accordance with the provisions of this paragraph and in a subsequent taxable year receives reimbursement for such loss, he does not recompute the tax for the taxable year in which the deduction was taken but includes the amount of such reimbursement in his gross income for the taxable year in which received, subject to the provisions of section 111↩, relating to recovery of amounts previously deducted.3. The record does not show whether it is a fact that petitioners' monthly mortgage payments were not reduced. However, since in our view if this is a fact it is immaterial to the determination made here, we will for the purpose of discussion accept petitioners' statement.↩4. Sec. 108, I.R.C. 1954↩, provides that a taxpayer who is discharged, in whole or in part, of indebtedness incurred or assumed in connection with property used in his trade or business may, at his election, not include the amount of the cancellation of indebtedness in gross income but use it as a reduction of the basis of the property. This section is obviously not applicable here since the property here involved is petitioners' home, not business property. Petitioners do not contend that this section is applicable, but in effect contend that a comparable exclusion should be available to them for the reduction in the indebtedness on their home.5. Petitioners in their brief also rely on the case of Conner v. United States, 303 F. Supp. 1187">303 F. Supp. 1187, 1191 (S.D. Tex. 1969), affirmed on this issue 439 F. 2d 974 (C.A. 5, 1971). In our view that case, which held that insurance paid for temporary living expenses of a taxpayer whose home was partially destroyed by fire was not income to the taxpayer but should be considered as part of the insurance compensation in determining the amount of the casualty loss, has no application to the facts here present. However, it is also noted that we took the opposite view in Neil F. McCabe, 54 T.C. 1745">54 T.C. 1745↩ (1970), concluding that such a payment constituted income but pointing out that Congress had for years subsequent to 1969 amended the Code to specifically provide that such an item was not includable in income.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624574/	HENRI CHOUTEAU, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Chouteau v. CommissionerDocket No. 38300.United States Board of Tax Appeals22 B.T.A. 850; 1931 BTA LEXIS 2049; March 20, 1931, Promulgated 2049 1. DEDUCTION - LOSS. - Petitioner's uncle's will created a trust and named petitioner and others as the beneficiaries thereof. Over a period of years while the trust was an active trust the property was completely absorbed by the payment of encumbrances thereon. The trust was terminated in 1924. Held, that petitioner did not sustain a deductible loss in 1924. 2. INCOME - JUDGMENT FOR DAMAGES. - On the basis of the rentals and income from a building which was the only asset of the corporation whose stock he purchased, the petitioner determined the amount he was willing to invest. The vendor breached its agreement by renewing certain leases without petitioner's knowledge and consent pending negotiations for the purchase and sale. Petitioner sued, and recovered in 1925 damages for such breach of contract. Held, that such amount did not constitute taxable income, but was a return of capital invested. 3. Id. - In 1925 petitioner received interest on said judgment from the date judgment was rendered to date of payment thereof. Held, that the interest constituted taxable income in that year. H. Chouteau Dyer, Esq., for the petitioner. T. M.2050 Mather, Esq., for the respondent. TRUSSELL 850 The respondent has determined deficiencies in the amounts of $5,714.24 and $3,173.09 in this petitioner's income taxes for the years 1924 and 1925, respectively. The petitioner contends that the respondent erred (1) in disallowing the amount of $34,770 as a loss deductible from income for the year 1924 and (2) in including in income for the year 1925 the amount of $1,635 as taxable income, the said amount having been received by petitioner in 1925 as a penalty or interest on a judgment (also paid in 1925) in the amount of $9,889.03 obtained by petitioner by suit on account of a breach of an agreement pertaining to the purchase by petitioner of the stock of a corporation owning an office building. The respondent, by his answer, has denied error as alleged by petitioner and further he contends that the said amount of $9,889.03 was income to petitioner in 1925; that he erred in not including said amount in his computation of the deficiency for that year and that such amount should now be included and the deficiency increased accordingly. The petitioner's reply denies that such amount representing damages constitutes2051 income, and, further, he pleads the statute of limitations in bar of an increase in the deficiency as asserted in the deficiency notice. 851 FINDINGS OF FACT. The petitioner is a resident of Missouri and his office is located in the International Life Building, St. Louis. J. Gilman Chouteau, an uncle of the petitioner, died in the city of St. Louis, leaving a last will and testament which was duly admitted to probate on January 15, 1908, in the probate court of that city which court ordered and adjudged that the cash value of the property or interest of said decedent, subject to the State inheritance or transfer tax, was $139,480. The decedent's will provided for certain specific bequests and further provided in part as follows: 3rd. All the rest of my estate, real personal and mixed, and wherever situate, I give, devise and bequeath to H. Chouteau Dyer in trust, for the persons and purposes subject to the conditions and limitations and with powers and duties hereinafter set out, that is to say; the trust estate shall be held, controlled, managed and disposed of by my trustee, or his successor in trust, as follows: My trustee shall collect rents, make repairs, 2052 pay taxes, insurance and other expenses incidental to the care, management and protection of the trust property, with power also to sell, convey, lease, release, mortgage, divide, build upon, and otherwise improve the property and in any other additional manner not above specified to care for, manage and develop the said estate and every part thereof in such manner as seems wise to my trustee for the benefit of the estate. It is the wish that my trustee shall sell such piece or pieces of property, real, or personal, as from time to time in his judgment shall be advantageous to the estate, and apply the proceeds thereof in so far as possible, to the payment and liquidation of existing indebtednesses. 4th. It is my desire that the net annual income derived from the estate to the extent of five thousand dollars, or such sum as may remain up to that sum, shall be divided into the equal parts and paid by the trustee to the following persons and in the following shares, viz: - One share to my sister Corinne Dyer; One share to my sister Beatrice Clark; One share to my sister Lillia Winthrop; One share to my niece Bertha Turner; One share to my nephew Azby Chouteau; two and one-half shares2053 to my great nephew Azby Chouteau, and two and one-half shares to my great nephew Henry Chouteau. I further desire that the share in the income to be paid to my great nephew Henry Chouteau, or so much thereof as in my trustee's judgment shall be necessary, shall be paid during the minority of my said nephew for his maintenance and the furtherance of his education, and in the event said nephew's share in the income shall not during any year be sufficient for his proper maintenance and education in the judgment of my said Trustee, than I direct my trustee to advance to said nephew out of said nephew's share in my estate sufficient therefrom, charging any such advance without interest to said nephew's share. In the event the net annual income derived from the estate exceeds the sum of Five Thousand Dollars, it is my will that my trustee shall apply such excess to the payment and liquidation of existing incumbrances, until such incumbrances shall be paid, and in such case, that is when no debts remain, the whole net annual income shall be divided in the proportions set out. In the event of any one or more of the persons named in the foregoing property shall die before the expiration2054 of the trust as hereinafter provided, then the share in the income payable to such person or persons, shall be paid by my trustee to the living child or children in equal parts of such 852 person or persons, and in the event such person or persons have no living issue at his or their demise, then such share in the income shall be paid to his or their heirs. 5th. It is my will, desire and direction that the trust hereinbefore created shall continue for the period of ten years and the end of that period my trustee shall pay off all remaining indebtednesses of the estate, if any, by selling as much of the property remaining in his hands as may be necessary therefor and shall divide the balance of the estate then remaining on his hands into ten equal parts, and convey it as follows: - One part to my sister Corrine Dyer; One part to my sister Beatrice Clark; One part to my sister Lillia Winthrop; One part to my niece Bertha Turner; One part to my nephew Azby Chouteau; Two and one-half parts to my great nephew Azby Chouteau; and Two and one-half parts to my great nephew Henry Chouteau. If before distribution any of the persons named in the foregoing paragraph to whom I have2055 devised and bequeathed the body of my estate, shall die, then the share of such person shall be conveyed by my trustee to the child or children in equal parts of such persons living at the time of the distribution, and in the event any such person shall die before distribution without issue at the time of distribution, then the share of such person shall be conveyed to the heir or heirs in equal parts of such person. The decedent's estate consisted of personal property including stock in a mining company, but principally of real estate situated in a manufacturing district in St. Louis. From 1890 up to the time of decedent's death that property increased in value due to the development of the district for commercial purposes, but subsequent to his death the values steadily declined. At the time of decedent's death he had four parcels of realty unencumbered and 10 parcels encumbered with mortgages totaling $165,000. The executor of his estate paid off those mortgages to the extent of $49,000 and at commencement of the trust there were eight parcels encumbered to the extent of $116,000. The trustee placed additional mortgages on four parcels in the amount of $49,500 and during2056 the first 10 years of the life of the trust there were foreclosures on three parcels and the trustee sold the rest of the property, except for four lots, for a total of $2,642.40 in excess of the mortgages thereon. The rents from the property and the proceeds from the sales were not sufficient to pay all of the obligations of the trust and at the end of the 10-year period in 1918 the trustee held $36.83 in cash, some worthless mining stock, four lots encumbered by a mortgage in the amount of $3,000, and the unpaid sundry debts amounted to 993.54. The trustee was unable to sell those four lots and the trust was continued until 1924, in which year it was terminated when no property remained in the trust estate. For 1924 the petitioner claimed a deduction as a loss in the amount of $34,770 as representing an undivided one-fourth vested interest in the value of the trust estate in 1908, which interest became worthless in 1924, due to the fact that the real estate declined in value to such an extent that the 853 entire trust estate was absorbed in the payment of mortgages on the property and other obligations of the trust estate. The respondent disallowed the deduction which2057 resulted in a portion of the deficiency asserted for the taxable year 1924. In 1920 the Missouri-Lincoln Trust Company owned 5,575 shares of the 6,000 shares of the outstanding stock of the International Building Company, whose sole asset was a 17-story office building, known as the International Life Building, and the leasehold upon which the building stood. Frank Carter was president of both corporations and the board of directors of the latter was selected from the directorate of the former. Carter's agent approached petitioner as to the purchase of the building and leasehold or the stock and furnished him with a written statement as to the names of the tenants, the rentals paid by each, the dates of the expiration of the leases, the gross income, and the cost of maintenance and operation of the building. The petitioner relied upon that statement in determining the amount he was willing to invest and in March, 1920, he submitted to Carter an offer to purchase for $92,000 the entire stock issue of the International Building Company or the building and leasehold free of all indebtedness except a mortgage securing a bond issue of $268,000, and he gave Carter his check for $2,0002058 as earnest money. At the same time Carter, at the petitioner's request, agreed that no new leases for space in the building would be made without the knowledge and consent of petitioner and during the negotiations Carter reiterated that agreement and petitioner relied upon it. The parties finally agreed that petitioner would pay $92,000 for the 6,000 shares of stock of the International Building Company at a price of $15.33 per share; that the Missouri-Lincoln Trust Company owned 5,575 shares and would endeavor to purchase from the owners the 425 remaining shares; and that in the event the said Trust Company could not purchase all of the 425 shares it would return to petitioner $15.33 for each share outstanding and unpurchased on June 1, 1920. The deal was consummated and petitioner acquired the said stock on April 2, 1920. However, pending the negotiations and while Carter was out of the city of St. Louis the vice president of the International Building Company, without the knowledge or consent of either petitioner or Carter, made two new leases for a large amount of space in the said building, one lease to commence on June 1, 1920, for a term of two years and the other to commence2059 on May 1, 1920, for a term of four years and nine months. The petitioner did not learn of the new leases until after he had purchased the stock and he believed that the new leases provided for rents at less than the reasonable rental 854 value of the space, and he would not have consummated the deal had he known that the new leases had been made. The petitioner instituted suit against the Missouri-Lincoln Trust Company for the recovery of damages alleged to have resulted from the breach of the said agreement. The court instructed the jury that if it found the facts to be substantially as set out above and that thereby this petitioner sustained loss and damage, the verdict should be for this petitioner; that the damage assessed should be, as found from the evidence, the sum which he, as a stockholder of the International Building Company, sustained by reason of the making of the new leases; that in determining the loss the total amount of rental required to be paid by the leases be deducted from the total amount which the jury found to be the reasonable rental value of the space and that there be allowed the plaintiff (this petitioner) such portion of said sum as the amount2060 of stock delivered to him by the Missouri-Lincoln Trust Company under the agreement bears to the total amount of the outstanding stock of the International Building Company. A verdict was returned for the plaintiff (this petitioner) in which his damages were assessed in the total sum of $9,889.03 and judgment was rendered in that amount on or about January 10, 1923. The defendant, the Missouri-Lincoln Trust Company, took an appeal from that judgment, which was affirmed by the Supreme Court of the State on or about July 30, 1925. On October 12, 1925, the Missouri-Lincoln Trust Company issued its check to petitioner in the amount of $11,524.03, which was paid on October 14, 1925, and the petitioner gave to that company his receipt certifying full payment and satisfaction of the judgment rendered on January 10, 1923, in the amount of $9,889.03 and also $1,635 interest thereon from January 10, 1923, to October 12, 1925. In his return for the year 1925 the petitioner did not include in gross income either of the said amounts of $9,889.03 and $1,635.03. In computing the deficiency asserted the respondent included in gross income the amount of $1,635 as interest, but he did not include2061 in gross income the $9,889.03 received as damages. For the years 1924 and 1925 the petitioner kept his books and made his income tax returns on the cash receipts and disbursements basis. The petitioner's return for 1925 was filed on March 12, 1926. The deficiency notice was mailed on March 14, 1928, and the petition initiating this proceeding was filed with the Board on May 7, 1928. OPINION. TRUSSELL: The first issue relates to the petitioner's contention that in 1924 he sustained a deductible loss in the amount of $34,770. 855 He alleges that that amount represents the value in 1908 of a legacy devised to him by his uncle and that the loss was sustained through the decrease in the value of the property which by 1924 was finally and totally absorbed by the payment of various mortgages on the various parcels of property in which he had an undivided vested interest. The Revenue Act of 1924 provides: SEC. 214(a) In computing net income there shall be allowed as deductions: (4) Losses sustained during the taxable year and not compensated for by insurance or otherwise, if incurred in trade or business; (5) Losses sustained during the taxable year and not compensated2062 for by insurance or otherwise, if incurred in any transaction entered into for profit, though not connected with the trade or business; * * * (6) Losses sustained during the taxable year of property not connected with the trade or business * * * if arising from fires, storms, shipwreck, or other casualty, or from theft, and not compensated for by insurance or otherwise. The basis for determining the amount of the deduction under this paragraph or paragraph (4) or (5) shall be the same as is provided in section 204 for determining the gain or loss from the sale or other disposition of property; The trust created in 1908 under the will of J. Gilman Chouteau for a period of 10 years until 1918 and then continued until 1924, because all of the encumbrances on the properties constituting the trust could not be liquidated as directed by the will, was an active trust. The trustee was directed to manage, control and dispose of the trust property and apply the proceeds of sales in so far as possible, to the payment and liquidation of encumbrances thereon and he was also directed to collect rents, make repairs, pay insurance, taxes, expenses, etc., and to divide and distribute the net2063 annual income to the extent of $5,000 to certain specified persons, including petitioner, and further to apply any net income in excess of $5,000 to the liquidation of encumbrances until such encumbrances be paid. The real property constituting the trust estate was disposed of at a loss by sale by the trustee and by foreclosure proceedings at various times over a period of years and it is clear that the losses were sustained by the trust, a taxable entity separate and distinct from the taxpayer who is the petitioner in this proceeding. The effect of the losses sustained by the trust was to reduce the income, if any, or the corpus of the trust distributable to petitioner, but it can not be said that in 1924 this petitioner sustained the loss in question in his trade or business; or in any transaction entered into by him for profit, or arising from fires, storms, etc. Cf. ; ; and . The respondent has properly disallowed as a loss the claimed deduction of $34,770 from petitioner's gross income for the taxable year 1924. 2064 856 The respondent has alleged that he erred in not including in petitioner's gross income for 1925 the amount of $9,889.03 received by petitioner in that year in satisfaction of a judgment in his favor for damages sustained through the breach of an agreement by the Missouri-Lincoln Trust Company from whom petitioner purchased the stock of the International Building Company, whose sole asset was an office building and leasehold. During the negotiations for the said purchase and contrary to the Missouri-Lincoln Trust Company's agreement, two new leases were made for space in the building without the knowledge and consent of the petitioner, who believed that such new leases provided for rentals at less than the reasonable rental value of the space. The respondent contends that petitioner contracted to pay and did pay a certain amount for the stock which he received; that the court decided that he was entitled to receive $9,889.03 in addition thereto as a result of the breach of the agreement; and that such amount constituted income derived from capital. We believe the respondent has become confused as to the reason petitioner was given judgment and the manner in which the2065 jury was instructed to compute the damage. It would seem that because the damage or loss was measured upon the difference between the rentals under the leases and the reasonable rental value of the space, the respondent concludes that the judgment represents a return to petitioner of a loss in rents from the building. However, the petitioner was not entitled to receive rents from the building, which was owned by the International Building Company, a corporation of which petitioner was merely a stockholder. It can not be said that the judgment recovered represented additional rent due for space in the building. The court's instruction to the jury was that the damages assessed should be the sum which petitioner, "as a stockholder of the International Building Company," sustained by reason of the making of the new leases and the difference between the rentals required to be paid by the new leases, and the reasonable rental value of the space was merely the basis for determining the amount of the damage. The petitioner was a capitalist investing in the stock of the International Building Company and prior to making his investment he made a study of the information furnished2066 him as to the tenants of the building, the rental paid by each, the dates of the expiration of the leases, the gross income, and cost of maintenance and operation of the building. He relied upon that information and his belief that rentals could be increased upon the renewal of certain leases about to expire, in determining the amount of $15.33 per share he was willing to invest in the stock in 1920. The market value of the stock was dependent, in a measure, upon the rentals or 857 returns from the building, which would determine the return upon petitioner's investment, and when the new leases were executed without petitioner's knowledge and consent and in breach of the agreement the value of the stock was decreased, with a resulting loss in or damage to petitioner's capital investment. The judgment in the amount of $9,889.03 recovered in 1925 represented a return of capital and reduced the cost of the stock to petitioner. It did not constitute income within the meaning of the Revenue Act of 1926 and the respondent did not err in failing to include such amount in petitioner's gross income for the year 1925. The judgment for petitioner in the amount of $9,889.03 was rendered2067 on or about January 10, 1923, and on appeal by the Missouri-Lincoln Trust Company, the judgment was affirmed on or about July 30, 1925. At the same time that the said company paid to petitioner the amount of $9,889.03 in satisfaction of the judgment, it paid interest thereon in the amount of $1,635 from January 10, 1923, to date of payment. The respondent has included that amount in petitioner's gross income for 1925, and the petitioner contends that such amount did not constitute taxable income, but represented a penalty. When petitioner's cause of action was merged into a judgment he became entitled, by statutory law, to interest on the debt of record as compensation for any delay in the payment of the debt by the Missouri-Lincoln Trust Company. . Section 213 of the Revenue Act of 1924 provides that gross income includes all "interest" except that upon (1) the obligations of a State, Territory or any political subdivision thereof, or the District of Columbia; or (2) securities issued under the Federal Farm Loan Act; or (3) the obligations of the United States or its possessions. We are of the opinion that the2068 amount of $1,635 received by petitioner in 1925 as interest constituted taxable income in that year. The petitioner has pleaded the statute of limitations in bar of the assessment of any increase in the deficiency for 1925 as asserted by the deficiency notice, but our decision that the $9,889.03 damages recovered did not constitute income obviates the necessity of expressing any opinion on this issue. Judgment will be entered for the respondent in the amounts as asserted in the deficiency notice.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624579/	MOLLIE NETCHER NEWBURY, TRUSTEE OF THE ESTATE OF CHARLES NETCHER, DECEASED, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Newbury v. CommissionerDocket No. 42435.United States Board of Tax Appeals31 B.T.A. 41; 1934 BTA LEXIS 1170; August 9, 1934, Promulgated 1170 1. Where the petitioner in the reorganization of a corporation exchanged 4,999 shares of stock in the old corporation, which had a March 1, 1913, value of $4,768,965.64, for 9,998 shares of no par value common stock in the new reorganized corporation and $3,655,518.25 in cash, held, the stock in the new corporation did not have a readily realizable market value at the time received by petitioner and no taxable gain resulted from the transaction. 2. Where the petitioner filed the appropriate return required of fiduciaries, and there is no income taxable to the fiduciary, but did not disclose the facts relative to a nontaxable transaction, the imposition of a penalty is improper. Joseph R. Little, Esq., and Laurence Graves, Esq., for the petitioner. Mason B. Leming, Esq., for the respondent. BLACK 42 This proceeding involves a deficiency in income tax of $342,704.88 for the year 1923 determined against the petitioner, Mollie Netcher Newbury, as trustee under the will of Charles Netcher, with a penalty of $85,676.22 for failure to file a return on time. The deficiency results from a determination by the respondent that the petitioner1171 realized a taxable profit of $3,655,518.75 in the reorganization of a corporation by which she exchanged 4,999 shares of the common stock of the Netcher Store, Inc., formerly the Boston Store of Chicago, an Illinois corporation, hereafter sometimes referred to as the Illinois corporation, for 9,998 shares of the no par common stock of the Boston Store of Chicago, Inc., a Delaware corporation, hereafter sometimes referred to as the Delaware corporation, and $3,655,518.75 in cash. Petitioner alleges that this determination of respondent was erroneous because the stock of the Delaware corporation did not have a readily realizable market value at the time of exchange, and that inasmuch as the cash received did not equal the March 1, 1913, value of $4,768,965.64, of the stock in the old corporation, no taxable gain resulted. A stipulation was filed in which the parties agreed to many facts, but which we deem too lengthy to incorporate here in full. Also, considerable oral testimony was received at the hearing and many exhibits were received in evidence. From these we make the following findings of fact. FINDINGS OF FACT. Prior to 1903 Charles Netcher had for a number of years1172 conducted a general merchandising business in Chicago, known as the Boston Store. It was located on the south half of block 58, original town of Chicago, on property bounded by State, Madison, and Dearborn Streets, and known as the busiest corner in the world. The business catered to customers of moderate means, described by some of the witnesses as the "shawl trade", and was operated on a cash basis. In 1903 an Illinois corporation, known as the Boston Store of Chicago, was formed with an authorized capital stock of 5,000 shares of common stock of the par value of $100 per share. The business was transferred to the corporation in exchange for its entire authorized capital stock, of which 4,999 shares were issued to Charles Netcher and one share was issued to his wife, Mollie Netcher, now Mollie Netcher Newbury. Charles Netcher died testate in 1904 and by the terms of his will he bequeathed and devised the residue of his estate, which comprised the major part thereof, to his wife in trust, to pay one third of the net income thereof to herself during her life, with power of appointment in her as to the remainder. It 43 was provided that the remaining two thirds of the1173 net income of the principal trust estate should be divided annually or oftener, as the trustee should see fit, into equal shares and one share should be held in trust for each of testator's surviving children, or their issue. Provisions were made for proper education and care of his children and for payments to them of specific sums on arrival at designated ages. The trusts were to continue until his youngest grandchild was 21 years of age. Certain other provisions not material here provided for the ultimate disposition of the estate. Decedent's wife, Mollie Netcher, now Mollie Netcher Newbury, the petitioner herein, qualified as executrix and trustee and has ever since acted as trustee. She was clothed with ample and practically complete authority as to the management, control, and disposition of the trust estate, to buy, sell, invest, and reinvest as to her might seem best and to continue the business he was engaged in, but he expressed the desire that his real estate holdings in block 58, town of Chicago, should be held together for the benefit of his entire estate. In addition to homes in Chicago, Illinois, and Buffalo, New York, the testator died possessed of cash, notes, 1174 and insurance, amounting to $615,522.15, 4,999 shares of common stock of the Boston Store of Chicago, certain warehouse property on South State Street, Chicago, and the entire south half of block 58, original town of Chicago, lying south of Calhoun Place and bounded by Dearborn, Madison, and State Streets, which was owned by him in fee, or under lease, or under contract to purchase by him. The Chicago residence, with furnishings, was left to Mollie Netcher individually and the entire residue went to the trust estate. The Illinois corporation, at the time of Charles Netcher's death, and subsequent thereto, occupied most of the buildings on block 58. These were old and becoming inadequate for the needs of the business. After the death of Charles Netcher the petitioner became the head of the business and continued in the management thereof and of the trust estate during all the time mentioned herein. In 1904 or 1905 petitioner, as trustee of the Netcher trust estate, began the erection of a modern 17-story building, with three basements, upon the land formerly under lease, owned in fee, or under contract to purchase by decedent Netcher, the contracts to purchase having been consummated1175 by petitioner. The building was erected in sections and since its completion in 1915 has been leased to and occupied by the Illinois company and its successor, the Delaware corporation. In order to pay for the construction of this building it was necessary for petitioner to borrow large sums of money, some of which were borrowed from the separate trusts created under the will of Charles Netcher for the benefit of his children. 44 In 1916 the petitioner entered into a lease with the Illinois corporation for the use and occupancy of the building, which had then been completed. This lease was for a period of 25 years and was to expire on, december 31, 1940. It called for the payment of an annual rental of $665,199.96 for the first 5 years, an annual rental of $755,682.60 for the next 5 years and an annual rental of $846,165.84 for the next 15 years, payable monthly in advance. In addition to these stipulated rentals the lessee was required to pay all taxes and special assessment taxes levied or charged on the property after the year 1918, and unpaid installments of special assessments levied previous to the year 1920 and unpaid in that year. On January 1, 1916, the1176 Illinois corporation entered into a lease with Mollie Netcher Newbury, individually, for the property owned by her and located at the northeast corner of the south half of block 58, original town of Chicago. This lease was for a period of 25 years, to expire on December 31, 1940, and called for the payment of rentals as follows: $94,800 annually for the first 5 years, $101,285.88 annually for the next 5 years, and $107,771.88 annually for the last 15 years, all payable monthly and in advance. In addition to the specified rentals, the Illinois corporation was required to pay all taxes and special assessment taxes levied or charged on the property after the year 1918 and all unpaid installments of special assessments levied previous to the year 1920 and unpaid in that year. At the time of the transfer of the assets of the Illinois corporation to the Delaware corporation, referred to later in these findings of fact, the two leases last mentioned were transferred and assigned to the Delaware corporation. These leases were never capitalized or carried as assets on the books of either the Illinois or the Delaware corporation. The taxes paid by the Delaware corporation in 1924, for the1177 year 1923, under these leases aggregated the sum of $277,436.02. The separate trusts for the benefit of decedent's children were duty set up on petitioner's accounts and each credited with its portion of the net income of the principal trust, but separate funds or investments were not set aside for any of them. The most of the funds of these separate trusts were borrowed and used by petitioner in erecting the building and in completing the contracts of purchase of real estate held by the decedent. On December 31, 1922, the petitioner, as trustee of the principal trust, was indebted to the four separate trusts for money borrowed in the aggregate amount of $2,872,433.83. The principal trust also had a mortgage indebtedness of $3,750,000 on that date and it was indebted to the Boston Store to the extent of $119,498.20 and to Mollie Netcher Newbury, individually, in the amount of $80,871.49, making a total indebtedness on that date of $6,822,803.52. 45 Petitioner was advised by her attorney that it was her duty to set up and maintain with separate funds the separate trusts for the children of the testator, Charles Netcher. In order to accomplish this it was determined1178 that a new corporation should be organized to acquire the business of the Illinois corporation, that the new corporation should issue and sell a $4,000,000 note issue, and exchange its entire capital stock and the proceeds of the note issue for the entire capital stock of the Illinois corporation, thus providing petitioner with funds for the establishment of the separate trusts. The Boston Store of Chicago, Inc., was incorporated under the laws of the State of Delaware, with an authorized capital stock consisting of 10,000 shares of no par value common. It entered into negotiations with Ames, Emerich & Co., investment bankers of Chicago, New York, and Milwaukee, for the sale of a note issue of $4,000,000. Ames, Emerich & Co. finally agreed to and did purchase an issue of $3,750,000 6 percent serial notes, under the following conditions: (a) That the issue be personally guaranteed by Mollie Netcher Newbury; (b) That current assets of $4,000,000 be maintained; (c) That the corporation should make no dividend distributions except out of earnings after April 1, 1923; (d) That such notes be paid within a period of eight years, $470,000 for each of the first seven years and1179 $460,000 the eighth year. In advertising the $3,750,000 guaranteed 6 percent serial gold notes of the Boston Store of Chicago, Inc., of Delaware, for sale, Ames, Emerich & Co. made the following statement in their printed advertisement: For information regarding these Notes we refer to the accompanying letter of Mr. Charles Netcher, President of the Company, which states that: BUSINESS The Boston Store is the second largest department store in Chicago, and is the second larges strictly cash store in America. It was established in 1873, and from a very small beginning has prospered and grown steadily until today it occupies a building covering half a city block. Its assets have grown to their present proportions wholly out of earnings. The business was incorporated under the laws of Illinois in June, 1903, by Charles Netcher. Since his death in 1904 Mrs. Mollie Netcher Newbury has been primarily responsible for the development of the business. This growth is indicated by comparing the Company's business, $5,500,000 in 1903, with that of over $28,500,000 in 1922. The business is now being incorporated under the laws of Delaware, and its ownership and management will be1180 identical with that of the previous company. GUARANTY The Notes, which will be the direct obligation of the Company, will be guaranteed principal and interest by Mollie Netcher Newbury. The estimated present value of the assets owned by the guarantor is approximately $10,000,000 (exclusive of stock in this Company). ASSETS According to the accompanying certified balance sheet, net tangible assets available for the payment of these Notes are $7,502,549, or approximately twice the amount of this Note issue. Of this amount $4,334,937 is net current assets. 46 EARNINGS In no year since its incorporation has the Boston Store failed to earn a profit. The worth of the Netcher Estate is about $20,000,000 and that of Mrs. Newbury about $10,000,000 (exclusive of stock in this company). This wealth has come primarily from the Boston Store and represents its earning power. The audited combined income account of the predecessor corporation and the guarantor shows average net income during the past five years, before Federal Income Taxes, of $1,533,967, or equal to more than seven times the maximum annual interest requirements on these Notes. Combined net income after Federal1181 Income Taxes for the same period averaged $921,298. SAFEGUARDS The agreement under which these Notes will be issued provides that during the life of the Notes (a) the Company will make no distribution to its stockholders in the form of dividends or otherwise, except out of profits earned after April 1, 1923, and (b) the Company shall maintain net current assets as defined of not less than $4,000,000. MANAGEMENT The entire capital stock of Boston Store of Chicago, Inc., will be owned by the Netcher Estate and Mrs. Mollie Netcher Newbury. Mrs. Newbury, as Chairman of the Board, will continue to control the policy of the business. On the back of the circular advertising the guaranteed 6 percent serial gold notes for sale was a balance sheet of the Boston Store of Chicago, Inc. (Delaware corporation), as at January 20, 1923 (after giving effect to the proposed financing). It is as follows: ASSETSCURRENT ASSETS: Cash in Banks and on Hand$655,574.64U.S. Government Liberty Loan Bonds and Treasury Certificates (at cost or market, whichever is lower)875,661.15 Notes Receivable26,000.00 Accounts Receivable205,137.90 Merchandise Inventory (at cost or market, whichever is lower)3,228,787.50 Merchandise in Transit (at cost)65,085.04------------- TOTAL CURRENT ASSETS$5,056,246.23FIXED ASSETS: (Sound Value as Appraised by Independent Appraisers) Land (Unencumbered)$75,750.00 Buildings (Barns and Warehouses)245,072.00 Machinery, Fixtures and Delivery Equipment2,620,963.45-------------$2,941,785.45INVESTMENT2,500.00DEFERRED CHARGES: Prepaid Rent, Insurance, Catalogue, Supplies, and Unamortized Discount223,325.56GOOD WILL1.00---------------$8,223,858.24 -----------------------------------------------------------------------LIABILITIESCURRENT LIABILITIES: Accounts Payable - Trade Creditors$178,520.15 Others40,925.96 Accrued Real, Personal and Federal Taxes386,092.20 Accrued Payroll87,025.91 Accrued Liability Insurance28,744.81-------------TOTAL CURRENT LIABILITIES721,309.03Serial 6% Gold Notes (this issue)3,750,000.00CAPITAL: Authorized and Issued - 10,000 Shares No Par Value Stock3,752,549.21---------------$8,223,858.241182 47 This same balance sheet was furnished to the Secretary of State of Illinois to comply with the Illinois Securities Law and its contents were sworn to by Charles Netcher, president of the Delaware company. The Delaware corporation sold the note issue of $3,750,000 to Ames, Emerich & Co. and received $3,656,250 therefor. On April 24, 1923, the name of Boston Store of Chicago, the Illinois corporation, was changed to the Netcher Store, Inc. On April 26, 1923, the Delaware corporation exchanged its 10,000 shares of no par value stock and $3,656,250 for the stock of the Illinois corporation, as a result of which the petitioner received 9,998 shares of Delaware corporation stock and $3,655,518.75 in cash. The business and assets of the Illinois corporation were thereupon transferred to the Delaware corporation, as of February 1, 1923. The Delaware corporation had no assets prior to the acquisition of the assets of the Illinois corporation, except the capital stock of the Illinois corporation. Both the Illinois corporation and the Delaware corporation kept their accounts and made their income tax returns on the basis of a fiscal year ending January 31. Prior to the1183 fiscal year 1909 and in the years ending January 31, 1909 to 1913, inclusive, the following amounts were paid by the Illinois corporation to its stockholders: Prior to 1909$585,000.001909142,954.321910370,000.00191150,000.001912$500,000.001913745,000.00-------------Total2,392,954.32No dividends were declared or paid during the years ending January 31, 1919 to 1922, inclusive. For the year ending January 31, 1923, dividends in the amount of $450,000 were paid. 48 The net taxable income of the Illinois corporation for the fiscal years ending January 31, 1910 to 1923, inclusive, before deduction for the statutory exemptions, was as follows: 1910$417,372.161911294,144.561912789,830.291913864,869.251914627,907.661915530,020.681916561,377.541917$1,105,799.621918667,007.7619191,304,920.5319202,034,723.941921436,739.171922667,325.441923680,329.03The gross sales and gross profits of the Illinois corporation for the years ending January 31, 1906 to 1923, inclusive, and of the Delaware corporation for the years ending January 31, 1924 to 1928, inclusive, were as1184 follows: YearGross salesGross profits1906$7,647,233.19$1,778,960.6319077,744,787.041,899,386.5019089,077,144.692,342,643.52190910,105,380.862,571,848.65191010,716,335.952,879,844.51191110,475,415.112,947,840.48191211,944,984.053,543,470.41191313,101,758.613,931,370.08191414,008,049.555,355,942.45191513,862,370.214,600,621.10191613,843,994.114,660,893.99191715,865,765.446,068,406.841918$17,021,203,90$5,264,649.05191920,304,532.517,174,705.43192026,597,625.209,018,419.44192132,487,965.828,542,077.32192230,418,620.088,518,572.26192328,516,377.708,844,084.23192429,805,622.008,484,958.53192527,676,913.418,237,560.86192626,341,273.067,957,401.20192725,563,420.037,741,843.09192823,361,379.127,162,780.09The business of the the Boston Store, both prior and subsequent to its incorporation in 1904, was a cash business. From 1913 to 1923 there were a number of changes in business conditions which affected the business of the Boston Store. Other department stores in Chicago, such as Marshall Field & Co. and Mandel Brothers, opened1185 bargain basements. Stores were opened in the outlying sections of the city which catered to the same trade as the Boston Store. These stores were open one or more nights a week, including Saturday night. Owing to the character of the trae existing in the Loop district it was found unprofitable to the Boston Store to remain open evenings. The deferred payment plan of merchandising also developed. The Boston Store did not employ this method of selling. It sold for cash only. The material increase in parking restrictions in the Loop district during this period adversely affected the business of the Boston Store. For the fiscal year ending January 31, 1923, the gross sales of the Boston Store were $28,516,377.70, compared to $30,418,620.08 for the fiscal year ending January 31, 1922, and $32,487,965.82 for the fiscal year ending January 31, 1921. The gross 49 sales decreased from the above figures for 1921 to a figure of $23,361,379.12 for the fiscal year ending January 31, 1928, a decrease of $8,926,586.70 in a period of seven years. On March 15, 1924, petitioner filed a fiduciary return of income on Form 1041 for the calendar year 1923. The income reported on this1186 return was from rents and royalties and from dividends on stock of domestic corporations. No income was reported as resulting from the exchange of 4,999 shares of stock of the Illinois corporation for 9,998 shares of stock in the Delaware corporation and $3,655,518.75 in cash. No income tax return on Form 1040 was filed by petitioner, she contending that under the terms of the will all the net income shown on Form 1041 was currently distributable to the beneficiaries named therein and therefore taxable to the beneficiaries and that there was no taxable income of the fiduciary to report resulting from the exchange of stock plus cash mentioned above. The 9,998 shares of the no par value common stock of the Boston Store of Chicago, Inc., receieved by the petitiner on April 26, 1923, had no readily realizable market value on that date. In his determination of the deficiency, the Commissioner determined that the March 1, 1913, fair market value of the 4,999 shares of common capital stock of the Illinois corporation was $4,768,965.64, which was greater than cost. The petitioner does not contest the correctness of this determination. OPINION. BLACK: The principal question involved1187 herein is one of fact, viz., whether or not the stock received by petitioner in the new Delaware corporation had a readily realizable market value when petitioner acquired it. The respondent determined that the stock in the Delaware corporation had a readily realizable market value at least of equal value with the March 1, 1913, fair market value of the stock in the old Illinois corporation, which he fixed at $4,768,965.64; and that consequently the entire cash payment of $3,655,518.75 constituted profit and taxable income to the petitioner. Petitioner, on the other hand, claims that the stock in the Delaware corporation did not have a readily realizable market value when she received it in exchange for the stock in the Illinois corporation, and that inasmuch as the $3,655,518.75 cash was less than the March 1, 1913, fair market value of $4,768,965.64 of the stock in the Illinois corporation, no taxable income resulted. Petitioner claims that the amount of cash received, under the applicable provisions of the revenue act, goes to reduce the basis. 50 The applicable provisions of the Revenue Act of 1921, as amended by the Act of Congress of March 4, 1923, effective January 1, 1923, are1188 printed in the margin. 11189 51 In , we thoroughly considered the question of the meaning and application of the term "readily realizable market value" as used in the quoted section of the Revenue Act of 1921, and it would serve no useful purpose to again review the authorities therein cited. It is sufficient to say that our interpretation of the term was substantially the same as the Commissioner has defined it in his regulations. In the Eisendrath case an Illinois corporation, with a capital stock of 500 shares of the par value of $100 each, was engaged in the tanning business in Chicago, Illinois. It had been very prosperous from its organization in 1904 until after the World War, when the tanning business began to decline. The March 1, 1913, fair market value of its shares was $1,410.03 for each share. In 1923 a reorganization was effected, by which a Delaware corporation was organized with a capital stock of 25,000 shares of the par value of $100 each and exchanged its entire issue of 25,000 shares and $700,000 cash in addition for the 500 shares of stock in the old Illinois corporation. Each stockholder in the old Illinois corporation1190 received in exchange for each share of his stock therein 50 shares of stock in the new Delaware corporation and $1,400 in cash. The respondent in that case determined that the shares of stock exchanged were of equal value and that the stock of the Delaware corporation had a readily realizable market value, and that the entire additional cash payment was profit and constituted taxable income to the recipients. We held, however, that the stock of the new Delaware corporation did not have a readily realizable market value, and as the cash received of $1,400 per share did not equal or exceed the March, 1, 1913, value of $1,410.03 per share, no taxable gain resulted. In the instant case the Commissioner has determined, as he did in the Eisendrath case, that the stock of the Delaware corporation which petitioner received in exchange for the stock which the estate owned in the Illinois corporation had a readily realizable market value at least equal to the March 1, 1913, value of the stock in the Illinois corporation and that hence all the cash received in the transaction was taxable gain. This determination of respondent is presumed to be correct, and so many decisions have held1191 that to be true that it is unnecessary to cite authorities. Petitioner recognizes this to be true and has offered much evidence to rebut the determination made by respondent. Petitioner has made no effort to prove that the stock did not have value. Indeed it is quite clear that the stock did have value - much value - because it unquestionably had large assets behind it, but that is not saying that under the circumstances existing at the time of exchange it had a readily realizable market value. As we said in 52 , "Before such a transaction is considered to give rise to taxable gain under the statute, the property received in the exchange must have a readily realizable market value, i.e., be practically the equivalent of cash." We do not think we can hold that the stock of the Delaware corporation to the extent of its fair value was practically the equivalent of cash at the time it was received. We feel constrained to hold that the weight of the evidence is against the conclusion that the stock of the Delaware corporation had a readily realizable market value at the time of the exchange. Under these circumstances the1192 cash which petitioner received in the transaction will go to reduce the basis of the Delaware corporation stock and any gain in the transaction to be taxable will have to await the future disposal of the stock. Such we believe was the intent of the statute which we have quoted in the margin. Seven qualified witnesses testified for the petitioner relative to the marketability of the stock in the Delaware corporation, some of whom were participants in the reorganization and loan transactions. The stock was not listed on any exchange and there had been no sales of any shares. All of these witnesses testified that the stock did not have a readily realizable market value at the time of the exchange. They gave various reasons for their opinions and we do not deem it necessary to report their testimony in detail in this discussion. We think it will suffice to give a summary of their reasons and this summary may be stated briefly, as follows: Under the trust indenture of April 1, 1923, which the Delaware corporation had to give to secure its gold note issue of $3,750,000, it was prohibited from paying any dividends out of anything except earnings which might accrue to the company1193 after April 1, 1923. It had a principal obligation, plus interest, to meet under that indenture, in excess of $4,704,000 over a period of eight years. Current assets of $4,000,000 at all times had to be maintained. Therefore the $4,704,000 which had to be paid over this term of eight years could only be paid out of future profits after April 1, 1923. The person who would want to buy the stock as of April 26, 1923, would therefore have to agree to pay off $4,704,000 out of future earnings, which would make the chances for any distributable dividends during that time very slim. The stock was not salable unless the person buying it could in a manner satisfactory to Mrs. Newbury, indemnify her and save her harmless from the personal guaranty which she had given to the purchasers of the $3,750,000 gold notes of the Delaware corporation. Under the leases the rentals and taxes amounted to approximately $1,250,000 annually and were burdensome, considering the volume of annual sales of the corporation, 53 and constituted a prior lien against the assets of the corporation in addition to the heavy payments on the note issue before anything was available for distribution as profits. 1194 One witness, who was a negotiator for the sale or purchase of large department stores, testified he had attempted to interest Isaac Gimbel of Gimbel Bros. of New York, Jesse Straus of Macy & Co. of New York, Samuel Mundheim of Kaufman's of Pittsburgh, S. S. Kresge of the S. S. Kresge Stores, and Morton May of the May Department Stores of St. Louis, in purchasing the Boston Store of Chicago (Delaware corporation), but without success. He testified that the shares of stock in the Delaware corporation did not have a readily realizable market value, nor a fair market value, and gave as reasons substantially the same reasons as we have set out in detail in the foregoing summary. In view of this testimony we think that petitioner has overcome the presumptive correctness of respondent's determination and that it was incumbent upon the Commissioner to offer evidence in rebuttal which would have satisfactorily established that the stock of the Delaware corporation did have a readily realizable market value at the time of the exchange. This we do not think he has done. Therefore, on this issue, we find in favor of petitioner. The respondent in determining the deficiency added 251195 percent thereof, amounting to $85,676.22, as a penalty for failure to file a return on time. Apparently this was imposed under section 3176, Revised Statutes, as amended by section 1103, Revenue Act of 1926, which provides in part as follows: In case of any failure to make and file a return or list within the time prescribed by law, or prescribed by the Commissioner of Internal Revenue or the Collector in pursuance of law, the Commissioner of Internal Revenue shall add to the tax 25 per centum of its amount, except that when a return is filed after such time and it is shown that the failure to file it was due to a reasonable cause and not to willful neglect, no such addition shall be made to the tax. It is not disputed that the petitioner did file a fiduciary return on Form 1041 in time, but on advice of tax accountants no report was made of the transaction herein involved, on the theory that it was not taxable and no profit for taxation on Form 1040 was returned. Since we have held that there is no tax due from the petitioner on the transaction, it follows that the imposition of the penalty was improper. Reviewed by the Board. Decision will be entered for the petitioner1196 that there is no deficiency and no penalty.Footnotes1. SEC. 202. (a) That the basis for ascertaining the gain derived or loss sustained from a sale or other disposition of property, real, personal, or mixed, acquired after February 28, 1913, shall be the cost of such property; except that - * * (b) The basis for ascertaining the gain derived or loss sustained from the sale or other disposition of property, real, personal, or mixed, acquired before March 1, 1913, shall be the same as that provided by subdivision (a); but - (1) If its fair market price or value as of March 1, 1913, is in excess of such basis, the gain to be included in the gross income shall be the excess of the amount realized therefor over such fair market value or price; [Italics supplied]. * * * (c) For the purposes of this title, on an exchange of property, real, personal or mixed, for any other such property, no gain or loss shall be recognized unless the property received in exchange has a readily realizable market value; but even if the property received in exchange has a readily realizable market value, no gain or loss shall be recognized - * * * (2) When in the reorganization of one or more corporations a person receives in place of any stock or securities owned by him, stocks or securities in a corporation a party to or resulting from such reorganization. The word "reorganization," as used in this paragraph, includes a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or of substantially all the properties of another corporation), recapitalization, or mere change in identity, form or place of organization of a corporation, (however effected); * * * (e) Where property is exchanged for other property which has no readily realizable market value, together with money or other property which has a readily realizable market value, then the mney or the fair market value of the property having such readily realizable market value received in exchange shall be applied against and reduce the basis, provided in this section, of the property exchanged, and if in excess of such basis shall be taxable to the extent of the excess; but when property is exchanged for property specified in paragraphs (1), (2) and (3) of subdivision (c) as received in exchange, together with money or other property of a readily realizable market value other than that specified in such paragraphs, the amount of the gain resulting from such exchange shall be computed in accordance with subdivisions (a) and (b) of this section, but in no such case shall the taxable gain exceed the amount of the money and the fair market value of such other property received in exchange. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624581/	ROBERT BROWN AND DOSHIE M. BROWN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentBrown v. CommissionerDocket Nos. 16092-81, 11602-82United States Tax CourtT.C. Memo 1983-726; 1983 Tax Ct. Memo LEXIS 59; 47 T.C.M. (CCH) 526; T.C.M. (RIA) 83726; December 7, 1983. Robert Brown and Doshie M. Brown, pro se. Joyce Levy, for the respondent. COHENMEMORANDUM FINDINGS OF FACT AND OPINION COHEN, Judge: In a notice of deficiency dated July 7, 1981, respondent determined a deficiency of $779 in petitioners' Federal income60 taxes for the calendar year 1978. In a notice of deficiency dated March 23, 1982, respondent determined deficiencies of $917 and $892 in petitioners' Federal income taxes for the years 1979 and 1980, respectively. Petitioners dispute respondent's disallowance of petitioners' deduction of costs incurred by Mr. Brown in commuting between their home in Huntington Beach, California, where they resided during the years in issue and at the time the petitions were filed herein, and his place of employment in Orange, California. Petitioners claimed such costs as business expenses on joint individual income tax returns timely filed for those years. During the years 1964 through 1980, Mr. Brown was employed by DeSoto, Inc. In 1964 he was transferred from his employer's Los Angeles, California, place of business to its Orange, California, place of business. At the time of the transfer, petitioners unsuccessfully attempted to purchase a home in Santa Ana, California, approximately 2 miles from Mr. Brown's new place of employment. They subsequently purchased a home in Huntington Beach, approximately 17-1/2 miles from his new place of employment. Petitioners are Black American citizens61 and contend that their inability to purchase the home in Santa Ana was due to racial discrimination. Petitioners filed a complaint with the Federal Housing Authority, which was involved in financing the tract in which the Santa Ana home was located, but they apparently did not pursue their complaint because of the expense involved. There is no indication that petitioners attempted to pursue remedies available to them under California law, e.g., Cal. Civ. Code sections 51 and 52 (Deering 1981). See Burks v. Poppy Construction Co.,57 Cal. 2d 463">57 Cal.2d 463, 370 P.2d 313">370 P.2d 313 (1962). See also Reitman v. Mulkey,387 U.S. 369">387 U.S. 369 (1967). Petitioners state their position as follows: Our main argument is that the recial discrimination forced us to live farther from [Mr. Brown's] employment and that the additional mileage should be deducted as a business expense. This should be the case since the Constitution guarantees our rights to choose where to live and not to have the federal government permit both directly or indirectly such discrimination. But for the discrimination, the extra expense would not have been incurred and there would be no62 deduction claimed. We feel the unconstitutional racial discrimination is a valid reason for the extra commuting expense to be deductible. Section 162 1 allows a deduction for ordinary and necessary expenses incurred in the carrying on of a trade or business, including expenses incurred by an employee in relation to his employment. Commuting expenses, however, are personal and not deductible. Section 262; section 1.162-2(e) and section 1.262-1(b)(5), Income Tax Regs. See Commissioner v. Flowers,326 U.S. 465">326 U.S. 465 (1946). In Sanders v. Commissioner,439 F.2d 296">439 F.2d 296 (9th Cir. 1971), affg. 52 T.C. 964">52 T.C. 964 (1969), taxpayers were civilian employees who were precluded from living on the Air Force base where they worked. They claimed that they should be entitled to deduct their automobile expenses incurred in traveling between the Air Force base and their homes in various areas distant from the work site. The Court held that neither the inability to live on the base nor the fact that public63 transportation was unavailable to and from the base was an adequate reason for permitting the taxpayers to deduct their commuting expenses. The Ninth Circuit Court of Appeals then cited with approval several other cases in which courts have held that the degree of necessity attached to the commuting was not a controlling factor. See, e.g., United States v. Tauferner,407 F.2d 243">407 F.2d 243 (10th Cir. 1969), where the taxpayer was required to travel 27 miles between his residence and a job site in a remote desert area. Tax deductions are a matter of legislative grace. New Colonial Ice Co. v. Helvering,292 U.S. 435">292 U.S. 435 (1934). The tax laws obviously do not and cannot make distinctions based on racial classifications. Petitioners are not being treated any differently than any other taxpayers similarly situated with respect to deductibility of commuting expenses. Petitioners' position, however, is that they should receive a special tax concession because they have been treated unfairly in a nontax context. Petitioners claim a substantial violation of rights to which they are undoubtedly entitled. Their situation is not significantly different, however, 64 than that of other taxpayers who believe that their individual constitutional rights are unfairly affected by uniform tax laws, e.g., persons whose religious principles are offended by the use of tax revenues for military expenditures or who are conscientiously opposed to social security taxes. In such cases the courts have consistently held that the uniform application of the tax laws does not violate the Fourteenth Amendment guarantee of equal protection of the laws. See Autenrieth v. Cullen,418 F.2d 586">418 F.2d 586 (9th Cir. 1969); Greenberg v. Commissioner,73 T.C. 806">73 T.C. 806 (1980); Henson v. Commissioner,66 T.C. 835">66 T.C. 835 (1976). Taxpayers are denied deductions in such other circumstances even though they have fewer direct alternative remedies than were available to petitioners here. The often-criticized complexity of the tax laws is primarily attributable to attempts to perform the awesome task of securing necessary revenues for the government in an equitable manner. Neither those laws nor the persons charged with administering them can carry the additional burden of resolving all grievances that citizens have against their government. Decisions65 will be entered for the respondent.Footnotes1. Unless otherwise indicated, all statutory references are to the Internal Revenue Code of 1954, as amended and in effect during the years here in issue.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624582/	WILLIA V. MOORE, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentMoore v. CommissionerDocket No. 6001-82United States Tax CourtT.C. Memo 1983-289; 1983 Tax Ct. Memo LEXIS 489; 46 T.C.M. (CCH) 229; T.C.M. (RIA) 83289; May 25, 1983. Willia V. Moore, pro se. Margaret K. Hebert, for the respondent. DAWSONMEMORANDUM FINDINGS OF FACT AND OPINION DAWSON, Judge: This case was assigned to and heard by Special Trial Judge Darrell D. Hallett pursuant to the provisions of section 7456(c) of the Internal Revenue Code490 1 and Rules 180 and 181, Tax Court Rules of Practice and Procedure.2 The Court agrees with and adopts his opinion which is set forth below. OPINION OF THE SPECIAL TRIAL JUDGE HALLETT, Special Trial Judge: Respondent Determined a deficiency in petitioner's 1978 Federal income tax in the amount of $336. The issues for decision are (1) Whether petitioner is entitled to a deduction with respect to a contribution to an Individual Retirement Account (IRA); and (2) whether petitioner is liable for the 6 percent excise tax imposed by section 4973 on excess contributions to an individual retirement account. Petitioner was a resident of Los Angeles, California at the time the petition was filed in this case. During the tax year 1978, petitioner was employed full time by the Cedars-Sinai Medical Center. Petitioner was covered491 by a retirement plan maintained by the medical center for its employees, and contributions were made to the plan on behalf of petitioner. During 1978 petitioner's rights to benefits under the plan were not vested, and would not become so until she had completed at least 10 years of service. In 1978, petitioner made a $1,500 contribution to an IRA and claimed the amount of the contribution as a deduction on her 1978 return. The law in effect for 1978 authorized a deduction with respect to contributions to an IRA, but it specifically prohibited a deduction for a taxpayer who was an active participant in a qualified retirement plan. Section 219(b)(2)(A)(i)([(B)]. Petitioner contends that she was not an active participant in the retirement plan maintained by her employer because she did not, as of 1978, have vested benefits in the employer's plan. However, we have previously addressed this issue and concluded that Congress intended the term "active participant" as it appeared in section 219 to include not only individuals whose benefits in a qualified plan are vested, but those who are accruing benefits that would be forfeited if the individual does not fulfill the minimum age492 and service requirements. This is because Congress was concerned with the potential double tax benefit an individual would obtain if he were allowed a deduction for contributions to an IRA at the same time he was accruing benefits in a qualified plan, and those benefits later became fully vested. Orzechowski v. Commissioner,592 F.2d 677">592 F.2d 677 (2nd Cir. 1979), affg. 69 T.C. 750">69 T.C. 750 (1978). See also Guest v. Commissioner,72 T.C. 768">72 T.C. 768 (1979); Horvath v. Commissioner,78 T.C. 86">78 T.C. 86 (1982); Johnson v. Commissioner,620 F.2d 153">620 F.2d 153 (7th Cir. 1980); Johnson, Jr. v. Commissioner,661 F.2d 53">661 F.2d 53, (5th Cir. 1981) affg. 74 T.C. 1057">74 T.C. 1057 (1980); Hildebrand v. Commissioner,683 F.2d 57">683 F.2d 57 (3rd Cir. 1982). 3 Accordingly, since petitioner was clearly covered by a qualified retirement plan maintained by her employer, her claimed deduction to the IRA must be disallowed. 493 We must also sustain respondent's determination and hold petitioner liable for the 6 percent excise tax. In this regard, section 4973 imposes a 6 percent excise tax on excess contributions to an IRA. In a case such as this, where the entire contribution fails to qualify for deduction, the entire amount of the contribution is considered an "excess contribution" and is subject to the tax. Orzechowski v. Commissioner,supra at 756, Guest v. Commissioner,supra;Randall v. Commissioner,T.C. Memo. 1980-490; Marsh v. Commissioner,T.C. Memo. 1980-193. 4 We recognize that petitioner claimed the deduction in good faith, believing that she was not precluded from doing so by reason of her participation in her employer's plan because her rights under that plan were not fully vested. However, in enacting the excise tax on excess contributions to IRA's, Congress chose to draw no distinction between excess contributions inadvertently made and those willfully made. Accordingly, we must sustain respondent's determination as to the excise tax imposed. *494 Decision will be entered for the respondent.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated. ↩2. Pursuant to the order of assignment and on the authority of the "otherwise provided" language of Rule 182, Tax Court Rules of Practice and Procedure↩, the post-trial procedures set forth in that rule are not applicable in this case.3. We note that the decision in Foulkes v. Commissioner,638 F.2d 1105">638 F.2d 1105↩ (7th Cir. 1981), revg. a Memorandum Opinion of this Court, is distinguishable since petitioner herein was employed by the hospital during the entire year 1978 and accrued benefits based on her participation in the plan during that year.4. Effective for years beginning after 1981, Section 408 was amended to permit the penalty to be avoided by the taxpayer causing the "excess" contributions to be repaid before the filing due date on his return.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624583/	Penn Mutual Indemnity Company (Dissolved), Francis R. Smith, Insurance Commissioner of the Commonwealth of Pennsylvania, Statutory Liquidator, Petitioner, v. Commissioner of Internal Revenue, RespondentPenn Mut. Indem. Co. v. CommissionerDocket No. 55553United States Tax Court32 T.C. 653; 1959 U.S. Tax Ct. LEXIS 146; June 15, 1959, Filed 146 Decision will be entered for the respondent. Held, the tax imposed upon mutual insurance companies (other than life or marine), computed under section 207(a)(2), I.R.C. 1939, as amended, is constitutional. The only possible objection to its validity is that it is a "direct" tax which must be apportioned according to population. The tax is not a "direct" tax within the meaning of the Constitution, and the fact that underwriting losses are not deductible is constitutionally irrelevant. John T. Curtin, Esq., for the petitioner.Morton A. Smith, Esq., for the respondent. Raum, Judge. Murdock, J., concurring. Turner, Harron, Opper, Tietjens, Bruce, Atkins, and Mulroney, JJ., agree with this concurring opinion. Turner, J., concurring. Harron, Tietjens, Fisher, and Atkins, JJ., agree with this concurring opinion. Pierce, J., dissenting. Withey, J., agrees, on point I only of this dissent. Train, J., dissenting. Forrester, J., agrees with this dissent. RAUM653 OPINION.Respondent determined a deficiency in the 1952 income tax liability of the Penn Mutual Indemnity Company in the amount of $ 12,566.76. The sole issue is whether section 207(a)(2) of the Internal Revenue Code of 1939147 is constitutional as here applied. The facts have been stipulated.Francis R. Smith, the Insurance Commissioner of the Commonwealth of Pennsylvania, is the statutory receiver of Penn Mutual Indemnity Company and as such, successor in right, title, and interest to its assets and liabilities.The company was incorporated in 1929 under the laws of Pennsylvania and became subject to the Insurance Company Law of that State (Act of May 17, 1921, P.L. 682.) The company was authorized under its charter, as amended, to transact business in Pennsylvania, "covering risks as insurance carrier, generally defined as casualty risks including public liability, plate glass insurance, burglary, workman's compensation, as well as issuing contracts of fidelity and surety, and fire and comprehensive insurance contracts."The company, at all times relevant, was authorized to transact business and issue contracts of insurance covering various risks within Pennsylvania only, and at all times confined its activities as an insurance carrier within the territorial limits of Pennsylvania. At no 654 time was it authorized or licensed by the United States or any Federal body or agency to transact business or issue 148 or write contracts of insurance.As a result of operations for the calendar year 1952, the company had a total "gross income" of $ 16,791.21 and "net premiums" of $ 1,239,884.49 for a "gross amount of income" of $ 1,256,675.70. 1149 It also had underwriting losses which exceeded its gross amount of income by $ 206,198.12, which losses are not recognized as a deduction under section 207(a)(2) of the Internal Revenue Code of 1939. The company filed its income tax return for the year 1952 with the district director of internal revenue at Philadelphia, Pennsylvania. The return disclosed a total tax due in the amount of $ 12,566.76, but by letter attached thereto, the company denied that this sum was owing on the ground that section 207(a)(2) of the Internal Revenue Code of 1939 was unconstitutional. Respondent thereafter determined a deficiency in the amount of $ 12,566.76. 2The parties have agreed that the company "was a mutual insurance company under Section 207 of the Internal Revenue Code of 1939 and if the said Section 207 is constitutional, the deficiency is $ 12,566.76."Section 207 of the Internal Revenue Code of 1939, as amended, 3150 established a system for the taxation of mutual insurance companies other than life or marine. Provisions for the taxation of stock insurance companies and mutual life or marine insurance companies are found in other, although closely neighboring, sections of the 1939 Code. The business of insurance has proven over the years an extremely difficult subject for Federal taxation. The determination of what should constitute "income" in the case of insurance companies, combined with differences in the methods of doing business of mutual and stock companies, has presented the Congress with problems of unusual complexity.Prior to 1942 most mutual insurance companies other than life were exempt from Federal income tax as a result of an exemption contained in section 101(11) of the 1939 Code. In 1942, Congress proceeded to an extensive revision of the income tax treatment of all insurance companies.655 The Revenue Act of 1942, as passed by the House, limited the existing exemption of mutual insurance companies to companies of a designated size; at the same time, it imposed a tax measured by underwriting and investment income similar to that which had been applicable to stock insurance companies other than life since 1921. See H. Rept. No. 2333, 77th Cong., 2d Sess., pp. 27-28, 113-118. However, the Senate Finance Committee apparently felt that the provisions formulated to adapt that scheme of taxation to 151 mutual companies were unworkable, and it appeared unable to develop any satisfactory technique to achieve the desired end within the framework of the House plan of taxation. See S. Rept. No. 1631, 77th Cong., 2d Sess., p. 31. Accordingly, the committee proposed an entirely different scheme of taxation, S. Rept. No. 1631, supra, pp. 31, 150-154, which the Senate approved. That plan was ultimately accepted by the conference committee, although modified in certain particulars not presently material. H. Rept. 2586, 77th Cong., 2d Sess., pp. 10-12. As thus modified, it was enacted into law in the provisions here for review.The new taxing provisions thus appearing in the Revenue Act of 1942 constituted a complete revision of section 207 of the 1939 Code. Section 207, incorporating amendments made subsequent to the Revenue Act of 1942 which are applicable to 1952, the taxable year here involved, is set forth in the margin. 4152 153 154 155 156 157 158 159 These latter amendments were 656 required primarily by changes in corporation income tax rates during the years subsequent to 1942 and did not alter the basic structure of the tax first imposed in 1942.657 The basic pattern of the new system adopted in 1942 was described by the Senate Finance Committee as follows (S. Rept. No. 1631, supra at 151):In the case of mutual insurance companies other than life or marine which are not granted exemption under section 101(11), 5160 it is proposed to subject such companies to income tax at the regular corporate rates on their net investment income or to a special tax of 1 percent on the gross amount received from interest, dividends, rents, and net premiums, minus dividends to policyholders, minus the interest which under section 22(b)(4) is excluded from gross income, whichever is the greater * * * [Italics supplied.]Section 207(a) levies a tax on every mutual insurance company (other than life or marine or a fire insurance company subject to tax under section 204) upon either one of two bases, whichever produces the greater amount of tax. The first base, embodied in section 207(a)(1), is net investment income to which is applied the rates applicable to corporation incomes generally. The second base, embodied in section 207(a)(2), is the "gross amount of income" from interest, dividends, rents, and net premiums, less dividends to policyholders and less wholly tax-exempt interest. If the base so computed exceeds $ 75,000, the tax is an amount equal to the excess of --658 (A) 1 per centum of the amounts so computed, or 2 per centum of the excess of the amount so computed over $ 75,000, whichever is the lesser, over(B) the amount of the tax imposed under Subchapter E of Chapter 2.The reference in subparagraph (B) to "Subchapter E of Chapter 2" is a reference to the excess profits tax, and since no such tax was applicable here, subparagraph (B) played no part in the present computation, which consisted merely of 1 per cent of the "gross amount of income."In this case the computation under 161 section 207(a)(2) produced a greater liability than the one determined under section 207(a)(1); accordingly, the amount of tax levied by section 207 was fixed by subsection (a)(2). There is no disagreement between the parties that if section 207(a)(2) is constitutional, the computation of the company's 1952 tax liability is governed thereby, and the deficiency determined by the Commissioner is correct. No issue of statutory construction or application of the statute is here presented.At the outset we may briefly dispose of the contention raised in the petition that the tax is "in effect, a license fee or charge to do business to which the United States is not entitled since it has not issued any license or grant to the taxpayer to operate or do business." The argument is wholly without substance. The United States has not sought to regulate the company, and the tax in question is part of a comprehensive revenue measure. Whether the business of the taxpayer can be subjected to Federal regulation has no bearing upon the validity of an exercise of taxing power with respect to that taxpayer. Steward Machine Co. v. Davis, 301 U.S. 548">301 U.S. 548, 582; Flint v. Stone Tracy Co., 220 U.S. 107">220 U.S. 107, 152-158. 162 We pass therefore to a consideration of whether the challenged exaction is otherwise authorized under the taxing power.An act of Congress is not lightly to be set aside, and doubt must be resolved in its favor. So much is familiar learning. Moreover, the presumption in favor of validity is particularly strong in the case of a revenue measure. As was stated many years ago by the Supreme Court in Nicol v. Ames, 173 U.S. 509">173 U.S. 509, 514-515:It is always an exceedingly grave and delicate duty to decide upon the constitutionality of an act of the Congress of the United States. The presumption, as has frequently been said, is in favor of the validity of the act, and it is only when the question is free from any reasonable doubt that the court should hold an act of the lawmaking power of the nation to be in violation of that fundamental instrument upon which all the powers of the Government rest. This is particularly true of a revenue act of Congress. The provisions of such an act should not be lightly or unadvisedly set aside, although if they be plainly antagonistic to the Constitution it is the duty of the court to so declare. The power to tax is the one great power upon which the whole 163 national fabric is based. It is as necessary to the existence and prosperity of a nation as is the air he 659 breathes to the natural man. It is not only the power to destroy, but it is also the power to keep alive.We cannot find that Congress has gone beyond permissible limits here.In dealing with the scope of the taxing power the question has sometimes been framed in terms of whether something can be taxed as income under the 16th amendment. This is an inaccurate formulation of the question and has led to much loose thinking on the subject. The source of the taxing power is not the 16th amendment; it is article I, section 8, of the Constitution. It is important that these provisions be clearly understood. What is required is an understanding of fundamental principles. The familiar statement that "at this time we need education in the obvious more than investigation of the obscure" (Holmes, Collected Legal Papers, pp. 292-293), although made in a different context, is peculiarly applicable here.The power to tax was one of the great powers granted to the National Government by the Constitution. Indeed, a glaring weakness of the Articles of Confederation was the absence of an effective 164 taxing power and "was one of the causes that led to the adoption of the present Constitution." Springer v. United States, 102 U.S. 586">102 U.S. 586, 595-596. See also The Federalist, Nos. 21, 30. It was in response to the perilous situation then existing that the Constitution conferred upon the Congress the power to tax in broad and sweeping terms. Article I, section 8, clause 1, provides:The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States; * * The authority thus granted "is exhaustive and embraces every conceivable power of taxation." (Italics supplied.) Brushaber v. Union Pac. R.R., 240 U.S. 1">240 U.S. 1, 12. The power was subject to only one prohibition, namely, that no tax or duty may be laid upon exports (art. I, sec. 9, cl. 5); 6 and only two qualifications were imposed upon the manner in which the power might be exercised: (1) Duties, imposts, and excises must be "uniform throughout the United States" (art. I, sec. 8, cl. 1, supra); and (2) capitation and other "direct" taxes must be apportioned 165 among the States according to population (art. I, sec. 2, cl. 3, 7166 and art. I, sec. 9, cl. 4 8). The comprehensive and all-inclusive 660 character of the taxing power was thus summarized by Chief Justice Chase in License Tax Cases, 5 Wall. 462">5 Wall. 462, 471:Congress cannot tax exports, and it must impose direct taxes by the rule of apportionment, and indirect taxes by the rule of uniformity. Thus limited, and thus only, it reaches every subject, and may be exercised at discretion.In Pacific Insurance Co. v. Soule, 7 Wall. 433">7 Wall. 433, the Court stated (p. 446):The taxing power is given in the most comprehensive terms. The only limitations imposed are: That direct taxes, including the capitation tax, shall be apportioned; that duties, imposts, and excises shall be uniform; and that no duties shall be imposed upon articles exported from any State. With these exceptions, the exercise of the power is, in all respects, unfettered.See also Flint v. Stone Tracy Co., 220 U.S. 107">220 U.S. 107, 153-154.Thus, where exports are not involved, the authority of Congress to impose a tax is plenary, except that direct taxes must be apportioned among the States according to population, and duties, imposts, and excises must be uniform throughout the United States. The latter requirement is not one of intrinsic equality; it is merely one of geographical uniformity, and is satisfied if the same rule for determining liability operates throughout the United States. Knowlton v. Moore, 178 U.S. 41">178 U.S. 41, 83-108; Flint v. Stone Tracy Co., 220 U.S. 107">220 U.S. 107, 157; Brushaber v. Union Pac. R.R., 240 U.S. 1">240 U.S. 1, 24; Florida v. Mellon, 273 U.S. 12">273 U.S. 12, 17; Poe v. Seaborn, 282 U.S. 101">282 U.S. 101, 117-118; Bromley v. McCaughn, 280 U.S. 124">280 U.S. 124, 138; Steward Machine Co. v. Davis, 301 U.S. 548">301 U.S. 548, 583. 167 Accordingly, since the statute now under attack satisfies the uniformity requirement, the only possible objection to its validity can be that it is not apportioned among the States according to population. But the apportionment requirement attaches only to "direct" taxes, and if the tax provided for under section 207(a)(2) is not a "direct" tax that requirement is not applicable.The question is not as to the existence of the power to tax the receipt of gross premiums, for that power certainly exists; rather, the issue is merely whether the tax must be apportioned according to population. In other words, in taxing gross premiums, as it has the power to do, must Congress impose that tax in such manner that the burden of the tax upon companies in each State will vary with the population of such State? If the tax is a duty, impost, or excise, the rule of apportionment does not apply; only if it is a "direct" tax does that rule come into play.The "terms duties, imposts and excises are generally treated as embracing the indirect forms of taxation contemplated by the Constitution." Flint v. Stone Tracy Co., 220 U.S. 107">220 U.S. 107, 151. Therefore, if a tax is not a direct tax, it falls within the 168 general category of indirect taxes, and it is a matter of no moment whether its classification 661 be further refined as a duty, or an impost, or an excise. As was said in Steward Machine Co. v. Davis, 301 U.S. 548">301 U.S. 548, 581-582:If the tax is a direct one, it shall be apportioned according to the census or enumeration. If it is a duty, impost, or excise, it shall be uniform throughout the United States. Together, these classes include every form of tax appropriate to sovereignty. Cf. Burnet v. Brooks, 288 U.S. 378">288 U.S. 378, 403, 405; Brushaber v. Union Pacific R. Co., 240 U.S. 1">240 U.S. 1, 12. Whether the tax is to be classified as an "excise" is in truth not of critical importance. If not that, it is an "impost" ( Pollock v. Farmers' Loan & Trust Co., 158 U.S. 601">158 U.S. 601, 622, 625; Pacific Insurance Co. v. Soule, 7 Wall. 433">7 Wall. 433, 445), or a "duty" ( Veazie Bank v. Fenno, 8 Wall. 533">8 Wall. 533, 546, 547; Pollock v. Farmers' Loan & Trust Co., 157 U.S. 429">157 U.S. 429, 570; Knowlton v. Moore, 178 U.S. 41">178 U.S. 41, 46).The wide and comprehensive nature of the category of indirect taxes, in striking contrast to the very narrow range within which "direct" taxes have been limited, is abundantly demonstrated by a hundred and seventy years of history and 169 an impressive number of decisions of the Supreme Court.For many years after the adoption of the Constitution the term direct taxes was thought to be limited to capitation taxes and taxes upon real estate. Hylton v. United States, 3 Dall. 171">3 Dall. 171; Springer v. United States, 102 U.S. 586">102 U.S. 586, 602. 9170 The impracticability and unfairness of the apportionment requirement were early recognized in the Hylton case, in which the Supreme Court held that an unapportioned annual tax upon carriages was within the power of Congress. In the course of his opinion Justice Chase stated (3 Dall. 171">3 Dall. 171, 174):It appears to me, that a tax on carriages cannot be laid by the rule of apportionment, without very great inequality and injustice. For example: suppose, two states, equal in census, to pay $ 80,000 each, by a tax on carriages, of eight dollars on every carriage; and in one state, there are 100 carriages, and in the other 1000. The owners of carriages in one state, would pay ten times the tax of owners in the other. A. in one state, would pay for his carriage eight dollars, but B. in the other state, would pay for his carriage, eighty dollars.Throughout the history of the country the term "direct" taxes has been given a narrow and restrictive interpretation, and unapportioned taxes over an extremely broad range have been sustained. Thus, notwithstanding the absence of apportionment, the Supreme Court has upheld a "license" or "special" tax upon dealers in certain commodities ( License Tax Cases, 5 Wall. 462">5 Wall. 462; cf. South Carolina v. United States, 199 U.S. 437">199 U.S. 437); a tax on sales at commodity exchanges ( Nicol v. Ames, 173 U.S. 509">173 U.S. 509); a tax on the transfer or sale of securities ( Treat v. White, 181 U.S. 264">181 U.S. 264; Thomas v. United States, 192 U.S. 363">192 U.S. 363; Provost v. United States, 269 U.S. 443">269 U.S. 443); a tax on the issuance of State bank notes ( Veazie Bank v. Fenno, 8 Wall. 533">8 Wall. 533); a tax on manufactured tobacco having reference to its origin and intended use ( Patton v. Brady, 184 U.S. 608">184 U.S. 608); a tax on the manufacture and sale of oleomargarine ( McCray v. United States, 195 U.S. 27">195 U.S. 27); a tax 171 on devolutions of title to real estate ( Scholey v. Rew, 23 Wall. 331">23 Wall. 331); a tax on the receipt of legacies ( Knowlton v. Moore, 178 U.S. 41">178 U.S. 41); a tax on transfers at death ( New York Trust Co. v. Eisner, 256 U.S. 345">256 U.S. 345); a tax on transfers inter vivos ( Bromley v. McCaughn, 280 U.S. 124">280 U.S. 124). In response to the contention in New York Trust Co. v. Eisner, supra, that the estate tax was invalid as an unapportioned direct tax upon property, the Supreme Court swept away all the logical arguments with the broad statement that "Upon this point a page of history is worth a volune of logic." 256 U.S. at 349.Among the numerous indirect taxes imposed by Congress under article I, section 8, of the Constitution were the various income taxes levied for a period of nearly 10 years at about the time of the Civil War. Act of August 5, 1861, ch. 45, 12 Stat. 292, 309, 311; Act of July 1, 1862, ch. 119, 12 Stat. 432, 473, 475; Act of March 3, 1863, ch. 74, 12 Stat. 713, 718, 723; Act of June 30, 1864, ch. 173, 13 Stat. 223, 281, 285; Act of March 3, 1865, ch. 78, 13 Stat. 469, 479, 481; Act of March 10, 1866, ch. 15, 14 Stat. 4, 5; Act of July 13, 1866, ch. 184, 14 Stat. 98, 137, 140; Act of March 2, 1867, 172 ch. 169, 14 Stat. 471, 477, 480; Act of July 14, 1870, ch. 255, 16 Stat. 256, 261. These taxes were not apportioned according to population; they were treated as indirect taxes and were held constitutional in a number of cases in the Supreme Court, notably in Springer v. United States, 102 U.S. 586">102 U.S. 586, where the constitutional issue was fully discussed.However, in addition to the foregoing income taxes, there were a number of taxes upon gross receipts. Thus, section 104 of the Act of June 30, 1864, 13 Stat. at 276, imposed a gross receipts tax upon express companies as follows:Any person, firm, company, or corporation carrying on or doing an express business, shall be subject to and pay a duty of three per centum on the gross amount of all the receipts of such express business.Similarly, section 107 of the same statute laid a tax of 5 per cent "on the gross amount of all receipts of" telegraph companies. 13 Stat. at p. 276. Again, section 108 imposed a tax of 2 per cent "on the gross amount of all receipts" with respect to theatres, operas, circuses, museums, and other public exhibitions and performances. Moreover, of particular interest here is the tax provided for with respect 173 to gross premiums of insurance companies. Section 105 of the same statute declared that:663 That there shall be levied * * a duty of one and a half of one per centum upon the gross receipts of premiums, or assessments for insurance from loss or damage by fire or by the perils of the sea, made by every insurance company. * * It should be noted that these were not taxes upon income in the sense that "gain" or "profit" might be an essential aspect of the subject matter taxed. They were simply taxes upon gross receipts, just as a sales tax is often measured by gross receipts from the goods sold and is applicable regardless of the profitable or unprofitable nature of the business. The foregoing gross receipts taxes were unapportioned, and their validity was challenged. In Pacific Insurance Company v. Soule, 7 Wall. 433">7 Wall. 433, the Supreme Court sustained the tax upon insurance companies. It rejected the contention that the contested exaction was a direct tax that had to be apportioned. In pointing out the bizarre and inequitable consequences that would flow from the apportionment of the tax upon gross premiums the Court stated (p. 446):The consequences which would follow the apportionment 174 of the tax in question among the States and Territories of the Union, in the manner prescribed by the Constitution, must not be overlooked. They are very obvious. Where such corporations are numerous and rich, it might be light; where none exist, it could not be collected; where they are few and poor, it would fall upon them with such weight as to involve annihilation. It cannot be supposed that the framers of the Constitution intended that any tax should be apportioned, the collection of which on that principle would be attended with such results. The consequences are fatal to the proposition.These words are equally applicable to the "special tax of 1 per cent" (S. Rept. No. 1631, 77th Cong., 2d Sess., p. 151) imposed by section 207(a)(2) of the 1939 Code which is here under attack.Similarly, section 27 of the Act of June 13, 1898, ch. 448, 30 Stat. 448, 464, imposed a tax of one-quarter of one per cent upon the gross receipts, in excess of $ 250,000, from the refining of sugar or petroleum or the operation of a pipeline. There was no provision for apportionment, but the tax was nevertheless sustained in Spreckels Sugar Refining Co. v. McClain, 192 U.S. 397">192 U.S. 397. True, the statute 175 had referred to the exaction as "a special excise tax. " But its validity could not have turned upon a mere label. It should be perfectly clear that if the power exists, the name applied to a particular tax is of no consequence. The validity of an exercise of congressional power cannot depend upon the verbal tag affixed to it. "The name of the tax is unimportant." Pollock v. Farmers' Loan & Trust Co., 157 U.S. 429">157 U.S. 429, 580-581.We think it clear that wholly apart from the 16th amendmentsection 207(a)(2) is entirely within the all-inclusive taxing power of Congress under article I, section 8, and that the crippling and inequitable 664 apportionment requirement has no application here. Nevertheless, since the 16th amendment is sometimes loosely and incorrectly treated as imposing certain limitations or restrictions upon the taxing power, we deem it important to show just what part the 16th amendment plays in relation to the taxing power.The story of the 16th amendment properly begins with Pollock v. Farmers' Loan & Trust Co., 157 U.S. 429">157 U.S. 429, 158 U.S. 601">158 U.S. 601. Sections 27-37 of the Act of Congress received by the President April 15, 1894, and which became law without his approval (ch. 349, 28 176 Stat. 509) provided for a comprehensive general tax upon net income. There was no apportionment, and a sharply divided Court held the Act invalid in two respects that are material here. It held that to the extent that the tax was upon rents or income from real estate and to the extent that it was upon income from invested personal property, it was for present purposes equivalent to a direct tax upon the real estate or the invested personal property and was therefore invalid for want of apportionment. In other words, the apportionment requirement was held applicable by reason of the source of those two classes of income, since in the opinion of the majority, the income from those two sources was so closely identified with the sources themselves that a tax upon the income had to comply with the requirements applicable to a tax upon the property from which it was derived. It was only in this limited respect that the lack of apportionment was held fatal. The Court made it plain beyond any doubt that it was not reaching any such result in respect of a tax on "professional receipts," 157 U.S. at 579, or "on gains or profits from business, privileges, or employments," 158 U.S. at 635. 177 The narrow scope of the holding in the Pollock case has been repeatedly recognized. See Nicol v. Ames, 173 U.S. 509">173 U.S. 509, 519-520; Knowlton v. Moore, 178 U.S. 41">178 U.S. 41, 80; Spreckels Sugar Refining Co. v. McClain, 192 U.S. 397">192 U.S. 397, 413; Flint v. Stone Tracy Co., 220 U.S. 107">220 U.S. 107, 148.But in spite of the limited scope of the holding in the Pollock case Congress was prevented from imposing a general tax upon all income without taking into account its obligation to provide for apportionment to the extent at least that the income was derived from property. It was to overcome this impossible situation that the 16th amendment was adopted. It provides:The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.The 16th amendment thus merely provides that regardless of the source of the income no apportionment is required. It is no new grant of power to tax income, "an authority already possessed and never 665 questioned." Brushaber v. Union Pac. R.R., 240 U.S. 1">240 U.S. 1, 17-18. Nor was it necessary in order to lift the apportionment requirement in respect of most types of income; for 178 the apportionment requirement, even under the Pollock case, applied only to income from property. But it was necessary to remove the apportionment requirement as to income from property and to make clear that, whatever the source, income could be taxed without the crippling effect of apportionment. As the Court in the Brushaber case said (240 U.S. at 18): "[The] whole purpose of the Amendment was to relieve all income taxes when imposed from apportionment from a consideration of the source whence the income was derived."In Stanton v. Baltic Mining Co., 240 U.S. 103">240 U.S. 103, the Supreme Court again made it clear that (pp. 112-113) "the Sixteenth Amendment conferred no new power of taxation but simply prohibited the previous complete and plenary power of income taxation possessed by Congress from the beginning from being taken out of the category of indirect taxation to which it inherently belonged and being placed in the category of direct taxation subject to apportionment by a consideration of the sources from which the income was derived, that is by testing the tax not by what it was -- a tax on income, but by a mistaken theory deduced from the origin or source of the income taxed." The 179 Court condemned as improper an approach to the 16th amendment which treated it as a new grant of power with the consequence that limitations in that new grant were a restriction upon its exercise. The 16th amendment merely made it clear that income taxes, regardless of the source of the income, were not subject to the apportionment requirement. It in no way subtracted from or diminished the all-inclusive power already provided for in article I, section 8. It would be ironic indeed if the amendment, which was intended to enlarge the preexisting taxing power by unfettering it from a crippling restriction, were to be interpreted so as to create new limitations upon its exercise. In Stanton v. Baltic Mining Co., supra, the Court overrode an objection to the 1913 income tax as applied to a mining company where the taxpayer complained that the allowance of a depletion deduction in the amount of only $ 150,000 in the face of actual depletion of $ 750,000 converted the tax into one upon property which was therefore invalid because not apportioned. The Court brushed the argument aside, sustaining the tax not only with the assistance of the 16th amendment, but also upon the ground that 180 it was valid "independently of the effect of the operation of the Sixteenth Amendment." It cited Stratton's Independence v. Howbert, 231 U.S. 399">231 U.S. 399, in support of its conclusion that the tax could be sustained as a true excise on the results of the business of carrying on mining operations. 240 U.S. at 114. But while it is true that the tax in Stratton's 666 Independence v. Howbert was eo nomine an excise, such was not the case of the 1913 income tax sustained in the Stanton case. Thus, the challenged tax herein is similarly sustainable as an excise on carrying on an insurance business, and is certainly as much an indirect tax as was the one upheld without apportionment in Pacific Insurance Co. v. Soule, 7 Wall. 433">7 Wall. 433. The power of Congress to impose the tax without apportionment depends upon whether it in fact falls within the broad category of indirect taxes and not upon whether Congress has used the magic words "excise" or "duty" or "impost. " Steward Machine Co. v. Davis, 301 U.S. 548">301 U.S. 548, 581-582. Cf. Wisconsin v. J. C. Penny Co., 311 U.S. 435">311 U.S. 435, 443-444; Lawrence v. State Tax Commission, 286 U.S. 276">286 U.S. 276, 280.Since we have concluded that the "special tax" imposed by section 207(a)(2) upon 181 mutual insurance companies (other than life or marine) is fully authorized by article I, section 8, and that it is not a "direct" tax requiring apportionment, it becomes unnecessary to consider whether the 16th amendment effectively dispenses with the apportionment requirement in this case. Nevertheless, even if it were necessary to make that inquiry, we think there is much force to the contention that even if the apportionment requirement were otherwise applicable it does not apply here by virtue of the 16th amendment, and that the failure of Congress to provide for deduction of underwriting losses does not prevent the 16th amendment from dispensing with the apportionment requirement here. It is familiar doctrine that deductions are a matter of legislative grace ( Stanton v. Baltic Mining Co., 240 U.S. 103">240 U.S. 103; Burnet v. Thompson Oil & Gas Co., 283 U.S. 301">283 U.S. 301, 304; Helvering v. Independent Life Ins. Co., 292 U.S. 371">292 U.S. 371, 381; New Colonial Co. v. Helvering, 292 U.S. 435">292 U.S. 435, 440; White v. United States, 305 U.S. 281">305 U.S. 281, 292; Commissioner v. Sullivan, 356 U.S. 27">356 U.S. 27, 28), and it seems unlikely that there is a constitutional requirement based upon the 16th amendment calling for the deduction which petitioner 182 insists is indispensable to the validity of the unapportioned tax. However, that is an issue that we need not reach.Finally, we recur to the statement in Nicol v. Ames, 173 U.S. 509">173 U.S. 509, 514-515, to the effect that the presumption is in favor of the validity of an act of Congress, "and it is only when the question is free from any reasonable doubt that the court should hold an act of the law-making power of the nation to be in violation of that fundamental instrument upon which all the powers of the Government rest." Similarly, in Ogden v. Saunders, 12 Wheat. 213">12 Wheat. 213, 270, the Supreme Court said:It is but a decent respect due to the wisdom, the integrity and the patriotism of the legislative body, by which any law is passed, to presume in favor of its validity, until its violation of the Constitution is proved beyond all reasonable doubt.667 The same thought has been expressed in sweeping terms on a number of occasions. See, e.g., Sinking Fund Cases, 99 U.S. 700">99 U.S. 700, 718 ("Every possible presumption is in favor of the validity of a statute, and this continues until the contrary is shown beyond a rational doubt."); Trade-Mark Cases, 100 U.S. 82">100 U.S. 82, 96 ("[A] due respect for a co-ordinate branch of 183 the government requires that we shall decide that it has transcended its powers only when that is so plain that we cannot avoid the duty."); Legal Tender Cases, 12 Wall. 457">12 Wall. 457, 531 ("'[An] act of the legislature is not to be declared void unless the violation of the Constitution is so manifest as to leave no room for reasonable doubt * '".).As the Court said further in Nicol v. Ames, supra at 515-516:In deciding upon the validity of a tax with reference to these [constitutional] requirements, no microscopic examination as to the purely economic or theoretical nature of the tax should be indulged in for the purpose of placing it in a category which would invalidate the tax.We think that the statute under attack is plainly within the power of Congress. But even if we were less sure, the foregoing standards for the adjudication of constitutional issues would compel us to uphold the tax. It may often be possible to generate doubts about the validity of a measure by piecing together words or concepts culled from various opinions or other writings. But such doubts cannot justify declaring an act of Congress unconstitutional while merely paying lip service to the presumption of validity. 184 That presumption is vital and real, and in such circumstances our duty is to uphold the statute, if there is any reasonable basis whatever for such action. That there is a most ample basis therefor in this case abundantly appears from the materials that we have considered above. We hold that section 207(a)(2) is constitutional, and that the deficiency determined by the Commissioner must be approved.Decision will be entered for the respondent. MURDOCK; TURNER Murdock, J., concurring: Although the question of jurisdiction was decided correctly by an order of Judge Train, who heard this case, and is the subject of a footnote only in the majority opinion, nevertheless, since it is dealt with at great length in a dissent, it may be well to discuss this issue briefly. "The amount shown as the tax by the taxpayer upon his return" in section 271(a) must be read in the light of the rest of the Code in order to determine the intention of Congress, and when so read it seems reasonably clear that Congress meant the tax shown to be due by the taxpayer upon his return. John Moir, 3 B.T.A. 21">3 B.T.A. 21. It is generally recognized that Congress intended the return to be a method whereby the taxpayer would 185 make a self-assessment 668 of the amount of tax which he agrees or concedes is due and which he intends to pay without any action by the tax-collecting Commissioner. Here, the taxpayer does not agree or concede that any amount of tax is due but, on the contrary, states in a letter accompanying the return that no tax is lawfully due and it will not pay as tax the contested amount shown in the calculation on the return. The return is in effect a "no-tax" return because the taxpayer, in connection with the filing of that return, states that no tax is lawfully imposed upon it. The taxpayer was not self-assessing any tax and it was thus proper for the Commissioner to determine a deficiency in the contested amount so that he could eventually assess and collect the amount as a tax. These same thoughts are discussed in and supported by the cases cited in the footnote in the prevailing opinion.Turner, J., concurring: It is my opinion that the tax imposed by section 207(a)(2) is a tax on income, and consequently any apportionment requirement is obviated by the 16th amendment. If I am wrong in that view, and in the disposition of the case it is necessary to consider the question of constitutionality 186 apart from the 16th amendment, I concur in what is said in the majority opinion. PIERCE; TRAINPierce, J., dissenting: Because of the importance of this case, in its bearing upon the statutory prerequisites to this Court's obtaining jurisdiction of income tax controversies, and also in its bearing upon the powers and duties of the Court in dealing with the issues presented in cases properly before it, I believe it appropriate to set forth the reasons for my dissent from the majority opinion. Such dissent is based on three principal grounds:I.This Court does not, in my opinion, have jurisdiction to decide the present case, on its merits. And I believe that the motion filed by respondent, to dismiss the case for lack of jurisdiction, should have been granted.The reasons for such position are that, as is hereinafter shown, the Commissioner did not make any adjustment whatever, either to the amount of the taxable income reported by the petitioner corporation 1669 on the income tax return which it filed for the taxable year involved, or to the applicable rate of tax which petitioner applied, or to the amount shown as the tax by the petitioner on said return. Thus, it is evident that the 187 Commissioner has not herein determined a "deficiency" within the meaning of section 271(a) of the 1939 Code; 2 that, in the absence of such determination by the Commissioner, there is no "deficiency" available for "redetermination" by this Court under section 272(a)(1); 3188 and that there is no jurisdiction in this Court, under section 1101, 4 to adjudicate the merits of the controversy.Moreover, as hereinafter further shown, the present controversy is not based on any contention of either party, that the Commissioner did make any determination that the amount of the tax imposed by chapter 1 of the Code exceeds the amount 189 "shown as the tax by the taxpayer upon his [its] return." The controversy is based, rather, on a "position" expressed by petitioner's counsel in a letter addressed to the director of internal revenue, that notwithstanding the completeness and correctness of the return in its relation to the applicable statute, payment of the tax was refused solely on the ground that such statute is unconstitutional. Section 272(a)(1) makes no provisions for adjudication by this Court of a case in which the tax has been completely and correctly returned, and in which no "deficiency" within the meaning of section 271(a) has been determined by the Commissioner.The facts material to this jurisdictional question are as follows. The petitioner filed a "U.S. Mutual Insurance Company Income Tax 670 Return" for the taxable year involved, on which it showed: Gross income taxable under section 207(a)(2)(A) of the 1939 Code (including "net premiums" of $ 1,239,884.49) -- $ 1,256,675.70; rate of tax -- 1 per cent of the above gross income; and total income tax owing -- $ 12,566.76. Attached to said return was a transmittal letter, signed by petitioner's general counsel who was not a signatory to the return and who 190 is not shown to have been an officer of the petitioner, which reads in material part as follows:Director of Internal RevenuePhiladelphia, Pa.Dear Sirs:Enclosed herein find return on Form 1120 M * .While the return is made in the form as required, this company, as indicated in its last year's return takes the position that the imposition of an income tax against this company based upon its receipts of net premiums , as indicated in line 20 of that return, is invalid and unconstitutional. * * Therefore, under the circumstances, this company will not, under my advice, issue a check to the United States covering any part of the income tax based upon what we deem an invalid tax, to wit, the imposition of a 1% so-called income tax upon the net premiums * * * indicated in the return. [Emphasis supplied.]* * * Respectfully yours,/s/ Peter P. ZionGeneral CounselThereafter, the Commissioner mailed to the petitioner a notice in the usual form of a deficiency notice. In this, he gave recognition to the return as filed; he made no adjustment whatever to any of the items therein pertaining to the section 207(a)(2)(A) tax; and he designated, as a "Deficiency in income tax," that portion of 191 the amount shown as the tax on the return, which had not been administratively assessed. His explanation and computation of this so-called "Deficiency in income tax," was:Adjustments [under sec. 207(a)(2)] -- 1952Gross income disclosed by return$ 1,256,675.70Adjustments to gross incomeNoneGross income as adjusted1,256,675.70 * * * Computation of Tax -- 1952Gross amount of income$ 1,256,675.70Income tax liability computed at 1%12,566.76Balance of income tax liability12,566.76Tax assessed on return account #959005NoneDeficiency in income tax$ 12,566.76[Emphasis supplied.]671 This Court has heretofore held in Hudson-Dugger Co., 7 B.T.A. 357">7 B.T.A. 357, that notwithstanding that the notice mailed to a taxpayer is in the form of a notice of deficiency, it is not sufficient to give this Court jurisdiction, if the so-called deficiency set forth therein is not, in reality, a "deficiency" within the meaning of section 271(a), but is merely a statement as to the portion of the returned tax which has not been administratively assessed. The Court there said:It should be noted that the definition of deficiency in the statute does not set out as a requirement that the taxes shown due on the return must be 192 assessed, but merely says "the amount shown as the tax by the taxpayer upon his return." * This Court, of course, has no jurisdiction or control over the assessment or collection of taxes.Other decisions of this and other courts, to the effect that the mailing of a so-called notice of deficiency is not sufficient to give this Court jurisdiction, if the Commissioner has not actually determined a "deficiency" within the meaning of section 271(a), include: New York Trust Co. et al., 3 B.T.A. 583">3 B.T.A. 583, 587; Stanley A. Anderson, 11 T.C. 841">11 T.C. 841; McConkey v. Commissioner, 199 F. 2d 892, 894 (C.A. 4), affirming an order of dismissal of this Court, certiorari denied 345 U.S. 924">345 U.S. 924; Bendheim v. Commissioner, 26">214 F. 2d 26 (C.A. 2). Also, it has been held that jurisdiction cannot be conferred either by consent of the parties or by estoppel, where jurisdiction does not exist by statute, National Builders, Inc. v. Secretary of War, 16 T.C. 1220">16 T.C. 1220, 1224-1225; Accessories Manufacturing Co., 12 B.T.A. 467">12 B.T.A. 467; Theodore Stanfield, 8 B.T.A. 787">8 B.T.A. 787; William C. Shanley, Jr., 7 B.T.A. 521">7 B.T.A. 521, 522; see also E. C. Newsom, 22 T.C. 225">22 T.C. 225, 228, affirmed per curiam 219 F. 2d 444 (C.A. 5). Jurisdiction must be established affirmatively, 193 Herbert Brush Mfg. Co., 22 B.T.A. 646">22 B.T.A. 646, 647; First Bond & Mortgage Co., 21 B.T.A. 1">21 B.T.A. 1; Consolidated Companies, Inc., 15 B.T.A. 645">15 B.T.A. 645, 651-652; see also 9 Mertens, Law of Federal Income Taxation sec. 50.09. And this Court must determine that it has jurisdiction, even though the existence of jurisdiction has not been questioned by the parties, National Committee to Secure Justice, Etc., 27 T.C. 837">27 T.C. 837, 839; National Builders, Inc. v. Secretary of War, supra.Moreover, this Court has no power to extend the statutory limits of its jurisdiction, so as to afford to a taxpayer the procedural advantages of litigating in this Court; for the extent of its jurisdiction is a matter of policy which is solely within the control of Congress. As was aptly said by the Court of Appeals for the Second Circuit, in Superheater Co. v. Commissioner, 125 F. 2d 514, 515:a taxpayer can invoke the jurisdiction of the Board [now the Tax Court of the United States] only when the Commissioner has determined a deficiency. This limitation inherent in Sec. 274 (a) (b) (e) and (g) of the Revenue Act of 1926 672 [which provisions are substantially the same as those in section 272 of the 1939 Code] * * has since been preserved 194 in all material respects and the courts have given it effect. * ** * * it seems clear that until the jurisdiction of the Board is further enlarged whatever procedural convenience might be attained by having a formal redetermination * * [by the Board] must give way to the greater necessity for recognizing and giving effect to the limited statutory jurisdiction of the Board.The fact that petitioner refused payment of the returned tax for reasons satisfactory to it, and the fact that it has taken the position that the applicable statute is unconstitutional, are wholly irrelevant in determining whether the essential prerequisites to this Court's acquiring jurisdiction have been met. The Congress has, in sections 271(a) and 272(a)(1), established objective standards governing this Court's jurisdiction, which are based solely on the return as filed, and upon the Commissioner's determination of a "deficiency" in respect of the "amount shown as the tax by the taxpayer upon his [its] return." Since these statutes are free from ambiguity, there is no room for a judicial construction based upon subjective positions adopted by the petitioner or its counsel; and any such construction would 195 violate the expressed policy of Congress.Nor do the cases cited in the second footnote of the majority opinion, 5 lend support to the Court's denial of respondent's motion to dismiss the case for lack of jurisdiction. These cases were decided in a setting, and on the basis of facts and circumstances, wholly different from those here present; and none of them involved a contention that the controlling statute was unconstitutional. The first five of these cited cases arose under an earlier practice, now obsolete, where the Commissioner had denied claims in abatement in which the taxpayer had sought the benefit of exemptions, credits, or deductions provided by the statute for use in suitable situations; and the question presented was whether the amount of the tax returned was the gross tax shown, or the net tax after taking into consideration the claimed adjustments. Such claims in abatement have now been abolished. Sec. 273(j), 1939 Code. Others of said cited cases, i.e., Powell Coal Co. and Taylor cases, involved in one instance a situation pertaining to the effect of an amended return, and in the other instance a situation where the taxpayer had filed no return whatever. This 196 Court, in the later case of John A. Gebelein, Inc., 37 B.T.A. 605">37 B.T.A. 605, specifically distinguished this line of cases cited by the majority, as follows:If the freedom from liability were alleged to be attributable to a statutory provision legislatively granting exemption to a described class, such as personal 673 service corporations, or building and loan corporations, it would be clear that a determination had been made which upon proper notice would be the foundation of a proceeding within the Board's jurisdiction, Continental Accounting & Audit Co., 2 B.T.A. 761">2 B.T.A. 761, and Fred Taylor, 36 B.T.A. 427">36 B.T.A. 427. See also I.T. 2400, VII-1 C.B. 138. But the claim here is not for statutory exemption, but for constitutional immunity, and, since for another reason the notice was ineffective to support a petition, consideration must be reserved as to whether the question is the same. * And finally the majority, in its acceptance 197 of jurisdiction in the instant case, has failed to observe the distinction between a controversy involving an originally returned tax in respect of which the Commissioner has not determined a "deficiency" within the meaning of section 271(a), and a controversy involving a "deficiency" administratively determined in respect of such originally returned tax. The procedures for handling these two classes of liability are entirely different. As to an originally returned tax, the Commissioner is authorized and required to assess the same, without notice to the taxpayer. See section 3640, 1939 Code; and the even more specific provisions of section 6201(a)(1), 1954 Code. The statute specifically prohibits any court from restraining the assessment or collection of the same. Sec. 3653, 1939 Code. And the taxpayer's remedy, in seeking relief from an originally returned tax which he believes to be illegal, lies in payment of the tax, filing a claim for refund, and bringing a suit in a District Court or in the Court of Claims, to get his money back. Dodge v. Osborne, 43 App. D.C. 144">43 App. D.C. 144, affd. 242 U.S. 118">242 U.S. 118. See also footnote 10 in Flora v. United States, 357 U.S. 63">357 U.S. 63 (1958).On the other hand, 198 as regards a deficiency determined by the Commissioner in respect of the originally returned tax, section 272(a)(1) provides for giving notice of same to the taxpayer, and for the filing of a petition to this Court for a "redetermination of the deficiency." After the filing of such a petition, assessment of the deficiency is stayed until this Court's decision has become final; and, notwithstanding the provisions of section 3653, earlier assessment of the deficiency (as distinguished from the original tax) may be enjoined by a proceeding in the proper court.In the instant case, the majority of the Court has accepted jurisdiction over a controversy as to the legality of the originally returned tax, which was completely and correctly reported by petitioner on its return, and in respect of which the Commissioner has not determined a "deficiency" within the meaning of section 271(a). The effect of this is to prevent prompt assessment of the correctly returned tax, notwithstanding the provisions of section 3653; and to disturb the existing balance between the jurisdictions of the various courts which are authorized to adjudicate tax controversies.674 As before stated, I think the respondent's 199 motion to dismiss the case for lack of jurisdiction, should have been granted.II.The second principal ground for my dissent from the majority opinion is that, assuming that the Court does have jurisdiction, it has failed to decide the issues raised by the pleadings.The petitioner herein assigned only one error which, though stated rather indirectly, may fairly be construed to present the question of whether section 207(a)(2) of chapter 1 of the 1939 Code is constitutional, in its imposition of an income tax on the "net premiums" received by the petitioner, notwithstanding that the company suffered a substantial loss in the operation of its business. Inherent in this assignment of error and also in the petition as a whole, are the following questions which should have been answered by the Court, in passing on said constitutional question: (1) Whether the principal subject of the tax (i.e., the "net premiums" received by the petitioner indemnity company), are in truth and substance "income," either gross or net, irrespective of their being so labeled in the statute; (2) whether, if such premiums are not "income," they constitutionally can be taxed "as income," under said section 207(a)(2)200 of the Code; and (3) whether, if such premiums do constitute "income," they constitutionally can be taxed on a "gross income" basis, as distinguished from a "net income" basis, notwithstanding that the petitioner suffered a substantial loss for the taxable year in the operation of its indemnity business. It is significant that the petitioner's refusal to pay the challenged tax was based on similar grounds, as is shown by the statements contained in the above-mentioned transmittal letter for its return.The majority opinion has not decided any of these questions. Rather, it devotes principal attention to the extent of the plenary power of Congress under article I, section 8, clause 1 of the Constitution, to lay "Taxes, Duties, Imposts and Excises," without apportionment; and to whether "the crippling and inequitable apportionment requirement has * * * application here."But in the instant case which involves liability for income tax, it is unnecessary to consider whether Congress had power to lay such tax without apportionment , for such power is specifically granted under article I of the Constitution, as modified by the 16th amendment. Nor does this case involve the power of Congress201 to lay duties, imposts, and excises without apportionment, for the only tax which has here been imposed upon the petitioner is one "upon the income of every mutual insurance company [other than those specifically 675 excluded]" which tax is measured at 1 per cent on the "gross amount of income from interest, dividends, rents and net premiums." (Emphasis supplied.) Thus the issue here is not as to the power of Congress to lay taxes, but rather the validity of the particular tax here laid, in its application to the facts of the instant case.Notwithstanding, that the tax here involved was laid on gross income under chapter 1 (relating to income taxes), that it was returned by petitioner on the prescribed Treasury form entitled "U.S. Mutual Insurance Company Income Tax Return," and that the so-called deficiency upon which the majority bases its jurisdiction is designated a "Deficiency in income tax," the majority opinion has nowhere determined that the "net premiums" subjected to tax actually were income. Nor has the majority opinion determined whether the income tax here imposed could validly be imposed on gross income, as distinguished from net income. Indeed, it is stated in the latter 202 portion of the majority opinion:it seems unlikely that there is a constitutional requirement based upon the 16th amendment calling for the deduction which petitioner insists is indispensable to the validity of the unapportioned tax. However, that is an issue that we need not reach. [Emphasis in last sentence supplied.]In Eisner v. Macomber, 252 U.S. 189">252 U.S. 189, the Supreme Court said:This case presents the question whether, by virtue of the Sixteenth Amendment, Congress has the power to tax, as income, of the stockholder and without apportionment, a stock dividend * It arises under the Revenue Act of September 8, 1916 * * which, in our opinion, notwithstanding a contention of the government that will be noticed), plainly evinces the purpose of Congress to tax stock dividends as income * * ** * * In order, therefore, that the clauses cited from article 1 of the Constitution may have proper force and effect, save only as modified by the amendment [16th amendment], and that the latter also may have proper effect, it becomes essential to distinguish between what is and what is not "income," as the term is there used, and to apply the distinction, as cases arise, according to truth and 203 substance, without regard to form. Congress cannot by any definition it may adopt conclude the matter, since it cannot by legislation alter the Constitution, from which alone it derives its power to legislate, and within whose limitations alone that power can be lawfully exercised. [Emphasis supplied.]The principle of the Macomber case is still in effect, notwithstanding the expressed but unsuccessful attempt of the Government, in Helvering v. Griffiths, 318 U.S. 371">318 U.S. 371, to have the Macomber case overruled. And, so long as such principle continues in force, it should be followed and applied by this Court.In my view, the Court should have decided, one way or the other, whether the "net premiums" herein taxed as gross income, are (as stated in the Macomber case) "income * * * according to truth and 676 substance, without regard to form." And, if the majority had determined that such premiums are not income, it should have decided whether they constitutionally can, under an income tax statute, be taxed as income. If on the other hand the majority had determined that said premiums are income, it should further have decided whether they constitutionally can be taxed under an income tax statute, 204 on a gross income basis as distinguished from net income basis, under the particular circumstances of this case.It is well settled that, under our judicial system, courts act only on "cases and controversies," involving issues which have been submitted to them by adverse parties. Old Colony Tr. Co. v. Commissioner, 279 U.S. 716">279 U.S. 716. The present parties have a right to expect that the income tax questions presented in the instant case, would be decided.I think it inappropriate for me, in this dissenting opinion, to express my views on these questions which the majority, in its opinion, has not decided.III.The third and final principal ground for my dissent is that, assuming this Court has jurisdiction to determine income tax liability herein, it does not, in my opinion, have jurisdiction to sustain the challenged tax as an excise, as the majority has done. The majority opinion states: "Thus, the challenged tax herein is * * * sustainable as an excise on carrying on an insurance business, * * " (Emphasis supplied.)But in the instant case, no excise tax has been laid, or been returned, or been determined to be owing. Nor has any issue regarding liability for an excise tax been raised 205 by the pleadings.The challenged tax is, as before shown, imposed under section 207(a)(2) of chapter 1 of the 1939 Code, which chapter is entitled "Income Tax"; and subsection (a) of said section provides:(a) Imposition of Tax. -- There shall be levied, collected and paid for each taxable year upon the income of every mutual insurance company [other than as specifically excepted] * * * a tax computed under paragraph (1) or paragraph (2) whichever is the greater * * * [Emphasis supplied.]Also, as hereinbefore shown, the prescribed Treasury form on which the tax was returned by the petitioner was entitled "U.S. Mutual Insurance Company Income Tax Return (Form 1120M)"; and the only tax liability determined by the Commissioner was stated, in his so-called notice of deficiency, to be a "Deficiency in income tax."In such circumstances, it is obvious that section 207(a)(2), both by its own terms and as interpreted and applied by the Commissioner of Internal Revenue "plainly evinces [to use the words employed in Eisner v. Macomber, supra] the purpose of Congress to tax * * * 677 [the subjects therein specified, including "net premiums"] as income"; and that no question as to the petitioner's 206 liability for any excise tax, has either been presented to this Court, or is properly before it.As regards the majority's emphasis on the power of Congress to impose an excise tax on the net premiums without apportionment, the Supreme Court aptly stated in Helvering v. Griffiths, supra, at 394: "Under our judicial tradition we do not decide whether a tax may constitutionally be laid until we find that Congress has laid it."Moreover, this Court has no jurisdiction or authority to determine liabilities for excise taxes on the carrying on of a business. No such jurisdiction is conferred by section 1101 of the 1939 Code (see footnote 4), wherein the scope and limits of the jurisdiction of this Court are specifically defined. Also, subtitle A of the Internal Revenue Code of 1939, which is designated "Taxes Subject to the Jurisdiction of the Board of Tax Appeals," does not include excise taxes on carrying on a business. The imposition of excise taxes on business is provided for in subtitles B and C; and as to such excises this Court has not been given jurisdiction.In my view, the majority's above-mentioned holding that "the challenged tax herein is * * * sustainable as an excise on carrying 207 on an insurance business" (emphasis supplied) is outside the limits of this Court's statutory jurisdiction.Train, J., dissenting. I respectfully dissent.In my opinion, section 207(a)(2) is unconstitutional as applied to the taxpayer here.Although disagreeing with the conclusion reached by the majority opinion, I agree with the analysis of the problem contained therein, and I believe that the opinion provides a significant service in clearing away certain misconceptions concerning the nature and scope of the Federal taxing power. Certainly, the 16th amendment did not create a new subject for taxation. The power to tax income had existed from the beginning. Nor did the amendment provide a new limitation upon the exercise of that power. The amendment does no more and no less than its plain words say, namely, that taxes on incomes regardless of source may be imposed without apportionment.Despite this fact, I think it fair to say that there is a widespread belief, not without support in the case law, that the 16th amendment in some fashion prohibits Congress from levying an income tax on anything which is not income, and that a tax so levied is invalid. 678 For example, it is not an uncommon 208 assumption that in taxing the income of a manufacturer Congress must, by virtue of the 16th amendment, permit an adjustment for cost of goods sold. This example may be multiplied by a number of other related situations involving recovery of capital, adjustments for basis, allowance for losses, and so forth. With respect to all of these, there has been an implicit assumption on the part of many that failure to permit an appropriate adjustment for such items in computing taxable income would be invalid because the result is simply not "income" within the meaning of the 16th amendment. A case in point is our own decision in Lela Sullenger, 11 T.C. 1076">11 T.C. 1076 (1948), where we declared at page 1077:Section 23 makes no provision for the cost of goods sold, but the Commissioner has always recognized, as indeed he must stay within the Constitution, that the cost of goods sold must be deducted from gross receipts in order to arrive at gross income. No more than gross income can be subjected to income tax upon any theory. * Again, in 1 Mertens, Law of Federal Income Taxation sec. 5.06, it is declared:While there has been considerable theoretical difficulty in determining when an increment in 209 capital has been realized so as to be taxable, there is substantial agreement that amounts received as a return of capital or investment are not income within the general meaning of that term and may not be taxed under the Sixteenth Amendment. * * * [Emphasis supplied.]So stated, this reasoning is without basis in the Constitution as is ably demonstrated by the majority opinion. Once it has been determined that a particular tax is imposed on something which is not income, that determination in and of itself decides nothing insofar as the constitutional validity of the tax is concerned. The inquiry must be pushed further. A tax imposed on that which is not income is nonetheless valid unless it is a direct tax unapportioned. Thus, the key question is whether the tax is direct or indirect. If it is indirect, as decided by the majority in the instant case, then it is constitutionally irrelevant whether or not the tax is limited to "income." Moreover, if there is no requirement implicit in the 16th amendment limiting Congress to a tax on "income" only, I do not believe that Congress by simply denominating a certain tax as an "income tax" can be considered to have created such a limitation. 210 Such a denomination may be material, as a matter of statutory construction, in determining whether or not Congress intended to include a certain item in the tax base, but it would be immaterial in determining whether the inclusion of the item exceeded the constitutional power of Congress to tax.Accepting this analysis as correct, a case such as that before us here may be approached properly in either of two ways. First, the initial 679 inquiry may be to whether the tax is direct or indirect. If found to be the latter, then the inquiry need proceed no further and the tax is valid, assuming uniformity of application. If, on the other hand, the tax is found to be direct under this same approach, then and only then is it necessary to determine whether it is a tax on "income" and, thus, by virtue of the 16th amendment not subject to the requirement of apportionment. The second approach, equally proper under this analysis, is to inquire first whether the tax is levied upon "income" within the meaning of the 16th amendment. If it is, then again we need pursue the matter no further because, regardless of the source of the income, the tax is relieved of the requirement of apportionment, and 211 it makes no difference whether it is direct or indirect. If found not to be levied on income, then it is necessary to determine whether the tax is direct and thus subject to the requirement of apportionment or indirect and thus valid irrespective of apportionment.All of these premises assume the tax in question to meet the requirement of uniformity of application. There is no question but that the tax involved here does meet that requirement. Moreover, it is equally clear that the tax is not apportioned.Since either approach set out above is logically correct, I have adopted the second simply because, initially at least, it leads onto what seems to be more familiar ground, namely, the nature of "income."While the majority opinion sets out in full detail the statutory provisions involved, I believe it appropriate to make clear at the outset that the computations under sections 207(a)(1) and 207(a)(2) are not "alternative" taxes as that term ordinarily is understood. The taxpayer has no choice as to the tax it is to pay but must pay whichever is greater in amount. There is actually only one tax lexied, i.e., the tax imposed by the introductory sentence of section 207(a) proper, and 212 subsections (a)(1) and (a)(2) are simply methods of computation of that tax.The primary contentions of the parties can be stated briefly. The petitioner maintains that the tax in question as applied to it is invalid as an income tax because, in failing to allow a deduction for underwriting losses, it taxes gross receipts and is not limited to either gross income or net income. The respondent contends that the tax is valid as an income tax because it is a tax on gross income, not gross receipts, and that in arriving at taxable income Congress has the power to limit or condition deductions from gross income. (It is perhaps noteworthy that the argument of both parties assumes that the validity of the tax turns upon whether or not it is limited to "income" within the meaning of the 16th amendment.)In Eisner v. Macomber, 252 U.S. 189 (1920), the Supreme Court declared that the term "income" as used in the 16th amendment means 680 the gain derived from capital, from labor, or from both combined, provided it be understood to include profit gained through a sale or conversion of capital assets. In effect, the Court was holding that the 16th amendment used the term in the same sense as it had 213 been construed by the Court in the cases arising under the Corporation Tax Act of 1909. Stratton's Independence v. Howbert, 231 U.S. 399 (1913); Doyle v. Mitchell Brothers Co., 247 U.S. 179">247 U.S. 179 (1918); Merchants' Loan & Trust Co. v. Smietanka, 255 U.S. 509 (1921). Implicit in this construction is the concept that gain is an indispensable ingredient of "income," and it is this concept which provides the standard by which we must determine whether the tax computed under section 207(a)(2) is a tax on "income" within the meaning of the 16th amendment.In expressing thus my reliance on the principle announced in Eisner v. Macomber, supra, I am not unmindful of the cautionary words of the Supreme Court in Commissioner v. Glenshaw Glass Co., 348 U.S. 426">348 U.S. 426 (1955), when it declared at page 431:The distribution, therefore, was held not a taxable event. In that context -- distinguishing gain from capital -- the definition [in Eisner v. Macomber] served a useful purpose. But it was not meant to provide a touchstone to all future gross income questions.However, the Court went on to point out in the latter case that "[here] we have instances of undeniable accessions to wealth, clearly realized, and 214 over which the taxpayers have complete dominion." (348 U.S. 426">348 U.S. 426, 431.) Conceding, therefore, that there can be many differences of opinion over what constitutes gain in particular circumstances, and recognizing that the decision in Eisner v. Macomber with respect to whether certain stock dividends represented gain to the taxpayer does not control every other determination of whether a specific item represents gain and, thus, income, I do not conceive that the soundness of the fundamental principle upon which that case was decided can now be questioned, namely, that income within the meaning of the 16th amendment means gain, and, conversely, that where there is no gain there is no income. The dissenting opinion of Mr. Justice Brandeis in Eisner v. Macomber disputed the Court's opinion only on the question of whether the particular stock dividends in fact represented gain and, thus, income. (252 U.S. 189">252 U.S. 189, 220-238.)Moreover, the dissenting opinion of Mr. Justice Douglas in Helvering v. Griffiths, 318 U.S. 371">318 U.S. 371, 404 (1943), while declaring that Eisner v. Macomber should be expressly overruled, was not based on a conclusion that "income" does not mean "gain." Rather, the dissent directed 215 its disagreement with Eisner v. Macomber to "[the] notion that there can be no 'income' to the shareholders in such a case within the meaning of the Sixteenth Amendment unless the gain is 'severed from' capital and made available to the recipient for his 'separate use, 681 benefit and disposal.'" (318 U.S. 371">318 U.S. 371, 410.) In the case before us, we clearly have no question of whether gain has or has not been severed from capital but simply of whether there is any gain at all.The rule of Eisner v. Macomber has been reaffirmed on so many occasions that citation of the cases to this effect would be unnecessarily burdensome. To depart from the rule at this late date would ignore the sound principles upon which that case was decided and would throw into confusion the fundamental income tax structure and law as it has developed in the almost half century which has elapsed since adoption of the 16th amendment. That there cannot be "income" without a "gain" accords with the common understanding of the term, a test of construction which is particularly appropriate in our system of a self-assessed Federal income tax. It is a test which has been applied frequently. For example, in United States v. Kirby Lumber Co., 284 U.S. 1">284 U.S. 1 (1931), 216 Mr. Justice Holmes concluded that the taxpayer there involved "has realized within the year an accession to income, if we take words in their plain popular meaning, as they should be taken here." See also Brown Shoe Co. v. Commissioner, 133 F. 2d 582 (C.A. 8, 1943); Helvering v. Edison Bros. Stores, Inc., 133 F. 2d 575 (C.A. 8, 1943). Moreover, that which is not income in fact manifestly cannot be made such by the legislative expedient of calling it income. Hoeper v. Tax Commission of Wisconsin, 284 U.S. 206">284 U.S. 206 (1931); Darcy v. Commissioner, 66 F. 2d 581 (C.A. 2, 1933).The petitioner filed its 1952 return on Treasury Department Form 1120M, entitled "U.S. Mutual Insurance Company Income Tax Return." Its computation of "Gross Amount of Income (under section 207(a)(2))" was as follows:[ITEM]19. Total gross income in items 1 to 3, inclusive$ 16,791.2120. Net premiums1,239,884.4921. Total gross amount of income from interest, dividends,rents, and net premiums (item 19 plus item 20) $ 1,256,675.7022. LESS: Dividends to policyholders23.Interest wholly exempt from tax * * * 24. Gross amount of income (item 21 minus the sum of items22 and 23) $ 1,256,675.70The "Total gross income" 217 referred to above in item 19 was made up as follows:Interest$ 16,091.21Dividends700.00RentsTotal 16,791.21 The tax at 1 per cent of the gross amount of income was computed at $ 12,566.76, petitioner denying liability for this amount.682 Petitioner's 1952 return with respect to the tax computation under section 207(a)(1) listed the following expenses:Investment expenses$ 36.00Taxes22.26Real estate expenses6,053.82Interest655.15Total expenses 6,767.23None of these latter amounts is permitted as a deduction in the computation of the gross amount of income under section 207(a)(2) nor does petitioner assert that they should be.In 1952, the petitioner incurred losses on its policies (sometimes hereafter referred to as underwriting losses), which exceeded its gross amount of income ($ 1,256,675.70) by $ 206,198.12. Adding the two amounts together, it can be seen that petitioner incurred underwriting losses in 1952 in the amount of $ 1,462,873.82. It is in the failure to permit these underwriting losses to be excluded or deducted in computing the tax base under section 207(a)(2) that petitioner asserts Congress has exceeded its constitutional power to tax.Respondent argues that petitioner's 218 contention is erroneous because deductions are a matter of legislative grace and that Congress may grant them or withhold them as it sees fit in arriving at the net to be taxed. From this principle, he concludes that Congress may validly deny a deduction for underwriting losses even though premium receipts are included in the tax base. The proposition that deductions are a matter of legislative discretion is so well established that it requires no reaffirmation. Helvering v. Independent Life Insurance Co., 292 U.S. 371 (1934); New Colonial Co. v. Helvering, 292 U.S. 435 (1934). Nevertheless, conceding the truth of that proposition, so stated it simply begs the question we must decide.The income tax is not a tax on gross receipts ( Doyle v. Mitchell Brothers Co., supra;Commissioner v. Weisman, 197 F. 2d 221 (C.A. 1, 1952); Lela Sullenger, supra), although it is my considered view that the majority opinion implicitly rejects this principle. Thus, amounts which must be subtracted, whether called "exclusions," "deductions," or whatever, in arriving at "income" within the meaning of the 16th amendment have been held not to be matters of legislative grace and to be required by the Constitution. 219 Davis v. United States, 87 F. 2d 323 (C.A. 2, 1937), certiorari denied 301 U.S. 704">301 U.S. 704, rehearing denied 302 U.S. 773">302 U.S. 773. Therefore, while accepting the principle that deductions are a matter of legislative discretion, the question remains of whether the failure to permit an exclusion for underwriting losses means that petitioner was taxed on something other than "income" in the constitutional sense of the term.683 The record before us does not disclose any details of the method of operation of the petitioner. We do not have a copy of its charter, or of its bylaws, or a sample of its policies. Nevertheless, while I recognize that there are a variety of ways in which mutual insurance companies may operate under the laws of the several States, I assume that petitioner possessed the general characteristics common to such companies. "The theory of a mutual insurance company is, that the premiums paid by each member for the insurance of his property constitute a common fund, devoted to the payment of any losses that may occur." Union Insurance Co. v. Hoge, 21 How. 35">21 How. 35, 64 (1858). The members constitute both insurer and insured, contributing by a system of assessments (or premiums) to the creation 220 of a fund from which all losses and liabilities are paid. See 1 Couch, Cyclo. of Ins. Law sec. 250.Here the net premiums collected in 1952 were insufficient to pay the policy losses incurred in the same year. Those losses were not estimated losses but were actual and realized in the year in question. How the losses were met, the record does not disclose. However, premiums were collected for the purpose of paying losses, and while we may conjecture reasonably that the amount of the premiums was fixed somewhat in excess of the normal loss expectancy in order to meet ordinary expenses and to provide a reserve against extraordinary contingencies, the fundamental nature of the premiums remains, namely, a fund for the payment of losses.The definition of "net premiums" 1 provided in section 207(b)(2) recognizes that a mutual insurance company may operate by a method of assessment upon its members rather than by levying premiums. Such assessments are treated under the section as the equivalent of premiums. Were a company simply to levy assessments to meet actually incurred losses, I cannot conceive of any concept of "income" which would justify the conclusion that the assessments, to the 221 extent of the losses, represent income to the company. Even in the broadest economic sense, they do not represent gain. I can see no difference here where the fund out of which losses were to be paid was created through the use of premiums.684 The record 222 does not disclose what reserves the petitioner possessed but we may infer reasonably that its interest income of $ 16,091.21 and its dividend income of $ 700 represented earnings on such a reserve. I also assume that the reserve, whatever its amount may have been, represented the accumulated excess in prior years of petitioner's premium receipts over underwriting losses and after the payment of the expenses of the operation. Since the very purpose of a reserve is to provide a fund out of which liabilities to policyholders can be met, does that fact provide a valid basis for arguing that Congress may tax current premium receipts as "income" without making allowance for current underwriting losses? Stated another way, do the totality of current premium receipts constitute gain, irrespective of current underwriting losses, simply because the taxpayer possesses a reserve built up in prior years out of which those losses, or part of them, may be met? I do not think so. The reserve exists to pay losses which cannot be met by premium receipts. In a very real sense it represents the "capital" of the mutual insurance company, the pooled resources of its members. To use the existence 223 of such a reserve to support the treatment of premium receipts as gains irrespective of underwriting losses would be equivalent to, and just as illogical as, computing the taxable gains of a manufacturer without allowance for losses on the ground that the manufacturer can provide for those losses out of capital. A tax base so constructed becomes a tax on capital, or potentially so, and that I have never understood the income tax to be. In any event, the argument is unconvincing because the section in question makes no provision with respect to reserves and the tax applies irrespective of whether a reserve in fact exists and irrespective of whether underwriting losses exceed the total of premium receipts and reserves both.It might be suggested that losses are properly a charge first against reserves and from that assumption argued that current premium receipts may be taxed in their entirety as "income" without taking those losses into consideration. However, I consider such reasoning to be without merit. If annual additions to the reserve were allowed as a deduction from premium receipts in computing the tax base, I might take a different view. Under that circumstance, it might 224 not be necessary to permit the deduction of actual losses in the tax year because properly chargeable to reserves, but such a system presupposes that the taxpayer would be permitted to deduct an annual addition to reserves and that this section does not do. It is true that a taxpayer who employs a bad debt reserve method of accounting must charge actual bad debts in the tax year against that reserve rather than against current receipts, but at the same time he is entitled to deduct a reasonable addition to the bad debt reserve. No such allowance is 685 provided here. On the contrary, the operation of section 207(a)(2) can be compared to requiring a taxpayer to include accounts receivable in taxable income in their entirety while at the same time refusing to permit the same taxpayer to deduct either bad debts as incurred or a reasonable addition to a reserve for bad debts.What the underwriting experience of this petitioner was in prior years or what its income, if any, was, we do not know, and I do not see that we are concerned with such questions. The income tax is based upon the annual concept of income and, in the complete absence of any expression of contrary congressional intent 225 here, I assume that section 207(a)(2) is intended to conform to that concept. We know the petitioner's receipts in 1952 and we know its underwriting losses incurred in that year. Beyond these facts we need not inquire on the supposititious ground that even though petitioner might have had no taxable income in 1952, the tax computed under section 207(a)(2) may somehow represent a fair measure of tax on income perhaps earned in another year.It is true that the tax with which we are here concerned is applied at a very low rate, a fact which may furnish a temptation to overlook deficiencies which might otherwise be more serious in their practical effect. However, just as it is not within the judicial province to inquire as to the propriety of a given rate of tax selected by Congress once it is established that the subject of the tax itself is within the taxing power of Congress, so I believe a corollary principle to be that, once it is determined that a given tax is not within the constitutional power of Congress, the rate of tax cannot be considered as affecting its invalidity. A tax which is beyond the power of Congress to levy, is invalid irrespective of the rate at which applied. 226 Likewise, if the tax is within the power of Congress, then Congress may, in its own judgment, select any rate to apply. Any other rule would, in effect, place the courts in the position of deciding at what point a tax rate becomes unreasonable, of substituting their judgment for that of Congress in an area where the elected representatives of the people should have sole responsibility. In any event, a particular tax rate does not in itself necessarily provide a fair measure of the burden of a tax, or the reasonableness of that burden. Here, the 1 per cent tax rate provided by section 207(a)(2) results in a tax computed at $ 12,566.76. This amount is equivalent to a tax of 75 per cent on the petitioner's gross investment income of $ 16,791.21, and of more than 100 per cent on the petitioner's "conventional" net income computed under section 207(a)(1).In support of the view that this tax can be construed as falling only on "income," it might be further argued that section 207(a) provides 686 a tax on net investment income at the regular corporation income tax rates subject to the proviso that the tax so computed cannot in any event be less than 1 per cent of net premiums plus dividends, 227 rents, and interest. So described, can the tax computed under section 207(a)(2), if not itself a tax on "income," be considered simply a measure of such a tax, a "floor" beneath which the tax on income cannot fall? Assuming for the sake of argument that, once there is determined to be taxable "income," Congress can then select any convenient yardstick by which the actual amount of the tax on that income is to be measured, the proposition still does not aid us here. Section 207(a)(2) is not applicable only if there is income. On the contrary, it applies irrespective of whether there is income. In this connection, a recent writer on the subject of the taxation of casualty insurers has made the following observation: 2Thus the true net income tax has appealing operating advantages. There is no tax payable for years of over-all loss, and there is an automatic offset of any underwriting loss against investment gain in years of over-all profit. The present tax formula for mutuals has neither of these economically sensible attributes. A mutual insurer with an underwriting loss is taxed upon its net investment income even though its underwriting loss exceeds that investment net. Indeed, 228 in a year of heavy losses the dividends to policyholders must commonly be reduced, thus increasing the "net premium" income base for the one per cent gross income tax despite the fact that gross premium writings show no gain. This can result in an economic idiocy, since in a year of over-all loss, the mutual insurer's "income" tax burden will not decline from that borne in a profit year, and it may actually increase both proportionately and absolutely.The tax computed under section 207(a)(2) clearly is in no way dependent upon whether the taxpayer has income. This being the case, I am unable to accept the proposition that the provision somehow represents a valid measure of a tax on income.Alternatively, it might be suggested that any going business, including a mutual insurance company, can be presumed to have income and that the computation under section 207(a)(2) simply represents a legislative determination of what constitutes, under certain circumstances, a fair and reasonable amount of tax on that income. The argument is ingenious but hardly persuasive. The imputation of "income" to the mere fact of business existence 229 does not accord with reality, as is perhaps partially evidenced by the fact that the taxpayer here has entered receivership.The petitioner argues that its losses are akin to the "cost of goods sold" to a manufacturer. The principle is well established, as the respondent agrees, that a manufacturer is entitled to deduct the cost of his materials from gross sales receipts in arriving at gross taxable income. Doyle v. Mitchell Brothers Co., supra;Davis v. United 687 ;Ray Edenfield, 13">19 T.C. 13 (1952); Lela Sullenger, supra.Nevertheless, the respondent disputes the analogy asserted by petitioner in these words:A mutual insurance company is not a mercantile business having a cost of goods sold, but is engaged in the business of selling a contract right or promise to perform certain acts upon the happening of a contingency. A mutual insurance company does not have an inventory or stock of goods. In the instant case Penn Mutual, as are all mutuals, consists of a group of persons banding together and pooling contributions to protect members from loss in case certain hazards should beset them. Section 207(a)(2) places a tax on items of gross receipts adjusted for premium returns, 230 etc., which are by definition gross income since a mutual insurance company has no cost of goods sold nor is the tax placed upon capital, borrowings, and the like. All the items enumerated under this section are items specifically includible in gross income, i.e., rents, dividends, interest and net premiums. Petitioner's contentions that gross receipts are being taxed is erroneous.Obviously, petitioner is not a mercantile business having a cost of goods sold, as such. However, there is nothing in the law which limits deductions from gross receipts to cost of goods sold on the part of a manufacturer. Indeed, the statute itself makes no provision for such a deduction, but rather its allowance arises from the implicit and long-established nature of income itself within the meaning of the 16th amendment. Davis v. United States, supra.Therefore, I assume that any other item, whatever label may be attached to it, which is of the same inherent character must also be allowed as a deduction or exclusion in arriving at "income." The same thought is expressed in 1 Mertens, Law of Federal Income Taxation sec. 5.10, as follows:To say that items of gross income may be taxed is not the same 231 as to say that under all circumstances the courts would countenance a tax on gross receipts. The terms "gross income" and "gross receipts" are not synonymous. "Gross receipts" is a broader term, including within it receipts which may constitute capital as well as income, and, as shown above, returns of capital may not be taxed.A contract of insurance is an agreement by which one party for a consideration promises to pay money or its equivalent, or to do an act which is valuable to the insured, upon the destruction, loss, or injury of something in which the other party has an interest. Vance, Insurance 83 (3d ed.). While the analogy is certainly not completely apposite, the payment by an insurance company of valid claims under its policies is little different in its practical effect, in my view, from the delivery of goods by a mercantile company. The payment of claims is what the company is selling. It is the very essence of the business in which it is engaged. In the words of the respondent himself, this taxpayer is "engaged in the business of selling a contract right." To argue that it does so at no cost to itself is to ignore reality and to indulge in a form of economic fantasy. 232 Its cost, in the clearest sense, is 688 represented by the amounts it pays out in satisfaction of claims of policyholders. The fact that here the cost is incurred subsequent to the sale while that of the manufacturer normally is incurred prior to the sale of goods cannot change the fundamental nature of the payment as "cost." Thus, while admittedly we are not dealing here with a mercantile business selling goods, I fail to see any distinction in principle.If a mutual company operating on a pure system of assessments levied no assessments in a given tax year because its members had incurred no losses in that year, I suppose no one would suggest that it had any "income" within the meaning of the 16th amendment (assuming for the purpose of this hypothesis that it had no investment income). Were the same company to incur losses on policies and levy assessments in an amount exactly needed to meet those losses, I am likewise unable to see how those assessments to the extent of the losses would suddenly constitute "income." The fact that a company operates by means of fixed premiums rather than by assessments cannot alter this conclusion. By mere possession of the premiums or assessments, 233 at least to the extent that they equal its losses, the company has nothing which it can apply to its own benefit or enjoyment.The respondent also argues, on brief, that by the section in question Congress did not tax underwriting gains and, therefore, "in its sound discretion was certainly entitled to deny a deduction for underwriting losses." Elsewhere in his briefs, respondent asserts, "Since underwriting gains were not taxed, it certainly appears reasonable that underwriting losses were not allowed as deduction." I can only conclude that these statements are based upon a misconception of section 207(a)(2). True, the section does not in terms tax "underwriting gains." Moreover, the report of the Committee on Finance states that the committee was unable to develop what it considered an equitable tax on underwriting income. However, if the taxpayer had underwriting gains (which this petitioner did not), they would presumably have been derived from the very premiums which are included here in its tax base. While section 207(a)(2) concededly does not tax net investment income or net underwriting income, as such, it taxes the sum total of their ingredients. Since total net premiums 234 are included in the "gross amount of income" subjected to tax, I am unable to accept the respondent's argument that Congress has excluded underwriting gains from the tax base. His argument would seem to suggest that a tax on a manufacturer's total sales receipts would not be a tax on manufacturing gains and, therefore, would not have to permit a deduction for cost of goods sold. The argument does not bear analysis. The mere fact that a tax base 689 is not limited to gains, which is the instant case, hardly leads to the conclusion that gains are not included in the base at all.The net premiums received by the petitioner do not by themselves constitute gains to it. I conclude, therefore, that section 207(a)(2), to the extent that it includes net premiums in the tax base unreduced by underwriting losses, is not a tax on "income" within the meaning of the 16th amendment. Eisner v. Macomber, supra;Bowers v. Kerbaugh-Empire Co., 271 U.S. 170 (1926).In the latter case, involving losses, the Supreme Court had the following to say:In determining what constitutes income substance rather than form is to be given controlling weight. Eisner v. Macomber, supra, 206 (40 S. Ct. 189).* * * The 235 transaction here in question did not result in gain from capital and labor, or from either of them, or in profit gained through the sale or conversion of capital. The essential facts set forth in the complaint are the loans in 1911, 1912, and 1913, the loss in 1913 to 1918 of the moneys borrowed, the excess of such losses over income by more than the item here in controversy, and payment in the equivalent of marks greatly depreciated in value. The result of the whole transaction was a loss. * * The contention that the item in question is cash gain disregards the fact that the borrowed money was lost, and that the excess of such loss over income was more than the amount borrowed. When the loans were made and notes given, the assets and liabilities of defendant in error were increased alike. The loss of the money borrowed wiped out the increase of assets, but the liability remained. The assets were further diminished by payment of the debt. The loss was less than it would have been if marks had not declined in value; but the mere diminution of loss is not gain, profit, or income.The question still remains of whether section 207(a)(2) is an invalid exercise of the taxing power. 236 As pointed out previously, once it is decided that the subject of a tax is not "income" within the meaning of the 16th amendment, no more has been decided than that the tax is not free from the requirement of apportionment if it is a direct tax. Thus, the next and crucial focus of inquiry must be upon whether the tax computed under section 207(a)(2) is a direct tax. Since the tax is unapportioned, a determination that it is a direct tax would require us to decide that it is invalid. "The Amendment allows a tax on 'income' without apportionment, but an unapportioned direct tax on anything that is not income would still, under the rule of the Pollock case, be unconstitutional." Commissioner v. Obear-Nester Glass Co., 217 F. 2d 56 (1954). So stated, this principle means nothing more than a clear recognition that article I, section 9, clause 4 of the Constitution remains in full force and effect today except to the extent that it is modified by the 16th amendment in the case of taxes on income.I am not unaware of the fact that distinguished authorities have suggested what may be a contrary view. For example, in his dissenting 690 opinion in Eisner v. Macomber, supra, Mr. Justice Holmes237 declared (252 U.S. 189">252 U.S. 189, 220): "The known purpose of this Amendment was to get rid of nice questions of what might be direct taxes." However, the 16th amendment did not repeal the constitutional requirement as to direct taxes. It could have done so but it did not. The only question it removed for the future was whether a tax on income was a direct tax. Brushaber v. Union Pac. R.R., 240 U.S. 1">240 U.S. 1 (1916). The 16th amendment was the outgrowth of the decision of the Supreme Court in Pollock v. Farmers' Loan & Trust Co., 158 U.S. 601">158 U.S. 601 (1895), which had held invalid an earlier effort of Congress to levy an income tax. 3 However, in that decision, the Court did not decide that Congress had no power to levy an income tax under the Constitution. What it did decide was that a tax on incomes of certain types was a direct tax and, thus, invalid in the absence of apportionment. It held that taxes upon rents and profits of real estate and upon returns from investments of personal property were in effect direct taxes upon the property from which such income arose, imposed by reason of ownership; and that Congress could not impose such taxes without apportioning them among the States according to population, 238 as required by article I, section 2, clause 3, and section 9, clause 4 of the original Constitution. Pollack v. Farmers' Loan & Trust Co., supra.Thus, the Pollock decision did not declare that any income tax would be a direct tax but limited its decision on this point to taxes on income from real estate and taxes on income from invested personal property. The Court specifically declared, at page 635:We have considered the act only in respect of the tax on income derived from real estate, and from invested personal property, and have not commented on so much of it as bears on gains or profits from business, privileges, or employments, in view of the instances in which taxation on business, privileges, or employments has assumed the guise of an excise tax and been sustained as such.Nevertheless, despite this limitation upon the scope of the opinion, the Court found that, since so many of the income tax provisions were invalid and since all of the income tax provisions together constituted "one entire scheme of taxation," all of the income tax provisions were void.The Pollock decision itself represented an expansion by the 239 Supreme Court of its earlier decisions as to what constituted a direct tax within the meaning of the Constitution. As early as 1796, the Court had decided in Hylton v. United States, 3 Dall. 171">3 Dall. 171 (1796), that a direct tax included only capitation taxes and taxes on real estate. 691 To the same effect, see Pacific Insurance Co. v. Soule, 7 Wall. 433 (1868); Veazie Bank v. Fenno, 8 Wall. 533 (1869); Springer v. United States, 102 U.S. 586 (1880). Some hundred years after the Hylton decision, the Court concluded that a tax imposed on property or the income therefrom by reason of its ownership is a direct tax. Pollock v. Farmers' Loan & Trust Co., supra. It would serve no useful purpose to review here the authorities set out in exhaustive detail by the Court in reaching that conclusion. See, in particular, the first Pollock opinion. (157 U.S. 429">157 U.S. 429 (1895)).The majority opinion discusses in some detail Supreme Court decisions involving the validity of various Civil War taxing statutes, particularly Pacific Insurance Co. v. Soule, supra. In the latter case, involving a tax very similar to that before use here, the Court held the tax valid, rejecting the contention that it was a direct tax, 240 unapportioned. However, the Court based its decision on the narrow ground that direct taxes were only capitation taxes and taxes on real estate, relying on Hylton v. United States, supra.I think there can be no real question but that the Supreme Court rejected this view of the scope of direct taxes in its Pollock decision. This conclusion has been recognized by the Supreme Court itself. In Eisner v. Macomber, for example, the Court pointed out with respect to one of the Civil War cases, namely, Collector v. Hubbard, 12 Wall. 1">12 Wall. 1 (1870), that it must be considered to have been overruled by Pollock. Collector v. Hubbard involved the validity of the Act of June 30, 1864, 13 Stat. 281, one of the statutes referred to in the majority opinion as an example of the numerous indirect taxes imposed by Congress. Thus, while Pacific Insurance Co. v. Soule, supra, and other contemporaneous decisions of that period are of considerable historical interest, I do not believe that the conclusions reached therein can be considered determinative today of the issue before us here.Among the considerations involved in the determination of the nature of the tax under section 207(a)(2) is whether or not 241 it is an excise tax. In this connection, it has long seemed apparent that the Federal taxing power might in effect reach through excise taxation subjects which it seemingly could not reach through direct taxation. For example, the portion of the Pollock decision quoted earlier points out that taxes on the gains and profits of business, privileges, and occupations had been sustained when they assumed the guise of an excise tax. (158 U.S. 601">158 U.S. 601, 635). Subsequently, in Flint v. Stone Tracy Co., 220 U.S. 107">220 U.S. 107 (1911), the Supreme Court upheld as an excise tax the Corporation Tax Act of 1909 4 which imposed a tax 692 on net income. Prior to that time, an 1898 tax on the gross receipts of businesses engaged in sugar refining had been upheld as an excise tax. Spreckels Sugar Refining Co. v. McClain, 192 U.S. 397">192 U.S. 397 (1904). Prior to the Pollock case, the Court had had before it the various Civil War tax acts. As noted previously, among these was a tax on the gross premiums of insurance companies which the Court upheld as an excise tax. Pacific Insurance Co. v. Soule, supra.Moreover, the Court has upheld as excise taxes, as against the contention that they were direct taxes, the Federal estate tax 242 in Knowlton v. Moore, 178 U.S. 41">178 U.S. 41 (1900), and the Federal gift tax in Bromley v. McCaughn, 280 U.S. 124 (1929). It seems to me that the question of whether or not a particular tax is an excise is basically the same question as whether it is direct or indirect. If found not to be direct, it can make no difference whether it is an excise or something else. I certainly subscribe to the statement in the majority opinion that the "validity of an exercise of congressional power cannot depend upon the verbal tag attached to it." It would be preposterous to have the Federal taxing power circumscribed by the artificialities of mere form. Nevertheless, I believe that the intent of Congress as evidenced by the statute itself and its legislative history is of significance in determining the nature of the tax imposed.In Spreckels Sugar Refining Co. v. McClain, supra, the Court accorded great weight to the intent of Congress as evidenced by the exact words of the particular statute. The section of the statute involved 5 provided in part:That every person, firm, corporation, or company carrying on or doing the business of refining petroleum, or refining sugar, or 243 owning or controlling any pipe line for transporting oil or other products, whose gross annual receipts exceed two hundred and fifty thousand dollars, shall be subject to pay annually a special excise tax equivalent to one quarter of one per centum on the gross amount of all receipts of such persons, firms, corporations, and companies in their respective business in excess of said sum of two hundred and fifty thousand dollars. * * Rejecting the argument that the tax so imposed was a direct tax, the Court interpreted the quoted provision in these words (192 U.S. 397">192 U.S. 397, 411):Clearly the tax is not imposed upon gross annual receipts as property, but only in respect of the carrying on or doing the business of refining sugar. It cannot be otherwise regarded because of the fact that the amount of the tax is measured by the amount of the gross annual receipts. The tax is defined in the act as "a special excise tax," and, therefore, it must be assumed, for what it is worth, that Congress had no purpose to exceed its power under the Constitution, but only to exercise the authority granted to it of laying and collecting excises.693 The 244 tax imposed oncorporation incomes by the Act of 1909 and upheld by the Supreme Court in Flint v. Stone Tracy Co., supra, was denominated in the statute itself as a "special excise tax with respect to the carrying on or doing business" as a corporation. Referring to this evidence of the nature of the tax, the Court declared (p. 145):While the mere declaration contained in a statute that it shall be regarded as a tax of a particular character does not make it such if it is apparent that it cannot be so designated consistently with the meaning and effect of the act, nevertheless the declaration of the lawmaking power is entitled to much weight, and in this statute the intention is expressly declared to impose a special excise tax with respect to the carrying on or doing business by such corporation, joint stock company or association, or company. * Can the tax computed under section 207(a)(2) be considered as an excise tax on the carrying on of business as a mutual insurance company (other than life or marine)? I think not. The only possible evidence in the statute itself in support of such a proposition is the fact that the tax is limited to corporations of a certain type. Indeed, 245 it is even more limited in scope because section 207(a), in the first instance, only applies to those mutual insurance companies (other than life or marine) which are not totally exempt under section 101(11) because of their small size. Further, even though not exempt under section 101(11), a company is only subject to the tax computed under section 207(a)(2) if the tax under (a)(1) -- a net income tax -- is smaller. To conclude from the very limitations on the scope of the tax that the tax must therefore be construed as having been imposed as an excise with respect to carrying on the particular type of activity which finds itself subject to the tax, would seem to require that any tax is an excise so long as the taxpayer class is sufficiently narrow. The illogic of such a conclusion is fatal to the proposition.Alternatively, can the tax be considered as an excise tax on the receipt of premiums? Recognizing that such a tax is commonly imposed by the States, which have no constitutional limitations in terms of direct taxes, I fail to see how section 207(a)(2) can be so construed in view of the fact that the gross amount of income taxed under the section includes dividends, rents, 246 and interest. Certainly, there is a complete absence of any language evidencing an intent to impose such a tax.I am unable to find any persuasive evidence here that the tax in question is an excise tax. Indeed, all of the evidence is to the contrary. Section 207(a)(2) is part of chapter 1 of the Internal Revenue Code of 1939 entitled "Income Tax." That its administration by the Treasury Department has recognized this classification is indicated by the return form entitled "U.S. Mutual Insurance Company Income Tax Return For Mutual Insurance Companies Other than Life or 694 Marine Insurance Companies or Fire Insurance Companies Issuing Perpetual Policies." Section 207(a) specifically imposes a tax upon "income" as such, the tax being computed under (a)(1) or (2) whichever produces the greater amount. As I have already pointed out, companies are subject to section 207(a) and its various parts only if not exempt from tax under section 101(11). Section 101 has always been conceived of as an income tax exemption section only. Certainly, organizations exempt from tax under section 101 have never been exempt, for that reason, from liability for any of the Federal excise taxes. Section 207(a)(2)247 excludes tax-exempt interest from the base of the tax and yet the Supreme Court had made it clear in Flint v. Stone Tracy Co., supra, that such an exclusion was not necessary to the validity of an excise tax. The whole framework of this tax evidences an intent to levy an income tax, a conclusion borne out by the debates in the Senate on the Revenue Act of 1942. In explaining these provisions of the bill, Senator George, who was chairman of the Committee on Finance where section 207(a)(2) had originated, declared:The tax does not apply to corporations if the gross amount received during the taxable year from interest, dividends, rents, and premiums, including deposits and assessments, does not exceed $ 75,000. Therefore practically all the farmers' and other small and local mutual companies will not be required to file income tax returns or pay income taxes. It is estimated that over 80 percent of all mutual companies will be exempt from filing returns under this provision. [Emphasis supplied.] 6248 Similarly, Chairman Doughton of the Committee on Ways and Means, in explaining the conference report to the House described section 207(a)(2) as a tax on "gross income." 7In determining whether section 207(a)(2) is an excise tax, consideration must be given to Stanton v. Baltic Mining Co., 240 U.S. 103">240 U.S. 103 (1916), referred to in the majority opinion and accorded considerable weight therein. In that case, arising under the 1913 income tax act, it was argued by the taxpayer that a failure to provide an adequate allowance for depletion of a mineral property resulted in the tax being a direct tax on property which must be apportioned. With reference to this argument, the Supreme Court stated:It moreover rests upon the wholly fallacious assumption that looked at from the point of view of substance a tax on the product of a mine is necessarily in its essence and nature in every case a direct tax on property because of its ownership unless adequate allowance be made for the exhaustion of the ore body to result from working the mine. We say wholly fallacious assumption because independently of the effect of the operation of the Sixteenth Amendment it was settled in Stratton's Independence v. Howbert, 231 U.S. 399">231 U.S. 399, [58 L. Ed. 285">58 L. Ed. 285, 34 Sup. Ct. Rep. 695 136] that such a tax is not a tax upon 249 property as such because of its ownership, but a true excise levied on the results of the business of carrying on mining operations * * The apparent meaning of the quoted language would seem to be that any tax on a mining corporation, and presumably on any other business entity, is per se an excise tax, sustainable as such without regard to the limitations normally demanded of an income tax. Yet Stratton's Independence v. Howbert, supra, cited in support of the statement, provides no authority for such a rule. Stratton's Independence v. Howbert involved the Corporation Tax Act of 1909, which, as pointed out above, had been upheld in Flint v. Stone Tracy Co., supra, specifically on the basis that it was intended to be and was enacted as an excise tax. The decision in the latter case, upon which Stratton's Independence v. Howbert was in large part based, very carefully pointed out that its specific nature as an excise was the material and significant distinction between the 1909 tax and the 1894 income tax held invalid in Pollock. To interpret Stanton v. Baltic Mining Co., supra, as standing for the proposition that this is merely a distinction without a difference seems to me to 250 be contrary to the reasoning of both Pollock and Flint v. Stone Tracy Co., and, perhaps more significant, completely contrary to subsequent Supreme Court decisions, notably Doyle v. Mitchell Brothers Co., supra, and Eisner v. Macomber, supra.Since, in my opinion, the tax here involved is nothing more or less than a tax on gross receipts, to hold it to be an excise tax in the complete absence of any real indicia of such a tax could only be grounded on the premise that a tax on the gross receipts of a business is per se an excise tax and sustainable as such. Certainly, to seize upon the phrase "special tax" employed in one instance in the lengthy Senate Finance Committee report 8 on section 207(a) as somehow being sufficient to impart to the tax the magical quality of being an excise is hardly convincing, especially in view of the bulk of the legislative history which demonstrates overwhelmingly that the tax was conceived and designed as an income tax. "Special" the tax may well be but "special" only in the sense of being unusual, different, a departure from the normal. Since the essential question here is whether the tax is direct or indirect, I cannot believe that, by mere reference 251 to a tax as "special," Congress can thus make it "indirect." To hold otherwise, would be to elevate form over substance with a vengeance. The use of the descriptive word "special" obviously can have no relevancy whatsoever to a determination of what it is that is being taxed or how 696 it is being taxed. This being the case, I consider the use of the word "special" equally irrelevant to a determintion of whether the tax is direct or indirect.Indeed, even though the tax were specifically denominated an "excise" in the statute, that fact alone, while entitled to great weight in determining the intent of Congress, could not preclude a holding that it is direct and thus must be apportioned. As declared by the Supreme Court in Brushaber v. Union Pac. R. R., supra at 16:Moreover, in addition, the conclusion reached in the Pollock Case did not in any degree involve holding that income taxes generically and necessarily came within the class of direct taxes on property, but, on the contrary, recognized the fact that taxation on income was in its nature an excise entitled 252 to be enforced as such unless and until it was concluded that to enforce it would amount to accomplishing the result which the requirement as to apportionment of direct taxation was adopted to prevent, in which case the duty would arise to disregard form and consider substance alone, and hence subject the tax to the regulation as to apportionment which otherwise as an excise would not apply to it. * * [Emphasis supplied.]Thus, whether called an excise or not, a direct tax is still subject to the constitutional requirement of apportionment.It is true, as pointed out earlier in this opinion, that the Supreme Court in the Pollock case limited its opinion to a decision that taxes on the income from real estate and on the income from invested personal property were direct taxes. It refused to decide whether taxes on the "gains or profits from businesses, privileges, or employments" (emphasis supplied) were equally direct taxes. In fact, the Court's opinion leaves the distinct impression that it might not have considered them as such had it been confronted squarely by the issue but would have sustained them as excises. Since the petitioner here is certainly a "business," must we conclude 253 in conformity with the above-quoted dictum that the tax computed under section 207(a)(2) is sustainable as an excise? I am satisfied that such a result is not required because the subject of the tax with which we are here concerned is not "gains or profits" but gross receipts. A direct tax is defined as a tax on property because of ownership. Pollock v. Farmers' Loan & Trust Co., supra. Gross receipts in the hands of an insurance company are property under any conceivable definition of the term. Here we do not have, as did the Supreme Court in Pollock, nice questions concerning the source of the receipts. Because Pollock involved a tax on net income, the Court felt impelled to consider the sources of the income in question in order to determine whether or not those sources fell within the category of "property." Admittedly, the Pollock decision has not been entirely free from criticism over the years. More than one authority has questioned its basic premise, namely, that a 697 tax on net income is per se a tax on the property from which the income is derived, and it can be argued with some force that a tax on the income from property is not a burden on the property itself because 254 being limited to "income" (whether called gross or net) it cannot diminish the underlying property. But, in my view, no such argument can be made reasonably with respect to a tax on gross receipts. In the simplest, most understandable sense, they are themselves property. Therefore, the tax here on petitioner's gross receipts, to the extent they are not reduced by losses and thus not limited to "income," is a tax on property because of ownership. This being the case, it is a direct tax, and being unapportioned, it is invalid.Is this view contrary to Pacific Insurance Co. v. Soule; Spreckels Sugar Refining Co. v. McClain; Stanton v. Baltic Mining Co., all supraI have indicated earlier the view that, since Pacific Insurance Co. v. Soule, supra, rested on the premise that direct taxes were only capitation taxes and taxes on real estate, the reasoning of the Court in that case must be considered to have been rejected, at least by implication, in the Pollock decision. The fact remains, however, that subsequent to Pollock the Supreme Court placed primary reliance upon the Pacific Insurance Co. case in its Spreckels Sugar Refining Co. decision which upheld a gross receipts tax on sugar 255 refiners. In the latter case, following the statement previously quoted in this opinion, the Court went on to say:This general question has been considered in so many cases heretofore decided that we do not deem it necessary to consider it anew upon principle. It was held in Pacific Ins. Co. v. Soule, 7 Wall. 433">7 Wall. 433, 19 L. ed. 95, that the income tax imposed by the internal revenue act of June 30th, 1864, amended July 13th, 1866 (13 Stat. at L. 276, chap. 173, 14 Stat. at L. 98, chap. 184), on the amounts insured, renewed, and continued by insurance companies, on the gross amount of premiums received, on dividends, undistributed sums and income, was not a direct tax, but an excise duty or tax within the meaning of the Constitution; * * Are we to understand that these two cases, taken together, stand for the principle that a tax on the gross receipts of a business is inherently an indirect tax? If so, then candor requires me to admit that my own conclusions in the instant case are plainly inconsistent therewith. On the other hand, does the fact that in its Spreckels decision the Supreme Court attached great weight to the announced intention of Congress to levy an excise together 256 with the fact that it there interpreted its earlier decision in Pacific Insurance Co. v. Soule as being based upon a similar consideration, permit the conclusion that the statutes there involved are distinguishable from that with which we are here concerned? This question forces us to return to the troublesome inquiry of whether the form of the tax carries with it real constitutional 698 significance. Certainly, the decided cases suggest that it does and yet this is a rationale which I find difficult to accept. I would suppose that constitutional limitations upon the Federal taxing power might be designed to accomplish any number of purposes, such as insulating certain subjects from the exercise of that power or reserving the taxation of those subjects to the States, but whatever their purpose, I think we must assume that the limitations were intended to be real and not directed to form alone. If, for example, the purpose of a given limitation is to reserve the exercise of a particular power to tax to the States, what possible difference does it make, in terms of whether the prerogative of the States is being invaded thereby, if the tax in question is levied as an excise tax, income 257 tax, or just as a plain tax? So long as the base and the rate are identical, the substantive effect and the real nature of the tax must remain the same, no matter what it is called.Inability to accept the result in the Pacific Insurance Co. and Spreckels cases as having been based upon form alone might seem to lead inevitably to the principle stated above that a tax on gross receipts is inherently an indirect tax and, thus, valid in the absence of apportionment and irrespective of whether there is "income" or not. Yet, adoption of this alternative would seem to be directly contrary to the rationale implicit in Southern Pacific Co. v. Lowe, 247 U.S. 330">247 U.S. 330 (1918), Eisner v. Macomber, supra, and Bowers v. Kerbaugh-Empire Co., supra, among others, as well as such lower court decisions as Davis v. United States, supra, and Commissioner v. Weisman, supra. Moreover, it would be contrary to what I conceive to be the commonly held view.Stanton v. Baltic Mining Co., supra, is sometimes considered to stand for the principle that Congress may levy an income tax on receipts without allowance for recovery of capital because in that case the Supreme Court rejected the taxpayer's contention that 258 the statute failed to permit him an adjustment for true depletion. If that is the proper interpretation of the decision, it would certainly seem to have been rejected in Doyle v. Mitchell Brothers Co., supra, and the other cases to which reference has just been made. However, I am satisfied that such an interpretation is not required. In the first instance, the value of a mineral deposit is often so conjectural as to make a computation of "true" depletion difficult if not impossible. Second, the statute involved did in fact provide for a deduction of a reasonable allowance for depletion, subject merely to an overall limitation. Thus, the Court was not presented with the question of whether Congress could have validly denied the taxpayer any allowance for depletion. This being the case, I see no reason to impute to that decision a principle plainly at variance with subsequent declarations of the Court.699 The majority opinion upholds the validity of section 207(a)(2) on the basis that it is an indirect tax. Having done so, it does not concern itself with whether something other than "income" under the 16th amendment is being taxed. It does not inquire as to the nature of the tax 259 base, other than to set forth the statutory provisions involved. With respect to the contentions of the petitioner concerning its underwriting losses, the opinion states simply:It is familiar doctrine that deductions are a matter of legislative grace * , and it seems unlikely that there is a constitutional requirement based upon the 16th amendment calling for the deduction which petitioner insists is indispensable to the validity of the unapportioned tax. However, that is an issue that we need not reach.As I stated previously, under the majority's approach, the question of whether the tax is limited to "income" is constitutionally irrelevant once it is determined that it is not direct.Moreover, aside from the passing reference to it as a "special tax," which I have indicated can hardly be considered to carry with it real constitutional significance, the majority decision that this is an indirect tax clearly does not seem to turn upon a determination that it is an excise. True, the opinion cites Stanton v. Baltic Mining Co., supra, as authority for the assertion that the tax here involved is "sustainable as an excise on carrying on an insurance business." However, since the opinion 260 does not inquire as to whether any of the usual indicia of an excise tax are present, I can only assume that this result is based upon the conclusion that any tax upon the receipts of a business is inherently an excise and inherently indirect. I say "any tax" advisedly because the majority opinion apparently considers any question of what elements go to make up the tax base under section 207(a)(2) to be immaterial, and it does not discuss them. This conclusion does seem to accord with the apparent holding in Stanton that the 1913 income tax is an excise tax, at least insofar as the particular taxpayer is engaged in business. The principle likewise accords with the statement by the Supreme Court in Spreckels Sugar Refining Co. v. McClain, supra, that the 1864 income tax on insurance companies had been sustained as an excise in Pacific Insurance Co. v. Soule, supra.If it is true that a tax on the receipts of a business is per se indirect, irrespective of whether imposed in terms as an income tax or as an excise tax or otherwise, then it is certainly true that there is no constitutional bar with respect to the taxation of business receipts without any allowance for cost of goods sold, 261 without any allowance for losses incurred, and without allowance for recovery of capital. Certainly, the statute involved in Spreckels permitted no adjustment for such items. However, if one believes, as I do, that these items and others 700 of a similar nature are constitutionally protected, then I think it necessary to take issue with the concept of "indirect" taxation embraced by the majority here. I have already agreed that it is incorrect to conceive of the 16th amendment as barring the taxation of such items because of their not being "income" within the meaning of the amendment. Thus, the only conceivable remaining constitutional barrier to such taxation would have to be based upon the conclusion that it is unapportioned direct taxation. This being the case, one's understanding of the scope of the term "direct tax" becomes of critical importance in determining the scope of the Federal taxing power.I cannot accept a conclusion that the receipts of a business taxpayer are entitled to a different constitutional protection than are the receipts of a nonbusiness taxpayer. Such a distinction would be untenable in principle as well as impractical of application in many instances. 262 We are all too familiar with the difficulties inherent in the determination of whether an individual is engaging in business or not. Nowhere in the Constitution do I find any warrant for such a distinction. Moreover, since recovery of capital is most frequently involved in what are business or business-type transactions, the drawing of such a distinction would simply make any constitutional restriction with regard to such an item quite meaningless.Certainly, the Pollock decision required no such distinction. While the opinion indicated that a tax on the gains and profits of businesses, privileges, and employments would be an indirect tax, there is no suggestion in the opinion that a tax on property in the hands of those so engaged would not be a direct tax invalid in the absence of apportionment to the same extent as if held by persons not so engaged. Indeed, the particular taxpayer as against which the validity of the tax was tested was a bank. That it was the type of property rather than who owned it which was the test applied by the Court was indicated by Mr. Justice Harlan in his dissent at 158 U.S. 601">158 U.S. 601, 673:And it is now the law, as this day declared, that under the Constitution, 263 however urgent may be the needs of the Government, however sorely the administration in power may be pressed to meet the moneyed obligations of the nation, Congress cannot tax the personal property of the country, nor the income arising either from real estate or from invested personal property, except by a tax apportioned among the States, on the basis of their population, while it may compel the merchant, the artisan, the workman, the artist, the author, the lawyer, the physician, even the minister of the Gospel, no one of whom happens to own real estate, invested personal property, stocks or bonds, to contribute directly from their respective earnings, gains, and profits, and under the rule of uniformity or equality, for the support of the government. [Second emphasis supplied.]The severest contemporaneous criticisms of the Pollock decision were directed to the fact that it resulted in different kinds of income being 701 accorded different constitutional protections, in income from real estate, stocks, and bonds being elevated to a preferred position. 9 It was to remove this very distinction that the 16th amendment was framed and adopted so that incomes regardless of source could 264 be treated and taxed alike. To read now into the Constitution a new distinction based, not upon source, but upon the status of the recipient would simply be to develop new disparities and new inequities of the very sort which the 16th amendment was adopted to proscribe. Such distinctions may be proper as a matter of legislative discretion but should not be established as constitutionally required.While the majority opinion makes no attempt to define a "direct" tax, it gives considerable weight to the suggestion that to require apportionment of the tax here involved would have "bizarre and inequitable consequences." While one can hardly take exception to such a characterization, I do not consider that it furnishes a very significant criterion of the nature of the tax. It is not a logical argument to say that a particular tax cannot be construed to be direct simply because it may be impractical to impose it by apportionment. The Supreme Court specifically rejected the same argument in the Pollock case. To levy a Federal tax on real estate by apportionment among the States according 265 to population would certainly lead to disparate results as between different taxpayers, but it has always been accepted that such a tax would be direct and would have to be apportioned.There is no suggestion in the majority opinion that it rejects any of the traditionally accepted views as to the meaning of "direct" taxes. Thus, while the opinion does not offer any definition of the term, I would suppose that it would adhere to the principles laid down in Pollock and elsewhere that capitation taxes, taxes on real estate, taxes on personal property, and taxes on the receipts from real estate and personalty are direct taxes which must be apportioned save to the extent the particular tax is limited to income and, thus, freed of apportionment by the 16th amendment. For example, I assume that a taxpayer's receipts from real estate are taxable, without apportionment, only to the extent that the receipts constitute income within the meaning of the 16th amendment. Thus, I conceive of a reasonable allowance for depreciation in such a case as being constitutionally required. In Helvering v. Independent Life Insurance Co., 292 U.S. 371 (1934), the Supreme Court clearly stated, in the case 266 of an insurance company taxpayer, that the mere rental value of a building used by the owner does not constitute income within the meaning of the 16th amendment, citing Eisner v. Macomber, supra, 702 and that a tax on such value as income would be a direct tax requiring apportionment, citing Pollock and a number of subsequent decisions. Yet, if one accepts the premise implicit in the majority opinion, based upon Stanton v. Baltic Mining Co., supra, that an income tax on an insurance company is sustainable in all events as an excise, then the principle stated by the Supreme Court in Helvering v. Independent Life Insurance Co., supra, must have been in error because excise taxation has never been considered as limited constitutionally to "income." Certainly, I find no suggestion in the latter case, consistent with the rationale of the majority opinion here, that the income tax there involved was simply an indirect tax on carrying on an insurance business so that no question of income under the 16th amendment was material to its decision. On the contrary, the entire opinion is reasoned within the framework of established concepts of "income."I assume that the cases do not require the elevation 267 of real estate, or the receipts therefrom, to a preferred position under the Constitution. Pollock made it clear that personal property was entitled to at least equivalent treatment, and in Willcutts v. Bunn, 282 U.S. 216">282 U.S. 216 (1931), the Supreme Court pointed out that a tax on the interest from bonds would be a tax on the owner "by virtue of the mere fact of ownership." Basically, it seems to me that an attempt to draw a distinction between different types of property is unwarranted in determining constitutional protection, and, as previously suggested, would be the very type of distinction which the 16th amendment was adopted to prevent. Property is property, whether it is real or personal, tangible or intangible, and a tax on gross receipts because of ownership, whether derived from real estate, invested personalty, or indeed from a valuable contractual right, is a direct tax on property requiring apportionment to the extent not limited to "income." Any other rule would lead to such disparate treatment of different types of property as to be foreign to established concepts of uniform treatment.In any event, as I have stated previously, we need not concern ourselves here with the source 268 of the receipts involved in the instant case because they are themselves property. If the tax computed under section 207(a)(2) is valid at 1 per cent, I assume it would be equally valid at 10 per cent, 50 per cent, or at any other rate. Levied annually, such a tax is an exaction, not out of income, but out of the underlying assets of the taxpayer and could result in their progressive liquidation. It is a clear example, in my mind, of direct taxation of property.To decide that gross receipts are property is not to signal a new point of departure in delineating the scope of the Federal taxing power but simply establishes a logical basis for the often-announced doctrine that an income tax on gross receipts, to the extent that it 703 falls on that which is not "income," is invalid. Indeed, no other conclusion is possible if one is convinced that such receipts in excess of "income" are not within the Federal taxing power except by apportionment. Nor would the principles suggested by myself disturb the basic scheme of Federal income taxation as embodied in the Internal Revenue Code. Section 207(a)(2) is the only provision of the entire income tax law, insofar as I have been able to determine, 269 that seeks to tax gross receipts in excess of income. Elsewhere, the statute, the regulations issued thereunder, and the decisions of the courts have sought to exclude from the tax base those elements of gross receipts, such as return of capital, cost of goods sold, and losses, which do not constitute income. Moreover, my analysis does not contravene the fact that, in many and perhaps most instances, gross receipts are identical to gross income and, thus, taxable in their entirety absent statutory deductions.I realize that in the recent case of Commissioner v. Sullivan, 356 U.S. 27">356 U.S. 27 (1958), the Supreme Court appeared to give some support to the view that Congress could tax gross receipts when it stated at page 29:If we enforce as federal policy the rule espoused by the Commissioner in this case, we would come close to making this type of business taxable on the basis of its gross receipts, while all other business would be taxable on the basis of net income. If that choice is to be made, Congress should do it. * The Court had before it the question of whether amounts paid by professional bookmakers as wages and rent were deductible from gross income as ordinary and necessary business 270 expenses. In their tax computation, the taxpayers presumably had already applied section 23(h) of the 1939 Code which permitted the deduction of gambling losses to the extent of the gambling gains. Thus, there was no question involved in the Sullivan case of a tax on gross receipts but simply of deductions from gross income.I certainly agree with the majority that there is a strong presumption in favor of the validity of a taxing statute and that doubts must be resolved in favor of its validity, and I cannot dispute the fact that some decisions of the Supreme Court appear to support the majority view. However, I am satisfied that the great weight of authority is contrary to that view and is largely embodied in decisions of the Supreme Court handed down subsequent to those relied upon by the majority. One fact is abundantly clear and that is that the scope of the Federal taxing power does not lend itself to dogmatism or categorical opinion. The concept of taxable income is at best "elusive and restless." United States v. Wyss, 239 F. 2d 658 (C.A. 7, 1957). Recognizing that judicial doctrine in the area necessarily has been developed on a case-by-case basis, it is perhaps inevitable 271 that some lack of harmony may have arisen. In view of this 704 fact, I do not conceive of the presumption of validity as necessarily requiring adoption in all events of those cases which extend the Federal taxing power especially when there are contrary cases of later date. Such a course inevitably would subject the constitutional limitations and qualifications on the exercise of that power to a process of judicial erosion.On the question of jurisdiction, I agree thoroughly with the concurring opinion of Judge Murdock. Footnotes1. This sentence is substantially as stipulated by the parties, and possible confusion that may arise therefrom is attributable to the sense in which the terms quoted above are used. The term "gross income" is used apparently to mean gross income from investments. On the other hand, the term "gross amount of income" appears to refer to the special statutory base, specified in section 207(a)(2), I.R.C. 1939 (see footnote 4, infra↩), which includes net premiums as well as investment income.2. The Government filed a motion to dismiss the present proceeding for lack of jurisdiction, which was denied. Such denial was in accord with well-established practice in this tribunal. Continental Accounting & Audit Co., 2 B.T.A. 761">2 B.T.A. 761, 763-764; John Moir, 3 B.T.A. 21">3 B.T.A. 21, 22; United States Fidelity & Guaranty Co., 5 B.T.A. 23">5 B.T.A. 23, 26; Powell Coal Co., 12 B.T.A. 492">12 B.T.A. 492, 497; Edward J. Lehmann, 21 B.T.A. 664">21 B.T.A. 664, 671; Fred Taylor, 36 B.T.A. 427">36 B.T.A. 427, 429↩.3. Reenacted in substantially identical form as sections 821- 823 of the Internal Revenue Code of 1954↩.4. SEC. 207. MUTUAL INSURANCE COMPANIES OTHER THAN LIFE OR MARINE.(a) Imposition of Tax. -- There shall be levied, collected, and paid for each taxable year upon the income of every mutual insurance company (other than a life or a marine insurance company or a fire insurance company subject to the tax imposed by section 204 and other than an interinsurer or reciprocal underwriter) a tax computed under paragraph (1) or paragraph (2) whichever is the greater and upon the income of every mutual insurance company (other than a life or a marine insurance company or a fire insurance company subject to the tax imposed by section 204) which is an interinsurer or reciprocal underwriter, a tax computed under paragraph (3): (1) If the corporation surtax net income is over $ 3,000 a tax computed as follows: (A) [No provision.](B) Taxable Years Beginning After March 31, 1951, and Before April 1, 1954. -- In the case of taxable years beginning after March 31, 1951, and before April 1, 1954 --(i) Normal tax. -- A normal tax of 30 per centum of the normal-tax net income, or 60 per centum of the amount by which the normal-tax net income exceeds $ 3,000, whichever is the lesser; plus(ii) Surtax. -- A surtax of 22 per centum of the corporation surtax net income in excess of $ 25,000.(2) If for the taxable year the gross amount of income from interest, dividends, rents, and net premiums, minus dividends to policyholders, minus the interest which under section 22(b)(4) is excluded from gross income, exceeds $ 75,000, a tax equal to the excess of -- (A) 1 per centum of the amounts so computed, or 2 per centum of the excess of the amount so computed over $ 75,000, whichever is the lesser, over(B) the amount of the tax imposed under Subchapter E of Chapter 2.* * * (4) Gross amount received over $ 75,000, but less than $ 125,000. -- If the gross amount received during the taxable year from interest, dividends, rents, and premiums (including deposits and assessments) is over $ 75,000 but less than $ 125,000, the amount ascertained under paragraph (1), paragraph (2)(A) and paragraph (3) shall be an amount which bears the same proportion to the amount ascertained under such paragraph, computed without reference to this paragraph, as the excess over $ 75,000 of such gross amount received bears to $ 50,000. * * (b) Definition of Income, Etc. -- In the case of an insurance company subject to the tax imposed by this section -- (1) Gross investment income. -- "Gross investment income" means the gross amount of income during the taxable year from interest, dividends, rents, and gains from sales or exchanges of capital assets to the extent provided in section 117;(2) Net premiums. -- "Net premiums" means gross premiums (including deposits and assessments) written or received on insurance contracts during the taxable year less return premiums and premiums paid or incurred for reinsurance. Amounts returned where the amount is not fixed in the insurance contract but depends upon the experience of the company or the discretion of the management shall not be included in return premiums but shall be treated as dividends to policyholders under paragraph (3);(3) Dividends to policyholders. -- "Dividends to policyholders" means dividends and similar distributions paid or declared to policyholders. The term "paid or declared" shall be construed according to the method regularly employed in keeping the books of the insurance company;(4) Net income. -- The term "net income" means the gross investment income less -- (A) Tax-free Interest. -- The amount of interest which under section 22(b)(4) is excluded for the taxable year from gross income;(B) Investment Expenses. -- Investment expenses paid or accrued during the taxable year. If any general expenses are in part assigned to or included in the investment expenses, the total deduction under this subparagraph shall not exceed one-fourth of 1 per centum of the mean of the book value of the invested assets held at the beginning and end of the taxable year plus one-fourth of the amount by which net income computed without any deduction for investment expenses allowed by this subparagraph, or for tax-free interest allowed by subsection (b)(4)(A), exceeds 3 3/4 per centum of the book value of the mean of the invested assets held at the beginning and end of the taxable year;(C) Real Estate Expenses. -- Taxes and other expenses paid or accrued during the taxable year exclusively upon or with respect to the real estate owned by the company, not including taxes assessed against local benefits of a kind tending to increase the value of the property assessed, and not including any amount paid out for new buildings, or for permanent improvements or betterments made to increase the value of any property. The deduction allowed by this paragraph shall be allowed in the case of taxes imposed upon a shareholder of a company upon his interest as shareholder, which are paid or accrued by the company without reimbursement from the shareholder, but in such cases no deduction shall be allowed the shareholder for the amount of such taxes;(D) Depreciation. -- A reasonable allowance, as provided in section 23(l), for the exhaustion, wear and tear of property, including a reasonable allowance for obsolescence;(E) Interest Paid or Accrued. -- All interest paid or accrued within the taxable year on indebtedness, except on indebtedness incurred or continued to purchase or carry obligations (other than obligations of the United States issued after September 24, 1917, and originally subscribed for by the taxpayer) the interest upon which is wholly exempt from taxation under this chapter.(F) Capital Losses. -- Capital losses to the extent provided in section 117 plus losses from capital assets sold or exchanged in order to obtain funds to meet abnormal insurance losses and to provide for the payment of dividends and similar distributions to policyholders. Capital assets shall be considered as sold or exchanged in order to obtain funds to meet abnormal insurance losses and to provide for the payment of dividends and similar distributions to policyholders to the extent that the gross receipts from their sale or exchange are not greater than the excess, if any, for the taxable year of the sum of dividends and similar distributions paid to policyholders, losses paid, and expenses paid over the sum of interest, dividends, rents, and net premiums received. In the application of section 117(e) for the purposes of this section, the net capital loss for the taxable year shall be the amount by which losses for such year from sales or exchanges of capital assets exceeds the sum of the gains from such sales or exchanges and whichever of the following amounts is the lesser:(i) the corporation surtax net income (computed without regard to gains or losses from sales or exchanges of capital assets); or(ii) losses from the sale or exchange of capital assets sold or exchanged to obtain funds to meet abnormal insurance losses and to provide for the payment of dividends and similar distributions to policyholders.(c) Rental Value of Real Estate. -- The deduction under subsection (b)(4)(C) or (b)(4)(D) of this section on account of any real estate owned and occupied in whole or in part by a mutual insurance company subject to the tax imposed by this section, shall be limited to an amount which bears the same ratio to such deduction (computed without regard to this subsection) as the rental value of the space not so occupied bears to the rental value of the entire property.(d) Amortization of Premium and Accrual of Discount. -- The gross amount of income during the taxable year from interest, the deduction provided in subsection (b)(4)(A), and the credit allowed against net income in section 26(a) shall each be decreased by the appropriate amortization of premium and increased by the appropriate accrual of discount attributable to the taxable year on bonds, notes, debentures or other evidences of indebtedness held by a mutual insurance company subject to the tax imposed by this section. Such amortization and accrual shall be determined (1) in accordance with the method regularly employed by such company, if such method is reasonable, and (2) in all other cases, in accordance with regulations prescribed by the Commissioner with the approval of the Secretary. * * (f) Double Deductions. -- Nothing in this section shall be construed to permit the same item to be twice deducted.(g) Credits Under Section 26. -- For the purposes of this section, in computing normal tax net income and corporation surtax net income, the credits provided in section 26 shall be allowed in the manner and to the extent provided in sections 13(a) and 15(a).↩5. Section 101(11), which had previously exempted most mutual insurance companies other than life, was rewritten so as to limit the exemption to small companies; but in seeking to attain that objective the Senate used a different formula from the one approved by the House.6. Article I, section 9, clause 5. -- No Tax or Duty shall be laid on Articles exported from any State.↩7. Article I, section 2, clause 3. -- Representatives and direct Taxes shall be apportioned among the several States which may be included within this Union, according to their respective Numbers, which shall be determined by adding to the whole Number of free Persons, including those bound to Service for a Term of Years, and excluding Indians not taxed, three fifths of all other Persons. * 8. Article I, section 9, clause 4. -- No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.↩9. See also 1 Story, Constitution of United States, sec. 955 (4th ed., 1873); 1 Kent, Commentaries 256; Miller, Constitution 237 (1891). Cf. Rawle, Constitution 80 (2d ed., 1829); Pomeroy, Constitutional Law, sec. 277 (3d ed., 1888); Sergeant, Constitutional Law 305 (1830); 1 Hare, American Constitutional Law 250 (1889).1. A statutory liquidator of Penn Mutual Indemnity Company is now the substituted petitioner herein.↩2. SEC. 271. DEFINITION OF DEFICIENCY.(a) In General. -- As used in this chapter in respect of a tax imposed by this chapter [chapter 1 -- income tax], "deficiency" means the amount by which the tax imposed by this chapter exceeds the excess of -- (1) the sum of (A) the amount shown as the tax by the taxpayer upon his return, if a return was made by the taxpayer and an amount was shown as the tax by the taxpayer thereon, plus (B) the amounts previously assessed (or collected without assessment) as a deficiency, over --(2) the amount of rebates, as defined in subsection (b)(2), made. [Emphasis supplied.]In the instant case, there were no amounts previously assessed as a deficiency, and no rebates.↩3. SEC. 272. PROCEDURE IN GENERAL.(a)(1) Petition to Board of Tax Appeals [now called Tax Court of the United States]. -- If in the case of any taxpayer, the Commissioner determines that there is a deficiency [which term is defined in section 271(a)] in respect of the tax imposed by this chapter, the Commissioner is authorized to send notice of such deficiency to the taxpayer by registered mail. Within ninety days after such notice is mailed * * the taxpayer may file a petition with Board of Tax Appeals for a redetermination of the deficiency↩. * * * [Emphasis supplied.]4. SEC. 1101. JURISDICTION.The Board and its divisions shall have such jurisdiction as is conferred on them by chapters 1 [income tax], 2 [additional income taxes], 3 [estate tax], and 4 [gift tax] of this title [Internal Revenue Title], by Title II and Title III of the Revenue Act of 1926, 44 Stat. 9 [relating to income tax and estate tax], or by laws enacted subsequent to February 26, 1926.↩5. The cases cited by the majority are: Continental Accounting & Audit Co., 2 B.T.A. 761">2 B.T.A. 761, 763-764; John Moir, 3 B.T.A. 21">3 B.T.A. 21, 22; United States Fidelity & Guaranty Co., 5 B.T.A. 23">5 B.T.A. 23, 26; Powell Coal Co., 12 B.T.A. 492">12 B.T.A. 492, 497; Edward J. Lehmann, 21 B.T.A. 664">21 B.T.A. 664, 671; Fred Taylor, 36 B.T.A. 427">36 B.T.A. 427, 429↩.1. The use of the word "net" is misleading to the extent that it may imply gain after the allowance of deductions as in the case of "net income." The premiums here are "net" only in the sense that return premiums to policyholders are taken out because they are not part of the actual total premiums finally collected. The following quotation from Mutual Benefit Life Insurance Co. v. Herold, 198 F. 199">198 F. 199, 205 (1912), concerning excess premiums returned to policyholders is relevant although that case involved a mutual level premium life insurance company: This excess payment represents, not profits or receipts but an overpayment -- an overpayment because, being entitled to his insurance at cost and having paid more than it cost, he [the policyholder] is equitably entitled to have such excess applied for his benefit. It makes no difference what this excess is called. * * *See Penn Mutual Life Insurance Co. v. Lederer, 252 U.S. 523↩ (1920).2. Scott, "Casualty Insurers," 44 Va. L.R. 935, 937, 938↩ (1958).3. Act of Aug. 27, 1894; ch. 349, sec. 27, 28 Stat. 509, 553.↩4. Ch. 6, sec. 38, 36 Stat. 112.↩5. Act of June 13, 1898, ch. 448, sec. 27, 30 Stat. 448, 464.↩6. 88 Cong. Rec., 77th Cong., 2d Sess., p. 7795.7. 88 Cong. Rec., 77th Cong., 2d Sess., p. 8456.↩8. Report of the Committee on Finance, U.S. Senate, to accompany H.R. 7378, S. Rept. No. 1631, 77th Cong., 2d Sess., pp. 150-154.↩9. For a discussion of this background, see S. Rept. No. 2140, Part 2, 76th Cong., 3d Sess., p. 33 et seq↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624585/	PRAXITELES INC., SHELDON M. SISSON, A PERSON OTHER THAN THE TAX MATTERS PERSON, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentPraxiteles Inc. v. CommissionerDocket No. 16653-91United States Tax CourtT.C. Memo 1993-622; 1993 Tax Ct. Memo LEXIS 641; 66 T.C.M. (CCH) 1778; December 27, 1993, Filed 641 Decision will be entered for respondent. Sheldon M. Sisson, pro se. For respondent: Victor A. Ramirez. BEGHEBEGHEMEMORANDUM FINDINGS OF FACT AND OPINION BEGHE, Judge: By notice of final S corporation administrative adjustment (FSAA), respondent determined a $ 2,179,217 adjustment to the S corporation return of income of Praxiteles, Inc., for the taxable year 1985. This adjustment resulted from the disallowance of deductions for interest, maintenance and insurance, option fees, professional fees, and a filing fee. Praxiteles, Inc. (Praxiteles), is an S corporation subject to the unified audit and litigation procedures for subchapter S items under sections 6221-6245 originally enacted as part of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. 97-248, sec. 402(a), 96 Stat. 324, 648. 1 When the petition in this case was filed, Praxiteles' principal place of business was Shandon, California. 642 The issues for decision are (1) whether the FSAA was barred by expiration of the statutory period of limitations and (2) whether Praxiteles was entitled to deduct $ 2,179,217 of interest and other expenses on its 1985 return. For the reasons discussed below, we hold that the FSAA was not time barred and that Praxiteles was not entitled to any of the deductions claimed on its 1985 return. FINDINGS OF FACT Some of the facts have been stipulated and they are so found. DeductionsPraxiteles, with four other California corporations (Picabia, Inc.; Persian, Inc.; Manet, Inc.; and LeBrun, Inc.), was formed under California law on June 1, 1984, and was promoted and syndicated as a tax shelter by Gerald L. Schulman. 2 Praxiteles elected under subchapter S of the Internal Revenue Code and otherwise qualified as an S corporation. Praxiteles' income tax accounting period was the calendar year, and it elected to use the cash method of accounting.643 Schulman was the largest shareholder of Praxiteles, with a 43.432-percent stock interest. Dr. Charles V. Bergquist was president of Praxiteles and the four other corporations mentioned above. He was also designated as tax matters person (TMP) of Praxiteles and had a .67-percent stock interest in the corporation. Petitioner Sheldon Sisson was a 4.79-percent shareholder in Praxiteles and served as its legal counsel. In January 1985, Praxiteles circulated an offering memorandum soliciting investors to purchase 31 units of 100 shares in Praxiteles to be sold for $ 100,000 per unit. The offering memorandum stated that 70 percent of each shareholder's capital contribution would be deductible by the corporation, and passed through to its shareholders, as of December 31, 1985, and that the balance would be deductible as of January 1, 1986. Praxiteles raised the entire $ 3.1 million in capital called for by the offering memorandum. According to the offering memorandum, on January 14, 1985, Praxiteles had entered into an option agreement with Schulman to purchase from him one or more of four pieces of improved real property for the predetermined amount of $ 10,320,000 per building in644 exchange for an option fee to be due December 31, 1985. Schulman's profit on the sale of any one property transaction was predetermined to be $ 1,850,000. Schulman also had entered into similar option agreements with the four other California corporations mentioned above. According to the offering memorandum, on March 1, 1985, Praxiteles exercised its option to acquire property in Denton, Texas, and the other four corporations made elections to acquire properties pursuant to their respective option agreements. However, because Schulman was unable to deliver the properties selected, Praxiteles and the other four corporations agreed with Schulman to acquire an interest in one property in San Antonio, Texas, to be leased to the Texas Department of Human Resources for 8 years beginning January 1, 1986. On December 30, 1985, Praxiteles and the other four corporations executed a merger agreement, stated therein to be effective December 27, 1985, on such terms that Praxiteles would be the surviving corporation. However, there is no evidence in the record that the merger agreement was filed or became effective during the calendar year 1985. Under the terms of a "Re-executed Agreement645 for the Purchase of Real Property" (which was never executed), stated therein to be effective March 1, 1985, Schulman was to sell the San Antonio property to Praxiteles for $ 10,320,000 pursuant to a 30-year nonrecourse note (which was never executed) in that principal amount with interest at 15 percent per annum for the first 22 months, 8.875 percent for the next 36 months, and thereafter at a rate determined under an amortization schedule. The building was to be turned over to Praxiteles and the first interest payment made on December 31, 1985. The offering memorandum also stated that Praxiteles had entered into a 5-year maintenance and insurance agreement with Postal Management Services Co. (PMSC), a California company wholly owned by Schulman. PMSC also purportedly agreed to prepare Praxiteles' returns of income and represent it in any State or Federal tax controversies that might arise as a result of the property transaction. According to a "Re-executed Maintenance and Insurance Agreement" (which was never executed), Praxiteles was to pay PMSC a fee of $ 114,212 on December 31, 1985. On December 30, 1985, one Praxiteles shareholder sold his entire stock interest. Praxiteles646 and its shareholders thereupon elected, under section 1377(a)(2) and the applicable regulation, to treat 1985 as 2 short taxable years, one ending December 30, 1985, and the other a 1-day taxable year beginning and ending December 31, 1985. Their purpose in so doing was to cause the interest, option, and maintenance and insurance payments due December 31, 1985, to be paid that day, so that Praxiteles would have zero income and deductions for the taxable year ending December 30, 1985, and zero income and a large net operating loss that would flow through to its shareholders for the 1-day short taxable year ending December 31, 1985. Praxiteles also planned to liquidate on January 2, 1986, the day after it would assertedly have been entitled to a deduction for the remaining 30 percent of the shareholders' capital contributions, and distribute its assets to a California limited partnership, Praxiteles, Ltd. Praxiteles dissolved under the California corporation law on September 4, 1987. On its timely filed U.S. Income Tax Return for an S Corporation (Form 1120S) for the taxable year ending December 31, 1985, Praxiteles reported that it had zero income and the following expense deductions: 647 ExpenseAmount Interest$ 1,290,000Maintenance & Insurance114,212Professional Fees1,000Filing Fee5Option Fees774,000Total$ 2,179,217Praxiteles thus reported a total net operating loss of $ 2,179,217 for the taxable year ending December 31, 1985, and attached Schedules K-1 indicating the shareholders' distributive share of that loss. Despite the recitations in the offering memorandum and the various exhibits attached thereto about Praxiteles' business plan, Praxiteles never acquired the real property that it was supposed to acquire from Schulman on December 31, 1985. There is also no evidence that Praxiteles ever paid any of the expenses that petitioner alleges it paid. Statute of LimitationsThe statutory period of limitations on assessment of income taxes attributable to S corporation items of Praxiteles would have expired in the ordinary course on April 17, 1989, 3 3 years after Praxiteles filed its 1985 return. On January 2, 1989, at the request of respondent's revenue agent, but contrary to the advice of petitioner, Dr. Bergquist signed an agreement to extend the period of limitations on assessment of S corporation items (Form 872-S) of 648 Praxiteles for the taxable year 1985 until June 30, 1990. On April 6, 1990, Dr. Bergquist executed another Form 872-S agreeing to extend the period of limitations until June 30, 1991. 4 Dr. Bergquist signed the forms on the signature line for the TMP. When Dr. Bergquist signed the agreements to extend the period of limitations, he was suffering from Parkinson's disease. The agreements were countersigned by respondent's designated agent before expiration of the respective periods of limitation. On March 18, 1991, respondent mailed Dr. Bergquist, as TMP of Praxiteles, an FSAA disallowing all deductions claimed on Praxiteles' 1985 return and determining a $ 2,179,217 adjustment. If the agreements to extend the period of limitations were valid, the FSAA was timely mailed. 649 OPINION The primary issue in this case, and the only one on which evidence was presented at trial, is whether the FSAA was barred by operation of the statute of limitations. After holding that it was not so barred, we briefly discuss petitioner's claim that Praxiteles was entitled to interest and other deductions in the amount of $ 2,179,217 for 1985. Inasmuch as petitioner has not carried his burden of proof with respect to the deductions, we sustain respondent's determination in its entirety. Statute of LimitationsUnder section 6229(a), as made applicable to S corporations by section 6244, the period of limitations on assessment of income taxes attributable to S corporation items (and affected items) is 3 years from the later of the date the S corporation return was filed or the last date for filing such a return (without regard to extensions). Sec. 6244; Bugaboo Timber Co. v. Commissioner, 101 T.C. (1993) (slip op. at 14-15). Under section 6229(b)(1)(B), the 3-year period of limitations may be extended with respect to all shareholders by agreement entered into by the Secretary and the TMP (or any other person authorized by the corporation in writing to650 enter into such an agreement) before the expiration of the 3-year period. Secs. 6229(b)(1)(B), 6244. The expiration of the statutory period of limitations is an affirmative defense, and the party raising the defense must specifically plead and carry the burden of proving its applicability. Rules 39; 142(a). The defense is deemed to be waived unless pleaded. Niedringhaus v. Commissioner, 99 T.C. 202">99 T.C. 202, 214 (1992); C-99 Ltd. v. Commissioner, T.C. Memo 1993-574">T.C. Memo. 1993-574. In this case, the defense was properly raised. In order to prevail on the defense, petitioner must make a prima facie case respecting the filing of Praxiteles' 1985 S corporation return of income, the expiration of the period of limitations, and the mailing of the FSAA after the expiration of the period of limitations. Amesbury Apartments, Ltd. v. Commissioner, 95 T.C. 227">95 T.C. 227, 240-241 (1990). If petitioner makes this showing, respondent has the burden of going forward with evidence that there is an applicable exception to the expiration of the period of limitations. Adler v. Commissioner, 85 T.C. 535">85 T.C. 535, 540 (1985);651 General Information Assoc. Partnership v. Commissioner, T.C. Memo. 1992-583. Respondent can discharge this burden by showing that the FSAA was mailed prior to expiration of the limitations period pursuant to an agreement to extend the period of limitations that is "valid on its face". Adler v. Commissioner, supra; Concrete Engineering Co. v. Commissioner, 19 B.T.A. 212">19 B.T.A. 212 (1930), affd. 58 F.2d 566">58 F.2d 566 (8th Cir. 1932); C & M Amusements, Inc. v. Commissioner, T.C. Memo. 1993-527; General Information Assoc. Partnership v. Commissioner, supra.An S corporation extension agreement is valid on its face if it identifies the S corporation, bears the signature of the TMP or authorized representative, identifies the taxable year, and is dated prior to expiration of the existing period of limitations. See C & M Amusements, Inc. v. Commissioner, supra.Once the extension agreement is shown to be valid on its face, the burden of going forward shifts back to petitioner to show652 that the extension is invalid or otherwise not applicable. The burden of proof, i.e., the burden of ultimate persuasion, never shifts from the party pleading the limitations defense. Adler v. Commissioner, supra at 540. Petitioner has made a prima facie case that the FSAA was time barred. However, Dr. Bergquist, Praxiteles' designated TMP, timely signed the agreements to extend the period of limitations on assessment of items attributable to Praxiteles for 1985. We therefore find the extension agreements to be facially valid, and the burden is on petitioner to show that they are invalid. Petitioner argues that the agreements were not signed by Dr. Bergquist. Although petitioner advised Dr. Bergquist not to sign them and Dr. Bergquist suffered from Parkinson's disease, we have found that Dr. Bergquist signed the extension agreements. 5 Moreover, as Praxiteles' president and TMP, Dr. Bergquist had authority to sign the agreements. Herring v. Fisher, 242 P.2d 963">242 P.2d 963, 968 (Cal. Ct. App. 1952); Schuyler v. Pantages, 201 P. 137">201 P. 137, 138 (Cal. Ct. App. 1921); Bugaboo Timber Co. v. Commissioner653 , supra at (slip. op. at 18-19; 22); see General Information Assoc. Partnership v. Commissioner, supra.Petitioner argues in the alternative that, because Praxiteles dissolved in 1987, Dr. Bergquist had no authority654 to act its behalf when he signed the extension agreements in 1989 and 1990. This argument has no merit. Under California law, a corporation that has dissolved may still carry out acts necessary to wind up its affairs, including those relating to taxes. Cal. Corp. Code sec. 2010(a) (1990); Callan v. Commissioner, 476 F.2d 509 (9th Cir. 1973), affg. 54 T.C. 1514">54 T.C. 1514 (1970). Thus, even though Praxiteles had dissolved in 1987, Dr. Bergquist, as president and TMP, still had authority to execute agreements to extend the period of limitations with respect to Praxiteles' taxable year 1985. Cal. Corp. Code sec. 2001(b), (c) & (h) (1990); see McPherson v. Commissioner, 54 F.2d 751">54 F.2d 751 (9th Cir. 1932), affg. Crosman v. Commissioner, 22 B.T.A. 390">22 B.T.A. 390 (1931). Cf. C-99 Ltd. v. Commissioner, T.C. Memo. 1993-574 (president of corporate tax matters partner that had its corporate status suspended under California law had capacity to execute agreements to extend the period of limitations). We therefore conclude that the FSAA was timely mailed and was not 655 barred by expiration of the statutory period of limitations. DeductionsIt is not clear whether respondent's FSAA covers only a 1-day taxable year beginning and ending December 31, 1985, or whether respondent disregarded the section 1377(a)(2) election and issued the FSAA for the calendar year 1985. In either event, the result we reach in this case would be no different. Praxiteles never acquired the real property that it was supposed to acquire from Schulman. This amounted to a failure of consideration under the "Re-executed Agreement for the Purchase of Real Property" and promissory note, which, although never executed, petitioner asserts were binding. Praxiteles never owed any debt to Schulman with respect to the acquisition property because Schulman never delivered the property. See Farnsworth, Contracts, sec. 8.9 at 581 (1982). Moreover, with the exception of self-serving recitations in the offering memorandum and Praxiteles' 1985 return, there is no evidence in the record of this case that Praxiteles ever paid Schulman interest on a purchase money obligation with respect to the property it was supposed to acquire from him. There is also no persuasive evidence in656 the record that Praxiteles ever paid the option fees called for in the offering memorandum or any amount for maintenance and insurance. Although Praxiteles may have had some legal expenses and filing fees in 1985, there is no evidence in the record whether or in what amounts such expenses were paid, to whom they were paid, or for what services. See Cleland v. Commissioner, T.C. Memo. 1993-589. We therefore hold that petitioner has failed to carry his burden of proving that Praxiteles was entitled to any of the deductions claimed on its 1985 S corporation return of income. Rule 142(a); C & M Amusements, Inc. v. Commissioner, supra; Sivic v. Commissioner, T.C. Memo. 1993-54. Petitioner's amended petition also asserted that Praxiteles is entitled to a theft loss deduction for 1985 for the full amount of the shareholders' unreturned investment in the corporation. However, petitioner conceded that Praxiteles did not sustain or discover a theft loss in 1985, so no theft loss deduction for 1985 is in issue. ConclusionHaving concluded that the FSAA was not barred by expiration of *657 the statutory period of limitations and that Praxiteles is not entitled to any of the deductions claimed on its 1985 return, we sustain respondent's $ 2,179,217 adjustment in its entirety. To reflect the foregoing, Decision will be entered for respondent. Footnotes1. Sec. 6244 provides that the TEFRA provisions relating to the assessment and determination of partnership items are extended to the assessment and determination of subchapter S items. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. Praxiteles was registered as a tax shelter with the IRS. The tax shelter program in this case, as described in the offering memorandum referred to herein, appears to have been similar to those in Marine v. Commissioner, 92 T.C. 958">92 T.C. 958 (1989), affd. without published opinion 921 F.2d 280">921 F.2d 280 (9th Cir. 1991), and Wolverine, Ltd. v. Commissioner, T.C. Memo. 1992-669↩, where limited partnerships undertook to purchase a building or buildings leased to the U.S. Postal Service, a public utility, or a State governmental unit, and claimed interest deductions equal to the capital contributions of the limited partners.3. April 15, 1986, was a Tuesday, and April 15, 1989, was a Saturday.↩4. Dr. Bergquist also signed a Form 872 on Apr. 6, 1990, agreeing to extend the period of limitations to June 30, 1991. It is not clear what effect this had, if any, on the period of limitations.↩5. An IRS handwriting expert, who had compared Dr. Bergquist's signatures on the extensions with known samples, credibly testified that Dr. Bergquist's signatures were genuine. In addition, under Fed. R. Evid. 901(b)(3) & (4), the trier of fact may identify handwriting by comparing it to known specimens and may consider the distinctive characteristics of the handwriting in conjunction with surrounding circumstances. See Kang v. Commissioner, T.C. Memo. 1993-601; General Information Assoc. Parntership v. Commissioner, T.C. Memo. 1992-583↩. Based on the expert's testimony and the Court's own review of the signatures, the Court finds that the signatures on the extension consents are those of Dr. Bergquist.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624586/	RECREATION CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Recreation Co. v. CommissionerDocket No. 20928.United States Board of Tax Appeals15 B.T.A. 757; 1929 BTA LEXIS 2792; March 11, 1929, Promulgated 2792 Compensation voted and paid by a corporation to an individual in the year 1920 for services rendered in prior years in securing the extension of a leasehold, floating of bond issues, selling capital stock the securing of credit in connection with the erection and equipping of a building and for advice relating to the design and arrangement of the building and the character and arrangement of the equipment, is not deductible from income in the fiscal year ending April 30, 1921. G. N. Bebout, Esq., and C. E. Mounteer, C.P.A., for the petitioner. E. W. Shinn, Esq., for the respondent. VAN FOSSAN 757 In this proceeding petitioner seeks a redetermination of the income and profits taxes for the fiscal year ending April 30, 1921, for which the Commissioner determined a deficiency of $15,628.37. Of this amount, $13,460.27 has been placed in controversy by the appeal. Petitioner alleges error on the part of the Commissioner in failing to allow as a deduction for the year ending April 30, 1921, an amount of $49,190 representing the undisputed value of certain shares of stock which the petitioner designated as compensation paid to an individual2793 for services rendered. FINDINGS OF FACT. Petitioner is a corporation organized and existing under the laws of the State of Michigan with principal office on the corner of LaFayette Boulevard and Shelby Street, Detroit. Petitioner, formerly called the Sweeney-Huston Co., was organized in 1915, and 758 was engaged in the operating of bowling alleys and billiard rooms in the City of Detroit. The Sweeney-Huston Co. secured a lease on a certain tract of ground for the purpose of erecting a large building for installing billiard and bowling equipment which it intended to operate in conjunction with the business then being carried on. The company enlisted the services of Charles Heddon, one of its stockholders, to assist it in financing the project. It was understood that in the event the project proved successful and financially profitable Heddon would be compensated in a suitable manner for the services rendered. No amount or form of compensation was discussed or agreed on. Heddon thereupon secured an extension of the lease from a 40-year term to a 99-year term. He assisted and was the leader in all negotiations with the Detroit Trust Co. for the sale of a first2794 mortgage bond issue. He induced one of the most successful financial companies in Detroit to place a leasehold loan on a building built especially for bowling, a financial arrangement which had not previously been carried out in the City of Detroit. He also assisted with the selection and installment of equipment, and used his influence in perfecting an arrangement whereby the Brunswick-Balke-Collender Co. installed between $250,000 and $300,000 worth of bowling and billiard equipment in the building without an initial cash payment. He was also of assistance in working out a creditors' agreement by which it was possible for the petitioner to carry on business during the years 1919 and 1920 without interference from the creditors. Heddon also induced various financial people to become stockholders of the petitioner, 13 of whom were bankers, and was responsible for the sale of capital stock of about $100,000 par value. While the new building was being constructed, business was being carried on in a rented building under the management of Irvin Huston, general manager, and Roscoe B. Huston, assistant manager. After the new building was completed the entire operations of the2795 business were under the management of these same two individuals. Heddon rendered no services in the actual operation of the business. Irvin Huston was president and Roscoe B. Huston was secretary-treasurer of the petitioner. Under the by-laws of the petitioner the officers or directors were not entitled to a salary. Irvin Huston, as general manager, received a salary for the year ending April 30, 1920, of $6,833.35, and Roscoe B. Huston, as assistant manager, received a salary for the year ending April 30, 1920, of $5,785.34. Heddon received no regular compensation or salary for the services he rendered. On August 9, 1918, at a meeting of the board of directors, the following resolution was adopted: 759 Resolved that the Sweeney-Huston Company pay Charles Heddon for the preliminary and organization services to date as follows: cash, $6,422.90, (b) $13,333.33 par value of common stock at such future date as the Sweeney-Huston Company might have had net earnings for a period of one year past amounting to 10% paid up to capitalization. The Huston brothers received an equal compensation for their services in the organization of the company. In August, 1920, after2796 receiving the annual audit of the petitioner's books for the year ending April 30, 1920, the petitioner considered that its business project was in such condition that it would be justified in reimbursing Heddon for the services he had rendered. At a special meeting of the board of directors on August 16, 1920, a resolution was passed, which read as follows: Moved by Joseph T. Schiappacasse as follows: that the balance of the Recreation Company's stock now in the treasury, viz, 644 shares of common stock, 2,132 shares of class (a) preferred stock and 143 shares of class (b) preferred stock be voted to Mr. Charles Heddon of Dowagiac, Michigan, as compensation to him for the executive services heretofore rendered the company without stipulated salary. The motion was seconded by William S. Sweeney and unanimously carried. Pursuant to this resolution and shortly thereafter a stock certificate was made out to Heddon for capital stock of a par value of $49,190. On the following day this stock was canceled and new certificates were issued distributing the $49,190 of stock one-third each to Heddon and the two Hustons. The books of the petitioner during the period when the company2797 was being refinanced and the new building constructed and equipped, and up to and including the fiscal year ending April 30, 1921, were kept on an accrual basis. The petitioner, in its income-tax return filed with the Commissioner of Internal Revenue for the fiscal year ending April 30, 1921, charged to expense for that fiscal year $49,190 par value in stock of the petitioner given to Charles Heddon as his compensation for services in financing the company, and deducted that amount from the earnings as an expense for the fiscal year ending April 30, 1921. The Commissioner in computing the taxable income of the petitioner for the fiscal year ending April 30, 1921, disallowed the deduction of $49,190 as an expense for that fiscal year. OPINION. VAN FOSSAN: Petitioner deducted and respondent disallowed as an ordinary and necessary expense for the year ending April 30, 1921, an item of $49,190, the amount representing the par value of certain stock issued to one of its stockholders pursuant to the resolution 760 of its board of directors April 16, 1920, quoted in full in the findings of fact. Said stock was voted "as compensation to him for the executive services heretofore2798 rendered to the company without stipulated salary." The services to which reference was made began in 1916, when the company was expanding its activities, and consisted particularly of negotiations conducted by Heddon in securing the extension of a lease from a 40-year term to a 99-year term; his assistance in floating a bond issue; the sale by Heddon to influential persons of $100,000 of petitioner's stock; arranging for favorable credit terms on equipment purchased, and assisting in adjusting relations between petitioner and its creditors. Substantially all of these services were rendered during 1916, 1917, and 1918. There is no evidence from which we can draw any conclusion of fact as to the nature, extent or value, if any, of Heddon's services subsequent to 1918. The inference is that they were minor or negligible. When Heddon's active assistance was first enlisted there was an oral understanding between him and the Hustons that if the business proved successful Heddon would be appropriately compensated. Whether this understanding attained to the dignity of a binding legal obligation it is not necessary to decide. However, no terms were fixed; no standards of value were2799 set up; no payment was to be made unless and until success was achieved; there was no obligation that could be accrued each year on petitioner's books. Cf. . The obligation first became fixed in 1920, pursuant to the resolution of the board of directors. Though the compensation was voted in 1920, the facts show that there was no causal or direct relation between it and the services rendered in the taxable year. It was actually in consideration of services rendered in prior years and by no stretch of reasoning could be held, on the record before us, to be reasonable compensation for services rendered in the year 1920. See ; . Furthermore, it is fundamental that to be allowable not only must the expense be incurred in the taxable year, but, if in compensation for services, it must be reasonable in amount. We have considerable evidence of the nature of the services performed but we are furnished no gauge or standard by which they should be tested to ascertain their value of the reasonableness of the amount allowed. Were this the2800 only question confronting us we would be left very largely to conjecture as to the reasonable worth of the services. Yet another obstacle besets petitioner's path in the nature and character of the services rendered. So far as the record shows the services were chiefly of aid in perfecting petitioner's capital structure and fall within the category of capital expenditures. See J. Alland& 761 Bro., inc.,; . In any event, it is impossible on the record to segregate clearly the services of a capital nature from those which might be classed as expense. In view of our conclusion indicated above it is unnecessary to discuss the legal effect of the cancellation, on the day following its issuance to Heddon, of the stock certificate and the reissuance of the same aggregate amount to Heddon and the two Hustons in equal shares. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624587/	ESTATE OF HAROLD C. SCHOTT, DECEASED, HOWARD J. VANDEN EYNDEN AND L. THOMAS HILTZ, CO-EXECUTORS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Schott v. CommissionerDocket No. 5283-78.United States Tax CourtT.C. Memo 1982-222; 1982 Tax Ct. Memo LEXIS 528; 43 T.C.M. (CCH) 1188; T.C.M. (RIA) 82222; April 26, 1982. 528 The top management employees of the Evendale operations of Avco sought to purchase that operation. The primary source of income of Evendale was from the manufacture and sale of high technology components to the U.S. Government. In order to effect the purchase, the employees organized CEC. The purchase could not be consummated without providing performance bonds covering the government contracts. After extensive negotiations, Harold Schott, an unrelated party, agreed to provide collateral for the performance bonds, to purchase and lease back the land and buildings of Evendale, to acquire a substantial block of stock of CEC for cash, and to provide a line of credit of $ 500,000. CEC paid Schott cash of $ 90,000, issued an option to purchase stock warrants and agreed to redeem Schott's stock at Schott's option at an agreed price between 18 and 30 months after closing. The arrangement with Schott provided the necessary capital for CEC to acquire the Evendale operation and provided the capital necessary for CEC to carry on Evendale's business. After the purchase, CEC prospered and it redeemed Schott's stock at the agreed price before the 18-month period elapsed. Schott exercised529 his option to purchase the warrants. Schott reported the gain from redemption of his stock as capital gain but CEC allocated most of the redemption cost to Schott's option to have his stock redeemed and CEC amortized it as performance bond expense. Held, the agreements between Schott and CEC were at arm's length; the form of the agreements coincides with its economic substance; and Schott is entitled to report the gain from redemption as capital gain. Carter Bledsoe,Thomas F. Allen,Eric M. Oakley and Frederick L. Fisher, for the petitioner. Carolyn M. Parr, for the respondent. GOFFEMEMORANDUM FINDINGS OF FACT AND OPINION GOFFE: Judge: The Commissioner determined deficiencies in the decedent's Federal income taxes in the amount of $ 508,200 for the taxable year 1973 and $ 306,641.56530 for the taxable year 1974. The respondent, in two amendments to his Answer, claimed increased deficiencies and raised additional issues and theories. The following issues are presented for our decision: 1. To what extent, if any, did the decedent realize ordinary income either upon receipt of the option to have his stock in CEC redeemed or upon the redemption of his stock? 2. Did the decedent realize ordinary income as a result of his purchase and leaseback of the land and buildings used by CEC? 3. To what extent, if any, did the right to purchase warrants to purchase stock or the subsequent transfer or redemption of such warrants result in the realization of income to the decedent? FINDINGS OF FACT Some of the facts are stipulated. The stipulations of facts and stipulated exhibits are incorporated herein by this reference. Harold C. Schott timely filed his individual Federal income tax returns for the taxable years 1973 and 1974, during which time he resided in Lakewood, Ohio. Harold J. vanden Eynden and L. Thomas Hiltz, the personal representatives of the Estate of Harold C. Schott, were fiduciaries with legal residence in Cleveland, Ohio, at the time they filed531 the petition in this case. A statutory notice of deficiency for the taxable years 1973 and 1974 was mailed to petitioner on March 1, 1978. The Commissioner, for protective reasons, asserted deficiencies in his statutory notice for the same adjustment in both 1973 and 1974 but concedes that petitioner is taxable in only one of the two years. On April 13, 1978, petitioner filed an amended Federal income tax return with respect to Mr. Schott's 1974 tax liability for the purpose of protecting itself from double taxation in the event that all or part of the 1973 deficiency is sustained. CEC is an Ohio corporation which was organized on September 13, 1972. It was organized for the purpose of acquiring all of the assets and business of the Evendale operation of the Avco Electronics Division ("Evendale") of Avco Corporation ("Avco"). CEC was organized by George Mealey, Raymond Rack, Allan Murray, Donald Huckins and J. J. King (collectively, the "Organizers"). At the time CEC was organized, each of the Organizers was a management employee of Evendale. Mealey was General Manager of Evendale. He was also Chairman of the Board, President, and Chief Executive Officer of CEC. Rack532 was Controller of Evendale and was also Executive Vice President of Finance and Treasurer of CEC. Huckins was Director of Finance for Evendale and was also Controller for CEC. Evendale was engaged in the business of designing and producing electronic equipment in a broad variety of product areas, including ground and airborne tactical communications equipment, space electronics, radar and infrared systems, and electronic countermeasures hardware. The vast majority of Evendale's products were produced for the United States Government pursuant to contracts with the Department of Defense. By letters dated August 23, 1972, and September 18, 1972, the Organizers agreed in principle to purchase, and Avco agreed in principle to sell, the assets and business of Evendale at a price equal to the net book value of Evendale (as shown on a balance sheet of Evendale prepared as if Evendale were a separate corporation) as of November 30, 1972. On October 7, 1972, the Organizers transferred to CEC their rights in the agreement with Avco, and in certain commitments relating to the financing of the purchase of Evendale, in exchange for 54,000 shares of CEC class B common stock. When the purchase533 and sale of Evendale was not completed by November 30, 1972, the date for determining the purchase price was amended to the date of closing of the purchase and sale (the "Closing Date"). Avco's agreement to sell the assets and business of Evendale was conditioned upon successful negotiation of a definitive agreement and approval of that agreement by the boards of directors of Avco and CEC. Avco requested that, prior to commencement of negotiations on such a definitive agreement, the Organizers provide assurance (a) that they had made arrangements in principle for sufficient financing to complete the proposed purchase and to carry on the business of Evendale and (b) that appropriate novation (transfer of responsibility for performance) arrangements satisfactory to Avco could be arranged with the principal customers of Evendale. The Organizers were persons of limited financial means and anticipated being able to raise, among themselves and other Evendale employees, a starting equity capital for CEC of $ 500,000 to $ 650,000. The Organizers estimated that the purchase price for Evendale would be approximately $ 10 million. Potential or actual participants in the financing of534 the Evendale acquisition by CEC were provided with copies of a "Blue Book." The book outlined CEC's proposed financing plan and included pro forma statements of CEC's condition after the acquisition. This Blue Book was revised and updated periodically. By November 10, 1972, the Organizers had obtained the following outside financial commitments to provide CEC's estimated required starting equity and the estimated purchase price for Evendale. SourceAmountTypeChandler Leasing Division$ 1,000,000Sale/Leaseback of Machineryof PepsiCo Leasing Corp.and EquipmentSidney Meyers & Associates$ 3,410,000Sale/Leaseback of Land andBuildingsCommercial Credit Business$ 4,500,000Factoring of AccountsLoans, Inc./First NationalReceivable and InventoryBank of CincinnatiJ. E. McDonald, Jr.$ 318,275Sale of Mortage NoteFirst National Bank of$ 460,000Short Term CreditCincinnati$ 9,688,275The agreement with Avco required the Organizers to arrange for satisfactory novation of Evendale's contracts with the United States Government, the principal customer of Evendale. Novation of United States Government defense contracts is535 governed by the Armed Services Procurement Regulations. In the case of CEC's purchase of Evendale, these regulations required either that Avco remain secondarily liable for performance of the contracts or that CEC post performance bonds in an appropriate amount. Avco refused to remain secondarily liable for CEC's performance, thereby necessitating that CEC obtain performance bonds. CEC encountered great difficulty in obtaining the required performance bonds. CEC employed, among others, Thomas Klinedinst ("Klinedinst"), President of Thomas E. Wood, Inc., an insurance agency, to obtain the required performance bonds. Mr. Klinedinst was an agent of United States Fidelity and Guarantee Company ("USF&G"), a surety company. When Mr. Klinedinst contacted USF&G concerning performance bonds, the immediate reaction of the surety company was that CEC was too thinly capitalized. Mr. Klinedinst contacted a number of other surety companies in his search. Several companies explained that they were not interested because it was a one-shot deal, that is, there would not be a continuing relationship requiring bonds. Other surety companies indicated that they had already rejected CEC before536 and that they would not reconsider their decisions. Based upon his conversations with USF&G, Mr. Klinedinst believed the performance bonds would be issued if additional equity capital were contributed to the corporation. The Organizers, therefore, began in late October, 1972, to explore the possibility of raising an additional $ 750,000 of equity capital and obtaining a letter of credit of equal amount from the First National Bank of Cincinnati (the "Bank"), both of which could be posted as security with any surety company willing to issue performance bonds. On October 23, 1972, Mealey met with Vincent Crisci, President of the Whitehall Group, Inc. (a corporate development firm specializing in venture capital, private placements, mergers, acquisitions, and divestitures), to discuss possibilities for raising the additional equity capital through a private placement. In late November or early December, 1972, without informing the Organizers, Klinedinst contacted Schott regarding CEC. Klinedinst had known Schott for a number of years because his insurance agency did a substantial amount of business with Schott's interests. Klinedinst contacted Schott because he had determined537 that, based on CEC's then existing financing plans and capabilities, it would be impossible to obtain the required performance bonds. Klinedinst described CEC's need to Schott as greater equity capital. They did not discuss collateralization of the performance bonds because Klinedinst believed that the reluctance of the surety company would be overcome with the infusion of additional equity capital. Schott asked Klinedinst for his personal assessment of the Organizers, the possibilities and pitfalls in the contracts CEC would acquire from Evendale, the reasons behind the performance bond requirement, the exposure that a performance bond would entail, and the events which could trigger a loss on the performance bonds. Schott's first direct contact with the Organizers occurred on December 28, 1972. This first meeting was arranged by Harold Kling, a Cincinnati real estate broker, as an inspection tour of Evendale's land and buildings. After the inspection tour, the parties met in the board room which was part of Mr. Mealey's office. Those present were Schott, Mealey, Kling, Jay Eckert (an associate of Schott), Marty Byrnes (an associate of Schott) and Jerry King, one of the Organizers.538 At this meeting Mealey indicated to Schott that CEC needed a total of $ 9.8 million to purchase Evendale from Avco, an additional $ 1 million for working capital, and performance bonds for the novated contracts. Schott indicated that he was interested in purchasing and leasing back the land and buildings and that, as CEC was looking for additional equity, he was also interested in acquiring enough CEC stock that he might be able to realize a sizable capital gain within a few years. Because CEC was a very high-risk, high-leverage situation, Schott also wanted voting control of CEC. At the same time that the Organizers were negotiating with Schott, they were also exploring other possibilities for restructuring the financing of CEC in order to solve the bonding problem. One of those possibilities involved Narragansett Capital Corporation ("Narragansett"). Among other things, the proposal submitted by Narragansett to Mealey called for Narragansett and the Organizers to each own 50 percent of CEC's voting stock. This proposal would have permitted the Organizers subsequently to acquire additional stock, but such additional stock would have been non-voting. Another of those possibilities539 involved LaPointe Industries, Inc. ("LaPointe"). LaPointe's proposal called for a merger of LaPointe and CEC immediately after the purchase of Evendale, with the shareholders of LaPointe having control of the combined entity after the merger. A specific goal of the Organizers was to have voting control of CEC. Negotiations between Mealey and Schott continued after the initial meeting until January 7, 1973. During these negotiations, Mealey, Klinedinst, and Schott discussed various alternative forms for a $ 500,000 capital investment in CEC by Schott, which Klinedinst believed was necessary to satisfy the surety company. These alternatives included convertible debentures, preferred stock, and common stock. These negotiations of necessity required that their resolution meet with the approval of USF&G. USF&G was the only surety company that indicated any willingness to work out a reasonable performance bond arrangement with CEC. USF&G did not indicate to Klinedinst what changes in CEC's financial structure would be necessary for it to agree to issue the bonds but instead reacted, favorably or unfavorably, to proposed changes developed by the Organizers and communicated to Klinedinst. 540 Mealey and Klinedinst were the primary movers in suggesting alternative forms for Schott's participation in CEC which might prove acceptable to USF&G. Schott would then react to their suggestions. USF&G rejected all forms of Schott's investment in CEC except his purchase of common stock. On January 3, 1973, Avco notified the Organizers that it was terminating negotiations on the sale of Evendale as of the opening of business on Monday, January 8, 1973, unless all substantive problems in the transaction were resolved to Avco's satisfaction by that time. Mealey called Schott's associate, Jay Eckert ("Eckert"), and told him that if an agreement were to be reached with Mr. Schott it would have to be done before 8:00 Monday morning. Eckert then talked to John McDowell ("McDowell"), CEC's attorney, who drafted an agreement and gave it to Eckert on January 6th. The parties met the following day, Sunday, January 7th, at the home of one of Schott's relatives, Marge Schott. The major participants at the meeting were Mealey, Schott, Eckert, and McDowell. Later Klinedinst and others were called. The parties had previously considered an arrangement whereby Schott would purchase class541 A stock and would have the right to cause CEC to redeem this stock at a set price during a certain period of time in the future. At the meeting, Schott requested that the redemption price at which his shares could be redeemed by CEC be increased to $ 1,300,000 from $ 1,000,000, to which Mealey agreed. By the end of the meeting, Schott and Mealey reached an agreement on Schott's participation in the CEC acquisition of Evendale. Under this agreement Schott would provide the necessary capital but would receive only a minority voting interest in CEC. Two memoranda of understanding were executed at the meeting. In final form, they provided that: (a) Schott would fully collateralize, in a form satisfactory to the surety company, the performance bonds required to effect novation of Evendale's government contracts. The projected amount of the performance bonds was approximately $ 7.5 million. CEC would pay the premiums on the performance bonds. (b) Schott would purchase the land and buildings (being acquired from Evendale) for $ 3 million and would lease them back to CEC for a period of 20 years under a net-net lease 1 yielding a 12-percent annual return on the purchase price.542 The lease would provide that Schott could sell (free from CEC's leasehold interest) that part of the land (approximately 39 acres) which was not being used in Evendale's operations as of the Closing Date. (c) Schott would purchase 16,667 shares of CEC common stock at a price of $ 30 per share (total price: $ 500,010). (d) CEC would grant Schott an option (the "Option"), exercisable between the 18th and 30th months after the Closing Date, to require CEC to redeem all or any portion of his shares at $ 78 per share. The Option applied only with respect to his shares and the Option was not transferable by Schott. (e) Schott would provide a secondary line of credit in the amount of $ 500,000 to CEC for a period not to exceed 24 months, with interest at 1 percent over the prime rate. CEC would use its best efforts to increase the Bank's commitment to provide short-term credit from $ 500,000 to $ 1,000,000. (f) Schott and Eckert would be elected as two of the seven members of CEC's543 Board of Directors and would continue in that capacity until the last to occur of (1) expiration or termination of the performance bonds which Schott had collateralized or (2) expiration of the Option. (g) CEC would provide an office for use by Schott and Eckert, part-time secretarial assistance to Schott and Eckert, a car for use by Eckert, and reimbursement of actual expenses incurred by Schott and Eckert on CEC business (up to $ 2,000 per month). After being shown at least one of the memoranda of agreement, but possibly unaware of the Option aspect of the agreement, Klinedinst then wrote a letter dated January 7, 1973, which was typed at Marge Schott's house. The letter states that, based upon the agreement which had been shown to Klinedinst, insuring full collateralization (in a form satisfactory to the surety company) of all required performance bonds, Klinedinst's agency would arrange for a surety company to issue the bonds. After the agreements were signed, Schott wrote out a check for $ 500,000 and gave it to Mr. Klinedinst. In addition to his position as president of Thomas E. Wood Insurance Co., Klinedinst was also a director of the Bank, and he agreed to deposit544 the check first thing the following morning. The following morning Mealey telephoned James R. Kerr, President of Avco. Mealey and McDowell read to Mr. Kerr, Klinedinst's letter and the memorandum of agreement with Schott. After checking with the Bank to ascertain that Schott's check had been deposited, Kerr called back to confirm that the sale would go through. On January 8, 1973, Avco agreed to guarantee all "cost-plus" type contracts. On or about January 18, 1973, an updated Blue Book was prepared. This Blue Book reflected the participation of Schott in the CEC acquisition of Evendale. The pro forma financial statements in the January 18, 1973, Blue Book did not reflect any change (from those in the previous Blue Book of December 11, 1972) either in CEC's projected gross earnings for 1973 ($ 2,005,000) or in its projected state and Federal income tax liabilities for 1973 ($ 837,000) as a result of Schott's participation in the CEC-Evendale acquisition. The pro forma financial statements in the January 18, 1973, Blue Book projected after-tax earnings for CEC during 1973-1975 of approximately $ 1 million per year. Mealey projected that CEC's stock would be valued at a price/earnings545 ratio of 10 in 1974-1975. Based on projected earnings of $ 1 million per year and projected price/earnings ratio of 10, Mealey expected that CEC's stock would have an aggregate value of approximately $ 10 million in 1974-1975. The Shares to be purchased by Schott represented approximately 17 percent of the common stock of CEC as of the Closing Date. Based on an expected aggregate value of $ 10 million for CEC's stock, Mealey expected the Shares would have a value of approximately $ 1.7 million in 1974-1975. Mealey believed that the Option, pursuant to which CEC could be required to redeem the Shares for approximately $ 1.3 million, was a good financial deal for CEC. After the agreement was reached on January 7, 1973, negotiations on the performance bonds began. USF&G indicated that it would accept as security for the bonds either collateral or a personal indemnity from Schott. Klinedinst advised Schott to post collateral rather than act as an indemnitor because, so long as the collateral required was less than 100 percent, Schott would incur less risk with collateral. On January 9, 1973, Mealey, Klinedinst, and Schott met in Klinedinst's office. At that meeting, Schott546 was extremely angry because USF&G had indicated that it would require 100 percent collateral. That requirement far exceeded the amount that Schott had been led to believe would be necessary in order to obtain the performance bonds. After the January 9, 1973, meeting, Klinedinst contacted USF&G to get the collateral requirement reduced. He indicated to USF&G that Schott would be monitoring CEC's finances and its performance on the contracts covered by the performance bonds. He also indicated that Schott had the financial and operational abilities and contacts to step into the situation if CEC appeared headed for default. On the basis of this information, USF&G agreed to reduce the collateral requirement to 50 percent. The Closing Date was originally scheduled for March 8, 1973. On March 7, 1973, L. Thomas Hiltz, an attorney for Schott, telephoned John McDowell, an attorney for CEC, and informed him that an agreement as to an amount to be paid Schott for collateralizing the performance bonds had to be reached before the scheduled closing could go forward. CEC was to pay USF&G a premium of $ 65,000. After heated negotiations, it was agreed that Schott would be paid $ 90,000547 in installments ($ 30,000 on the Closing Date and $ 10,000 per month for six months thereafter) and would be granted the right to purchase stock warrants (the "Warrants") at $ .10 per Warrant. Each Warrant entitled Schott to purchase, for a period of five years, one share of CEC class A common stock at an exercise price of $ 30 per share. Similar warrants were purchased by almost all of the shareholders. Schott assigned the right to purchase 200 of the Warrants to Howard J. vanden Eynden ("vanden Eynden"), a business associate. On March 9, 1973, the purchase of Evendale by CEC was closed. The purchase price, determined under the formula provided in the agreement of purchase, was $ 9,270,001.13, which was paid in cash at the closing. The shareholders of CEC as of the Closing Date were as follows: Equity HoldingsTotalNameClass AClass BWarrantsInvestmentMealey6,66633,2325,000$ 200,480.00Rack5,00017,3721,000150,100.00Murray1,6661,51149,980.00Huckins83375524,990.00King1,2501,13050037,550.00Other current or former3,6654,233110,373.30CEC employeesSchott16,667466500,056.60vanden Eynden20020.0035,74754,00011,399$ 1,073,549.90548 Each shareholder paid $ 30 per share for class A common stock, no cash consideration for class B common stock, and $ .10 per warrant for warrants to purchase class A common stock. CEC's class A and class B common stock were identical except that the class A common stock was entitled to a $ 35 per share liquidation preference and that no cash dividends could be declared on the class B common stock. The class B common stock was convertible into class A common stock in accordance with a formula based on the accumulated earnings of CEC. The certificates issued to Schott to evidence the Shares were identical to all other certificates evidencing CEC class A common stock. Schott's purchase of the Shares was carried on the books of CEC as equity capital. CEC's initial financing sources, which were used to meet the purchase price for Evendale and to provide working capital for the conduct of CEC's business, were as follows: SourceAmountTypeChandler Leasing Division of$ 1,000,000Sale/Leaseback of MachineryPepsiCo Leasing Corp.and EquipmentSchott$ 3,000,000Sale/Leaseback of Landand BuildingsCommercial Credit Business$ 3,987,000Factoring of Accounts ReceivableLoans, Inc.and InventoryIndustrial National Bank of$ 383,000Sale of Mortgage NoteProvidence, Rhode IslandOrganizers and current or1 $ 572,400Private Equityformer employees of CECSchott1 $ 500,010Private EquityFirst National Bank of$ 500,000Secured Line of CreditCincinnatiSchott$ 500,000Unsecured Secondary Lineof Credit549 As of the Closing Date, the land and buildings acquired by CEC had a net book value, on the books of Evendale, of approximately $ 1.7 million. The conveyance of the land and buildings by general warranty deed from Avco to CEC and the conveyance by general warranty deed by CEC to Schott were simultaneous. Schott's $ 3,000,000 purchase price for the land and the buildings was wired directly to Avco to meet the cash purchase obligation of CEC. Schott's purchase and leaseback of the land and buildings were evidenced by a purchase agreement, a deed, a receipt for the purchase price, a lease, a memorandum describing the terms of the lease, and a landlord's waiver permitting Chandler Leasing to have its equipment on the property. This arrangement is known as a "straight pass-through sale/leaseback arrangement" whereby CEC acquired all of the assets, including the real estate, business, and contracts of Evendale, and then passed the land and buildings through to the ultimate owner and lessor, Schott. Schott provided a secondary line of credit in the amount of $ 500,000 with interest at 1 percent over prime, i.e., 7.25550 percent. This was the same rate of interest as the rate charged by the Bank on its line of credit to CEC. As finally determined, the total amount of performance bonds required by the government on novated contracts was $ 6,500,000. Schott provided collateral for these bonds in the total amount of $ 3,250,000. As a further condition of the issuance of these bonds, USF&G required Mealey, Rack, and Murray to become jointly and severally obligated with CEC for any loss arising by reason of CEC's default in performance on the contracts covered by the performance bonds. With respect to five contracts with nongovernmental customers of Evendale, CEC arranged with the Bank to issue a letter of credit in favor of Avco in the amount of $ 200,000 to secure CEC's performance of these contracts. Additionally, Schott agreed to provide collateral in favor of Avco as security for CEC's performance on the contracts in the aggregate amount of $ 425,000. Schott thus provided total collateral of $ 3,675,000. Both types of collateral posted by Schott were initially provided in the form of letters of credit issued by the Bank. These were subsequently replaced by certificates of deposit held551 by the Bank on behalf of USF&G. Interest on the certificates of deposit accrued for the benefit of Schott. All of the minority shareholders had repurchase agreements with CEC. The terms of these agreements, other than the Schott repurchase agreement, are not entirely clear. These agreements with the minority shareholders other than Schott appear to provide that CEC would pay the minority shareholders the greater of $ 30 a share or book value, and that if the minority shareholder wanted to sell to an outsider, CEC had an option period during which it could purchase the stock by matching the outside offer. The repurchase agreement of Schott, who was also a minority shareholder, differed from the above description and complied with the terms bargained for at the January 7, 1973, meeting. Schott's repurchase agreement became effective on March 9, 1973, the date on which he actually acquired his shares, so that the time for exercising his Option began to run on that date. On May 15, 1973, a special meeting was held of the shareholders of CEC. At that special meeting, a "Summary of Closing of the Purchase of the Evendale Operation and Related Transactions on March 9, 1973" was552 distributed to all shareholders. The Summary was prepared and distributed on advice of CEC's legal counsel. The purpose of the Summary was to protect CEC from liability under the blue sky laws of Ohio, which requried full disclosure to CEC's shareholders of all aspects of the Evendale purchase. The Summary lists the major items of expense incurred by CEC in connection with the performance bonds and collateralizing the bonds as $ 65,000 paid to USF&G and $ 90,000 paid to a corporation controlled by Schott. The Summary does not list any amount associated with the Option, with the Warrants, or with a "bargain purchase" of the land and buildings as an expense incurred in connection with the performance bonds or providing collateral. After the close of CEC's first fiscal year (September 30, 1973) the Organizers, who were now the officers of CEC, discussed matters with their accountants and decided, for the first time, to treat the Option for redemption of Schott's stock as part of the performance bond expense and thus amortize it for Federal income tax purposes. At that time, CEC hired an appraiser to value the Option as of the Closing Date and began amortizing the appraised value553 of the Option over the life of the contracts covered by the performance bonds. CEC did not treat the issuance of the Warrants or any "bargain purchase" on the land and buildings as an expense (in connection with the performance bonds or otherwise) for financial or Federal income tax purposes. When Shott learned of CEC's treatment of the Option for Federal income tax purposes, "he did not like it." By January 1974, CEC had settled a contract dispute which had arisen between the United States Government and Evendale. As a result of that settlement, CEC was to receive sufficient cash in early 1974 to fulfill its obligations under the Option. At the January 18, 1974, meeting of CEC's Board of Directors, Schott was asked if it were his intent to exercise his option in 18 months, and whether he was interested in an earlier exercise. He expressed an interest and the Executive Committee was directed to develop an offer for early redemption of the Shares. During the Board meeting, Schott also indicated his desire to transfer his remaining Warrants to vanden Eynden. The Board approved the proposed transfer of 466 Warrants from Schott to vanden Eynden and authorized waiver of the non-assignability554 condition with regard to the Warrants. Schott rejected initial offers by CFC to repurchase the Shares for less than $ 78 per share. On March 25, 1974, Schott sold his remaining 466 Warrants to vanden Eynden for $ .10 per Warrant. The early repurchase of the Shares was completed on April 3, 1974, at a meeting of the Executive Committee of CEC. The final terms were carried out as follows: (a) CEC repurchased the Shares at $ 78 per share. The purchase price was paid in two installments ($ 800,026 on April 3, 1974, and $ 500,000 on August 15, 1974). (b) Schott granted CEC an option to purchase the land and buildings leased from Schott for $ 5,000,000. Schott also granted CEC a right of first refusal on that property. (c) CEC released Schott from his obligaton to provide the secondary line of credit. Schott resigned from CEC's Board of Directors that same day. On September 30, 1974, CEC repurchased the Warrants from vanden Eynden for $ 50 each. The Commissioner's notice of deficiency, dated March 1, 1978, and issued to the Estate of Harold C. Schott, determined a deficiency in petitioner's Federal income taxes for both the taxable year 1973 and the taxable year555 1974. The Commissioner determined as to the taxable year 1973: (a) It is determined that during the tax year 1973, you received commissions and fees of $ 726,000 from Cincinnati Electronics Corporation that were not reported on your income tax return. Accordingly, your taxable income is increased $ 726,000. He determined as to the taxable year 1974: (a) In your income tax return for 1974 you reported a long-term capital gain from the sale of 16,667 shares of Cincinnati Electronics Corporation stock in the amount of $ 800,016. It is determined that $ 726,000 of the reported gain represents ordinary income from commissions and fees from Cincinnati Electronics Corporation. Accordingly, your taxable income is increased $ 726,000. Respondent filed an Amendment to his Answer, wherein he alleged: (e) The transactions discussed in subparagraphs 7(a) through 7(c) [Schott's participation in the CEC purchase of Evendale] were in substance a loan by Schott of moneys to CEC, and the receipt by Schott of interest income (Theory 1). (f) In the alternative, the transactions discussed in subparagraphs 7(a) through 7(c) resulted in substance in the performance of services by Schott, 556 and the receipt by Schott of compensation for services rendered (Theory 2). (g) In the alternative, the transactions discussed in subparagraphs 7(a) through 7(c) resulted in the receipt by Schott of ordinary income representing commissions and fees (Theory 3). Respondent further alleged in his Amendment to Answer: (k) Under Theories 1, 2, or 3, Schott's reported $ 800,016 gain is includable in 1973 and not 1974, and as ordinary income and not as capital gain. This results in a deficiency in income tax due from the petitioners for the taxable year 1973 in the amount of $ 560,011.20. This deficiency is $ 51,811.20 more than that stated in the statutory notice of deficiency for the year 1973. Respondent hereby claims an increased deficiency in income tax in the amount of $ 51,811.20 for the year 1973, under I.R.C. sec. 6214(a). Respondent alleged that this income is properly included in the taxable year 1973, but in the alternative argued for inclusion in the taxable year 1974. Subsequent to his Amendment to Answer, respondent filed a Second Amendment to Answer, wherein he alleged: (a) Certain negotiations between petitioners' decedent Harold C. 557 Schott ("Schott") and Cincinnati Electronics Corporation ("CEC") are described in paragraph 7 of respondent's first amendment to answer filed in this case on April 4, 1979. In addition to the option to compel CEC to repurchase his stock at a minimum profit of $ 800,016 (as described in paragraph 7), Schott bargained for and received the following benefits which were ordinary income to him: (1) A payment of $ 90,000 cash. This was paid in two installments in 1973 to Schott's controlled corporation, American National Corporation at Schott's direction. (2) A bargain in the amount of at least $ 410,000 on the purchase-leaseback of the land and buildings being used by CEC. (3) The right to purchase 666 warrants at $ .10 each. Each warrant entitled Schott for a period of five years to purchase one share of Class A stock at $ 30 per share. These warrants were redeemed by CEC for $ 50 each in 1974, for a total profit of $ 33,233.00. Respondent contends they had a value of $ 30,000 in 1973. (b) Schott failed to report as income either the cash, or the value of the bargain purchase, or the value of the warrants in either 1973 or 1974. (c) The cash, bargain on the purchase-leaseback, 558 and the warrants received by Schott were all in the nature of additional interest or loan fees, commissions, bonding premiums, compensation for services, or any combination of these, or other income taxable as ordinary income.(d) The amounts described in subparagraph 8(a)(1), (2) and (3) should have been included in Schott's ordinary income in 1973, in the total additional amount of $ 530,000. Alternatively, if it is determined that the warrants did not have an ascertainable value in 1973, then the transaction remained open until the warrants were sold in 1974. In that event, the amount of $ 33,233 should be included as ordinary income to Schott for 1974. (e) Alternatively, if the warrants were not received as additional interest, fees, compensation or other ordinary income, they were taxable to Schott as gains from the sale of capital assets in the year or years in which they were transferred or redeemed. Respondent claimed increased deficiencies with respect to the allegations in his Second Amendment to Answer. ULTIMATE FINDING OF FACT The agreement between Schott and CEC was carefully negotiated and represents an arm's-length agreement between unrelated parties. The559 economic reality of this agreement is that Schott made an equity investment in CEC pursuant to the formal terms of the agreement, purchased CEC's land and buildings at fair market value, and received the right to purchase CEC warrants at fair market value. OPINION The issues presented for our decision all emanate from the transactions between the decedent and CEC in 1973 and 1974. In amending his answer twice, respondent alleged that Schott received ordinary income either when he received the option to have his stock in CEC redeemed or when his stock was redeemed. In addition, respondent alleged that Schott received ordinary income from a bargain purchase of the land and buildings in 1973 and ordinary income upon the receipt of the right to purchase warrants to purchase CEC stock in 1973, or ordinary income or capital gain upon the disposition of such warrants in 1974. It is the position of respondent that the economic substance of the transactions between CEC and Schott did not conform to the form of the transactions used by them. He argues that the taxable events result in realization of ordinary income under several theories, i.e., interest, loan fees, commissions, bond560 premiums, or compensation for services.In the alternative, respondent determined that if the stock warrants had no ascertainable fair market value in 1973 when received by Schott that the transaction remained open until 1974 when Schott disposed of them and their sale resulted in ordinary income in 1974. Also, in the alternative, if the warrants were not received as ordinary income, their disposition in 1974 resulted in realization of capital gain.Petitioner maintains that the economic reality of the transactions between the decedent and CEC coincides with the formal agreement and actions of them. A number of management employees of a portion of a division of Avco known as Evendale learned that Avco wanted to sell their portion of the company. They saw before them the opportunity of a lifetime. With the confidence of vision, they mortgaged their homes and future and began to piece together the many components that would be necessary to make the purchase and to set the new company upon a sound basis. They obtained an agreement in principle with Avco to purchase Evendale at net book value. Prior to beginning negotiations on an actual agreement, however, Avco required that561 the Organizers provide it assurance (a) that they had arrangements in principle for sufficient financing to complete the proposed purchase and to carry on the business of Evendale and (b) that they make arrangements for appropriate novation agreements with the customers of Evendale which would be satisfactory to Avco. The Organizers lined up tentative sources of financing which would put them reasonably close to the amount of financing they expected to need, provided there were no unforeseen snags in the financing on the date of closing or on the basis of the finalized agreement. The inevitable snag which more often than not afflicts such business deals arose, however, in novation. The vast majority of the business that the Organizers hoped to acquire consisted of manufacturing under government contracts. The novation of these contracts proved extremely difficult. Novation of these contracts, under government regulations, required either that the new corporation, CEC, post performance bonds or that Avco remain secondarily liable for performance on the contracts. Avco refused to remain secondarily liable for CEC's performance so CEC had to seek performance bonds. These performance562 bonds were not easily found.CEC was turned down by numerous surety companies. Thomas Klinedinst, president of an insurance agency and one of the people CEC used in its search for financing, was more encouraging. Although USF&G, a surety company which he represented, turned down CEC's initial request, he believed they would provide the needed bonds if there were additional equity capital invested in the corporation. The Organizers proposed, at that time, to provide equity of only $ 500,000 to $ 650,000 on total financing in the neighborhood of $ 10,000,000. With this encouragement, CEC sought additional capital. Mr. Klinedinst contacted Harold Schott, with whom he had had previous business dealings. Mr. Schott was initially primarily interested in acquiring CEC's land but did have extensive venture capital experience and appeared receptive to Klinedinst's proposal that he provide the additional capital that CEC needed. On December 28, 1972, after being given an inspection tour of the Evendale plant, Schott and two of his associates met with George Mealey, the head of the Organizers. Schott explained at this meeting that he would be willing to provide a significant amount of venture563 capital but that he also wanted a sizable return on his investment within a few years. He also expressed interest in purchasing CEC's land and buildings which he would then lease back to CEC.In view of the high-leverage, high-risk nature of the proposed deal Schott wanted voting control, which was very possible as he was looking to provide almost one-half of all the equity capital that was needed. At the same time that the Organizers were negotiating with Schott, they were also exploring other possibilities for restructuring the financing of CEC.As with Schott, they found that such venture capital would be accompanied by a loss of control, contrary to their goals. On January 3, 1973, Avco notified the Organizers that it was terminating negotiations on the sale of Evendale as of the opening of business on January 8, 1973, unless all substantive problems in the transaction were resolved to Avco's satisfaction by that time. In previous negotiations CEC and Schott had discussed an equity investment by Schott with a repurchase agreement whereby Schott would have the option to cause CEC to redeem his stock at a set price during a specified period of time in the future. An equity564 investment was chosen because USF&G rejected any form of investment by Schott other than common stock. CEC's attorney drafted a proposed agreement which he gave to one of Schott's associates on January 6. The parties met the following day. As part of the long and deliberate negotiations, Schott requested that the redemption price at which he could sell his shares back to CEC be increased to $ 1,300,000 from $ 1,000,000, to which Mealey agreed. An agreement was reached. Under the final agreement Schott did not have voting control. He was given two seats on the board of directors. In final form the terms of the agreement provided that: (a) Schott would fully collateralize, in a form satisfactory to the surety company, the performance bonds required to effect novation of Evendale's government contracts. The projected face of the performance bonds was approximately $ 7.5 million. CEC would pay the premiums for the performance bonds. (b) Schott would purchase the land and buildings (being acquired from Evendale) for $ 3 million and would lease them back to CEC for a period of 20 years under a net-net lease yielding a 12-percent annual return on the purchase price. The lease would565 provide that Schott could sell (free from CEC's leasehold interest) that part of the land (approximately 39 acres) which was not being used in Evendale's operations as of the Closing Date. (c) Schott would purchase 16,667 shares of CEC common stock at a price of $ 30 per share (total price: $ 500,010). (d) CEC would grant Schott an option (the "Option"), exercisable between the 18th and 30th months after the Closing Date, to require CEC to redeem all or any portion of his shares at $ 78 per share. The Option applied only with respect to his shares and was not transferable by Schott. (e) Schott would provide a secondary line of credit in the amount of $ 500,000 to CEC for a period not to exceed 24 months, with interest at 1 percent over the prime rate. CEC would use its best efforts to increase the Bank's commitment to provide short-term credit from $ 500,000 to $ 1,000,000. (f) Schott and Eckert would be elected as two of the seven members of CEC's Board of Directors and would continue in that capacity until the last to occur of (1) expiration or termination of the performance bonds which Schott had collateralized or (2) expiration of the Option. (g) CEC would provide566 an office for use by Schott and Eckert, part-time secretarial assistance to Schott and Eckert, a car for use by Eckert, and reimbursement of actual expenses incurred by Schott and Eckert on CEC business (up to $ 2,000 per month). After the January 7, 1973, agreement, negotiations on the performance bonds began. USF&G indicated that it would accept as security for the bonds either collateral or a personal indemnity from Schott. Klinedinst advised Schott to post collateral rather than act as an indemnitor because, so long as the collateral required was less than 100 percent, Schott would incur less risk. Schott became very angry when he learned that USF&G would require 100 percent collateral, which was much greater than he had been led to believe would be required. Klinedinst went back to USF&G and explained that Schott, who would of course be closely watching the operation because of his own personal exposure, was an experienced and astute businessman who had the financial and operational abilities and contacts to step in if CEC faltered. USF&G agreed to reduce the collateral requirement to 50 percent. Schott then went back to CEC requesting to be paid for the collateral he567 was going to provide. After tough bargaining it was agreed that Schott would be paid $ 90,000 in installments and would be granted the right to purchase stock warrants at $ .10 per warrant. This was the same price at which all other shareholders purchased these warrants, a right which almost all of the shareholders exercised. The purchase and sale of Evendale was closed on March 9, 1973. Mr. Schott performed under the terms of the written agreement. The stock which was issued to Schott was identical with all other class A common stock issued by CEC. After the close of CEC's first fiscal year (September 30, 1973) the Organizers, who were now the officers of CEC, discussed matters with their accountants and decided, for the first time, to treat the option for redemption of Schott's stock as part of the performance bond expense and thus amortized it for Federal income tax purposes.Schott was not pleased. As the result of a contract dispute settlement, CEC had sufficient funds in January of 1974 to try to buy out Schott's interest in CEC. Although this was prior to the time the Option to redeem Schott's stock became effective, CEC negotiated with Schott to redeem his stock.568 CEC redeemed his stock in April of 1974 at the price Schott could later require under the option agreement, i.e., $ 78 per share, and CEC also received an option to purchase its leased land and buildings together with a right of first refusal on Schott's sale of the property. Schott resigned from the board of directors that same day. We will begin our discussion of the issues with an examination of the burden of proof, which we find divided. The determination of the Commissioner as to a deficiency in tax is presumptively correct. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933). Accordingly, the burden of proof is generally on the petitioner to show that the Commissioner erred in his determination.The presumption applies, however, only to the determination contained in the statutory notice of deficiency. The burden of proof is on respondent as to any increased deficiencies or any new matter. Rule 142, Tax Court Rules of Practice and Procedure.2Respondent asked for increased deficiencies in both an Amended Answer and a Second Amended Answer. Respondent concedes that he bears the569 burden of proof as to increased deficiencies. The statutory notice of deficiency determined that Schott realized ordinary income in 1973 or 1974 and characterized that ordinary income only as "commissions and fees." Fees and commissions are two examples of compensation for services, as explained in section 1.61-2, Income Tax Regs.; therefore, the language used in the statutory notice embraces "compensation for services." We see no substantive difference in the use of these terms as they appear before us. Although it might appear possible that "compensation for services" is the broadest term and might encompass more than the term "fees and commissions" so that some part of its import is not included in the determination of the Commissioner, we see no grounds for such a conclusion here. Accordingly, the burden of proof is on petitioner to show that the Commissioner erred in his determination that Schott realized ordinary income from fees, commissions or compensation for services in 1973 or 1974. The-bargain-sale-of-land issue and the warrants issue are outside the statutory notice. Respondent does not argue otherwise. Respondent has the burden of proof regarding these new matters. 570 Petitioner contends that respondent bears the burden of proving that the decedent received interest income because that theory is new matter not contained in the statutory notice of deficiency. The respondent argues that the language of the statutory notice--"commissions and fees"--is broad enough to cover interest on the theory that a loan fee is interest. Respondent contends that this Court has used the words "interest" and "loan fee" interchangeably, citing Duncan Industries, Inc. v. Commissioner,73 T.C. 266">73 T.C. 266 (1979). To begin with, that opinion does not involve confusion of the two words. In that case there were both loan fees and interest involved. The best support that respondent can hope for from that opinion comes from a footnote in which we suggest that a fee paid to obtain a loan is in the nature of interest.But this does not resolve the matter. The statutory notice must be read with a view to the plain meaning of the words therein. The respondent argues, concerning the compensation for services theory, that "commissions and fees" and "compensation for services rendered" are simply different words for the same concept and we agree. But these words571 cannot suit respondent's purpose, like a chameleon which changes color. While a loan fee may be in the nature of interest, it is not the same thing. The respondent frequently argues that such a fee is for services and not interest. Indeed, respondent's interest theory is not one of a fee paid to obtain a loan but rather is one wherein the purchase of stock, coupled with an option for redemption, in substance, represented the loan of money to CEC with the stock being transferred as security for the obligation to repay the loan with interest.This would be interest in the trust sense. No stretch of the imagination would cause such interest to be commissions or fees. The respondent attempts to bootstrap his way by saying "fees" includes "loan fees" which may include "interest" so "fees" equals "interest." The argument falls of its own weight. The interest theory, raised by the respondent for the first time in an amended answer, does not simply narrow the issue raised by the notice of deficiency. It requires the presentation of entirely different evidence and is clearly new matter. Accordingly, respondent bears the burden of proof on this theory. Although there remains one further572 dispute as to the burden of proof, our holding herein renders its resolution unnecessary. 3We will now consider the various alternative theories of respondent with respect to the option to redeem Schott's stock in CEC. Respondent argues that the only reason that CEC dealt with Schott was the corporation's desperate need for his collateral. Respondent suggests that it is questionable whether the terms of the agreement between Schott and CEC were negotiated at arm's length. Respondent further suggests that, in truth, the agreement was more like an adhesion contract in that Schott flatly stated the terms of the agreement573 and CEC agreed to those terms. Respondent argues that Schott's purchase of the stock in CEC coupled with the redemption agreement was in substance an 18-month loan of $ 500,000 with guaranteed interest of $ 800,016. In the alternative, respondent argues that the redemption agreement was given to Schott as a "collateral fee," "bonding premium," commission or some other form of compensation for services. To support these arguments, respondent maintains that although the stock and redemption agreement were tied together, the redemption agreement had value in addition to and distinguishable from the value of the underlying stock. The thrust of respondent's argument is that the substance of Mr. Schott's participation in the Evendale deal resulted in his realization of ordinary income based upon one or another theory. The general rule that substance will control over form is well established in the judicial review of tax consequences. E.g., United States v. Phellis,257 U.S. 156">257 U.S. 156, 168 (1921). By its very nature, the application of this rule requires a factual determination of the economic substance of the contract or transaction and must be made with a view to the574 particular facts in each case. We have previously set forth the facts which we have found to be true and have also summarized the salient facts at the beginning of this opinion. Respondent's theories are based upon an interpretation of the facts at variance with our findings of fact. Much of this follows from respondent's reliance, at least for the purposes of this trial, on the position taken by CEC. Evaluation of the testimony of respondent's witnesses from CEC must be considered in light of the fact that many of them, as officers and stockholders of CEC, have a direct interest in the outcome of this case. Respondent's strongest witness, Mr. Mealey, and Chairman of the Board, President, Chief Executive and largest stockholder in CEC, is also the person who stands to gain or lose the most. CEC sought additional equity capital because it was thinly capitalized and the necessary performance bonds would not be issued without such additional equity. CEC investigated numerous sources of additional financing, and even as CEC negotiated with Schott it was negotiating with more than one alternative source of capital. Mr. Mealey and his associates were extremely competent and astute575 businessmen, as demonstrated by their success in managing Evendale and thereafter acquiring and managing Evendale for CEC. Circumstances foced them to permit an outsider to take a significant equity position in their venture, but this was not to their liking and they bought out Mr. Schott at the earliest opportunity. During the negotiations with Mr. Schott, Mr. Mealey and associates possessed perhaps the most important card on the table: knowledge. Although blue books of financial information were prepared and updated, no one understands financial data better than the people who prepare it. 4 Mr. Schott's equity investment had to be very substantial in order to safisfy USF&G. Schott contributed nearly half of all the equity that went into the venture. Schott wanted control but he did not get it. Schott wanted to be able to liquidate his investment in the near future and proposed terms that were agreeable to the Organizers. The Organizers certainly would have preferred permitting this outsider a smaller share in the potential success of their venture, but they well knew that if things went according to plan this was really a small price to pay--the expected value of Schott's576 stock during the option period was approximately $ 1.7 million while they expected to buy out this outsider for only $ 1.3 million. The parties carefully negotiated this Schott-CEC agreement, and we have found that this agreement represents an arm's-length agreement between unrelated parties. We will first consider the interest theory. Respondent's argument that Schott's stock purchase coupled with the redemption agreement was, in substance, an 18-month loan is not persuasive. The respondent directs our attention to the fact that early in the negotiations between CEC and Schott the parties considered various forms of Schott's participation in the venture including convertible debentures. Such preliminary negotiations are no evidence of the agreement that was actually reached, at least in the context before us. USF&G rejected any form of participation by Schott other than an equity investment. Respondent suggests that Schott's stock purchase577 when coupled with the redemption agreement was a subterfuge to placate USF&G while in reality creating a debenture. 5 Respondent maintains that Schott received "guaranteed" interest because CEC was a sure bet. To say that Schott's investment was not subject to risk is to ignore reality. Subterfuge or not, Schott had an equity investment which under state law would not rate a high priority on liquidation. This risk is compounded by both the inherent risk of such venture capital investments and the highly leveraged capital structure of the CEC acquisition of Evendale. Neither do we find that Schott's investment was truly in the nature of a debenture as a result of this imagined subterfuge. On careful examination of the evidence, we conclude that in economic reality Schott did make an equity investment in CEC. Respondent seeks support from, among others, Comtel Corp. v. Commissioner,376 F.2d 791">376 F.2d 791 (2d Cir. 1967), affg. 45 T.C. 294">45 T.C. 294 (1965); and Green v. Commissioner,367 F.2d 823">367 F.2d 823 (7th Cir. 1966), affg. a memorandum opinion of this Court. Substance versus form by its nature entails a determination based on the facts and circumstances578 of each case. Any authority cited by the parties could at best provide this Court guidance, and this only when the attendant facts and circumstances are substantially similar. We do not find respondent's cited authority persuasive. In the above cited cases, in which redemption agreements were present, it was the "sellers" of the stock who had options to repurchase, as opposed to the purchaser of the stock in the instant case. In view of the attendant facts and circumstances in those cases, we found that the "sellers" had retained the beneficial ownership of the stock and had merely passed legal title to the taxpayers as a security device. We find petitioner's authority, although similarly not controlling, to be more persuasive. In both Zilkha & Sons, Inc. v. Commissioner,52 T.C. 607">52 T.C. 607 (1969), and Ragland Investment Company v. Commissioner,52 T.C. 867">52 T.C. 867 (1969), affd. per curiam 435 F.2d 118">435 F.2d 118 (6th Cir. 1970), we found preferred stockholdings with significant investment protection to be equity and not debt. Notwithstanding this investment protection, in Zilkha & Sons, we stated that: 579 * * * despite the unusual protection given the petitioners, we have concluded that the arrangement more resembles the acquisition of stock rather than the making of a loan. Primarily, we are led to this conclusion because ot the parties' treatment of the transaction, and because the petitioners have assumed the risks of investors in equity. [52 T.C. at 612, 613.] This analysis applies and we note that neither party to the CEC-Schott transaction ever treated the transaction as a loan. We will now consider the theory that the benefits accruing to Schott were for his providing equity and collateral.Our examination of the economic substance of Mr. Schott's participation in the Evendale deal does not reveal that he received the redemption agreement as a "collateral fee," "bonding premium," commission or some form of compensation for services. CEC needed equity in order to obtain performance bonds and he provided it. At the time the parties entered into the agreement defining Schott's participation in the venture it was far from clear that Schott would be required or would choose to do more than guarantee the performance bonds.The guarantor of a note or similar580 instrument is not ordinarily considered to be the recipient of compensation income for performing personal services. When it was later determined that Schott would provide collateral, the parties had a second round of negotiations at which time Schott asked for and received $ 90,000 as compensation for providing collateral. Both parties agree that this $ 90,000 represents ordinary income to Schott. In arguing that Schott was paid more than this $ 90,000 to provide equity and collateral, respondent places great weight on the fact that CEC agreed to redeem Schott's CEC stock. We learned from the cross examination of respondent's first witness, Donald Huckins, who was one of the original organizers of CEC, that all minority shareholders had agreements with CEC under which CEC would redeem their stock. Although the terms of Schott's redemption agreement were negotiated separately from those of the other minority shareholders and differ from these other agreements in its terms, the existence of the Schott redemption agreement does not appear unusual in this light. The existence of the Schott redemption agreement was not only not unusual in the circumstances, but if further explained581 by the fact that the Organizers were not pleased with having Schott or any other outsider as a partner sharing in their future. They bought him out at the earliest opportunity. We find that Harold Schott's purchase of CEC stock, coupled with the nontransferable right to cause CEC to redeem this stock under certain terms, was neither in economic substance a loan nor compensation for services, however described. Accordingly, we find that the decedent, Harold Schott, did not realize ordinary income either upon receipt of the option to have his stock in CEC redeemed or upon the redemption of this stock. Respondent relies heavily on his contention that the redemption agreement had value in addition to and distinguishable from the value of the underlying stock. We, therefore, feel compelled to comment thereon. The parties to the agreement ascribed no value to Schott's right to have his CEC stock redeemed. Much of the opinion of respondent's expert witness who valued the "put" 6 is based upon comparison to publicly traded put options. 7 While the analogy is attractive because of the common use of the term "put," the opinion offered by respondent's expert witnesses does not convince582 us that the valuation analogy is applicable in light of the facts of this case. Unlike our facts, publicly traded put options are purchased by investors who do not own the underlying, publicly traded securities. Such publicly traded put options, unlike Schott's redemption option, are backed by an escrow deposit so that there is no risk that the issuer of the option will have insufficient funds to perform. Finally, Schott's option to require CEC to redeem his shares was expressly nontransferable. In context, however, all of the above is but determinative of the valuation of Schott's basis in his stock. The option was exercised in 1974 and the stock was redeemed in 1974; therefore, even if respondent's evidence were more persuasive, it would not by itself change our holding herein. 583 We will now consider the bargain purchase and warrants issues. Respondent argues that the bargain purchase of the real estate was part of the total package required to obtain Schott's collateral. Respondent further argues that Schott received the right to purchase the warrants as part of the "bonding premium" so that Schott realized ordinary income either upon the receipt of these warrants or upon their subsequent transfer or redemption. Although respondent presented an alternative position in his Second Amendment to Answer that the bargain purchase and receipt of warrants represented additional interest income, respondent, in his briefs, did not present any arguments to support this theory. Respondent argues that Schott received a bargain on his purchase of CEC's land and buildings as part of his compensation for providing equity and collateral. In his search for the fair market value of the land and building involved, respondent has rejected the evidence of what we have found to be the arm's-length purchase of this real property by Schott. We consider as evidence the fact that CEC had lined up a tentative purchaser for this same real property at a higher price. We also consider584 as evidence the significantly lower price at which CEC purchased this real property from Avco. Respondent presents the testimony of Mr. Mealey as evidence that Schott received this bargain purchase in exchange for providing collateral. Mr. Mealey's testimony does not directly support respondent's position. In that testimony Mr. Mealey, respondent's witness, answered a leading question which assumed that CEC sold the land and buildings to Schott at a bargain price. In addition, we do not find the testimony of Mr. Mealey to be credible, in view of his interest in this matter and our observation of his demeanor as a witness. It is well settled that the fair market value of property is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both reasonably informed as to all relevant facts. 8Jack Daniel Distillery v. United States,180 Ct. Cl. 308">180 Ct. Cl. 308, 379 F.2d 569">379 F.2d 569, 574 (1967). As we explained in VGS Corp. v. Commissioner,68 T.C. 563">68 T.C. 563 (1977), the best evidence of such value results from arm's-length bargaining which comports with economic reality. We find585 that the valuation accorded this real property by CEC and Schott is such a value. We are not persuaded by respondent's argument that this valuation was determined under compulsion, as we do not so view the facts. Finally, respondent argues that Schott received ordinary income either on the receipt or subsequent transfer of the warrants. CEC paid USF&G $ 65,000 to provide the performance bonds. It paid Schott $90,000 to put up the collateral. The essence of respondent's argument is that Schott received the right to purchase the warrants at the same time that he was paid $90,000 to provide collateral, so that the receipt of the right to purchase these warrants must represent additional "bonding premium." The warrants which Schott purchased were held by almost all of the CEC shareholders. Schott paid the same price for these warrants as did every other shareholder. These rights were no more valuable to Schott than they were to any other shareholder. Respondent suggests that the parties had an unwritteen "gentlemen's agreement" that the warrants purchased by Schott would be later redeemed at a set586 price. Respondent originally argued that this price was $ 30,000 but later maintained that it was $ 20,000. We find this arrangement surprising, given the parties' demonstrated attention to detail and practice of reducing this detail to writing, and given the fact that there was no love lost between Schott and Mealey; indeed we find that respondent's evidence of this "gentlemen's agreement," coming from the testimony of Mr. Mealey himself, lacks credibility. Respondent has presented no convincing evidence that these warrants had a fair market value greater than the price at which Schott purchased them, either at the time he received the right to purchase them or later when he transferred them to vanden Eynden. We, therefore, find that neither the receipt by Schott of the right to purchase warrants nor the subsequent transfer or redemption of these warrants resulted in the realization of income by the decedent, Harold Schott. In view of the foregoing, we find that petitioner has borne its burden of proof as to the commissions and fees and compensation for services theories regarding the first issue and respondent has failed in his burden on all other issues. In view of our review587 of the evidence we would not find for respondent on the interest theory even if petitioner bore the burden of proof thereon. Because of concessions by the parties, Decision will be entered under Rule 155.Footnotes1. A "net-net" lease is one in which the tenant pays all operating expenses, maintenance costs, insurance, real estate taxes, etc.; such a lease is also referred to as a "100-percent-net" lease.↩1. These figures do not include amounts paid for warrants.↩2. All references to Rules are to the Tax Court Rules of Practice and Procedure.↩3. The petitioner maintains that respondent should be held to a burden of strong proof because he is challenging the form of a transaction negotiated at arm's length between unrelated parties who have adverse tax interests, citing numerous opinions of this Court including Ragland Investment Co. v. Commissioner,52 T.C. 867">52 T.C. 867, 878-879 (1969), affd. per curiam 435 F.2d 118">435 F.2d 118↩ (6th Cir. 1970). The respondent maintains that the strong proof rule never applies to respondent, who is free to accept or challenge the form of a transaction.4. The Organizers testified that this inside knowledge of the underlying strengths and weaknesses of the financial data was critical to their negotiations with Avco. We find it no less important in their negotiations with Schott.↩5. A debenture is a writing or certificate issued as an evidence of debt.↩6. Although we have given the fact no weight, we note that while one of respondent's expert witnesses insists that Schott's option is a "put" the other insists that it cannot be. Also, after holding our breath for some considerable time we found this option to be inevitably referred to as a "Schott put." ↩7. A "put" is an option that gives the holder the right to sell a fixed amount of stock within a specified time and at a specified price. Puts are purchased by investors who think the stock price may fall.Standard & Poors, A Glossary of Financial/Investment Terms.↩8. Moss American, Inc. v. Commissioner,T.C. Memo. 1974-252↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624588/	Alexander Washington, Petitioner v. Commissioner of Internal Revenue, RespondentWashington v. CommissionerDocket No. 7092-80United States Tax Court77 T.C. 601; 1981 U.S. Tax Ct. LEXIS 60; September 17, 1981, Filed 60 Decision will be entered for the respondent. Petitioner filed for divorce from his wife in April 1977. His wife filed a counterclaim for divorce and sought temporary support. They continued to live in the same house for the remainder of the year. On Aug. 1, 1977, the Circuit Court for Wayne County, Mich., ordered petitioner to make all mortgage payments on the house and pay the utility bills. Petitioner claimed a deduction for the mortgage and utility payments as alimony, which was disallowed by respondent. Held: That petitioner is not entitled to a deduction under sec. 215(a), I.R.C. 1954, for the mortgage and utility payments. He and his wife were not "separated" within the meaning of sec. 71(a)(3) when the payments were made because they continued to live in the same house. Sydnes v. Commissioner, 577 F.2d 60">577 F.2d 60 (8th Cir. 1978), revg. on this issue 68 T.C. 170">68 T.C. 170 (1977), not followed. Alexander Washington, pro se.Clyde W. Mauldin, for the respondent. Dawson, Judge. Caldwell, Special Trial Judge. Fay, J., dissenting. Wilbur and Nims., JJ., agree with this dissenting opinion. Sterrett, J., dissenting. Nims, J., agrees with this dissenting opinion. Ekman, J., dissenting. Tannenwald, Irwin, Wilbur, and Nims, JJ., agree with this dissenting opinion. DAWSON; CALDWELL601 This case was assigned to Special Trial Judge Randolph F. Caldwell, Jr., for trial pursuant to General62 Order No. 6, 69 T.C. XV (1978). The Court agrees with and adopts his report which is set out below.OPINION OF THE SPECIAL TRIAL JUDGECaldwell, Special Trial Judge: Respondent determined a deficiency in petitioner's 1977 Federal income tax in the amount of $ 432. At issue is whether petitioner is entitled to a deduction under section 215(a)1 for the temporary support of his wife by making mortgage and utility payments during 1977 when both resided in the same house. The resolution of this issue depends upon whether petitioner and his wife were then "separated" within the meaning of that term as used in section 71(a)(3).FINDINGS OF FACTSome of the facts were stipulated. The stipulation of facts and the exhibits attached thereto are incorporated herein by reference.602 Petitioner resided in Detroit, Mich., at the time he filed his petition in this case.Petitioner and Jean Virginia Washington63 (Jean) were married on November 7, 1944, in Detroit, Mich. They resided in Michigan until the time of their divorce in 1978.In April 1977, petitioner filed an action for divorce from Jean in the Circuit Court of Wayne County, Mich. (the divorce court). The principal asset of the parties at the time of the divorce action was the marital home located at 3511 Oakman Boulevard, Detroit, Mich. (the residence), which was owned by petitioner and Jean jointly, either as joint tenants or as tenants by the entireties. There was a mortgage on the property in the amount of approximately $ 13,000.The issues with respect to property settlement and alimony to be paid by petitioner were litigated in the action in the divorce court.In July 1977, Jean filed a petition with the divorce court asking that the petitioner herein (i.e., Alexander Washington) be required to pay the mortgage note, utilities, maintenance, and other expenses with respect to the residence during the pendency of the divorce action.On July 18, 1977, the divorce court entered an order to show cause which required petitioner to show cause why that court should not direct him to make payments on the mortgage note, and utilities, 64 maintenance, and other expenses with respect to the residence, during the pendency of the divorce action.On August 1, 1977, the divorce court entered an order requiring petitioner to pay all mortgage payments on the residence as well as the gas, electric, and water bills. However, as to the telephone bills, petitioner and Jean, who had separate telephones, were each required to pay his or her own bill.Petitioner and Jean, during the period from August 1, 1977, until the time of their divorce in 1978, continued to reside in the residence.The residence was a 2 1/2-story house consisting of a basement, first floor, and second floor. On the first floor, there were a center entrance, a center hallway, and a center staircase. On the right side of the center hallway, there were a living room and a den which together extended the full length of the house. On the left side of the center hallway, there were 603 a kitchen, breakfast nook, dining room, and a lavatory. On the second floor, there were a master bedroom and sitting room with two master closets, on the right side. On the left side, there were two bedrooms and a bath. In the basement, there were a recreation room, a65 darkroom, and a laundry room in which there were a stove, a refrigerator, and a deep freeze. The residence contained 1,863 square feet of living space.Petitioner and Jean had not lived together as husband and wife since 1971. They occupied separate bedrooms, used separate bathrooms, prepared meals at different places (Jean in the first floor kitchen, petitioner on the facilities in the laundry room in the basement), did not eat together, and did not converse with each other.Between August 1 and December 31, 1977, petitioner paid the following utility bills with respect to the residence:Gas$ 188.00Electric440.00Water47.32Total675.32With respect to the payments on the mortgage on the residence during the period from August 1 through December 31, 1977, petitioner paid a total amount of $ 1,578, as follows:Principal$ 226.04Interest477.40Escrow874.56Total1,578.00Prior to August 1, 1977, petitioner had also paid the utilities and the mortgage payments.Petitioner claimed itemized deductions for real estate taxes and interest on the mortgage in the amount of $ 732.34 and $ 779.93. Petitioner also claimed a deduction for alimony of $ 2,185.18, 66 included in which were the real estate taxes and interest separately deducted. Petitioner has conceded that he is not entitled to deduct the same amounts twice. Respondent disallowed the claimed alimony deduction.OPINIONWe must decide whether the amounts paid by petitioner for the utilities and the mortgage payments on the residence, as 604 he was directed to do by the Michigan divorce court, are deductible by him under section 215(a). 2 The answer depends upon whether the amounts would be includable in Jean's gross income under section 71(a)(3). 3 However, if petitioner and Jean were not "separated" when the payments were made, as respondent contends, then the amounts are not includable in Jean's gross income and petitioner is not entitled to a deduction.67 What the word "separated" means for purposes of the alimony deduction is not entirely clear. In Sydnes v. Commissioner, 68 T.C. 170">68 T.C. 170, 173-176 (1977), this Court reasoned that a husband and wife involved in divorce proceedings, but still living in the same house, were not "separated," emphasizing the language contained in section 1.71-1(b)(3), Income Tax Regs., that they must be "separated and living apart." After reviewing the pertinent legislative history, we said (68 T.C. at 175-176):The statutory history of the 1954 changes emphasizes that the factual status of whether the parties are separated rather than their marital status under local law is the key in determining whether amounts paid under a court order are includable in the recipient's gross income and deductible by the payor. See S. Rept. No. 1622, 83d Cong., 2d Sess. 10 (1954). We conclude that "separated" as used in the statute and "separated" as used in the regulations mean living in separate residences. Only when living in separate residences do the parties incur the duplicate living expenses normally incurred by divorced or separated couples. In the absence68 of such duplication, and in the absence of any legislative history cited to us which expressly elucidates what Congress intended, we find it hard to believe that a mere continuation of shared living expenses following estrangement was intended by Congress to generate a deduction when the identical expenses would have been unavailable to the husband as a deduction before the estrangement took place. Moreover, the Court should not be required to delve into the 605 intimate question of whether husband and wife are in fact living apart while residing in the same house. We therefore conclude that petitioner and Lugene were not separated during the period from April 1 to July 9, 1971, and that petitioner is not entitled to a deduction under section 215 for the temporary support payments made to Lugene.But the Court of Appeals for the Eighth Circuit, in reversing the Tax Court on this issue (577 F.2d 60">577 F.2d 60), held that the requirement that the parties be "separated and living apart" may be met as a factual matter, even though they occupy the same residence, provided they occupy separate quarters. 469 We respectfully disagree with the Court of Appeals for the Eighth Circuit. It is our view Congress intended that a husband and wife should not be treated as "separated and living apart" when both are living under the same roof. See H. Rept. 1337, 83d Cong., 2d Sess. 9-10 (1954); S. Rept. 1622, 83d Cong., 2d Sess. 10-11 (1954). Consequently, we will adhere to the rationale of our prior opinion in Sydnes.Since we hold that petitioner and Jean were not "separated" during the period from August 1 through December 31, 1977, none of the amounts paid by petitioner would be includable in Jean's gross income, and therefore, no deduction is allowable to petitioner under section 215(a).It is unnecessary to decide what portion of the disputed payments would be deductible by petitioner if he and Jean had been "separated" within the meaning of section 71(a)(3).Decision will be entered for the respondent. FAY; STERRETT; EKMANFay, J., dissenting: I respectfully dissent. In my view, a husband and wife are not required to maintain separate physical residences in order to be "separated."Section 71(a)(3) requires a wife to be "separated" from her husband. See sec. 7701(a)(17). 70 Section 1.71-1(b)(3), Income Tax Regs., requires a wife and husband to be "separated and living 606 apart." (Emphasis added.) At first blush, it seems that the regulation adds a requirement that simply is not in the statute and, therefore, is invalid to that extent. However, two considerations compel me to conclude that declaring section 1.71-1(b)(3), Income Tax Regs., invalid is not the proper action.First, the legislative history indicates that Congress thought "living apart" was part of "separated." See S. Rept. 1622, 83d Cong., 2d Sess. 10 (1954); H. Rept. 1337, 83d Cong., 2d Sess. 9-10 (1954). While it is axiomatic that the statute and not its history is the law, that history should not be ignored needlessly. Secondly, regulations should be read so as to be valid, and the regulation at issue herein can be read in just such a way. I agree with the Eighth Circuit Court of Appeals that a wife and husband can live apart, and thus separately, in the same residence. Sydnes v. Commissioner, 577 F.2d 60">577 F.2d 60 (8th Cir. 1978), revg. 68 T.C. 170">68 T.C. 170 (1977). Surely, two persons living on separate floors of the same house are71 living as separate and apart as two persons occupying adjacent apartments.Basically, the majority opinion, citing Sydnes v. Commissioner, 68 T.C. 170">68 T.C. 170, 175-176 (1977), gives two reasons for its result: (1) Duplicate living expenses are present only when separate residences are maintained, and (2) this Court should not be required to "delve into" intimate questions. I find neither reason convincing.I fail to see how duplicated living expenses are required under section 71. In fact, one reading of section 71(a)(1) dispels any notion that they are. If a couple is actually divorced, there is absolutely nothing in either the statute or the regulations that would deny the payor spouse an otherwise allowable alimony deduction if the divorced parties shared a residence. Should not the same rule apply for "separated" persons? As to the second reason given in the majority opinion, suffice it to say that I cannot agree that what is convenient for us should in any way interfere with our decisions as to the law.For the above reasons, I would overrule our decision in Sydnes and adopt the approach of the appellate court.Sterrett, J., dissenting: I respectfully72 dissent. While the rigid position espoused by the majority admittedly avoids the 607 envisioned administrative nightmare born of a factual inquiry into the issue at hand, such position fails to reflect sympathy for the unhappy realities of a disintegrating marriage and the difficult economic constraints occasioned thereby. On the other hand, the case-by-case factual inquiry proposed by my dissenting brethren would be prohibitively cumbersome and only would add to this Court's litigation backlog.A more reasonable approach would be to rely on a State court decision, in the form of a decree for support, to determine when parties are "separated" for purposes of section 71(a)(3). It can be fairly assumed that a State court would issue a decree for support only in the event that the parties are "separated" in every meaningful sense of the word. Therefore, it seems feasible to hold that, when such decree has been entered, the husband and wife will be deemed to be "separated" for purposes of section 71(a)(3). Under this view, it would not be necessary for the Court to look behind the support decree to determine whether a husband and wife are in fact separated and living apart 73 (by some ill-defined standard) while residing in the same house. Such an approach would relieve the Court of the need to make an examination of individual circumstances in cases where, for example, the parties cannot afford to live in separate residences during their period of separation.Federal courts long have superimposed Federal tax consequences on State determinations of property rights. It seems equally appropriate to attach Federal consequences to a State court determination of marital rights, for such rights are peculiarly within the jurisdiction of State courts to delineate.While I recognize that this approach does not eliminate the need for a factual determination of whether the parties are "separated" for purposes of section 71(a)(2), it does offer the benefit of some certainty to the determination of separate status required by section 71(a)(3).Ekman, J., dissenting: I respectfully dissent. Although it is undisputed that the parties were living separately and had no "physical, emotional, or social contact," the majority resolutely 608 adheres to the position that we may not under any circumstances make an examination of the facts so long as the parties occupy74 the same residence. I find this position totally unsupported by the legislative history and expressly rejected by the Eighth Circuit in Sydnes v. Commissioner, 68 T.C. 170">68 T.C. 170 (1977), revd. on this issue 577 F.2d 60">577 F.2d 60 (8th Cir. 1978). Moreover, we should recognize that in today's society, economic conditions often make it impracticable for divorcing spouses to maintain separate residences.The majority's view is reminiscent of the aura of judicial disapproval expressed nearly a half century ago in the much cited case of Holt v. Holt, 77 F.2d 538">77 F.2d 538, 540 (D.C. Cir. 1935). I submit that the inflexible rule adopted by the majority is erroneous and that we should follow the rational approach of the Eighth Circuit in Sydnes. Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩2. Sec. 215(a) provides in pertinent part:(a) General Rule. -- In the case of a husband described in section 71, there shall be allowed as a deduction amounts includible under section 71 in the gross income of his wife, payment of which is made within the husband's taxable year. * * *↩3. Sec. 71(a)(3) provides:(3) Decree for support. -- If a wife is separated from her husband, the wife's gross income includes periodic payments (whether or not made at regular intervals) received by her after the date of the enactment of this title from her husband under a decree entered after March 1, 1954, requiring the husband to make the payments for her support or maintenance. This paragraph shall not apply if the husband and wife make a single return jointly.↩4. There was apparently no physical, emotional, or social contact between the petitioner and Jean in the instant case. Indeed, the petitioner argues that, in view of the liberality of the Michigan divorce laws, it is not necessary for the parties "to go running into the streets screaming 'we're separated' in order to establish that fact."↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624591/	BETHLEHEM SILK COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Bethlehem Silk Co. v. CommissionerDocket No. 103861.United States Board of Tax Appeals43 B.T.A. 515; 1941 BTA LEXIS 1499; January 31, 1941, Promulgated 1499 Before May 1, 1936, a bank approved the making of a loan to the taxpayer under the condition, inter alia, that the taxpayer pay no dividends before payment of the loan. The approval was not to be binding until the execution, approval, and delivery of the necessary papers. In June 1936 the papers were delivered and the loan was made. The contractual prohibition against paying dividends, held, not operative until June 1936, and the taxpayer was not entitled to a credit under section 26(c)(1), Revenue Act of 1936. Sidney J. Schwartz, Esq., for the petitioner. Brooks Fullerton, Esq., for the respondent. STERNHAGEN 515 OPINION. STERNHAGEN: The Commissioner determined deficiencies of $6,169.98, $5,589.42, and $2,852.64 in petitioner's income taxes for 1936, 1937, and 1938, respectively. The petitioner bases a claim for credit on an alleged contract prohibiting dividends, and the question narrows down to whether a written contract was excuted prior to May 1, 1936, as section 26(c)(1) requires. The facts are not in dispute. 516 After making application for a loan, petitioner received a letter from the Federal Reserve Bank1500 of Philadelphia, dated March 25, 1936, advising that the bank had approved a loan of $37,500, subject to eleven conditions. One condition was that no dividends should be paid until the loan was paid in full. Other conditions required petitioner to secure the loan by a mortgage on its real estate, plant, and equipment; to procure from another bank a new mortgage loan with a maturity beyond the period of this loan, and to liquidate a certain claim. It is understood that this approval shall not be considered as binding on this bank until all papers necessary to complete this loan shall have been executed by you, delivered to and finally approved and accepted by this bank. By letter dated March 27, 1936, petitioner advised the bank "that we accept this loan under all the conditions mentioned in your letter of approval." The conditions were met after May 1, 1936; the mortgage was executed and delivered to the bank; the final papers were approved, and the amount of the loan was received by petitioner on June 5, 1936. The loan has not yet been repaid. The petitioner contends that the letters of March 25, 1936, and March 27, 1936, constitute the prohibitory contract which the statute1501 requires. This contention must be rejected. The letters placed no enforceable duty on petitioner to refrain from distributing a dividend. They served only as an admonition to petitioner that if it exercised its reght to pay a dividend, no contract would be executed and no loan made. If the loan had been tendered by the bank before May 1, petitioner would have been entitled to refuse it, just as it was entitled to pay a dividend if it chose. The bank had no remedy if the petitioner failed to go forward with the necessary acts preliminary to the execution of the written contract. The bank made a conditional promise to execute a loan agreement if it approved the papers. This promise it fulfilled; but not until June, 1936, when the contract was executed whereby the petitioner was bound to pay no dividends. The petitioner's letter of acceptance of March 17, 1936, can not be regarded as the execution of the prohibitory contract, for the bank had expressly stated that its approval of the loan would not be binding until the papers were executed, approved, and accepted by it. Petitioner could not, in the face of this, make the contract nevertheless binding by its letter of acceptance, 1502 even though the bank had asked for a written acceptance of the conditions. The prohibition against paying dividends was not operative until June 1936, and not until then could a dividend have been regarded as in violation of a contract. The contract was not executed before May 1, 1936. The credit was properly denied. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624592/	I. J. Marshall and Claribel Marshall, Petitioners v. Commissioner of Internal Revenue, Respondent; Flora H. Miller, Petitioner v. Commissioner of Internal Revenue, RespondentMarshall v. CommissionerDocket Nos. 6756-70, 6757-70, 6758-70United States Tax Court60 T.C. 242; 1973 U.S. Tax Ct. LEXIS 126; 60 T.C. No. 29; May 21, 1973, Filed 126 Decisions will be entered under Rule 50. Held: 1. The provisions of sec. 1.1372-4(b)(5)(iv), Income Tax Regs., that repayments of loans are not properly includable in gross receipts of a corporation for the purpose of determining whether income from interest, rents, and royalties for the taxable year exceeds 20 percent of gross receipts for that year within the meaning of sec. 1372(e)(5), I.R.C. 1954, is valid.2. When receipts of interest by a corporation actively engaged in a small loan business in any taxable year after its first 2 years of operation exceed 20 percent of that corporation's gross receipts for that taxable year, the election of that corporation under sec. 1372(a), I.R.C. 1954, not to be subject to corporate taxes is terminated under the provision of sec. 1372(e)(5). House v. Commissioner, 453 F. 2d 982 (C.A. 5, 1972), reversing a Memorandum Opinion of this Court, not followed. James M. Parker, for the petitioners.Charles H. Powers, for the respondent. Scott, Judge. Sterrett, J., concurring. SCOTT 242 Respondent determined deficiencies in the Federal income taxes of petitioners I. J. Marshall and Claribel Marshall for the taxable years 1967 and 1968 in 128 the amounts of $ 819.06 and $ 10,113.09, respectively. Respondent determined deficiencies in the Federal income taxes of petitioner Flora H. Miller for the taxable years 1965 through 1968 as follows:Docket No.YearDeficiency6758-701965$ 1,152.306758-7019662,066.796757-701967665.336757-701968497.39243 The issue for decision is whether more than 20 percent of the gross receipts of Realty Investment Co. of Roswell, Inc., for its fiscal year 1968 was passive investment income within the meaning of section 1372(e)(5), I.R.C. 1954, 1 so as to terminate its election under section 1372(a) not to be subject to corporate income tax with the result that each of petitioners, its shareholders, is not entitled to a pro rata deduction of its fiscal year 1968 operating loss.FINDINGS OF FACTSome of the facts have been stipulated and are found accordingly.Petitioners I. J. Marshall and Claribel Marshall, 129 husband and wife, resided at Roswell, N. Mex., at the time they filed their petition in this case. They filed joint Federal income tax returns for their taxable years 1967 and 1968 with the district director of internal revenue at Albuquerque, N. Mex.Petitioner Flora H. Miller resided in Roswell, N. Mex., at the time she filed her petition in this case. She and her late husband filed joint Federal income tax returns for the taxable years 1965 and 1966, and she filed a separate Federal income tax return as a widow with dependent child for the taxable years 1967 and 1968 with the district director of internal revenue at Albuquerque, N. Mex.Realty Investment Co. of Roswell, Inc. (Realty), is a corporation organized under the laws of the State of New Mexico on June 30, 1960. Realty kept its books and reported its income on the basis of a fiscal year ended June 30. It filed its Federal income tax returns as a regular corporation through its fiscal year ended June 30, 1967. Realty filed an election to be taxed as a small business corporation under the provisions of subchapter S of the Internal Revenue Code of 1954, as amended, to be effective for its taxable year commencing July 130 1, 1967. This election was accepted by respondent as being in compliance with applicable law.Realty is authorized under its articles of incorporation to conduct a small loan business; insurance agency; discount purchase of sales contracts other than motor vehicle sales contracts; discount purchase of promissory notes, secured and unsecured; make direct loans over $ 1,000; make direct loans under $ 1,000 at general interest rates; conduct a real estate brokerage business, including the operation, development, handling, management, and sale of real property; and to operate in any business activity which the board of directors deemed necessary and proper in connection with its primary objects and purposes.244 Small loan license No. 33 which Realty had held throughout its corporate existence was in good standing during its fiscal year ended June 30, 1968.Realty on the small business corporation income tax return (Form 1120-S) which it filed for its fiscal year 1968, reported gross receipts of $ 79,028.06 which consisted of the following items:(a) Small loan department:Interest earned$ 35,938.67Default and deferment charges2,509.99Life insurance premiums3,562.48Filing and recording fees155.62$ 42,166.76(b) Real estate department:Rentals received12,297.25Commissions earned5,299.86Interest income14,731.01Discounts earned572.51Escrow fees105.7833,006.41(c) Rental income -- office building:Rentals received1,678.00Miscellaneous income63.301,741.30(d) Farnsworth Building:Rentals received1,321.03(e) Oil and gas royalties792.56Total79,028.06131 During its fiscal year 1968 Realty received repayment of loans in the amount of $ 288,129.79.During its fiscal year ended June 30, 1968, Realty, through its small loan department, made installment loans to customers in amounts ranging from $ 100 to $ 1,000. There were approximately 500 such loans outstanding as of June 30, 1968. The interest income in the amount of $ 35,938.67 reported on Realty's income tax return from the small loan department was interest received on its loans to customers in amounts of $ 1,000 or less which were outstanding during its fiscal year 1968. The $ 2,509.99 in "default and deferment charges" reported on its return was additional interest for borrowers who wished to defer their payments plus fees charged to borrowers who had defaulted or had made a late payment.The $ 14,731.01 interest income reported by Realty from its real estate department was the amount it received as interest on mortgages it took from purchasers of houses it sold less the interest it paid on the mortgages it assumed when it purchased the houses. This difference arose because Realty would purchase a house and assume a mortgage which the seller had on the house with an interest132 rate of 4 or 4 1/2 percent 245 and then sell the house and take back a mortgage from the purchaser at an interest rate of 7 or 7 1/2 percent. The $ 572.51 reported by the real estate department of Realty as discounts earned represents deferred-payment charges and extra interest paid when an installment payment on a mortgage was not timely made. The $ 12,297.25 in rental income reported by Realty from its real estate department was the rentals it received from tenants of 24 houses it owned in its fiscal year 1968. Realty also received rental income in its fiscal year 1968 of $ 1,678 from rentals of space in an office building. Realty attempted to keep its rental properties in good condition and collected the rents from these properties.Realty was the lessee for a term of 11 years of the Farnsworth Building which prior to its fiscal year 1968 it sublet to the Federal Government at an annual rental of $ 13,210.30. Realty renovated the building prior to the sublessee's taking possession and received the amount of $ 13,210.30 in the first year of the sublease in addition to the first year's rent. Realty, on its books, treated this $ 13,210.30 as an advance rental, proratable133 over a 10-year period. The rental income from the Farnsworth Building reported by Realty for its taxable year ended June 30, 1968, in the amount of $ 1,321.03 consisted solely of the pro rata part of the entire $ 13,210.30 it had received in the first year it sublet the Farnsworth Building to the Federal Government. The Government vacated the Farnsworth Building prior to Realty's fiscal year 1968 and Realty received no rental payments on the building in that year.The Form 1120-S filed by Realty for its fiscal year 1968 disclosed a loss from operations in the amount of $ 90,404.32. On Schedule K of the Form 1120-S, shareholder's share of income, the following shares of undistributed net operating loss were shown:I. J. Marshall($ 44,599.43)Flora H. Miller(44,599.43)P. L. Duncan(1,205.46)On the 1968 Federal income tax return filed by I. J. and Claribel Marshall, they claimed a deduction for an ordinary distributive loss realized from Realty in the amount of $ 44,599.43.Flora H. Miller, on her income tax return for the year 1968 showed a distributive loss of $ 44,599.43 from Realty which loss was claimed as an ordinary deduction to the extent of $ 7,395.76.On February134 15, 1969, Flora H. Miller filed an Application for Tentative Loss Carryback Adjustment covering the taxable years 1965, 1966, and 1967, and based on the unused portion of the 1968 claimed distributive loss from Realty, was granted a tentative allowance resulting in refunds in the full amount of the tax paid for such years, 246 plus interest as provided by law. The refunds were for tax (exclusive of interest) in the following amounts for the years indicated:1965$ 1,152.3019662,066.721967665.33Respondent in his notice of deficiency determined that each petitioner was not entitled to deduct a pro rata share of the loss of Realty for the fiscal year ended June 30, 1968, because Realty "is not eligible to report its income as a tax option corporation under the provisions of section 1372(a)." Because of disallowing the claimed loss deduction to Flora H. Miller respondent determined a deficiency in her income tax for each of the years 1965, 1966, and 1967 in the amount previously tentatively allowed based on her loss carryback claim.OPINIONSection 1372(e)(5), 2 applicable to the years here in issue, provides that except in the first or second year of active135 conduct by a corporation of any trade or business, its election to be taxed as a small business corporation under subchapter S will terminate if it has gross receipts more than 20 percent of which is passive investment income. This section further states (sec. 1372(e)(5)(C)) that "for purposes of this paragraph, the term 'passive investment income' means gross receipts derived from royalties, rents, dividends, interest, annuities, and sales or exchanges of stock or securities (gross receipts from such sales or exchanges being taken into account for purposes of this paragraph only to the extent of gains therefrom)."136 247 Petitioners' first contention is that during Realty's fiscal year ended June 30, 1968, it had gross receipts in the total amount of $ 367,157.84 composed of the $ 79,028.06 reported as gross income on its 1968 return plus the $ 288,129.78 which it received in its fiscal year 1968 as repayment of loans and that the total amount of interest, rent, and royalty income it received in 1968 is less than 20 percent of its gross receipts of $ 367,157.84.In the alternative petitioners contend that Realty's interest income, both from its small loan business and its real estate business should not be considered as "passive investment income" within the meaning of section 1372(e)(5) since this interest was derived from the active conduct of its small loan and real estate business. It is petitioners' position that if we accept their contention with respect to the definition of "passive investment income," Realty's "passive investment income" for its fiscal year 1968 was less than 20 percent of the gross receipts of $ 79,028.06 reported as gross income on its return since the amount of $ 1,321.03 which Realty reported as rentals received from the Farnsworth Building was not in fact rentals. 137 Respondent takes the position that the $ 288,129.78 of repayment of loans which Realty received in its fiscal year 1968 is not properly a part of its gross receipts within the meaning of section 1372(e)(5), that under the definition of "passive investment income" contained in section 1372(e)(5)(C), Realty's interest, rent, and royalty income are all "passive investment income," and finally, that even if Realty's interest income were held not to be "passive investment income" within the meaning of section 1372(e)(5), Realty's rental income exceeded 20 percent of the $ 79,028.06 of gross receipts which it reported on its return as gross income since the prepaid rental of the Farnsworth Building was properly includable as rental income in making the computation of Realty's rental income for its fiscal year 1968.The term "gross receipts" used in section 1372(e)(5)(C) is not defined in the Revenue Code. However, respondent, by regulation ( sec. 1.1372-4(b)(5)(iv), Income Tax Regs.), 3 has defined this term 248 to mean the total amount received or accrued under the method of accounting used by the corporation in computing its taxable income with the exception of amounts received138 in certain nontaxable sales or exchanges, and amounts received as a loan, as a repayment of a loan, as a contribution to capital, or on the issuance by the corporation of its own stock. Petitioners, relying primarily on Valley Loan Association v. United States, 258 F. Supp. 673">258 F. Supp. 673 (D. Colo. 1966), contend that respondent's regulation is invalid in excluding from the definition of gross receipts amounts received as repayment of a loan. In the Valley Loan Association case, the court held respondent's regulation to be invalid as applied to a finance or loan company, giving as its reasons therefor the following (258 F. Supp. at 675-676):There is nothing in subchapter S which specifically excludes from gross receipts the amount received for repayment of such loans.It is obvious that if the defendant's position is correct, finance or loan companies are excluded from the benefits of subchapter S for their gross receipts under the defendant's theory are for all practical purposes limited to receipts of interest.We find nothing in subchapter S or in its legislative history that indicates that congress had any such intent. 139 The act itself indicates that congress intended § 1372(e)(5) to apply only to personal holding company income, for that is the subheading of that particular section. Since 1938 loan companies engaging in activities similar to those of the plaintiff have been excluded by congress from the definition of a personal holding company (see Title 26 U.S.C. § 542 and the legislative history therein). In the court's opinion the section as written indicates no intent to exclude loan and finance companies from the benefits of subchapter S.Since subchapter S does not expressly or by implication exclude from gross receipts the repayments of the principal of the plaintiff's loans and installment contracts, the court concludes that Treasury Regulation 1372-4 insofar as the defendant construes it to exclude from gross receipts the repayment of the loans made and installment contracts acquired by the plaintiff in the ordinary course of its loan business is contrary to the congressional act and congressional intent as evidenced by the act and is therefore invalid as applied to the plaintiff's operations. Commissioner of Internal Revenue v. Netcher, 7 Cir., 143 F. 2d 484,140 cert. denied 323 U.S. 759">323 U.S. 759, 65 S. Ct. 92">65 S.Ct. 92, 89 L. Ed. 607">89 L.Ed. 607 (1944).141 This Court, in Buhler Mortgage Co., 51 T.C. 971">51 T.C. 971 (1969), affirmed per curiam 443 F. 2d 1362 (C.A. 9, 1971), held that the specific exclusion of the gain on the sale of securities by security dealers by section 543(a)(2) from personal holding company income did not justify the implication of any such exclusion under the provisions 249 of section 1372(e)(5) since there was no statutory exclusion in that section. Therefore, we have taken the contrary position to the holding of the court in Valley Loan Association v. United States, supra, that the exclusion of a corporation from the definition of personal holding company under the section of the Code dealing with the personal holding company tax is a basis for a holding that such corporation does not come within the provisions of section 1372(e)(5) with respect to termination of its election under section 1372(a). Since we disagree with the underlying basis of the holding in the Valley Loan Association case, we do not view it as adequate authority for holding the provisions of respondent's regulation that gross receipts do not include142 a repayment of a loan invalid. We consider it necessary to view this regulation in the light of the statute which it is implementing and unless we find it unreasonable or plainly inconsistent with the statute, its validity should be upheld, Commissioner v. South Texas Co., 333 U.S. 496">333 U.S. 496 (1948). This regulation was adopted in December 1959, T.D. 6432, 1 C.B. 317">1960-1 C.B. 317, 329, shortly after the enactment of subchapter S and insofar as the definition of gross receipts is concerned has remained unchanged even though section 1372(e)(5) was amended by Pub. L. 89-389 (Apr. 14, 1966) to change the heading of paragraph (5) from "personal holding company income" to "passive investment income," and to exclude from the termination of election provisions of section 1372(e)(5) for 2 years new corporations which elect to file their income tax returns under subchapter S. See H. Rept. 1285, 89th Cong., 2d Sess. (1966) to accompany H.R. 12752, 1 C.B. 532">1966-1 C.B. 532-533, 541.There is added reason for not setting aside, except for weighty reasons, a regulation which has been in continued effect for a period143 of time during which the statute has been reenacted and amended without disapproval of the regulation. Estate of Richard R. Wilbur, 43 T.C. 322 (1964), and cases there cited.In Alfred M. Sieh, 56 T.C. 1386">56 T.C. 1386, 1391, 1392 (1971), affd. F.2d (C.A. 8, 1973), we held the provisions of section 1.1372-4(b)(5) (iv) of the Income Tax Regulations that "gross receipts" means the total amount received or accrued under the method of accounting used by the corporation in computing its taxable income to be a valid interpretation of the statute. In that case the taxpayer was contending that gross receipts of a corporation which reported its income on a cash basis should include the total price that corporation had received for property sold and not merely the payments on principal received, and that amounts paid into escrow for the payment of insurance and taxes should be included in gross receipts. We held that only the amount of principal payments received during the taxable year was properly 250 includable in the gross receipts of a taxpayer employing the cash method of accounting, and that respondent's regulation providing144 to this effect was a valid interpretation of the statute. While the portion of the regulation with which we were concerned in the Sieh case differs from the portion with which we are concerned in the instant case, our holding in that case lends support to the reasonableness of the provision of section 1.1372-4(b)(5)(iv), Income Tax Regs., that repayments of loans are not gross receipts. The repayment of a loan is never considered a receipt either under the cash or accrual method of accounting in computing a corporation's taxable income. The items normally considered as a part of gross receipts are the items listed in respondent's regulation as comprising those receipts, not reduced by returns and allowances, costs, or deductions.In our view the exclusion of repayments of loans from gross receipts under the provisions of section 1372(e)(5) is a reasonable interpretation of the statute. Certainly this interpretation is not unreasonable or plainly inconsistent with the statute. We therefore hold respondent's regulations to be valid and conclude that the $ 288,129.78 received by Realty as repayment of loans is not properly a part of its gross receipts within the meaning of section145 1372(e)(5).Petitioners base their alternative contention that Realty's interest income, both from its small loan department and its real estate department, should not be considered as "passive investment income" within the meaning of section 1372(e)(5) primarily on the holding of House v. Commissioner, 453 F. 2d 982 (C.A. 5, 1972), reversing a Memorandum Opinion of this Court. The Fifth Circuit in the House case, held that the term "interest" as used in section 1372(e)(5) did not include interest which would not be a part of the "personal holding company income" of a corporation and that a finance company not subject to personal holding company tax, because of the provisions of section 542(c)(6), could have no "personal holding company income." That court stated that a lending company such as the taxpayer in that case was specifically excluded from the definition of a personal holding company and therefore the fact that more than 20 percent of its gross receipts was from interest did not cause it to have "personal holding company income." That court concluded from these statements that such a corporation likewise could not have "personal holding146 company income" or "passive investment income" within the meaning of section 1372(e)(5). The Fifth Circuit in that case pointed out that the opinion of this Court had relied on our opinion in Buhler Mortgage Co., supra, as being controlling but in its view that case was not applicable. In our view the Fifth Circuit misread our opinion in Buhler Mortgage Co., 251 .The Fifth Circuit looked only to that portion of our opinion which referred to the parties having agreed on "the amount of personal holding company income earned by petitioner during the year in issue" and did not analyze the basis of our holding that the election of the taxpayer in that case to be taxed as a small business corporation had terminated under section 1372(e)(5). In Buhler Mortgage Co., we explained our holding as follows (51 T.C. at 977-979):In support of its position, petitioner cites the legislative history of the subchapter S provisions, specifically S. Rept. No. 1007, 89th Cong., 2d Sess. (1966), 1 C.B. 532">1966-1 C.B. 532, which states that the subchapter S provisions were passed 147 to allow only small businesses actively engaged in a trade or business to make the election. Those businesses with large amounts of passive income were not to have the option of electing subchapter S treatment. Consequently, Congress denied the election to those corporations which had large amounts of investment-type income such as royalties, rents, dividends, interest, annuities, and profits from the sales or exchanges of stock and securities. From this, petitioner concludes that since it had to expend a great deal of effort and engage in many activities in order to produce the notes which it sold to Bankers and Acacia, such proceeds should not be considered of a passive nature. Petitioner concludes that the proceeds are thus not within the definition of the Code or the regulations as personal holding company, or passive income. [Fn. omitted.]In support of this position petitioner cites section 1.543-1(b)(5)(ii), Income Tax Regs., which excludes security dealers' sales of securities from personal holding company income.Though we agree with petitioner that the subchapter S provisions were not intended to include corporations with large amounts of investment-type income (as opposed148 to those actively engaging in trade or businesses) we cannot find that the nature of the income changes simply because the corporation earning it must engage in many activities and exert a great deal of effort in doing so. The standard used by the Code and the regulations does not permit us to look behind the normal characterizations of a corporation's receipts in order to classify them as active or passive. If this were not so, we can only guess at what criteria might be properly used to say, e.g., that a rent item was "active" because the tenant was such poor pay, or that a dividend item was "active" because a stockholder's bill had to be brought to force the directors to declare and pay it. We conclude that the test established is one which requires us to look only to the plain meaning of the words used to define the income, not to the activity required to produce it. Secured promissory notes are clearly within the meaning of "securities" as that term is employed by section 1372(e)(5).The evidence in the instant case indicates that the interest income which petitioner collected on unsold deed-of-trust notes required a considerable amount of its time. However, we do not look149 behind this interest income for the effort expended in collection before calling it personal holding company income, and petitioner does not ask us to do so. We see no persuasive reason for treating proceeds from sales of notes any differently. * * Petitioner's citation of section 1.543-1(b)(5)(ii), Income Tax Regs, is not helpful. That section, exempting gain on sales of securities by securities dealers from personal holding company income, was promulgated in connection with section 252 543(a)(2) of the Code which read (prior to its amendment in 1964, Pub. L. 88-272) as follows:SEC. 543. PERSONAL HOLDING COMPANY INCOME.(a) General Rule. -- For purposes of this subtitle, the term "personal holding company income" means the portion of the gross income which consists of: * * * (2) Stock and securities transactions. -- Except in the case of regular dealers in stock or securities, gains from the sale or exchange of stock or securities.Thus the above exception was granted only by virtue of a specific provision of the Code. No similar provision exists under the subchapter S provisions, and in the absence of any such statutory exclusion, we cannot imply any150 exclusion, for petitioner's benefit by judicial flat.In our view we specifically held in Buhler Mortgage Co. that the fact that active efforts might have been exerted to produce interest or rental income did not cause that income not to be "personal holding company income" or "passive investment income" under the provisions of section 1372(e)(5). We further held that the fact that an exemption of certain income or a certain type of income from the provisions of the personal holding company income under section 543 did not cause a similar exclusion to exist under section 1372(e)(5). In our view our holding in Buhler Mortgage Co. which has now been affirmed per curiam by the U.S. Court of Appeals for the Ninth Circuit (443 F.2d 1362">443 F.2d 1362), cannot be reconciled with the holding of the Fifth Circuit in House v. Commissioner, supra.We therefore respectfully decline to follow the Appeals Court's holding in the House case and conclude that interest and rental income are part of "passive investment income" even though the recipient of such interest or rental income may be actively engaged in a small loan or real estate151 business.Since we have concluded that Realty's election to come within the provisions of subchapter S was terminated under section 1372(e)(5), since in its fiscal year 1968 more than 20 percent of its gross receipts was from interest which by definition is "passive investment income" within the meaning of section 1372(e)(5), we need not decide whether Realty had rental income which when added to the $ 792.56 of royalty income which petitioners conceded to be "passive investment income" within the meaning of section 1372(e)(5) would constitute more than 20 percent of Realty's gross receipts for its fiscal year 1968. It is obvious from the figures we have found that the $ 12,297.25 of rentals received by the "Real Estate Department," plus the $ 1,678 of rental income received from the "office building" when added to the royalty of $ 792.56 do not exceed 20 percent of Realty's gross receipts for its fiscal year 1968. However, if the amount of $ 1,321.03 which Realty listed as 253 rental from the Farnsworth Building is added to the two items conceded to be rental income plus the royalty income which Realty had in its fiscal year 1968, the total is in excess of 20 percent of Realty's152 total gross receipts for that year.Since we have concluded that the election of Realty to be taxed as a small business corporation under subchapter S terminated for its fiscal year 1968 because of the provisions of section 1372(e)(5), we hold that respondent properly disallowed the deductions of petitioners as shareholders of Realty for their pro rata share of the net operating loss of Realty for its fiscal year 1968. We therefore decide the only issue presented for our decision for respondent, but in order to reflect adjustments to which the parties have agreed,Decisions will be entered under Rule 50. STERRETTSterrett, J., concurring: I concur in the result reached by the majority because petitioner has failed to show that the interest received by Realty was not within the traditional concepts of "passive investment income." However, I do not believe that the term "interest" as used in section 1372(e)(5)(C) means that any interest, in all events, must be so classified. To so hold would be to accord a substantive meaning to the change in heading for subparagraph (5) when Pub. L. 89-389 changed the heading from "Personal Holding Company Income" to "Passive Investment Income." 153 It seems to me that interest may not, under some circumstances, qualify as passive income. Cf. sec. 542(c)(6). Footnotes1. All references are to the Internal Revenue Code of 1954, unless otherwise indicated.↩2. SEC. 1372. ELECTION BY SMALL BUSINESS CORPORATION.(e) Termination. -- * * * (5) Passive investment income. --(A) Except as provide in subparagraph (B), an election under subsection (a) made by a small business corporation shall terminate if, for any taxable year of the corporation for which the election is in effect, such corporation has gross receipts more than 20 percent of which is passive investment income. Such termination shall be effective for the taxable year of the corporation in which it has gross receipts of such amount, and for all succeeding taxable years of the corporation.(B) Subparagraph (A) shall not apply with respect to a taxable year in which a small business corporation has gross receipts more than 20 percent of which is passive investment income, if -- (i) such taxable year is the first taxable year in which the corporation commenced the active conduct of any trade or business or the next succeeding taxable year; and(ii) the amount of passive investment income for such taxable year is less than $ 3,000(C) For purposes of this paragraph, the term "passive investment income" means gross receipts derived from royalties, rents, dividends, interest, annuities, and sales or exchanges of stock or securities (gross receipts from such sales or exchanges being taken into account for purposes of this paragraph only to the extent of gains therefrom).↩3. Sec. 1.1372-4(b). Methods of termination -- * ** * * (5) Passive investment income -- * ** * * *(iv) Gross receipts. (a) The term "gross receipts" as used in section 1372(e) is not synonymous with "gross income". The test under section 1372(e)(4) and (5) shall be made on the basis of total gross receipts, except that, for purposes of section 1372(e)(5)↩, gross receipts from the sales or exchanges of stock or securities shall be taken into account only to the extent of gains therefrom. The term "gross receipts" means the total amount received or accrued under the method of accounting used by the corporation in computing its taxable income. Thus, the total amount of receipts is not reduced by returns and allowances, cost, or deductions. For example, gross receipts will include the total amount received or accrued during the corporation's taxable year from the sale or exchange (including a sale or exchange to which section 337 applies) of any kind of property, from investments, and for services rendered by the corporation. However, gross receipts does not include amounts received in nontaxable sales or exchanges (other than those to which 337 applies), except to the extent that gain is recognized by the corporation, nor does that term include amounts received as a loan, as a repayment of a loan, as a contribution to capital, or on the issuance by the corporation of its own stock.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624593/	ST. LOUIS UNION TRUST COMPANY, EXECUTOR OF THE WILL OF WILLIAM NORTHRUP MCMILLAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.St. Louis Union Trust Co. v. CommissionerDocket No. 45966.United States Board of Tax Appeals27 B.T.A. 318; 1932 BTA LEXIS 1088; December 14, 1932, Promulgated 1088 1. Decedent, a native of this country living abroad, described himself as "of St. Louis, Missouri." Thereafter he took an oath of allegiance to Great Britain. He never returned to the United States to live, nor was he engaged in business here. After his death his administrators described him as being domiciled in this country at the time of death. Held, decedent was a nonresident alien when he died. 2. Decedent left property physically located in the United States. It consisted of domestic corporation stocks and securities, United States bonds and certificates, corporate and municipal bonds, cash on deposit, real estate in Missouri, and outstanding claims. Held, only the corporate stocks are subject to Federal estate tax. 3. Held, decedent's personal property located abroad is not subject to estate tax by this Government. 4. During his life decedent made voluntary payments to his mother's estate so that certain of her wishes might be carried out. Held, the amount so paid should not be included in decedent's gross estate. 5. Held, deductions for funeral and administration expenses, et cetera, may not exceed 10 per cent of the value of1089 the property subject to tax. Philip Nichols, Esq., for the petitioner. Frank T. Horner, Esq., for the respondent. MARQUETTE 319 This proceeding is for the redetermination of a deficiency in Federal estate tax, asserted by the respondent in the amount of $172,857.82, less a credit of $22,511.19 for inheritance taxes paid to the States of Missouri and New Jersey. The following are alleged as errors; 1. Determining that decedent at the time of his death was a citizen of the United States; 2. Including in decedent's gross estate the following: (a) the amount of principal received by his executor from the estate of William McMillan; (b) bonds, notes and certificates of indebtedness of the United States, and accrued income thereon, received from the William McMillan estate; (c) certain securities, intangible personal property, and money on deposit, received from the William McMillan estate; (d) the amount of $152,285.27 received as income from the William McMillan estate; (e) the amount of $72,302.63 received from the William McMillan estate, and consisting of interest on bonds, notes and certificates of indebtedness of the United States; 1090 (f) certain securities, accounts receivable and other intangible personal property kept by decedent in St. Louis, Missouri; (g) moneys deposited by decedent in banks in the United States. 3. In not deducting from decedent's gross estate funeral expenses, debts of decedent, administration expenses, income taxes, allowance for support of dependents, and a payment of $50,000 made out of the assets of the estate. The respondent, in his answer, asserts that there should be added to decedent's gross estate, as previously determind by respondent, (a) $278,779.97 representing the value of decedent's personal property 320 situated in England and in East Africa; (b) $289,544.86 representing an escrow fund; and (c) $399,635.53 representing the value of decedent's claim against the estate of Eliza McMillan. FINDINGS OF FACT. From the stipulation of the parties to this proceeding, we find the following facts. William Northrup McMillan, hereinafter called the decedent, was born in St. Louis, Missouri, in 1872. His father, a British subject, became a naturalized American citizen in 1874. Decedent married in 1894 and, with his wife, lived in St. Louis until September, 1899. 1091 He then removed to London, England, where for four years he represented an American business concern. In 1903 he went to British East Africa, later called Kenya Colony, where he maintained his home until his death in 1925. In Africa decedent acquired large tracts of land which he used for farming and cattle raising. He built a house on the land, and many smaller houses for his farm employees, stables, etc. In 1906 he erected a stone bungalow in Nairobi, in Kenya Colony. In 1914 he acquired another large tract of land, on which he erected a large residence. He also acquired an important residential estate in Nairobi. Decedent enlisted in the British Army in 1915 and served through out the World War, retiring with the rank of major. In 1918 he was knighted by the British Crown. In 1920 decedent was elected a member of the Legislative Council which governed Kenya Colony, and remained a member of that body until his death. To qualify for such membership he took the oath of allegiance to the British Crown. At no time after entering the British army did decedent take the oath of allegiance to the United States. After leaving this country decedent returned every second year1092 to visit his mother, until her death in 1915. From that time, until his own death in 1925, he was in the United States but once, for a short visit with relatives. Decedent was not engaged in any business in the United States after 1899, nor did he or his wife own or lease any place of residence in the United States at the time of his death nor for many years prior thereto. When decedent's mother died she devised the family home in St. Louis to decedent and her summer home to his wife. Neither of these homes was thereafter occupied by decedent or his wife and both pieces of property were sold soon after the mother's death. Thereafter neither decedent nor his wife owned any real estate interest in this country except in some of the property held by his father's estate in trust. Decedent was one of the trustees of that estate and as such trustee he signed papers sent to him for the purpose, but he took no active part in managing the trust property. 321 In 1913, in an executed power of attorney to a London solicitor, decedent described himself as "of Juja Farm, Nairobi, British East Africa." In his will, executed in February, 1915, decedent described himself as "of St. 1093 Louis, in the State of Missouri." After decedent's death that will was probated in St. Louis as the will of a resident decedent. A London solicitor, applying for administration as to the decedent's property in Great Britain, described decedent as "of the City of St. Louis and State of Missouri in the United States of America," and further stated that decedent died "domiciled" in the State of Missouri. In the Federal estate tax return filed by petitioner the decedent's permanent residence at the time of death was set forth as St. Louis, Missouri, and his "business address" as Nairobi, Kenya Colony. William McMillan, a resident of St. Louis, died in 1901, survived by his widow and his son, William N. McMillan, the petitioner's decedent. Under the will of the elder McMillan all of his property was left in trust for his widow and son in equal shares during their lives, and upon the death of either all the income from the property was to go to the survivor. If the son died leaving issue, such child or children became entitled to his share of the income. The will provided that after the death of William McMillan's widow, as each child of the present decedent reached the age of twenty-one, 1094 it was to receive its pro rata share of the corpus of the estate. It was further provided that if the present decedent died leaving no surviving issue or lineal descendants thereof, and after the death of the testator's widow, the trust estate was to pass to the heirs of William McMillan's two brothers. At various times prior to 1914 certain of such contingent heirs sold and assigned their respective interests in the trust estate to the present decedent and his mother. The total so transferred amounted to 58/120 of the entire trust estate, 29/120 to the present decedent and the same proportion to his mother. The mother died in 1915. Decedent died March 22, 1925, survived by a widow but no children or lineal descendants thereof, and no posthumous child was born. On the date of his death the principal of his father's trust estate had a value of $6,927,627.18. That estate included real property in St. Louis worth $82,527.15; 100 shares of stock in a Missouri corporation worth $334,649.79, and United States Liberty Bonds and Treasury notes worth $4,098,562.54. After decedent's death some of the contingent heirs to the trust estate brought suit to set aside their assignments of1095 interest in the trust property which they had made to decedent and his mother. The court, on February 19, 1927, held that the assignments were valid and directed the surviving trustee to pay over to decedent's executor 29/120 of the principal of the William McMillan trust 322 estate, and that was done. The property so paid over consisted of the following items, valued as of the date of decedent's death: ItemAmountUnited States Liberty Bonds$751,499.94Interest accrued thereon12,745.18United States bonds and certificates of indebtedness372,789.09Income accrued thereon407.76County road improvement bonds19,040.75Income accrued thereon64.17Railway Exchange Bldg. bonds22,937.50Income accrued thereon587.5040 shares Annuity Realty Co$36,936.60Note, Bedford Holding Co520,000.00Income accrued thereon12,234.46Cash47,959.23Due from decedent2,613.78Total1,799,815.96The above items were included in decedent's gross estate by the respondent in his determination of deficiency. Under the will of William McMillan, the net income from the trust estate was to be paid to the present decedent and his mother in equal1096 parts, free from interference or control of creditors. The will contained a declared intention that neither beneficiary should have the right to alienate, encumber, or otherwise dispose of his or her interest in the trust estate, nor in any way to anticipate or charge the income therefrom. In 1913 decedent and his mother made a written agreement by which, upon the death of either, the survivor was to pay, during his or her life, to the representative of the other, one-quarter of the total income received annually from the trust estate. A cancellation of that agreement was signed by both during the mother's last illness, but in order to carry out her wishes decedent voluntarily paid to her representatives, from the time of his mother's death in 1915, until April, 1921, a total of $399,635.53, pursuant to the original agreement. He then declined to make further payments. In 1924 a suit was brought in the St. Louis courts to determine the validity of the agreement. Trial occurred after decedent's death. The lower court held the agreement valid and ordered decedent's executor to pay over the amount of the unpaid balance, with interest, a total of $94,351.72. Also, what was called1097 the escrow fund, consisting of the accruals of one-fourth the trust estate income and which had been placed with a depositary pending the outcome of the litigation, was ordered by the court to be paid over under the agreement. The decision of the lower court was appealed to the Supreme Court of Missouri and while the appeal was pending the respondent issued his deficiency notice. In 1929 the Supreme Court reversed the decision below and thereafter the depositary paid the amount of the escrow fund to decedent's executor. The inventory and valuation of that fund, as of the date of decedent's death, was: U.S. 4th Liberty Bonds$149,756.25Interest accrued on same307.26U.S. Treasury notes134,163.75Interest accrued on same277.99Cash3,722.32Total288,227.57323 The Federal return filed with respect to decedent's estate contained the following: Schedule B, stocks and bonds - Fair market value at day of death - Stocks of domestic corporations$920.00Bonds71,935.0072,855.00Accrued interest or dividends1,032.4173,887.41These values are correctly stated, except that $8.75 should be added to accrued interest and dividends, making the correct total of this item73,896.16Schedule C, Mortgages, Notes, Cash and Insurance - Fair market value at day of death47,186.73Accrued interest or income1,390.8348,577.56These values are correctly stated.Schedule D, Other Miscellaneous Property - There may be additional personal property being administered upon Kenya Colony, Tanganyika Territory and London, England; the value of which this Executor cannot at this time ascertain.Prior to the death of the decedent, he had acquired 24 1/6 per cent of the interests of all the remainders created by the will of the late William McMillan * * Said remainders have not as yet determined and no property from that source has come into the hands of the Executors.Decedent's estate also has a claim to funds held in escrow * * * which claim on the date of death amounted to approximately $285,000.00. Said claim is now in the process of litigation.Open accounts against Alice Warfield$6,552.321098 Decedent's executor also received $152,285.27 accrued and undistributed income of the William McMillan Trust Estate. Of that amount $72,302.63 consisted of interest on bonds, notes and other obligations of the United States. No other property belonging to decedent at the time of his death, or coming into the hands of his executor, was physically situated within the United States, except the so-called escrow fund. Decedent's gross estate outside of this 324 country constituted slightly more than 8 per cent of his entire gross estate, and was as follows: In Great BritainIn KenyaIn TanganyikaIntangible personal property$23,121.52$94,654.72$25,595.75Tangible personal property1,750.00110,836.189,840.00Real estate331,023.3124,383.50Total24,871.52536,514.2159,818.75None of the intangibles in the above three jurisdictions consisted of stocks, bonds, or other obligations of corporations organized under the laws of the United States, or any state therein, or of obligations of residents of the United States. The following items were claimed as deductions from the gross estate: ItemAmountFuneral expenses$524.26Debts380,960.47Expenses of administration, including litigation expense over the escrow fund253,799.22Additional Federal income taxes of decedent, 1919 to 1924126,981.97Net interest accrued thereon$105.77Allowance for support of dependents24,000.00Compromise payment to settle claim of remaindermen50,000.00Total836,371.691099 The respondent disallowed those deductions, but now concedes error in so doing. OPINION. MARQUETTE: The first question is whether William Northrup McMillan was a resident and a citizen of the United States at the time of his death in 1925. In our opinion he was not. Title 8, section 17, United States Code of laws, provides that "Any American citizen shall be deemed to have expatriated himself when * * he has taken an oath of allegiance to any foreign State." It is undisputed that the decedent took an oath of allegiance to the British Crown in 1920, perhaps even earlier than that, and he never thereafter repatriated himself as a citizen of this country. A statement in his will, made prior to his oath of allegiance to Great Britain, that he was "of St. Louis, Missouri," and like statements concerning him made by others after his death, do not constitute repatriation. It is clear from the facts before us that he was not a citizen of the United States at the time of his death. We think it equally clear from the facts that he was not a resident of this country at the time of his death, nor for many years prior thereto. A resident is one who resides in a place and to reside1100 325 is to live; to make an abode for a considerable time; to dwell as in a home. (Standard Dictionary.) Under no aspect of that definition can it be said that decedent ever resided in the United States after 1899. He made his home elsewhere, acquired extensive property and business interests outside this country, and looked after those interests in person. During the last ten years of his life he was in this country but once, for a brief visit. Respondent cites, as authorities to the contrary, Adolph Rosenberg, Executor,2 B.T.A. 720">2 B.T.A. 720; Union Trust Co. of Cleveland, Executor,5 B.T.A. 1272">5 B.T.A. 1272; Noah C. Rogers, Executor,17 B.T.A. 571">17 B.T.A. 571; Bank of New York & Trust Co., Executor,21 B.T.A. 197">21 B.T.A. 197; Guaranty Trust Co., Executor,25 B.T.A. 507">25 B.T.A. 507. But in each of those cases there was no expatriation, as here, and there were definite evidences of intention to retain domicile in the United States. In the instant proceeding the evidence not only fails to support the theory that decedent retained or intended to retain his domicile in this country, but it shows that he had no such idea or intention. The second1101 question relates to the inclusion in decedent's estate of various items of property received from his father's estate, of certain intangibles kept in this country, and of money deposited in banks in the United States. The property received from the estate of decedent's father consisted of United States bonds and Treasury notes, county road improvement bonds, corporate stocks and securities, a debt owing from decedent to his fathers' estate, cash in bank, accrued interest on bonds, and real estate valued at $82,527.15. The pertinent provisions of the Revenue Act of 1924, here applicable, are: SEC. 302. The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated - (a) To the extent of the interest therein of the decedent at the time of his death which after his death is subject to the payment of the charges against his estate and the expenses of its administration and is subject to distribution as part of his estate * . SEC. 303. For the purpose of the tax the value of the net estate shall be determined - * * (d) For the purpose of Part1102 I of this title, stock in a domestic corporation owned and held by a nonresident decedent shall be deemed property within the United States, * * (e) * * * and any moneys deposited with any person carrying on the banking business, by or for a nonresident decedent who was not engaged in business in the United States at the time of his death, shall not, for the purpose of Part I of this title, be deemed property within the United States. 326 In Ernest Brooks, et al., Executors,22 B.T.A. 71">22 B.T.A. 71, we considered the statute above cited respecting its application to intangible property of a nonresident alien. The property consisted of stock in a foreign corporation, bank deposits, bonds of foreign corporations, foreign governments, domestic corporations, and a domestic municipality. All that property was kept in New York, where the income was collected and deposited to the credit of the alien decedent. We there held that the situs of such securities was at the domicile of the owner, and hence they should not be included in his taxable estate in this country. That decision was affirmed by the 1103 Circuit Court of Appeals for the Second Circuit on July 29, 1932, 60 Fed.(2d) 890. In both decisions a distinction, due to statutory provision, was drawn between the securities mentioned and stock in a domestic corporation. In the above case court decisions are reviewed, and it is apparently settled in the Federal jurisdiction that stocks, bonds and similar securities, mortgages and other evidences of indebtedness, money on deposit, and other intangibles, if not part of a localized business elsewhere have an exclusive situs for tax purposes at the domicile of the owner. Cf. Baldwin v. Missouri,281 U.S. 586">281 U.S. 586. That principle is modified by section 303(d) of the Revenue Act of 1924, which provides that, for Federal estate tax purposes, "stock in a domestic corporation owned and held by a nonresident decedent shall be deemed property within the United States." None of the personal property in this country which was owned and held by petitioner's decedent at his death was employed by him in business here. In our opinion none of that property was subject to Federal estate tax except the 40 shares of stock in the Annuity Realty Company, a domestic1104 corporation, received in the distribution of the William McMillan estate, and the stock in domestic corporations included in the return filed with respect to decedent's estate. Under the laws of Missouri, in 1925 real property was not subject to the expenses of administration of a decedent's estate. Hence it could form no part of such estate for Federal estate tax purposes, under section 302(a) of the Revenue Act of 1924. Crooks v. Harrelson,282 U.S. 55">282 U.S. 55; Oreon E. Scott et al., Executors,25 B.T.A. 131">25 B.T.A. 131. Therefore, whatever interest in real property in Missouri was held by petitioner's decedent at his death can not be subjected to estate tax by the respondent. Respecting personal property of the decedent in Great Britain and Africa, respondent concedes that such property is not taxable here if we decide, as we have, that decedent was not a resident or citizen of the United States. The value of that property, $265,798.17, therefore should not be included in the gross estate upon a recomputation of the tax. 327 The decedent and his mother made an agreement respecting a portion of the income from the William McMillian trust estate. 1105 During the mother's last illness the agreement was canceled, but in order to carry out certain provisions of her will the decedent voluntarily paid to her executors amounts aggregating $399,635.53. The payments began in 1915 and continued until some time in 1921. The respondent contends that the amount so paid constituted a valid claim by decedent's estate against the estate of his mother, and hence should be included in his gross estate. The evidence indicates that decedent made the payments with full knowledge of all pertinent facts. If he was under any misapprehension at all, and it is by no means certain that he was, it was only concerning the legal effect of the agreement with his mother. We think the respondent's contention is not well founded. It is a general principle of law that payments voluntarily made with full knowledge of all the facts, although under mistake or ignorance of the law, are not recoverable in the absence of fraud or improper conduct of the payee. Little v. Bowen,134 U.S. 547">134 U.S. 547. Here, no fraud, or improper conduct by his mother's executors, induced the payments in question. Respondent has admitted error in disallowing deductions1106 on account of funeral and administration expenses and the like under the Revenue Act of 1924, and of a payment of $50,000 in compromise of a claim against decedent's estate. In the case of a nonresident decedent such deductions are allowable in the proportion which the value of his gross estate located in this country bears to his entire estate, but in no case to exceed 10 per cent of the value of his gross estate situated in the United States. Section 303 of the statute deals only with such property of a decedent as may become subject to Federal estate tax. It is not concerned with any property not subject to such tax. Obviously, the language used and the deductions allowed can only refer and apply to such taxable property. Oreon E. Scott et al., Executors, supra.The only property of the decedent subject to Federal estate tax was his stock in domestic corporations, having an aggregate value of $37,856.50. Not more than 10 per cent of that amount should be allowed as a deduction in recomputing the tax. Reviewed by the Board. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624595/	Edna S. Ullman, Petitioner, v. Commissioner of Internal Revenue, RespondentUllman v. CommissionerDocket No. 76740United States Tax Court34 T.C. 1107; 1960 U.S. Tax Ct. LEXIS 67; September 23, 1960, Filed 67 Decision will be entered for the respondent. Petitioner, in the taxable years 1954, 1955, and 1956, received payments on an award from the Mixed Claims Commission, United States and Germany. She acquired the right to receive these payments by bequest from her husband who acquired such right by bequest from his mother who in turn had inherited such right from her husband. Petitioner's husband died November 10, 1953. The total amount of the original capital investment of petitioner's father-in-law in the property covered by the award had been received by him prior to his death. Held, the amounts received by petitioner constituted income in respect of a decedent to her under section 691(a), I.R.C. 1954. Harold M. Baron, Esq., for the petitioner.Henry T. Nicholas, Esq., for the respondent. Scott, Judge. SCOTT 1107 OPINION.Respondent determined deficiencies in petitioner's income tax for the calendar years 1954, 1955, and 1956, in the amounts of $ 281.92, $ 278.01, and $ 228.31, respectively. The deficiencies resulted from the inclusion by respondent in petitioner's income of amounts received by her in the respective years from the Secretary of Treasury of the United States under an award of the Mixed Claims Commission, United States and Germany (hereinafter referred to as the Mixed Claims Commission), made to the Joseph Ullmann Company, a partnership, which amounts respondent determined constituted 1108 income to petitioner reportable in accordance with sections 61 and 691(a) of the Internal Revenue Code of 1954. 70 Whether the amounts received by petitioner under the award from the Mixed Claims Commission are includible in whole or in part in her income for the taxable years involved requires a determination of the following issues:1. Do the amounts paid to petitioner in the taxable years represent a return of capital of the partnership, Joseph Ullmann Company, or interest thereon?2. If the amounts represent interest payments as to the Joseph Ullmann Company, are they income in respect of a decedent to petitioner and, if so, are the amounts ordinary income or capital gains?All the facts have been stipulated and are found accordingly.Petitioner filed her income tax returns for the years 1954, 1955, and 1956 with the district director of internal revenue at Cincinnati, Ohio. The petitioner is the widow of Jacques C. Ullman, who died on November 10, 1953. Jacques C. Ullman was the son of Lilian R. and Emanuel S. Ullmann. Emanuel S. Ullmann died on December 21, 1943, and Lilian R. Ullmann died on August 29, 1946.In 1928 the Mixed Claims Commission awarded to the Joseph Ullmann Company, a partnership, a principal amount of $ 237,000 for damages suffered in World War I, plus accrued interest71 from October 1, 1920, to January 1, 1928, in the amount of $ 85,936.85, making a total award of principal and interest of $ 322,936.85. Emanuel S. Ullmann held a 26 2/3 per cent interest in the partnership and thus in the award made by the Mixed Claims Commission to the Joseph Ullmann Company. Upon the death of Emanuel, his widow, Lilian R. Ullmann, acquired his interest in the award. Jacques C. Ullman acquired the interest of Lilian R. Ullmann by the terms of her will and by assignment of her executors. Petitioner, as executrix and then as sole residuary legatee of her husband's estate, acquired the interest of Jacques C. Ullman in the award.Commencing with a payment of $ 100,000 on August 15, 1928, periodic payments were made at various dates through November 10, 1941, to the partners of the Joseph Ullmann Company or their successors in interest by the Secretary of Treasury on account of the award of the Mixed Claims Commission to the company. A total amount of $ 264,269.69 had been paid on the award by November 10, 1941. No payments were made on the award from November 10, 1941, until February 10, 1948, when a payment of $ 7,643.41 was made. On January 12, 1949, a payment72 of $ 3,175.82 was made on the award, and on September 17, 1952, a payment of $ 1,018.31 was made. Jacques was recognized by the Commissioner of Accounts 1109 of the Treasury Department as being entitled to receive 26 2/3 per cent of the payments made in 1948, 1949, and 1952. Further payments were made on the award during each of the years 1953 through 1959. During the years 1954, 1955, and 1956 payments in the net amounts of $ 2,017.09, $ 1,217.80, and $ 1,007.53, respectively, were made to petitioner.All payments made in connection with the award to the Joseph Ullmann Company were made pursuant to the authority of the Settlement of War Claims Act of 1928 (Act of March 10, 1928, ch. 167, 45 Stat. 254) and subsequent amendments thereto, specifically the Act of August 6, 1947 (ch. 506, Pub. L. 375, 80th Cong.). Under the provisions of the Settlement of War Claims Act of 1928, the Secretary of Treasury was authorized to pay (but only out of the German special deposit account created by that Act) the principal of each award certified by the Mixed Claims Commission, plus interest thereon accrued before January 1, 1928, and simple interest at the rate of 5 per cent per annum 73 from January 1, 1928, upon such total amount payable which remained unpaid. Beginning January 1, 1928, the order of priority for payment provided first, for the payment of $ 100,000 of the amount of the award with accrued interest to January 1, 1928, on all claims which with such accrued interest exceeded $ 100,000; second, for an additional payment which when aggregated with the $ 100,000 prior payment would constitute 80 per cent of the amount of the award with interest accrued to January 1, 1928; third, the payment of interest accruing after January 1, 1928; and finally, the payment of any amount remaining unpaid. All amounts paid by the Secretary of Treasury under the award to the Joseph Ullmann Company from August 15, 1928, through November 10, 1941, were designated as payments on principal.The Act of August 6, 1947, amending the War Claims Act, revised the order of priority of payment giving priority to the payment of accrued interest. All payments made from February 10, 1948, to June 1, 1957, by the Secretary of Treasury on the award to the Joseph Ullmann Company were designated as payments on interest.On February 27, 1953, the United States of America and the Federal Republic74 of Germany entered into an agreement entitled "Settlement of Indebtedness of Germany for Awards Made by the Mixed Claims Commission," providing for a total payment of $ 97,500,000 to the United States in satisfaction of unpaid awards of the Mixed Claims Commission, including accrued interest, in the amount of $ 104,000,000. This treaty became effective September 16, 1953.The appraiser designated by the Surrogate's Court of the County of New York to appraise the estate of Jacques C. Ullman, entered his 1110 report determining the fair market value of the award of the Mixed Claims Commission owned by Jacques C. Ullman at the time of his death to be $ 6,413.Petitioner's position is that the payments made to her by the Secretary of Treasury pursuant to the award of the Mixed Claims Commission to the Joseph Ullmann Company are a return of capital and not income. Petitioner first contends that the terms of the treaty between the United States and Germany entered into on February 27, 1953 (ratified by the United States Senate on July 13, 1953), in effect merged the principal amount of the award still owing to the Joseph Ullmann Company with the interest thereon, making all subsequent75 payments a return of capital. Respondent takes the position that the principal amount of the award to the Joseph Ullmann Company of $ 237,000 had been paid by November 10, 1941, and that any payments subsequent to that date were in satisfacttion of interest accrued on the principal amount.This award has been the subject of previous litigation in this Court. We held in Emanuel Solomon Ullmann, 30 B.T.A. 764">30 B.T.A. 764, affd. 77 F. 2d 827 (C.A. 2, 1935), certiorari denied 296 U.S. 631">296 U.S. 631, that the taxpayers realized no taxable income on payments made to them by the Secretary of Treasury pursuant to the award of the Mixed Claims Commission until their capital basis for the property covered by the award had been recovered. In Emanuel Solomon Ullmann, supra, respondent took the position that the original payment should be prorated between the principal sum of $ 237,000 and the accrued interest of $ 85,936.85, and the portion applicable to interest included in the taxable income of the taxpayers. On the authority of James Speyer, 30 B.T.A. 517">30 B.T.A. 517, affd. 76 77 F. 2d 824 (C.A. 2, 1935), certiorari denied 296 U.S. 631">296 U.S. 631, we held that the uncertainty of future payments and the doubt that the awards would ever be paid in full were such that the taxpayers should not be charged with taxable interest income until their basis in the principal of the award had been recovered. The clear corollary of this holding is that when the cost basis covered by the award had been paid in full, subsequent payments would constitute interest. Since the capital basis of the award ($ 237,000) had been recovered by November 10, 1941, all subsequent payments constitute payments of interest.There is nothing in the treaty between the United States and Germany, effective in 1953, to change the nature of the award as made by the Mixed Claims Commission or the nature of the payments made by the Secretary of Treasury pursuant thereto. The treaty effected a settlement of the obligation of the German Government to the United States Government with respect to the remaining indebtedness for the awards made by the Mixed Claims Commission and reduced the total amount owing from $ 104,000,000 to $ 97,500,000 as of the 1111 77 effective date of the treaty. It also provided for the payments of this amount in installments over a 26-year period with interest at the rate of 3 3/4 per cent on any installment or part thereof remaining unpaid after the date such installment became due. The treaty effected a reduction in the overall indebtedness of the German Government to the United States, but did not change the nature of the payments made by the Secretary of Treasury out of the German special deposit account to the recipients thereof. The capital basis of the award having been recovered, the payments made to petitioner during the years 1954, 1955, and 1956 represented interest on the portion of the capital basis of $ 237,000 of the award which was originally owned by Emanuel S. Ullmann.Petitioner further contends that since she obtained her interest in the award by bequest from her husband, she is entitled to recover as capital the fair market value of this interest in the hands of her husband at the date of his death, which amount she claims is $ 6,413, the evaluation placed on her husband's interest in the award by the appraiser of the New York Surrogate's Court. She also contends that any amount received78 in excess of the $ 6,413 return of capital would constitute capital gains to her.Since petitioner received her interest in this award by bequest from her husband, the amounts are a return of capital to the extent of the fair market value of the right to receive these amounts at the date of her husband's death unless such amounts are includible in her gross income as income in respect of a decedent. Mary Tighe, 33 T.C. 557">33 T.C. 557 (1959).Section 691(a)(1) of the Internal Revenue Code of 1954, 180 applicable to the years here involved, provides that all items of gross income in respect of a decedent which are not properly includible in respect of the taxable period in which falls the date of his death or a prior period (including the amount of all items of gross income in respect of a prior decedent acquired by reason of death of the prior decedent) shall be included when received in the gross income of the estate or person 1112 who acquires the right to receive such amounts by bequest. Section 691(a)(2)2 provides that if the right described in paragraph (a)(1) is transferred, there shall be included in the income of the transferor (either the estate79 or person who receives the right by reason of the death of the decedent) the fair market value of such right at the time the transfer occurs plus any consideration received in excess of such fair market value. It is specifically provided that the term "transfer" shall not include transmission at death.Section 126(a)(1) of the Internal Revenue Code of 1939, 382 applicable to years prior to 1954, 81 is substantially the same as section 691 (a)(1) of the 1954 Code except that it does not provide for the inclusion of income in respect of prior decedents. Section 126(a)(2) of the 1939 Code 4 is substantially the same as section 691(a)(2) of the 1954 Code except that it does not exclude the transmission at death from the definition of the term "transfer."Since Emanuel S. Ullmann had, prior to his death on December 21, 1943, received a return of his entire capital investment, any further amounts he would have received would have been income to him. There is no indication83 that Emanuel reported his income on an accrual basis and even if he had, under the holding in Emanuel Solomon Ullmann, 1113 , amounts payable on the award from the Mixed Claims Commission were not sufficiently definite to be accrued. Therefore, any accrual of these items would have been required, if at all, solely because of his death which was excepted from accruals under section 42(a) of the 1939 Code 5 applicable at his death. Under these circumstances, any payments which his widow might have received on such award (even though in fact she actually received no payment) would have constituted income in respect of a decedent to her under section 126(a) of the Internal Revenue Code of 1939.84 Under section 126(a)(2) of the Internal Revenue Code of 1939 and section 39.126(a)-1(f) of Regulations 118, 685 when the right to receive income in respect of a decedent was transferred by bequest, the fair market value of such right at the time of such disposition was required to be included in the gross income of the testator. Since Lilian bequeathed to Jacques the right to receive the payments on the award, the statute and regulations effective at the date of her death required that her final income tax return include the fair market value of the right to receive such payments. Under section 126(a)(2) of the 1939 Code in effect at the date of Lilian's death, when Jacques obtained the right to payments on the award from the Mixed Claims Commission by bequest from Lilian, he is considered to have received this right by transfer to the same extent as if he had purchased the right from Lilian for its fair market value at the date of her death. It follows that payments he received under the award do not represent "income in respect of a decedent" to him. 7 For the same reason these 1114 payments would not constitute income in respect of a prior decedent to petitioner. 886 This requires an answer to the question whether the payments on this award made during 1954, 1955, and 1956 would have constituted income to Jacques had they been received by him as amounts in excess of the fair market value of his mother's interest in the award at the date of her death and, if so, would such payments be "income in respect of a decedent" to petitioner.Had Jacques purchased the right to receive this income from his mother, amounts received by him in excess of his basis therein would have constituted income to him. Frances E. Latendresse, 26 T.C. 318">26 T.C. 318, 326 (1956), affd. 243 F. 2d 577 (C.A. 7, 1957), certiorari denied 355 U.S. 830">355 U.S. 830.For years governed by the revenue laws prior to the amendment of the 1939 Code by section 134(e) of the Revenue Act of 1942, providing for inclusion in income of income in respect of a decedent, this Court (as the Latendresse case shows) has held that amounts received by the estate, legatee, or heir, in excess of the fair market value of the right to receive the income at the date of the decedent's death, constitute income to the recipient. William P. Blodget, et al., 1243">13 B.T.A. 1243 (1928);87 Peak v. Commissioner, 80 F. 2d 761 (C.A. 8, 1936), affirming a Memorandum Opinion of this Court; cf. Mary Tighe, supra.The record does not show the amount of the fair market value of the right to receive payments under the award at the date of Lilian's death. We, therefore, assume, against petitioner's interests, that at the date of Lilian's death the right to receive income under the award had a fair market value less than the amounts received by Jacques on the award from 1948 to the date of his death. Under this assumption, Jacques had received prior to his death a return of his basis in the award and any further payments on the award would have constituted income to him. Under section 691(a) of the 1954 Code, the payments would, therefore, constitute "income in respect of a decedent" to petitioner unless the value thereof was properly includible in Jacques' income for the period in which fell the date of 1115 his death or a prior period. Estate of Thomas F. Remington, 9 T.C. 99">9 T.C. 99, 107 (1947).Section 126(a)(2) of the 1939 Code and section 39.126(a)-1(f) of Regulations 118, 88 applicable at the date of Jacques' death, would not have required the inclusion in his income for the period in which fell the date of his death of the fair market value of the right to receive payments on the award since the amounts being received by him were not income in respect of a decedent to him. There is no indication in the record that Jacques reported his income on an accrual basis of accounting but even if he did, no amount would be properly includible in his income for the period in which fell the date of his death or a prior period because of his right to receive payments under the award from the Mixed Claims Commission. Section 42(a) of the 1939 Code, applicable to the year 1953, provides that where a taxpayer is on an accrual basis of accounting, amounts accruable only by reason of the taxpayer's death shall not be included in computing the net income for the period in which falls the date of his death. The payments received by petitioner under the award of the Mixed Claims Commission constituted income in respect of a decedent to her under section 691(a) of the 1954 Code. Cf. Frances E. Latendresse, supra.Petitioner contends that 89 if the payments on the award of the Mixed Claims Commission are income to her, such amounts constitute capital gains. Under section 691(a) of the 1954 Code and the regulations 9 issued pursuant thereto, the income in respect of a decedent has the same character in the hands of the recipient as it would have in the hands of the decedent. The amounts received during the taxable years on the award from the Mixed Claims Commission would have constituted ordinary income to Jacques had they been received by him since such amounts were not received from a sale or exchange of the right to receive payments on this award. May D. Hatch, 14 T.C. 237 (1950), reversed on another issue 190 F. 2d 254. It follows that these payments when received by petitioner constituted ordinary income to her.90 Decision will be entered for the respondent. Footnotes1. SEC. 691. RECIPIENTS OF INCOME IN RESPECT OF DECEDENTS.(a) Inclusion in Gross Income. -- (1) General rule. -- The amount of all items of gross income in respect of a decedent which are not properly includible in respect of the taxable period in which falls the date of his death or a prior period (including the amount of all items of gross income in respect of a prior decedent, if the right to receive such amount was acquired by reason of the death of the prior decedent or by bequest, devise, or inheritance from the prior decedent) shall be included in the gross income, for the taxable year when received, of: (A) the estate of the decedent, if the right to receive the amount is acquired by the decedent's estate from the decedent:(B) the person who, by reason of the death of the decedent, acquires the right to receive the amount, if the right to receive the amount is not acquired by the decedent's estate from the decedent; or(C) the person who acquires from the decedent the right to receive the amount by bequest, device, or inheritance, if the amount is received after a distribution by the decedent's estate of such right.↩2. Sec. 691(a)(2)↩. Income in case of sale, etc. -- If a right, described in paragraph (1), to receive an amount is transferred by the estate of the decedent or a person who received such right by reason of the death of the decedent or by bequest, devise, or inheritance from the decedent, there shall be included in the gross income of the estate or such person, as the case may be, for the taxable period in which the transfer occurs, the fair market value of such right at the time of such transfer plus the amount by which any consideration for the transfer exceeds such fair market value. For purposes of this paragraph, the term "transfer" includes sale, exchange, or other disposition, or the satisfaction of an installment obligation at other than face value, but does not include transmission at death to the estate of the decedent or a transfer to a person pursuant to the right of such person to receive such amount by reason of the death of the decedent or by bequest, devise, or inheritance from the decedent.3. SEC. 126. INCOME IN RESPECT OF DECEDENTS.(a) Inclusion in Gross Income. -- (1) General rule. -- The amount of all items of gross income in respect of a decedent which are not properly includible in respect of the taxable period in which falls the date of his death or a prior period shall be included in the gross income, for the taxable year when received, of: (A) the estate of the decedent, if the right to receive the amount is acquired by the decedent's estate from the decedent;(B) the person who, by reason of the death of the decedent, acquires the right to receive the amount, if the right to receive the amount is not acquired by the decedent's estate from the decedent; or(C) the person who acquires from the decedent the right to receive the amount by bequest, devise, or inheritance, if the amount is received after a distribution by the decedent's estate of such right.↩4. Sec. 126(a)(2)↩. Income in case of sale, etc. -- If a right, described in paragraph (1), to receive an amount is transferred by the estate of the decedent or a person who receives such right by reason of the death of the decedent or by bequest, devise, or inheritance from the decedent, there shall be included in the gross income of the estate or such person, as the case may be, for the taxable period in which the transfer occurs, the fair market value of such right at the time of such transfer plus the amount by which any consideration for the transfer exceeds such fair market value. For the purposes of this paragraph, the term "transfer" includes sale, exchange, or other disposition, but does not include a transfer to a person pursuant to the right of such person to receive such amount by reason of the death of the decedent or by bequest, devise, or inheritance from the decedent.5. SEC. 42. PERIOD IN WHICH ITEMS OF GROSS INCOME INCLUDED.(a) General Rule. -- The amount of all items of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under methods of accounting permitted under section 41, any such amounts are to be properly accounted for as of a different period. In the case of the death of a taxpayer whose net income is computed upon the basis of the accrual method of accounting, amounts (except amounts includible in computing a partner's net income under section 182) accrued only by reason of the death of the taxpayer shall not be included in computing net income for the period in which falls the date of the taxpayer's death.↩6. Regs. 118, sec. 39.126(a)-1(f)↩. If the right to receive an amount of income in respect of a decedent is transferred by the estate or the person entitled to such amount by bequest, devise, or inheritance, or by reason of the death of the decedent, the fair market value of such right at the date of the transfer shall be included in the income of the estate or of such person, plus the amount by which any consideration received on such transfer exceeds the fair market value of such right. Thus, upon a sale of such right, the fair market value of the right or the amount received upon the sale, whichever is greater, is included in income. Similarly, if the right to receive the income is disposed of, as by gift or bequest, the fair market value of such right at the time of such disposition must be included in the gross income of the donor, testator, or other transferor. * 7. The record nowhere specifically shows the amounts received by Jacques under the award. Presumably he received 26 2/3 per cent of the total payments made on the award during 1948, 1949, and 1952, less the one-half of 1 per cent deduction provided for under the War Claims Act, since the record shows that he was recognized during these years by the Commissioner of Accounts of the Treasury Department as being entitled to receive this percentage of the total payments.↩8. The respondent's regulations provide: Sec. 1.691(a)-1(c) [Income Tax Regs., I.R.C. 1954] (T.D. 6257, 2 C.B. 342">1957-2 C.B. 342, 344). Prior decedent↩. -- The term "income in respect of a decedent" also includes the amount of all items of gross income in respect of a prior decedent, if (1) the right to receive such amount was acquired by the decedent by reason of the death of the prior decedent or by bequest, devise, or inheritance from the prior decedent and if (2) the amount of gross income in respect of the prior decedent was not properly includible in computing the decedent's taxable income for the taxable year ending with the date of his death or for a previous taxable year. * 9. Sec. 1.691(a)-3(a) [Income Tax Regs., I.R.C. 1954] (T.D. 6257, 2 C.B. 342">1957-2 C.B. 342↩, 346). Character of Gross Income. -- The right to receive an amount of income in respect of a decedent shall be treated in the hands of the estate, or by the person entitled to receive such amount by bequest, devise, or inheritance from the decedent or by reason of his death, as if it had been acquired in the transaction by which the decedent (or a prior decedent) acquired such right, and shall be considered as having the same character it would have had if the decedent (or a prior decedent) had lived and received such amount. The provisions of section 1014(a), relating to the basis of property acquired from a decedent, do not apply to these amounts in the hands of the estate and such persons. * *	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624596/	George R. Newhouse and Helen C. Newhouse, Petitioners v. Commissioner of Internal Revenue, RespondentNewhouse v. CommissionerDocket No. 969-71United States Tax Court59 T.C. 783; 1973 U.S. Tax Ct. LEXIS 159; 59 T.C. No. 77; March 12, 1973, Filed 159 Decision will be entered for the respondent. Held: The proceeds from a forced sale of collateral by a creditor made in circumstances of the debtor's insolvency were properly applied by the creditor to unpaid principal on the indebtedness. Accordingly, where such proceeds were insufficient in amount to cover even the principal due on the secured obligation, the debtor was not entitled to any deduction for interest paid. Neil D. McCarthy, for the petitioners.Norman H. McNeil, for the respondent. Raum, Judge. RAUM784 The Commissioner determined an $ 8,097.87 deficiency in petitioners' income tax for the calendar year 1968. Petitioner George R. Newhouse had pledged certain shares of stock to secure certain indebtedness. The proceeds from the forced sale of those shares were insufficient to cover the full balance of Newhouse's160 obligations, and the only issue for decision is whether the amounts realized from the foreclosure proceedings should have been applied first to accrued interest rather than principal, thus entitling Newhouse to deductions under section 163 of the 1954 Code.FINDINGS OF FACTThe parties have filed a stipulation of facts which, together with accompanying exhibits, is incorporated herein by this reference.Petitioners are husband and wife. They filed a joint Federal income tax return for 1968 with the district director of internal revenue at Los Angeles, Calif., and resided in that city when their petition herein was filed.In 1962 George R. Newhouse (petitioner) joined with William M. Alberts, Robert E. Gibson, and Roy M. Good to purchase a controlling stock interest in a California corporation known as General Savings & Loan Association (General Savings). A substantial portion of the funds used to finance that purchase was advanced by the Sacramento, Calif., branch of the Wells Fargo Bank.On August 29, 1963, petitioner and his associates obtained loans from First Western Bank & Trust Co. of Los Angeles ("First Western" or "the bank") in the aggregate amount of $ 2,231,709.06, and161 used the proceeds to satisfy their aggregate indebtedness to the Wells Fargo Bank. The First Western loans were evidenced by individual promissory notes of each borrower in the following respective amounts:Petitioner$ 1,038,533.77Alberts450,255.41Gibson450,255.41Good292,664.472,231,709.06Concurrently with the making of the foregoing notes, petitioner and his associates jointly executed an instrument wherein they pledged, as collateral on their respective loans, certain individually held shares of stock in General Savings and two other California corporations. The pledge agreement authorized First Western to sell the collateral in "the event of the nonpayment of any part of the principal or interest under any of the said promissory notes * * , or any extensions or renewals thereof, when due." The agreement did not direct the manner of apportionment of the proceeds from such a sale in the event 785 that those proceeds were insufficient in amount to cover both unpaid principal and accrued interest. Petitioner and First Western executed a bilateral amendment to the pledge agreement on or about October 25, 1963, the terms of which are not directly relevant162 to the present controversy.On or about December 16, 1963, petitioner and his associates borrowed additional funds from First Western amounting to $ 330,000 in the aggregate and represented by individual promissory notes of each borrower in the following respective amounts:Petitioner$ 155,100Alberts66,000Gibson66,000Good42,900330,000The proceeds were used to purchase additional shares of General Savings stock. Pursuant to the terms of an amended and supplemental pledge agreement of December 11, 1963, both the newly purchased shares and the stock covered by the original pledge agreement of August 29, 1963, became collateral on the total indebtedness to First Western, and the rights and remedies of the parties in respect of that collateral were those set forth in the August 29, 1963, agreement.The total principal on the two aforementioned notes executed individually by petitioner amounted to $ 1,193,633.77 ($ 1,038,533.77 plus $ 155,100). During the years 1963 through 1966 the notes were renewed from time to time, and petitioner made payments to First Western in respect thereof in the aggregate amount of $ 345,937.40. 1 The bank applied $ 198,415 of that163 amount against principal, and it treated the remaining $ 147,522.40 1 as interest. There is no dispute that the bank made proper allocations of these items.By June 24, 1966, the date of petitioner's last payment to First Western, he had thus reduced his aggregate indebtedness in respect of principal to $ 995,218.77. On or about June 30, 1966, he executed another note, promising to pay that sum with interest to First Western on "demand, or if no demand is made, then on September 28, 1966." Concurrently therewith, Mrs. Newhouse executed a "continuing guarantee" of her husband's indebtedness in favor of First Western. In that instrument164 Mrs. Newhouse authorized the bank to apply the collateral on petitioner's indebtedness as it "in its discretion may determine."786 The value of petitioner's pledged stock then represented nearly the entire worth of all of his assets. The liquidation of certain of those securities was therefore necessary to provide funds to repay the First Western loan, and the bank thus authorized petitioner to arrange sales of certain of the pledged shares of General Savings stock on its behalf. The first such sale was made on August 4, 1966; 10 shares of General Savings were sold on that day for $ 630, and that amount was applied against interest due on petitioner's note. Thereafter, 100 shares were sold on August 11, 1966, for $ 6,300, and another 100 shares were sold on August 25, 1966, also for $ 6,300; the proceeds of both these sales were similarly applied against interest. No further sales were made prior to or on the due date of the note, September 28, 1966. The note was in default on September 28, 1966, and petitioner made no payments whatever thereafter with respect to his liability on the note, apart from the application of proceeds of sales of collateral to that liability. 165 After that date petitioner similarly arranged for four additional sales of General Savings stock held as collateral. Such sales were as follows:DateSharesAmountNov. 1, 1966100$ 6,300Dec. 21, 196620012,600Mar. 14, 19671006,400Mar. 20, 19671006,30031,600Unlike the application of the proceeds of the first three sales to interest, the proceeds of all four of these post-default sales were applied against principal. Such application to principal was made in accordance with an understanding between petitioner and an officer of the bank. The principal amount of petitioner's debt to First Western was thus reduced to $ 963,618.77. Petitioners claimed no deduction for interest paid to First Western on their joint return for 1967.As already indicated, petitioner made no further payments in respect of his indebtedness to First Western. By a letter dated May 10, 1968, an agent of the bank notified petitioner that it planned to sell a large block of the remaining pledged securities, i.e., all of the shares of stock of one of the two corporations other than General Savings held as collateral for petitioner's note. The proposed sale was made on or166 about July 2, 1968, for the net amount of $ 263,657.21. Having determined that the collectibility of the full balance owing in respect of principal was in grave doubt, the bank applied the proceeds of the July 2, 1968, sale against the principal on petitioner's note, as was its 787 usual practice in such circumstances. Upon receiving notice, in a letter of June 26, 1968, 2 of the manner in which First Western had treated the proceeds, petitioner complained to certain bank officials that the $ 263,657.21 should instead have been applied first to accrued interest. The bank, however, made no modification in its treatment of these amounts.In a letter dated June 3, 1968, petitioner was notified of the bank's intention to sell all the remaining pledged securities. Certain of those securities (all 167 of the remaining General Savings stock) 3 were sold on or about September 11, 1968, for $ 227,477.97, which amount the bank also applied against principal. Although petitioner objected to the bank's sale of those securities, he made no objection to the application of the proceeds against principal; since he had been unsuccessful in his earlier effort to have the bank treat the proceeds of the July sale as interest rather than principal, he thought it would be futile to put forth a similar proposal in respect of the September sale.As of September 11, 1968, First Western's ledger thus showed that $ 472,483.59 of principal remained unpaid. Notations made by the bank on the note disclosed that petitioner owed an additional168 $ 140,289.90 of accrued interest as of August 16, 1968, plus $ 131.24 per day thereafter. By September 10, 1968, the accrued interest payable, pursuant to the bank's computations, amounted to $ 143,570.90, and petitioner's total indebtedness thus amounted to $ 616,054.49. On or about that date, First Western brought an action in the Los Angeles Superior Court against petitioner, Mrs. Newhouse, and two of petitioner's associates and their respective spouses. The bank alleged in its complaint that petitioner and Mrs. Newhouse had failed to make required payments under the terms of their note and guaranty, respectively, and prayed for damages in the aforementioned amount of $ 616,054.49 plus interest at 10 percent per annum from the date of the complaint.The trial of the present case was held on June 27, 1972. Thereafter, on July 19, 1972, the parties to the State court action appeared in the California court and requested a conference in chambers with the court. Such conference was held but not reported. Then on the same day brief proceedings were held in open court where it appeared that 788 the parties had settled their differences. During the course of the proceedings169 the court made the following comments:Now, the Court has considered the discussions had with counsel in chambers concerning the law that applies to the performance of an obligation and the application of payments made thereon, and the Court is of the opinion that the bank should have applied the sums so obtained first to the interest then due, and that the cross-complainants Newhouse were reasonable in assuming that the proceeds had been so first applied to the payment of interest then due and the balance to the principal. * * In fact, Miss Clerk, I would ask that you make a minute order to this effect, if you please, that the counsel and the Court conferred in chambers for further settlement negotiations and, as a result thereof, the case was agreed to be settled with dismissals with prejudice to be filed by the plaintiff and by the cross-complainants.On their joint return for 1968 the Newhouses claimed a $ 143,567 deduction for interest paid to First Western. The Commissioner disallowed that entire deduction.OPINIONPetitioner has taken the position that First Western was required by law to apply the proceeds from the foreclosure sale of September 11, 1968 ($ 227,477.97), 170 first to accrued interest (approximately $ 143,570.90, by the bank's computations) and not to treat those proceeds, as it did, entirely as a recovery of overdue principal. The Commissioner maintains that the bank's actions were proper, and we think that his position must prevail.To be sure, it is well established that a voluntary partial payment on indebtedness, made in ordinary course without any designation by the debtor as either principal or interest and in the absence of any agreement in this respect between debtor and creditor, is to be applied to interest before principal. See Story v. Livingston, 38 U.S. (13 Pet.) 359, 371; Motel Corp., 54 T.C. 1433">54 T.C. 1433, 1440; Estate of Paul M. Bowen, 2 T.C. 1">2 T.C. 1, 5, 7; cf. George S. Groves, 38 B.T.A. 727">38 B.T.A. 727, 737, limited in another respect by B. F. Edwards, 39 B.T.A. 735">39 B.T.A. 735, 738-739. However, that rule does not appear to be applicable in the case of an involuntary foreclosure of mortgaged property, particularly where the debtor is insolvent.In John Hancock Mutual Life Ins. Co., 10 B.T.A. 736">10 B.T.A. 736,171 a creditor foreclosed on mortgaged property and purchased that property itself at a price less than the outstanding principal on the underlying obligation. It was held that no portion of the purchase price was allocable 789 to accrued interest owing at the time of the foreclosure proceedings. Although the creditor in that case was a life insurance company which was taxed under special provisions of the statute, the term "interest" as used in such provisions was construed to have its "usual and ordinary meaning." 10 B.T.A. at 739. In similar circumstances, where a debtor conveyed mortgaged property to his creditor in order to avoid a foreclosure sale on that property and the fair market value thereof was less than the amount of unpaid principal, it has consistently been held that the creditor realized no interest income from the recovered property even if interest as well as principal was payable at the time of the conveyance. Helvering v. Missouri State Life Ins. Co., 78 F. 2d 778, 780 (C.A. 8); Manufacturers Life Insurance Co., 43 B.T.A. 867">43 B.T.A. 867, 873-874; 4 cf. Manhattan Mutual Life Insurance Co., 37 B.T.A. 1041">37 B.T.A. 1041, 1043-1044.172 Thus, cases of this character are to be sharply distinguished from those involving voluntary partial payments. Nor is the result reached in such cases to be limited to life insurance companies, for, as indicated above, the meaning of the word "interest" as used in the life insurance provisions of the statute is the same as in other parts of the Code.Estate of Paul M. Bowen, 2 T.C. 1">2 T.C. 1, relied upon by petitioner, is distinguishable. To be sure, that case holds that the "interest-first" rule may be applicable even to the proceeds of a foreclosure sale. But the Bowen Court carefully pointed out that the creditor had "arranged by voluntary agreement with" the debtor that the collateral should173 be sold to repay the debt and "that the payments made were voluntary." 2 T.C. at 9. No such finding was made in the John Hancock case. And the conveyances in the other "life insurance" cases were "voluntary" only in the sense that the creditor acquiesced therein solely to avoid forced sales of the mortgaged properties. The September 11, 1968, foreclosure sale by First Western, in respect of which petitioner seeks to have the Bowen rule apply, was unquestionably involuntary on his part. At the trial herein, he emphasized that he had made plain his opposition to such a sale well before it took place.Moreover, Bowen is further distinguishable on the ground that the Court there explicitly stated that there was "no evidence" that the taxpayer was "insolvent." 2 T.C. at 7. In the present case, on the other hand, the record strongly indicates that petitioner was insolvent. Petitioner's note was in default at maturity, on September 28, 1966, and beginning in November 1966, he agreed to the application of 790 the proceeds of certain sales of collateral to principal. He admitted at the trial that he did not have any174 other assets of consequence at that time. Nor did he show that his financial condition improved between that time and the forced sale of the collateral here in issue in 1968. He made no payments whatever on his note after maturity (apart from the application of proceeds of sales of collateral), and the bank quite understandably treated the note as uncollectible apart from the collateral. Thus, the evidence shows that on March 9, 1967, it set up a reserve of $ 227,190 against the loan, that on July 2, 1968, it set up an additional reserve of $ 89,500 against the loan, and that finally, on September 17, 1968, it increased the reserve by an additional $ 155,793.59, thereby wiping out the entire asset on its books. Further, the evidence shows that for internal accounting purposes, the bank not only ceased to accrue any interest on the loan after December 12, 1966, but that on March 9, 1967, it retroactively reversed the accrual of unpaid interest (in the amount of $ 30,511.15) from June 30, 1966, to December 12, 1966. We have no doubt on the evidence before us that petitioner was insolvent at all relevant times in respect of the issue before us.The significance of petitioner's insolvency175 cannot be minimized. What would be deductible by him as interest would similarly be includable in the bank's income as interest received. And we find it difficult to believe that a creditor who was foreclosed on the collateral of an insolvent debtor, and who will never get back the full amount of his principal, is required to report a fictitious amount of income designated as interest." 5Nor is any support for petitioner's position to be found in the statement by the Los176 Angeles Superior Court during the course of the July 19, 1972, hearing, or otherwise in the law of California. We are required to give only "proper regard," and not necessarily to follow, decisions of local trial courts as to matters of local law. Cf. Commissioner v. Estate of Bosch, 387 U.S. 456">387 U.S. 456, 465. The trial judge's remarks, which were supported by no citation to authority and uttered after discussions in chambers of an undisclosed nature, but which obviously related to the settlement of the case between the parties, are hardly persuasive in the context of the issue before us. And petitioner's reliance 791 on section 1479 of the California Civil Code (West 1954) 6 is likewise misplaced. That section plainly does not govern the application of "involuntary" payments, particularly those arising out of a foreclosure sale not agreed to by the debtor. Ohio Electric Car Co. v. Le Sage, 198 Cal. 705">198 Cal. 705, 709, 247 Pac. 190, 192; Brunswick Corporation v. Hays, 16 Cal. App. 3d 134">16 Cal. App. 3d 134, 138-139, 93 Cal. Rptr. 635">93 Cal. Rptr. 635, 637-638 (2d Dist. Ct. App.).177 Decision will be entered for the respondent. Footnotes1. The figures are taken from a copy of First Western's loan liability ledger for petitioner's account. A separate exhibit, purporting to be a summary of the transactions shown on the ledger, reflects aggregate payments and interest in amounts different from those shown above. Both exhibits were stipulated to by the parties, and they have offered no explanation of these discrepancies.↩2. Why the June 26 letter referred to the July 2 sale as if it had already taken place is not explained on the record. A possible explanation is that the June 26 letter was actually written and sent at a later time.↩3. Although the bank also attempted to sell the securities in the third corporation held by it as collateral, it was unsuccessful in this respect. The record does not show that such securities were of substantial value in relation to the amount of petitioner's outstanding indebtedness to the bank.↩4. A different situation exists where the amount of the creditor's bid on a foreclosure is equal to principal plus accrued interest, as noted in the Manufacturers Life Insurance Co. case, which thus distinguished Helvering v. Midland Insurance Co., 300 U.S. 216">300 U.S. 216↩.5. A different result may be called for where the creditor unilaterally elects to treat the proceeds from a foreclosure sale as payments of interest rather than principal. See Kate Baker Sherman, 18 T.C. 746">18 T.C. 746, 753, questioned in another respect in Mozelle Rushing, 58 T.C. 996">58 T.C. 996, 1000↩. First Western applied the proceeds here in issue to principal, however, and we express no opinion as to the tax consequences attaching to such an exercise of discretion by a creditor in other circumstances.6. Sec. 1479. Act of performance applicable to two or more obligations; application to specific obligation --Where a debtor, under several obligations to another, does an act, by way of performance, in whole or in part, which is equally applicable to two or more of such obligations, such performance must be applied as follows:One -- If, at the time of performance, the intention or desire of the debtor that such performance should be applied to the extinction of any particular obligation, be manifested to the creditor, it must be so applied.Two -- If no such application be then made, the creditor, within a reasonable time after such performance, may apply it toward the extinction of any obligation, performance of which was due to him from the debtor at the time of such performance; except that if similar obligations were due to him both individually and as a trustee, he must, unless otherwise directed by the debtor, apply the performance to the extinction of all such obligations in equal proportion; and an application once made by the creditor cannot be rescinded without the consent of [the] debtor.Three -- If neither party makes such application within the time prescribed herein, the performance must be applied to the extinction of obligations in the following order; and, if there be more than one obligation of a particular class, to the extinction of all in that class, ratably:1. Of interest due at the time of the performance.2. Of principal due at that time.3. Of the obligation earliest in date of maturity.4. Of an obligation not secured by a lien or collateral undertaking.5. Of an obligation secured by a lien or collateral undertaking.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624597/	ALEXANDER SPRUNT & SON, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Alexander Sprunt & Son, Inc. v. CommissionerDocket No. 38408.United States Board of Tax Appeals24 B.T.A. 599; 1931 BTA LEXIS 1620; November 4, 1931, Promulgated 1620 1. Payments made by the petitioner, under the guise of commissions, to a partnership composed of all of petitioner's common stock holders, the interest of each member of the partnership being fixed in direct proportion to his holdings of petitioner's common stock, held, to have been in the nature of distributions of profits and not proper deductions in computing net income. 2. Amounts accrued on petitioner's books as commissions due to a foreign corporation for services actually rendered are ordinary and necessary expenses of carrying on the petitioner's business and constitute proper deductions in computing net income. 3. Upon the evidence, held, that the net income of the petitioner's branch office at Houston, Tex., was not understated in the return, and that the respondent erred in increasing petitioner's net income by $601.05 on account of the alleged understatement. 4. A contribution made by the petitioner to a fund raised by various cotton exchanges, to be used in the control and eradication of the boll weevil in the cotton-producing States, and certain expenditures for advertising in manazines published or sponsored by the American Legion and various labor1621 and trade organizations, were ordinary and necessary in the conduct of petitioner's business and constitute proper deductions in computing net income. 5. Respondent's adjustment of the inventory of the Charlotte branch office sustained for lack of evidence to show error in such adjustment. 6. During the taxable year, the petitioner paid a fee to a firm of attorneys for prosecution of a claim for refund of war risk insurance premiums paid by itself and its predecessor in business, a partnership. Held, that a portion of the fee was paid to establish petitioner's right, as assignee of the partnership by purchase, to recover a portion of the premiums paid by the partnership, and such portion of the whole fee paid represents an additional cost to the petitioner of the partnership assets, a capital expenditure which may not be deducted in computing net income. Held, further, that since the petitioner has failed to establish any basis for a reasonable apportionment of the fee to the claims of the two entities, the respondent's disallowance of the whole fee as a deduction in computing net income must be sustained. 7. Certain expenditures made during the year by the petitioner, 1622 and claimed by it in the return as deductions for repairs, held to have been in the nature of permanent betterments which materially prolonged the lives of the buildings affected and such expenditures may not be deducted in computing net income. Respondent's action in disallowing certain other expenditures sustained for lack of evidence upon which to base an apportionment of such expenditures to capital and expense, the evidence indicating that a substantial portion of such expenditures was for work and alterations which rendered the building better suited to petitioner's purposes. 8. Respondent's adjustment of the inventory of the Wilmington office sustained for lack of evidence to show error in such adjustment. 9. Held, that respondent erred in failing to exclude from the net income reported by the petitioner an item of $11,449.37 representing a write-up in the book value of petitioner's compress equipment. 10. The expense incurred by the petitioner in moving a cotton compress from one branch to another held to be an ordinary and necessary expense which may be deducted in computing net income. 11. Payments made by the petitioner during, the taxable year, 1623 totaling $350,000, to holders of petitioner's certificates of paid-in surplus were dividend distributions and not interest payments, and the amounts so distributed may not be deducted in computing net income. 12. The petitioner and the partnership of Alexander Sprunt & Son, Bremen, are separate and distinct taxable entities; and there is no provision of law under which the net loss of the Bremen firm for 1923 may be deducted in computing the petitioner's net income for that year. J. Marvin Haynes, Esq., and C. J. McGuire, Esq., for the petitioner. B. M. Coon, Esq., and C. R. Marshall, Esq., for the respondent. MARQUETTE 600 This proceeding is for the redetermination of a deficiency asserted by the respondent for 1923, in the amount of $71,729.51. Of the fourteen assignments of error in the amended petition, two have been waived, leaving twelve for our consideration, which are as follows: 1. The Commissioner has erred in failing to allow as a deduction from gross income commissions of $286,071.30 paid to the partnership of Alexander Sprunt & Son, Bremen, Germany. 2. The Commissioner has erred in failing to allow as a deduction1624 from gross income commissions of $33,736.28 paid to a French corporation by the name of Societe Cotonniere Franco-Americaine. 3. The Commissioner has erroneously increased the income from the Houston branch in the amount of $601.05. 4. The Commissioner has erred in failing to allow as a deduction from gross income certain alleged donations in the amount of $19,120.32. 5. The Commissioner has erred by increasing the closing inventory for the Charlotte office in the amount of $11,185.96. 6. The Commissioner has erred in failing to allow as a deduction from gross income legal expenses in the amount of $7,500. 7. The Commissioner has erred in failing to allow as a deduction from gross income certain warehouse expenses in the amount of $7,315.07. 8. The Commissioner has erred in failing to decrease the closing inventory for the Wilmington office by $33,412.60. 9. The Commissioner has erred in failing to reduce taxable income by the amount of $15,622.53 which represents a write-up of certain assets. 601 10. The Commissioner has erred in failing to allow as a deduction from gross income the amount of $8,335.19 cost of removing a press from Wilmington, 1625 North Carolina, to Houston, Texas. 11. The Commissioner has erred in failing to allow as a deduction from gross income, interest paid in the amount of $350,000. 12. In the alternative, if the United States Board of Tax Appeals sustains the Commissioner's position with respect to the commissions paid to the foreign partnership (Alexander Sprunt & Son, Bremen), then the Commissioner has erred in failing to use the losses of the foreign partnership in the amount of more than $100,000 to reduce the gross income of the petitioner. FINDINGS OF FACT. The petitioner, a North Carolina corporation with its principal office at Wilmington, was organized on June 9, 1919, as successor to the business theretofore carried on by the partnership of Alexander Sprunt & Son (hereinafter referred to as the Wilmington firm), and throughout 1923 was engaged in buying raw cotton in the United States and reselling that commodity, principally in Central European markets. 1. The Wilmington firm was organized in 1868 and, until succeeded by the petitioner, had been engaged continuously in buying and exporting raw cotton. In June, 1913, the partnership was composed of James, William H., Walter1626 P., J. Lawrence, and T. E. Sprunt. On or about July 1, 1913, a new partnership known as Alexander Sprunt & Son, Bremen (hereinafter referred to as the Bremen firm), was formed by the above named five persons with Devereaux H. Lippitt and William L. Walker. Lippitt and Walker did not have any interest in any other firm organized, owned or controlled by the five Sprunts. The Bremen partnership agreement, after fixing the working capital at 2,000,000 marks, sets forth the following provisions: 2nd. As the Bremen firm was established primarily to subserve the interests of the parent firm of Alexander Sprunt & Son in Wilmington, North Carolina, U.S.A., and as the relations of the two firms are now mutually dependent upon each other it is understood and agreed that the Bremen firm will always give preference to the Wilmington firm in buying, and that the Wilmington firm will confine its business in Germany, Austria, Italy, Russia and Holland to the Bremen firm, it being understood and agreed that any departure from this rule shall be first approved by the respective firms. It is also agreed that the Bremen firm shall endeavor to promote the interests of the various firms of Alexander1627 Sprunt & Son by active preferential cooperation. 3rd. The management of the firm in Bremen shall at the discretion of the majority of the interests continue to be vested in a resident partner and an assistant resident partner, such resident partner being entitled to withdraw from the running expenses of the business as a living allowance the equivalent of $10,000.00 (ten thousand dollars) per year, and the assistant resident partner the equivalent of $5,000.00 (five thousand dollars) per year. 602 4th. It is hereby agreed that at the discretion of the majority of the interests Devereaux H. Lippitt shall remain resident partner, and that William L. Walker shall remain assistant resident partner. * * 7th. This partnership agreement shall come into force on the first day of July nineteen hundred and thirteen, and shall continue in force for a period of five years from that date, after which time it shall continue from year to year unless dissolved by mutual agreement and consent, but any partner may retire from the partnership at the expiration of the five years withdrawing his interests as determined by the annual balance sheet upon giving his partners in writing1628 six months notice of his intention. 8th. The death or retirement of any partner shall not dissolve the partnership as to the other partners, but in the event of the death of a partner during the term of this five-year agreement it is mutually agreed that for the remainder of the then current season his estate is to receive his regular proportion of profits and share in any losses, and at the end of the then current season his estate is to withdraw one-half of the deceased's capital from the firm and for the remaining seasons, if any, until the expiration of this five-year agreement said estate is to share in the profits and losses of the firm in proportion of one-half of the deceased's former interest, and at the expiration of this five-year partnership agreement said estate is to withdraw balance of deceased's capital from the firm. After its formation, the Bremen firm purchased raw cotton in the United States and sold it in Central Europe, principally in Germany, Austria and Italy. Almost all of its raw cotton purchases were made from the Wilmington firm, but it did make some purchases from other sources. Upon the outbreak of hostilities between the United States and the1629 Imperial German Government, Lippitt and Walker, who were the only members of the Bremen firm located and actively engaged in the business in Europe, and who were American citizens, returned to the United States, and the properties of the firm in Germany were seized by a representative of the German Government. After the conclusion of hostilities the members of the Bremen firm decided not to resume operations in Bremen, because of the heavy taxes being levied by the German Government, and the Bremen office of the firm was reopened solely for the purpose of liquidating the assets and business of the firm. Throughout the period of the war, and thereafter until it was revived in 1922, as will hereinafter more fully appear, the Bremen firm did not engage in any business activities. As heretofore stated, the petitioner corporation succeeded to the business of the Wilmington firm on June 9, 1919. In September, 1919, the petitioner opened a branch office in Rotterdam, Holland, for the conduct of all of its European affairs. Walker, who had been the assistant resident partner of the Bremen firm, was made manager and placed in charge of this branch office, and no other member of the Bremen1630 firm had any connection therewith. All subsequent sales of 603 raw cotton in Europe were handled through this branch office. Such sales were made principally in the territory in which the Bremen firm had operated and practically to the same trade. About the latter part of 1921, the members of the Bremen firm made representations to the petitioner that the current sales of the latter in Central Europe were being made to the trade which they, as members of the Bremen firm, had built up and that they felt they were entitled to receive commissions upon such sales. After much discussion of the matter, the seven members of the Bremen firm, together with seven other persons who in the interim had become stockholders of the petitioner corporation, entered into an agreement, amending the Bremen partnership agreement of July 1, 1913, or thereabout, which reads as follows: The foregoing partnership agreement of Alexander Sprunt & Son, Bremen, Germany, is hereby continued in force under the following amended conditions: From and after this first day of January, 1922, it is hereby agreed that the division of the profits or losses arising from the old business, still in course1631 of liquidation, of this firm shall be prorated among the seven original partners on the following basis: James Sprunt 8/40 W. H. Sprunt 8/40 D. H. Lippitt 8/40 J. L. Sprunt 6/40 W. L. Walker 5/40 Walter P. Sprunt 4/40 T. E. Sprunt 1/40 It is hereby further agreed that this partnership shall include hereafter the following additional members: T. R. Orrell J. H. Wood W. J. Bergen H. M. Crosswell L. B. McKoy Alex. Sprunt Dalziel Hedderwick These new partners only to share in the profits on current business, and in commissions, accruals, etc., received from the Rotterdam office of Alex. Sprunt & Son, Inc. The basis of division on this new and current business is hereby mutually agreed shall be as follows, from the first day of January, 1922: James Sprunt25%W. H. Sprunt23%J. L. Sprunt10%Walter P. Sprunt10%D. H. Lippitt7%T. R. Orrell5%T. E. Sprunt4%W. L. Walker3%J. H. Wood3%W. J. Bergen2%Alex. Sprunt2%H. M. Crosswell2%L. B. McKoy2%Dalziel Hedderwick2%This supplemental agreement to become effective this first day of January nineteen hundred and twenty-two and to remain in force one year1632 and thereafter by mutual consent. The fourteen members of this new Bremen firm were the owners of all of the outstanding common stock of the petitioner corporation, 604 and each was given a proportional share in the profits of the new Bremen firm which bore the same ratio to the whole as his holdings of common stock of the petitioner corporation bore to the total of such stock outstanding. After the new Bremen firm came into existence, Walker continued in his post as manager of petitioner's Rotterdam office. He was the only member of the new Bremen firm actively engaged in the affiairs of the firm in Europe. He spent about one-half of his time in Bremen attending to the affairs of the old and new Bremen firms. Lippitt and W. H. Sprunt, executive officers of the petitioner, as well as members of both Bremen firms, made several trips to Europe for the purposes of assisting in the liquidation of the affairs of the old Bremen firm and of further developing and retaining the business of the firm for the petitioner's benefit. As sales were made through its Rotterdam office, the petitioner credited the account of the new Bremen firm with "commissions" ranging from 1 to1633 3 per cent of invoice price, less freight. The amount of "commissions" to be paid on any sale was agreed upon at the time of sale. The "commissions" allowed to the Bremen firm were the same as those customarily paid by the petitioner to its other agents in Europe, as between whom and itself no other relation existed that that of principal and agent. During 1923 the petitioner kept its books of account of an accrual basis. In that year it credited to the account of the new Bremen firm net "commissions" on sales made through the Rotterdam office in the amount of $336,554.48. This entire amount was distributed by the petitioner to the members of the new Bremen firm, during 1923 and the early part of 1924, in accordance with their respective partnership interest. The members of the new Bremen firm have reported, for the purposes of the income tax, the amounts so distributed to them by the petitioner, and have paid the tax thereon, and the amounts so reported have not been excluded from their returns by the respondent. In its return for 1923 the petitioner claimed the entire amount paid or credited to the new Bremen firm for commissions, $336,554.48, as a deduction from gross income. 1634 Of the amount so claimed, the respondent has allowed the sum of $50,483.18, and has disallowed the remainder of $286,071.30. 2. Prior to 1921 the petitioner maintained a branch office at Havre, France, through which it sold cotton to French merchants and mills. Two brothers, T. R. and F. B. Orrell, were managers of the office. In 1921 the petitioner closed this branch bacause of heavy taxation in France. The two Orrell brothers had resided in France for several years and were desirous of continuing in business there and, to satisfy their wishes, the petitioner organized a French corporation, known 605 as Societe Cotonniere Franco-Americaine, for the purpose of acting as petitioner's selling agent in France. The entire capital of this corporation, 1,000,000 francs, was furnished by the petitioner, and though the certificates of capital stock were held by the Orrell brothers, petitioner was at all times the owner thereof. The Orrell brothers were made managers of the corporation, and the petitioner delegated to them full authority to act in all matters. The French corporation was in existence and sold cotton for the petitioner's account throughout all of 1923. Its1635 operations, however, were not confined exclusively to sales for the petitioner's account; the major part of its earnings were derived from commissions received from other sources. In all business transactions between them, the petitioner dealt with the French corporation on the same basis as with its other agents, and the commissions allowed to it, ranging from 1 to 2 per cent of invoice price, did not exceed those usually paid to petitioner's other agents for like services. The petitioner carried an account on its books with the French corporation, known as "Havre Special." During 1923 the petitioner allowed to the French corporation and credited the said account with net commissions of $39,689.75 on sales made within the year. At the request of the managers of the French corporation, these commissions were withheld and not paid by the petitioner in 1923, the purpose of the request being to avoid the heavy taxation of money in France. In its return for 1923 the petitioner, in computing taxable net income, claimed the amount of said commissions as an expense deduction, and of the whole amount so calaimed, the respondent has allowed $5,953.47 and disallowed $33,736.28. 3. The1636 petitioner maintained a branch office of Houston, Tex. The employees at that branch received stated salaries and in 1923 some of them received bonuses also, amounting in all to $601.05. It was the petitioner's desire that the fact of payment of the bounses, and the amount thereof, should not appear on the books of the Houston branch. Consequently, payment thereof was made directly from the petitioner's home office at Wilmington. When the profits of the Houston branch, as reported by that branch, were taken up on the books of the home office, a charge was made against them for the amount of the bonus payments. The respondent has held that the profits of the Houston branch were understated by $601.05, and he has increased the net income reported by the petitioner by that amount. 4. During 1923 various cotton exchanges and cotton merchants united in raising a fund to be used in eradicating the boll weevil, and the petitioner contributed $5,000 to such fund. The presence of the boll weevil in the cotton-producing centers was a serious 606 menace to the cotton industry as a whole, as it tended to reduce, very materially, the crop yield. The petitioner was not engaged1637 in growing cotton, but its business of exporting cotton and of operating a warehouse for the storage of that commodity was dependent upon the amount and quality of cotton produced; and inroads by the boll weevil would seriously menace the successful conduct of the petitioner's business. The amount so contributed was claimed as a deduction by the petitioner in computing net income in its return, but the respondent disallowed the deduction. During 1923 the petitioner expended $287.50 for advertising in magazines published by the Order of Railway Yardmen, the American Legion, and various labor and trade organizations. The advertising was done in good faith and with the expectation of results similar to those derived from advertising in other mediums. The amount so expended was claimed as a deduction by the petitioner in computing net income in its return, but the respondent disallowed the deduction. 5. It has been the petitioner's consistent inventory practice to include in its annual inventories bales of cotton which had been purchased by its agents at distant points but which have not been actually received at destination at the inventory date. These bales of cotton are referred1638 to as "en route cotton." Such cotton was inventoried on the basis of the cost, weight and grade used by the agents in its purchase. When the cotton was received at its destination, the bales were reweighed and regraded and adjustments were made with the sellers. In making adjustments, sometimes the petitioner paid additional amounts to the sellers and sometime the sellers were required to make refunds to the petitioners. Adjustments with sellers in respect of en route cotton included in the preceding year's inventory were currently recorded in the accounts of the year in which the adjustments were made, either as an expense, if the petitioner was required to make additional payments for the cotton, or as income, if the sellers were required to make refunds to the petitioner. There was never a revision of the preceding year's inventory so as to reflect the adjustments made with the sellers. At the close of 1923 there were 1,396 bales of cotton which had been purchased by the petitioner's agents and not received at destination at the inventory date, but were en route to the petitioner's warehouse at Charlotte. Consistent with its inventory practice, these 1,396 bales of cotton1639 were included in the 1923 inventory, on the basis of the cost, weight and grade used by the agent at Charlotte in making the purchases. At the time the 1922 inventory, which was the opening inventory for 1923, was taken, there were 96 607 bales of cotton en route to the warehouse at Charlotte. The respondent increased the 1923 inventory of the Charlotte office by $11,185.96, and thereby increased the net income reported by the petitioner in its return by that amount. The respondent did not make any adjustment in the 1922 inventory on account of any adjustments made with the sellers of the 96 bales of en route cotton not received at destination at the date of that inventory. 6. In 1923 the petitioner paid $7,500 to Goldman and Unger, a New York firm of lawyers, for services rendered in connection with legal proceedings to recover the sum of $2,225,521.36 which had been paid by the petitioner and the predecessor partnership, during the period 1914 to 1920, for war risk insurance premiums. The "bulk" of these premiums had been paid by the predecessor partnership in 1917. Upon reorganization, the petitioner took over all of the assets and business, and assumed all of the1640 liabilities, of the predecessor partnership. If any part of the sum so paid for war risk insurance premiums is recovered, it will be received and retained by the petitioner. The amount paid in 1923 for legal services was claimed as a deduction by the petitioner in computing net income for that year, and the deduction has been disallowed by the respondent. 7. The petitioner owned a warehouse at Charlotte, N.C., which was located in a gully between two railroad embankments. The building rested on wooden props and was surrounded by a wooden wall to prevent the flow of water down the railroad embankments from washing away the underpinning. In 1923, in order to better protect the wooden props from water flowing down the embankments, the petitioner built a concrete retaining wall extending the full length of the building along the foot of the railway embankments. The cost of the retaining wall was $4,200 and the petitioner deducted that amount as an expense in computing net income. The respondent disallowed the deduction. In 1923 the petitioner completely renovated an old office building which it owned at Wilmington, for the purpose of renting it. The work included, among other1641 things, a complete overhauling of the plumbing system, rewiring for electricity, replacement of window sashes, screen doors and window screens, painting, new glass in windows, etc. The preliminary estimate of the cost, made by the petitioner's superintendent and based upon the use of new materials, amounted to $3,050.07. However, considerable old material on hand was utilized for the work and the actual cost of the completed work was only $1,630.44. In computing net income the petitioner deducted the entire cost of the work as an expense. The respondent held that the entire amount was expended for additions and betterments and 608 no part thereof constituted a proper deduction; however, instead of restoring to income the actual cost of the work and the amount deducted by the petitioner in the return, to wit, $1,630.44, the respondent added to income the amount of the superintendent's preliminary estimate of cost, to wit, $3,050.07. 8. The petitioner's inventory of December 31, 1923, showed that there were on hand in and en route to its warehouse at Wilmington, 25,130 bales of cotton, of 26 different grades, having a total weight of 12,235,930 pounds and a total value1642 of $4,122,404.33. Sometime after filing the return for 1923, it was discovered that the inventory weights of six grades of cotton were wrong. The following statement shows, for those six grades, the inventory weights, the correct weights, the inventory value of those grades based on inventory weights, and the revised value of those grades based on corrected weights and unit prices used in the inventory: GradeInventory weightCorrect weightInventory valueRevised valuePoundsPoundsFLM1,356,0491,322,077$450,886.29$439,590.60LM614,557601,727196,658.24192,552.64FMT394,696378,216132,223.16126,702.36MT421,041405,219134,733.12129,670.08FLMT55,56448,95217,224.8415,175.12LWT56,70047,25017,010.0014,175.00Total948,735.65917,865.80In the deficiency notice the respondent reduced the net income reported in the return by $3,403.29, with the following explanation: "This item represents the decrease necessary in the closing inventory of cotton of the Wilmington Agency." 9. On or about December 31, 1923, the petitioner made an inventory of its compress equipment and ascertained that1643 the value of the same was understated on its books of account. To bring the book value of that equipment into accord with the petitioner's valuation, property account was charged and profit and loss account was credited with the sum of $15,622.53. The amount so credited to profit and loss was included by the petitioner in the gross income reported in the 1923 return, but the respondent, in the deficiency notice, eliminated $4,173.16 from income. 10. In 1923 the petitioner removed one of its cotton compresses from Wilmington, N.C., to Houston, Tex. The cost of such removal was $8,355.19, which included only the cost of the dismantling at Wilmington, freight charges to Houston, and the expense of reassembling at Houston, and did not include any part of the cost of the foundation for the compress at Houston. The entire cost of removal was charged to capital accounts on the petitioner's books, 609 and no part thereof was claimed by the petitioner as a deduction in computing net income, nor has any portion of such cost of removal been allowed as a deduction by the respondent. 11. The petitioner was incorporated with an authorized capital of $3,000,000, consisting of1644 30,000 shares of common stock of the par value of $100 per share. No other kind or class of capital stock was authorized to be issued by the charter or any subsequent amendment thereto. Included in the liabilities of the predecessor partnership assumed by the petitioner were partners' credit balances, amounting in the aggregate to approximately $9,000,000, in respect of which the following resolution was unanimously adopted at the stockholders' meeting of June 9, 1919: WHEREAS: Alexander Sprunt & Son, a partnership with principal office at Wilmington, North Carolina, and with a capital contributed by the partners and employed in the business of the partnership on June 7th, 1919, amounting to $9,000,000 (nine million dollars) was, on June 9th, 1919, duly incorporated under the laws of North Carolina, providing for the incorporation and organization of business companies; AND WHEREAS the charter of the aforesaid corporation provides for an authorization of three million dollars ($3,000,000) of common stock consisting of thirty thousand shares of the par value of One Hundred Dollars each, but that only two million dollars of such common stock so provided for shall be issued for1645 a like amount and value of the assets of the partnership; AND WHEREAS it is the purpose and intention of the partners aforesaid to dedicate to the corporation succeeding the partnership all the capital employed in the business of the partnership; NOW, THEREFORE, RESOLVED: I. That the capital of the partnership employed in its business on June 7th, 1919, in excess of the aforesaid two million dollars for which a like amount of common stock of Alexander Sprunt & Son, Incorporated, are to be issued, shall be taken, held and employed by said corporation as Paid-in-Surplus; II. That there shall be issued to the contributors of the Paid-In-Surplus aforesaid, certificates of interest therein of the par value of one hundred dollars per share (the number of shares to be included in one certificate to be at the election of the shareholder and in the absence of election by the shareholder then at the election of the corporation) as evidence of their share of interest in said Paid-In-Surplus of the corporation aforesaid; III. That the acceptance by the corporation of the sum of seven million dollars ($7,000,000) aforesaid as Paid-In-Surplus and the issuance therefor of its certificates1646 of interest and the acceptance by the contributors of such Paid-In-Surplus of the certificates of interest therein issued by the corporation aforesaid shall be full and complete evidence and acquitance of the fact and bona fide of the dedication of said Paid-In-Surplus as property of the corporation, to the risks of the corporation's business. Pursuant to the foregoing resolution, there were issued to the members of the predecessor partnership, in satisfaction of the amounts shown to be due them by the partnership books, common stock of a total par value of $2,000,000, and certificates of paid-in 610 surplus of a total par value of $7,000,000. The certificates of paid-in surplus were in the following form: THIS IS TO CERTIFY THAT is the owner of shares, fully paid and non-assessable, of the par value of $100.00 (one hundred dollars) each in the paid-in surplus capital of Alex. Sprunt & Son, Incorporated, transferable only in person or by attorney upon the books of the said corporation upon the surrender of this certificate. The holders of certificates of interest in the paid-in-surplus capital shall be entitled to receive, when and as declared as of the first day of1647 June and December in each year, from the surplus or net profits of the corporation, yearly dividends at the rate of seven per centum, and no more, payable semi-annually as of the dates herein specified or as may be otherwise determined as to them by the by-laws. The dividends on said certificates of interest shall be cumulative, and shall be payable before any dividend on the common stock shall be paid or set apart, so that if in any year dividends amounting to seven per centum shall not have been paid thereon, the deficiency shall be payable before any dividends shall be paid upon or set apart for the common stock. When all cumulative dividends on the certificates of interest for all previous years shall have been declared, and shall have become payable, and the accrued installments for the current year shall have been declared, and the corporation shall have paid such cumulative dividends for previous years and such accrued semi-annual installments, or shall have set aside from its earned surplus or net profits a sum sufficient for the payment thereof, the board of directors may declare dividends on the common stock payable then or thereafter, out of any remaining earned surplus1648 or net profits. In the event of any dissolution or winding up (whether voluntary or involuntary) of the corporation, the holders of the certificates of interest in the paid-in surplus capital shall be entitled to be paid in full both the par amount of their shares and the unpaid dividends accrued thereon, before any amount shall be paid to the holders of the common stock, and after the payment to the holders of the certificates of interest on their par value, and the unpaid accrued dividends thereon, the remaining assets and funds shall be divided and paid to the holders of the common stock according to their respective shares. The certificates of interest in paid-in surplus may, at the election of the corporation and on ninety days previous notice given next preceding any dividend date, said notice to be in writing addressed to each certificate holder at his last known address or by publication in the public press as the corporation may elect, retire any part or all of the certificates of interest in paid-in surplus at one hundred and five and accrued dividends. Any retiring of the certificates of interest in paid-in surplus shall be ratably according to the holdings thereof as1649 evidenced by the records of the corporation. No authority was ever requested of, or received from, the State of North Carolina for the issuance of these certificates of paid-in surplus. No taxes were paid to the State of North Carolina, under section 1218 of the corporate laws of that State, upon the issuance of these certificates, and such certificates have always been excluded from capital-stock returns, for the purposes of the franchise tax of that State. During 1923 certificates of paid-in surplus of a total par value of $5,000,000 were outstanding. Payments at the rate of 7 per cent per annum upon the par value of the certificates were made semiannually 611 to the certificate holders as a matter of course, without any special authorization by petitioner's board of directors. The total payments made to certificate holders in 1923 amounted to $350,000. No part of the amount so paid to certificate holders has been allowed as a deduction by the respondent in computing net income for 1923. 12. During 1923 the original partnership of Alexander Sprunt & Son, Bremen, sustained a net loss of $130,434.30 in connection with the liquidation of its prewar business. No1650 part of that loss has been allowed as a deduction by the respondent in computing the petitioner's net income for 1923. OPINION. MARQUETTE: 1. The first issue has been somewhat beclouded by the different positions taken by the petitioner in the pleadings and in its brief. In the preliminary statement of this report, we have quoted verbatim under (1) the assignment of error as set forth in the petition. In the statement of facts contained in the petition, the petitioner alleged as follows: These commissions were taken as a deduction from gross income in the 1923 tax return filed by the petitioner. The respondent has in its 60-day letter disallowed these commissions as a deduction from gross income and has stated in its 60-day letter the following reason for the disallowance: "This item represents commissions earned through your Bremen agency and represents taxable net income to you." In his answer the respondent, though denying any error in his determination, admitted the above allegation of fact; and upon the basis of these pleadings the case came on for hearing. In its brief the petitioner entirely ignores the question of whether the amount credited on its books to1651 the Bremen firm in 1923 and subsequently paid as commissions constitutes a proper deduction from the gross income of that year, and, contending that the respondent is bound by the explanation of his determination in the deficiency notice and that he must win or lose accordingly as the Board finds that such explanation does or does not legally support his determination, it sets forth that the sole question for decision is whether the commissions received by the Bremen firm are properly chargeable to the petitioner as its income. Devoting its entire brief to an argument on the latter question, the petitioner asserts that the evidence conclusively proves that the Bremen firm and the petitioner are separate and distinct taxable entities; consequently, that the income of the Bremen firm can not be charged to this petitioner; and that the respondent's deficiency determination, so far as based on the addition of $286,071.30 to the reported net income, must fail. In other words, the petitioner argues that, since the respondent explained the addition of $286,071.30 to the reported net income as income of 612 its "Bremen agency" properly includable in its tax return, and since he did1652 not specifically say that the addition was based upon the disallowance of a portion of the deduction which the petitioner claimed for commissions paid or credited to the Bremen firm, the Board must assume that the respondent's determination is that the petitioner is entitled to a deduction for the entire amount of such commissions and it must set aside so much of the deficiency as is based upon this item, if it finds that the petitioner is not properly chargeable with the income of the Bremen firm. There are fundamental weaknesses in this line of argument that are not easily disposed of. In the first place, the pleadings contain allegations by the petitioner, readily admitted by the respondent, to the effect that the petitioner claimed "a deduction from gross income in the 1923 tax return" for the commissions paid to the Bremen firm, in the amount of $286,071.30, and that "the respondent has in its 60-day letter disallowed these commissions as a deduction from gross income," though the respondent admits further that the explanation of his action in the deficiency notice was entirely different. Further, as was stated by the Board in 1653 : The phrasing of the notice of deficiency relating to the item in controversy, even if clear, is not the cause of action and does not frame the issues. The petitioner may not, without an expressly pleaded admission or a stipulation, treat the notice as an official acquiescence by the Commissioner in all petitioner's propositions as to this item except those expressly determined adversely to him. If the Commissioner finds one fact or reason which he believes supports his adverse determination, he is not required to express his views on any or all other matters relating to the item, and his failure to deal with them carries no implication as to their treatment. It is not the Commissioner's method of determination or computation which is the substance of the proceeding, for the deficiency may be correct despite a weakness in arriving at it or explaining it. ; . "It is immaterial whether the Commissioner proceeded upon the wrong theory in determining the deficiencies. In any event the burden was on the petitioner to show that1654 the assessment was wrong." . On the record before us, it is clear that the petitioner claimed a deduction, in computing taxable net income for 1923, of $336,554.48 for "commissions" paid or accrued in that year; and that the respondent allowed a deduction of only $50,483.13 and disallowed $286,071.30. The question, therefore, to be decided is whether the petitioner is entitled to the whole amount of the deduction claimed. It is obvious that if this item is a proper deduction in computing net income, authority therefor must be found in section 214(a)(1) of the Revenue Act of 1921, since no other section of the statute is broad enough to include an item of this character. That section 613 provides for the deduction of "All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered * * ." It seems clear enough from the findings of fact that the new Bremen firm and the petitioner corporation are separate and distinct entities, though1655 composed of the same persons, with like interests in both. These two entites were entirely free to deal with each other and fix their relations, by formal or informal agreements, as though they were composed of different persons, and business transactions between them are entitled to the same respect and consideration, in fixing their income-tax liabilities, as are accorded to dealings between less closely related business organizations, so long as their relations are not availed of as a mere vehicle for evasion of the tax. Cf. . If, therefore, the payments made by the petitioner to the new Bremen firm were ordinary and necessary in the conduct of its business and in the earning of its income, and were reasonable in amount, considering the services rendered, there is no bar to their deduction in the computation of net income. For what then were these payments, totaling $336,554.48, made by petitioner to the new Bremen firm? It may be conceded, upon the evidence, that the old Bremen firm had enjoyed a very lucrative business in the cotton markets of Central Europe, and, at the outbreak of hostilities between the United States1656 and the German Government, was possessed of an established good will of considerable value. With the outbreak of hostilities, however, it was forced to cease its business activities at Bremen, the seat of its operations, and apparently elected to remain inactive during that emergency. After the close of the war, it definitely abandoned the thought of resuming the business and reopened the Bremen office solely for the purpose of liquidation. In the interim, the petitioner had opened a branch office at Rotterdam and through that office had established connections with the former customers of the old Bremen firm and was carrying on business with those customers with apparently much success and not at all handicapped by reason of the former connections of those customers with the old Bremen firm. Such were the conditions existing at the time of the alleged demands of the members of the old Bremen firm for some sort of compensation, because the petitioner was capitalizing upon the business which they had built up, and when the petitioner was actually in possession of and enjoying the benefits of that business and its good will. What then was the necessity for the payment of these so-called1657 "commissions" to the members of the old Bremen 614 firm? The only explanation therefor is to be found in the testimony of the petitioner's president, who was a member of the old and new Bremen firms and a stockholder in the petitioner, that it was very much to the petitioner's interest "to keep the former partners of the Bremen partnership in a friendly frame of mind." We are left to draw upon our own imagination as to the probable consequences of petitioner's failure to meet those alleged demands. The record does not show that the new Bremen firm was directly responsible for a single dollar's worth of petitioner's sales in 1923, that is, that the members of the firm consummated a single dollar's worth of sales for the petitioner's benefit. If any portion of the petitioner's 1923 cotton sales in Central Europe can be attributed to the activities of any of the fourteen members of the firm, they may likewise be attributed to their activities as officers, directors and stockholders of the petitioner corporation. So far as we have been able to discover, the only services rendered by the new Bremen firm in 1923, for the petitioner's benefit, were represented by the activities1658 of only three of its fourteen members, Walker, Lippitt and W. H. Sprunt. Walker was also manager of petitioner's branch office at Rotterdam, and Lippitt and Sprunt were executive officers of the petitioner, located at Wilmington, N. C. Walker divided his time about equally between Rotterdam and Bremen, at the latter place attending to the affairs of the old and new Bremen firms. Lippitt and Sprunt made several trips to Europe for the purposes of assisting in the liquidation of the affairs of the old Bremen firm and of further developing and retaining the business of that firm for the petitioner's benefit. It is wholly impossible from the evidence to draw any line of demarcation between their activities, as members of the Bremen firm, in the interests of the petitioner and their activities as officers, directors and stockholders of the petitioner. In any event the evidence does not justify the conclusion that they, as partners, rendered any services to the petitioner which would not ordinarily have been required or expected of them as officers of the petitioner. The fact that the payments made to the Bremen firm were not in excess of the commissions usually paid to selling agents1659 does not of itself prove the reasonableness of these payments. The question is, was the total amount paid reasonable for the services rendered by the Bremen firm to the petitioner; and the answer must be in the negative, since the evidence is far from convincing that the firm rendered any services of substantial benefit to the petitioner. If the respondent had no more before him upon which to reach a determination in the matter than the evidence presented to us, we think he was more than reasonable in the allowance which he made. 615 We think the true character of these payments to the Bremen firm is best indicated by the fact of the admission to the partnership, apparently without any contribution of capital or services, of the seven individuals who were not members of the old Bremen firm but who, at the time of the organization of the new firm, were holders of common stock in the petitioner corporation, and the allotment to each of the fourteen members of the firm of an interest proportionate to his holdings of common stock in the petitioner. Asked if he could explain the admission to the firm of the seven new members under such circumstances, the petitioner's president1660 testified that they were admitted "merely by agreement to satisfy their claim." What claim had these seven new members which could be satisfied only in this fashion? They had no interest in the old Bremen firm and no claim upon its business and good will. They contributed nothing in the way of capital or services to the new firm. All of the circumstances of which we have been apprised tend to indicate that their sole claim was the right to share with the majority of petitioner's common stock holders in any distribution of profits. We find no error in the respondent's determination in this matter. 2. The second issue raises the question as to whether the entire amount of commissions accrued on the petitioner's books, to the credit of the Societe Cotonniere Franco-Americaine, may be deducted in computing net income. The respondent contends that the French corporation is "merely an incorporated branch office of the petitioner," and that the accruals in its favor, on the petitioner's books, represent nothing more than distributions of profits. We think that the respondent's determination in this matter is erroneous. The evidence leaves no room to doubt the separateness of the1661 two corporations, and there is no indication of fraud, attempt at tax evasion, or other circumstance which might justify or require a disregard of the separate corporate entities. The allowance of commissions to the French corporation could hardly be termed distributions of profits, since the corporation owned none of the petitioner's capital stock. The only question which might arise in connection with these commission allowances would be the matter of the bona fides of the allowances, and as to that, the evidence shows clearly that the allowances were made for services actually rendered in the consummation of sales for petitioner's benefit, and were computed at rates customarily allowed to petitioner's other selling agents. They represent a proper charge against the petitioner's gross sales as a part of their cost, and are a proper deduction in computing net income. The net income shown in the deficiency notice should be reduced by $33,736.28. 3. The third issue relates to respondent's action in adding to the reported net income an item of $601.05 on the ground that the net 616 income of the Houston branch office had been understated by that amount. The evidence1662 shows that the respondent's determination in this matter is erroneous. The alleged understatement is due to the petitioner's payment of bonuses of $601.05 to employees of the Houston branch office. For reasons of its own, the petitioner made payments direct from its Wilmington office and without making any record thereof in the books of account of the branch office. In accounting for the profits of the branch office on the books of the home office, a charge was made against those profits for the amount of the bonus payments; consequently, the profits of the branch office as shown by the home office books were less, by the stated amount, than the profits shown by the branch office books. The net income shown by the deficiency notice should be reduced by $601.05. 4. In this issue the petitioner questions the propriety of the respondent's action in disallowing as deductions eight items, totaling $19,120.32, which the petitioner had claimed in its return as a part of its general expenses. The respondent, in his brief, confesses error as to the disallowance of two of these items, to wit: bonuses to employees, in the amount of $13,682.82, and cost of purchases of cotton samples, 1663 in the amount of $50; and the petitioner, in its brief, withdraws the assignment of error as it relates to three other items, to wit: payment to the New York Cotton Exchange in the amount of $20, a further payment to the New York Cotton Exchange in the amount of $20, and Wilmington Light Infantry dues in the amount of $100. There are left for our consideration three items, to wit: a contribution of $5,000 to a fund to be used in eradicating the boll weevil; a payment of $25 to the Order of Railway Yardmen for advertising inserted in a magazine published by that order; and payments amounting to $262.50 for advertising inserted in magazines published by the American Legion and various labor and trade organizations. The respondent contends that the contribution of $5,000 to the fund raised by various cotton exchanges, to be used in the eradication of the boll weevil, should not be allowed, for the reason that the petitioner has failed to show definitely that it was in any way benefited by this contribution. We are of a different opinion. The petitioner was engaged in the business of exporting raw cotton and of operating a warehouse for the storage of the same commodity. Its business1664 was dependent upon a normal production and a crop of good quality, both of which were, in turn, dependent upon the successful control of the boll weevil. We may take judicial notice of a situation generally known to exist, the prevalence of the boll weevil and its destructive effects upon the cotton crops of our southern States, to remedy which much is being done by the States and 617 national and private enterprise. In making the contribution there was no thought of charity or philanthropy; the motives of the petitioner were purely mercenary, its expectation being that its business would be benefited proportionately to the degree of success attendant upon the campaign of eradicaiton or control of the pest. It is entirely unreasonable to ask the petitioner to measure the benefits of this contribution in terms of dollars and cents. The question always is whether balancing the outlay against the benefits to be reasonably expected, the business interests of the taxpayer will be advanced. . All circumstances considered, we think the benefits "to be reasonably expected" to flow from this contribution1665 were, at least, fairly proportionate to the expenditure. As to the amounts expended for advertising inserted in magazines published by the Order of Railway Yardmen, American Legion and various trade and labor organizations, totaling $287.50, the respondent contends that the names of the magazines in which the advertisements were inserted indicates that the expenditures were merely "good will donations." While such an inference might be drawn, it does not necessarily follow and it is negatived by the evidence. Accordingly, the net income shown in the deficiency notice should be reduced by $13,682.82 for bonuses to employees; by $50 for cost of purchases of cotton samples; by $5,000 for contribution to the fund for eradication of the boll weevil; and by $287.50 for advertising in various magazines, a total of $19,020.32. 5. For some reason not disclosed by the deficiency notice, any admitted pleadings, or evidence, the respondent increased the 1923 inventory of petitioner's Charlotte branch office by $11,185.96. The petitioner asks us to set aside the respondent's determination in this matter, on two grounds: (1) Because his action, in holding that adjustments with sellers1666 of en route cotton should be treated as additional cost of that cotton and reflected in its inventory value and not accounted for as an expense of the later year in which such adjustments are made, is contrary to the petitioner's consistent accounting practice and the best accounting practice in the industry; and (2) because the respondent failed to make a similar revision of the 1922 inventory, which is the opening inventory for 1923, in respect of the 96 bales of en route cotton included in that inventory, thus placing the opening and closing inventories for 1923 on different bases, with a resulting distortion in net income. Both reasons are premised on the assumed fact that the increase made by the respondent in the Charlotte inventory reflects the adjustments made in 1924 with the sellers of the 1,396 bales of en route 618 cotton included in the 1923 inventory of the Charlotte branch. But we do not know whether the assumption is correct or not. Certainly, nowhere in the record is there an admission of the fact by the respondent - his brief is entirely silent on this issue; and there is no proof of a single fact which would indicate that the respondent's inventory adjustment1667 is related to the 1,396 bales of en route cotton included in that inventory. For all we know, the respondent may have determined, in respect of the Charlotte inventory, that there was an erroneous count in the number of bales of cotton, or that inventory weights were incorrect, or any other of a number of possible errors which might be suggested. In short, we do not know why the respondent increased the Charlotte inventory by $11,185.96; consequently, the decision on this issue can not be limited to the consideration of any one particular element of the inventory valuation, but must embrace the whole matter of that valuation. Since the petitioner has failed to show that the Charlotte inventory was of a value less than that determined by the respondent, we are not in any position to disturb the respondent's determination. Furthermore, even if we could assume that the premise of petitioner's contentions is correct, there is no evidence that there were adjustments with sellers in 1923 in respect of the 96 bales of en route cotton included in the 1922 inventory; consequently, the petitioner has failed to prove that the respondent has been inconsistent in his treatment of adjustments1668 with sellers in respect of the en route cotton in the opening and closing inventories for 1923 and thereby has placed the two inventories on different bases. 6. The record does not show whether the sum of $7,500 paid to Goldman and Unger in 1923, for services in connection with legal proceedings to recover war risk insurance premiums, was in payment of services rendered entirely to the petitioner or in payment of services rendered partly to the predecessor partnership and partly to the petitioner. If any part thereof was in payment for services rendered to the partnership, the payment was in satisfaction of a liability of the partnership which the petitioner assumed in part payment for the partnership's assets, and that part of the whole amount paid would represent a capital expenditure - additional cost to the petitioner of the partnership's assets, which would not be a proper deduction in computing net income. Even if we assume that the payment was for services rendered entirely to the petitioner, the whole amount thereof still would not be deductible, because a portion thereof was expended in establishing petitioner's right, as assignee of the partnership by purchase, to1669 recover amounts paid out by the partnership for war risk insurance premiums; and that portion of the payment represents an additional 619 cost to the petitioner of the partnership assets, a capital expenditure which may not be deducted in computing net income. The evidence does not contain any facts upon which we could base a reasonable apportionment of the payment to the claims of the two entities, and we are unable, therefore, to determine what portion of the whole payment is a proper deduction in computing net income. Under the circumstances, the respondent's determination in the matter must stand. 7. This issue raises the question of the propriety of respondent's action in holding that certain expenditures made in 1923, and claimed as deductions by the petitioner in computing net income, were made for additions and betterments which materially prolonged the lives of the buildings, and, therefore, were of a capital nature and may not be deducted in computing net income. As to the payment of $4,200 for the construction of a concrete wall around the petitioner's warehouse at Charlotte, the findings of fact clearly show the nature of this expenditure. Unquestionably, 1670 the concrete wall which replaced a wooden one no longer useful for the purposes for which constructed was a substantial and permanent betterment and rendered the building better suited to the purposes for which it was used. The expenditure for the construction of the concrete wall is of a capital nature and, therefore, is not a proper deduction in computing net income. Cf. ; ; affd., ; certiorari denied, . It is also clear that much that was done in renovating Building A at Wilmington, for the purpose of renting the building, was in the nature of permanent betterments. The entire plumbing system was overhauled, the building was rewired for electricity, new window sashes were installed, and window screens and screen doors replaced. While these betterments may not have materially prolonged the life of the building, they unquestionably rendered it better suited to the petitioner's purposes. Some part of the work done might well be considered as ordinary repairs which may be deducted in computing net income; however, the1671 record affords no basis for a segregation of these items from those of a capital nature and, consequently, we can not determine what part of the entire cost of renovating the building is a proper deduction. . However, the respondent restored to income the sum of $3,050.07, which was the superintendent's estimate of the cost of renovating the building, whereas the actual cost was only $1,630.44, and only the latter amount was deducted by the petitioner in computing net income. Our conclusions on this issue require a reduction in the net income as shown by the deficiency notice, in the amount of $1,319.63. 620 8. The petitioner contends that the inventory of the Wilmington branch, as of December 31, 1923, was overstated by $33,412.60, due to using incorrect and excessive weights in valuing the cotton of six grades, resulting in a like overstatement of net income. In the deficiency notice, the respondent reduced the net income reported in the return by $3,403.29; but the petitioner contends that there should be a further reduction of $30,009.31. The petitioner placed in evidence the original inventory sheet showing the grades1672 of cotton on hand, number of bales of cotton in each grade, weight of cotton in each grade, and value of the cotton in each grade. This sheet showed a total value for the inventory, of $4,122,404.33. It also put in evidence a revised inventory sheet showing corrected weights for six grades of cotton; and the total value of the inventory, as shown by this revised sheet, is $4,088,991.73, which is $33,412.60 less than the value shown by the original inventory sheet. Not all of the difference of $33,412.60 is due to a correction in weights. An examination of the revised inventory sheet shows that of the total difference, $2,526.73 is due to a change in the unit price per pound of cotton en route to destination - the original inventory showing a unit price of $0.345 per pound, while the revised inventory shows a unit price of $0.3325 per pound. No evidence was presented by the petitioner to support this change in price; hence, the change may not be allowed. While we have found that incorrect weights were used as to six grades of cotton in valuing the inventory, there is not sufficient proof to show error in the respondent's determination as to the value of the inventory. After1673 investigating the inventory, the respondent determined, as indicated by the deficiency notice, that the inventory reported in the return had been overstated by $3,403.29. The deficiency notice, pleadings and evidence do not show the basis of that determination. The fact that the respondent did not make as great a reduction in the inventory as might be required by a revision of weights in six grades of cotton indicates that in all probability he found offsetting errors elsewhere in the makeup of the inventory. He was under no obligation to set forth fully in the deficiency notice the basis of his determination. The obligation rested on the petitioner, therefore, to prove the value of the inventory and the inventory value used by the respondent in his deficiency determination. The first required proof of quantities, according to grades, basis used in valuing the inventory, whether cost or cost or market, whichever is lower, and the unit price of each grade, cost or market, according to the basis of valuation, but the petitioner failed to prove either the basis or the unit prices used. As to the inventory value used by the respondent in the deficiency determination, we can only1674 assume that it was the value shown 621 by the original inventory sheet reduced by $3,403.29; the deficiency notice indicates only that the respondent reduced the inventory value reported in the return by $3,403.29, but the value reported in the return may have been entirely different from the value shown by the original inventory sheet. The evidence is insufficient to show error in the respondent's determination as to the value of the inventory of the Wilmington branch. 9. The petitioner increased the book value of its compress equipment in 1923 by $15,622.53, and credited profit and loss account with a like amount. The amount so credited to profit and loss was included in gross income in the return, but $4,173.16 was eliminated from income by the respondent in the deficiency notice. The revaluation of the compress equipment and the arbitrary write-up on the books of the value of that equipment on the books did not give rise to any taxable income, and the whole amount of the write-up should have been excluded by the respondent from income. The net income shown in the deficiency notice should be reduced by $11,449.37. 1675 10. The expense of removing a cotton compress from Wilmington to Houston, was an ordinary and necessary expense of carrying on the petitioner's business, ; ; and since the cost thereof has not been allowed as a deduction by the respondent, the net income shown by the deficiency notice should be reduced by $8,355.19. 11. The petitioner complains of respondent's failure, in computing net income for 1923, to allow as a deduction the sum of $350,000 representing alleged interest paid to the holders of petitioner's certificates of paid-in surplus in that year. In , it was held that the payments received from this petitioner on the certificates of paid-in surplus under consideration in this case were interest income and not dividend income to the trust, and were subject to both the normal and surtaxes. In the instant case, however, the evidence as to the nature of these payments is much more full and complete than that presented to the Board in the cited case, and clearly reveals the true nature of these1676 payments to be dividends and not interest. Clearly the holders of these certificates of paid-in surplus are shareholders in the petitioner and not creditors. The resolution adopted at the stockholders' meeting of June 9, 1919, and the instrument itself disclose that the funds represented by these certificates have been invested in the business without any guarantee of return and subject to all the risks and hazards of the business. The semiannual payments to the certificate holders of 7 per cent upon the face value of the outstanding certificates are denominated "dividends" in the 622 certificate, and are required to be paid, by the provisions of the certificate, out of earned surplus or net profits of the corporation. The rights of the certificate holders to repayment of the principal sums or face values of their certificates and the accrued dividends thereon are subordinate to those of the general creditors of the business. They have only preferred rights over the holders of common stock. In the last analysis, these certificates are nothing more nor less than certificates of preferred stock, and the amounts paid to the holders thereof in 1923, in accordance with the*1677 provisions as to dividends, are dividends and not interest payments. The decision in , is not controlling here. There is no error in respondent's determination by reason of his failure to allow as deductions, in computing net income, the amounts so paid to holders of certificates of paid-in surplus. 12. We have already held in our decision of the first issue that the Bremen firm and the petitioner are separate and distinct taxable entities; and there is no provision of law under which the net loss of the Bremen firm for 1923 may be allowed as a deduction in computing the petitioner's net income for that year. Reviewed by the Board. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624600/	CALDWELL & COMPANY, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Caldwell & Co. v. CommissionerDocket No. 43708.United States Board of Tax Appeals26 B.T.A. 790; 1932 BTA LEXIS 1247; August 12, 1932, Promulgated 1247 Where petitioner corporation had acquired assets of a partnership in consideration of assumption of its liabilities, which firm, in turn, had secured assets of an earlier partnership upon a like consideration, and petitioner had reimbursed members of the original partnership for attorney fees paid by them in defending asserted income-tax deficiency for 1917 against the original partnership, held, reimbursement was either voluntary payment of the debt of another or a capital expenditure and not an ordinary and necessary expense of doing business, deductible by petitioner corporation under section 234(a)(1) of the Revenue Act of 1926. Benjamin Weiner, Esq., Arthur Rothstein, Esq., and Herman Goldman, Esq., for the petitioner. F. K. Slanker, Esq., for the respondent. LEECH791 This proceeding seeks redetermination of a deficiency of $2,970 for the calendar year 1926. The only error assigned is upon respondent's action in disallowing a deduction of $20,000 taken by petitioner in computing net income for that year as a business expense. FINDINGS OF FACT. Petitioner is a New York corporation, with its principal office in New York1248 City, and is engaged in the business of freight broker, marine insurance broker and forwarding agent. Prior to May 1, 1918, the business was conducted as a partnership, consisting of three individuals, Caldwell, Rademan, and Fowler, under the firm name of Caldwell & Company. On that date the partnership was dissolved by the retirement of Caldwell, it being then agreed that the business would be continued under a new partnership composed of Rademan and Fowler under the original firm name of Caldwell & Company and that Caldwell would receive for his interest $50,000 plus $5,200 per year for three years. It was further agreed that Caldwell would assume liability for one-third of any large claims against the business growing out of transactions prior to his retirement. In accordance with the agreement, a new partnership was created by Rademan and Fowler, which operated the business of Caldwell & Company until September 19, 1919, when all of the assets and business of the partnership were acquired by petitioner, caldwell & Company, Inc., which Rademan and Fowler had caused to be organized. The consideration paid by petitioner for the assets and business was agreed to be $749,000, 1249 payable by the delivery of 7,490 shares of the capital stock of petitioner, of a par value of $100 per share, to Rademan and Fowler and the assumption by petitioner of all the debts, obligations and liabilities of the business as of June 30, 1919, the contract of sale providing: The Vendors hereby give and grant to the Vendee Company its successors, legal representatives and assigns full power and authority in their name, the firm name or otherwise, but for its own use and benefit and at its own cost and expense to collect the outstanding accounts and notes receivable of the said Vendors and in their name, the firm name or otherwise to give receipt therefor and to endorse any checks, notes, drafts and any and all other instruments or orders for the payment of money made to the said Vendors, in payment thereof and to institute, prosecute, withdraw, compromise and settle any and all suits or proceedings at law or in equity relating to or arising out of the property and business hereby sold and delivered. Following its acquisition of the property and business of Caldwell & Company, petitioner operated the business, Rademan and Fowler 792 being at all times the owners of practically1250 all of its stock and in active control of its affairs. On March 5, 1923, respondent mailed a deficiency letter addressed to Caldwell & Company, 50 Broad Street, New York City, this being the address at which the business in question had been carried on by petitioner and by the two predecessor partnerships. This deficiency letter asserted a deficiency of $303,387.11 additional tax for the calendar year 1917 and this proposed deficiency was assessed against Caldwell & Company on respondent's March, 1923, list. This notice of deficiency was, on its receipt in petitioner's office, referred by Rademan and Fowler, to one Herman Goldman, who was the regularly retained attorney for petitioner and who had also represented, as attorney, both of the prior partnerships of Caldwell & Company. Rademan and Fowler also notified their former partner, Caldwell, of the determination of the deficiency and he in turn entrusted the protection of his interests to the said Goldman. As a result of the efforts of Goldman in contesting the deficiency asserted the assessment was abated in the amount of $303,039.53 and sustained in the sum of $347.58. Toward the close of the year 1923 a bill for1251 $30,000 for legal services was forwarded by Herman Goldman to petitioner. This bill was returned to Goldman with the request that he make up three bills for $10,000 each to Caldwell, Rademan and Fowler, individually. This was done and these bills were paid in cash instance by the individual by his separate check dated December 31, 1923. These individuals deducted the amount of the payments made by them, respectively, in computing their individual net incomes for the calendar year 1923. During the calendar year 1926 the treasurer of petitioner, one Robinson, in making up some statistical data for petitioner, examined the records pertaining to the acquisition of the partnership business and concluded that petitioner was liable for the attorney fees paid by Rademan and Fowler. He then called the latter's attention to this and, as a result, a directors' meeting of petitioner was held, at which the reimbursement by petitioner of these two individuals was authorized. Under this authority Rademan and Fowler were each paid by the corporation the sum of $10,000, and the total of these payments was deducted as regular and necessary business expenses upon petitioner's return for that1252 year. Petitioner kept its books and determined its income for this year, as in prior years, upon the basis of cash receipts and disbursements. The $10,000 received by Fowler from petitioner in 1926 was included in income by him upon his return for that year. Petitioner did not reimburse Caldwell for the $10,000 paid by him to Herman Goldman, as detailed above. 793 OPINION. LEECH: The tax liability in connection with which the legal fees here sought to be deducted were paid was that of the original partnership of Caldwell & Company for the year 1917, during which a partnership was a taxable entity. The evidence shows clearly that the second partnership, composed of Rademan and Fowler, assumed the liability for two-thirds of any tax liability of the prior partnership for 1917 and that petitioner assumed such liability as one existing on June 30, 1919, as a part of the consideration for its acquisition of the assets of the second partnership. It is clear that if petitioner's liability was limited to the reimbursement of Rademan and Fowler to the extent of additional taxes the latter were required to pay for 1917, and did not extend to liability for attorney fees1253 accruing in connection therewith, as created subsequent to June 30, 1919, then its reimbursement of the former partners for these expenditures was voluntary and accordingly not an expense ordinary and necessary in carrying on business. It would follow that it was not deductible under section 234(a)(1) of the Revenue Act of 1926. Cf. ; ; . Conversely, if petitioner was liable to Rademan and Fowler for the $20,000 in fees paid by them, such liability was one assumed as a part of the consideration for the acquisition of the property of the second partnership and we can see no difference between this and any other item of the capital cost of any such property to petitioner. The fact that the legal fees in question accrued subsequent to the acquisition of the assets is of no significance when the obligation to assume them, if and when they accrued, was one assumed under the contract, and as a part of the consideration for the property received. If petitioner was liable to Rademan and Fowler for a deficiency in tax1254 for 1917, recovered from them, the payment of such liability would not entitle it to a corresponding deduction as an expense of doing business. In the case of , often cited with approval by us in later cases, we said: "The liquidation of a liability of known or unknown amount assumed by a corporation as a part consideration for the purchase of assets is not an ordinary and necessary expense of doing business. It is a capital transaction. It is not a legal deduction from gross income." It makes no difference as to petitioner, that the liability of Rademan and Fowler for attorney fees might, as to them, represent a deductible expense. As to petitioner, the reimbursement of that expense by it to Rademan and Fowler is merely the payment of something 794 it agreed to pay in part consideration for the assets acquired and, accordingly, constitutes a capital expenditure. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624604/	CARTER PUBLICATIONS, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Carter Publications, Inc. v. CommissionerDocket Nos. 44838 66891.United States Board of Tax Appeals28 B.T.A. 160; 1933 BTA LEXIS 1173; May 23, 1933, Promulgated 1173 The petitioner, a newspaper corporation, purchased the circulation structure and part of the physical assets of a competing company for an agreed price based upon an appraisal of the assets taken over. Prior to the transfer the selling corporation distributed all assets not included in the sales agreement to its president and sole stockholder, in liquidation of his stock, which was thereupon canceled and reissued, without consideration, to petitioner's president and four other stockholders, who took control and through proper corporate formalities completed the transfer as per agreement and then dissolved that corporation. Held, under the facts shown, the petitioner's acquisition of the assets involved was by purchase and not through reorganization as defined in section 203 of the 1924 Act. H. A. Mihills, C.P.A., for the petitioner. F. B. Schlosser, Esq., for the respondent. LANSDON 160 The respondent has determined deficiencies in income tax for the years 1926 and 1929, in the respective amounts of $2,111.55 and 161 $2,929.39. For its causes of action the petitioner alleges (1) that the respondent has erroneously disallowed1174 a loss sustained in 1926 by the sale of certain assets acquired in the year 1925, and (2) that he has erroneously decreased the depreciation to which the petitioner is entitled for 1929. The second allegation of error involves both the rate and the basis for depreciation in 1929, but the petitioner has abandoned his contention for a higher rate. The two proceedings have been consolidated for hearing and report. The parties have filed a stipulation which we accept and adopt as our finding of fact. FINDINGS OF FACT. (1) The Wortham-Carter Publishing Company was incorporated under the laws of the State of Texas in January 1909, and has been engaged in publishing and distributing an evening newspaper called "The Star-Telegram" in Fort Worth, Texas. The name of the company was subsequently changed to Carter Publications, Incorporated, the petitioner. A. G. Carter was President of the company during the taxable year and owned a majority of the outstanding stock. (2) The Fort Worth Record Company published a morning newspaper in Fort Worth, Texas, known as the "Fort Worth Record." The principal stockholder of the company was W. R. Hearst who owned no stock of the petitioner. 1175 (3) The petitioner desired to publish a morning newspaper and upon learning that the Forth Worth Record was being offered for sale, A. G. Carter, acting for and on behalf of the petitioner as its agent, entered into negotiations with W. R. Hearst. On October 8, 1925, in a letter addressed to W. R. Hearst, A. G. Carter agreed to purchase from him the entire capital stock of the Fort Worth Record Company, effective as of November 1, 1925. (4) Preparatory to carrying out the agreement of October 8, 1925, the Fort Worth Record Company, pursuant to a resolution of its Board of Directors passes at a special meeting held on October 30, 1925, assigned and distributed to W. R. Hearst its cash, receivables, claims and all other assets with the exception of physical property, rights, franchises and privileges. After this assignoment and distribution the Fort Worth Record Company had assets consisting of physical property, rights, franchises and privileges and liabilities of $350,000. W. R. Hearst then transferred to A. G. Carter or his nominees all of the capital stock of the Fort Worth Record Company. No consideration passed for this transfer, as under agreement of October 8, 1925 the1176 purchase price of $350,000 was to be liquidated or reduced by bills and accounts payable and other obligations of the Fort Worth Record Company assumed by the purchaser. After such transfer the stock of the two companies was held as follows: Stockholders CarterFt. Worth(Names)Publications, Inc.Record Co.(Number shares)(Number shares)A. G. Carter5,0001,392B. W. Honea7502A. L. Sherman7502J. M. North, Jr7502H. V. Hugh2502Total7,5001,400162 (5) Following the transfer of stock to Carter and his nominees they caused the Fort Worth Record Company to convey to the petitioner all of its assets which as heretofore stated consisted only of physical properties, rights, franchises and privileges. The consideration for the conveyance was $175,000 for the physical properties and $175,000 for the rights, franchises and privileges. This consideration was paid by the assumption of liabilities of the Fort Worth Company of $350,000 by the petitioner. Upon conveyance of its assets to the petitioner, the Fort Worth Record Company dissolved. (6) The foregoing properties were duly conveyed to petitioner on October 31, 1925, by1177 appropriate bill of sale which recorded the consideration of $350,000 as being paid for the properties acquired on the basis of $175,000 for the physical properties and $175,000 for the rights, franchises and privileges. (7) A. G. Carter, as an individual, had no intention of acquiring either the capital stock or the assets of the Fort Worth Record Company, but was acting in the capacity of agent for and on behalf of the petitioner. The entire purchase price of the said Fort Worth Record Company was paid by petitioner and no part of the personal funds of A. G. Carter was used in any manner in connection with the transaction. (8) A. G. Carter was informed that it would facilitate closing up the affairs of the Fort Worth Record Company if the capital stock of the company could be transferred rather than the assets which petitioner desired to purchase. Upon making inquiry of the attorneys for the petitioner, A. G. Carter was informed that under the laws of the State of Texas, a corporation was not permitted to own the capital stock of another corporation, and for this reason it would be necessary for him, as the nominee of petitioner, to acquire the capital stock of the Fort Worth1178 Record Company and cause the assets of that company to be conveyed to petitioner. It was the purpose and intent at all times that petitioner should acquire certain specific assets - the physical properties, and the rights, franchises and privileges. The transfer of the capital stock of the Fort Worth Record Company was merely a formality. (9) Prior to October 31, 1925, A. G. Carter did not own any of the capital stock of the fort Worth Record Company, nor did any of the stockholders of petitioner. (10) The petitioner used an appraisal prepared by the American Appraisal Company at July 1, 1924, showing a reproductive sound value on that date of $185,015.36, as a basis for valuation of the physical assets acquired. An actual inventory of physical assets on October 31, 1925, based upon the appraisal, and subsequent additions at cost, amounted to $189,241.40, from which depreciation of 8% was deducted to arrive at the purchase price of $175,000 which was then recorded upon the books of petitioner in accordance with the detailed classification used in the appraisal report. (11) The valuation of $175,000 for intangibles was determined on the basis of 24,000 daily and 30,000 Sunday1179 subscribers, at an average between $6.00 and $7.00 for each subscriber. (12) On November 1, 1925, the petitioner began the publication of a morning newspaper known as the Record-Telegram. It was considered to be more economical for petitioner to publish the two newspapers with one plant and one organization rather than to maintain two plants and separate organizations, and for this reason the plant of the Fort Worth Record Company was dismantled, part of the machinery being put in use at petitioner's plant, and the balance sold and siposed of at the best available prices. (13) During the latter part of November and December, 1925, the petitioner sold and junked certain equipment which it decided not to use in the converted 163 plant, and deducted as a loss the difference between the proceeds therefrom and the specific cost to petitioner of the asset disposed of as shown in the detailed cost classification of $175,000 as spread upon its books on October 31, 1925. Respondent has limited the loss claimed to the book value of the asset disposed of as shown by the books of the predecessor company, the Fort Worth Record Company, and has allowed depreciation only on the book1180 value to the predecessor, the Fort Worth Record Company. (14) During the taxable year 1926 the balance of the equipment acquired from the Fort Worth Record Company was put in use, sold, turned in with other equipment of petitioner in part payment for new machinery, or junked. The combined cost to petitioner of the assets disposed of in 1926 as shown by the classified cost aggregating $175,000 as spread upon its books was $22,591.61 and the proceeds therefrom were $14,988.56, the difference of $7,603.05 being deducted by petitioner as a loss in its return for the taxable year. Respondent has disallowed the aforementioned loss of $7,603.05 and in lieu thereof computed a profit on the sales transaction by use of the book value to the predecessor, the Fort Worth Record, as a basis for computing gain or loss, and has determined in this manner that the cost of the assets disposed of by petitioner was $8,200.76 and a profit resulted in the amount of $6,787.80, which accounts for the amount of income in controversy, $14,390.85 for the taxable year 1926. (15) The amount of $39,405.76 shown in the tax return of petitioner for the taxable year as being the amount received, includes the1181 cost of assets put in use during the taxable year aggregating $24,417.20 in addition to the proceeds of assets disposed of aggregating $14,988.56. (16) Petitioner deducted in its tax return for the taxable year 1929 depreciation on its physical equipment in the amount of $71,929.06, whereas respondent has allowed as a deduction the amount of $47,025.40 and disallowed the amount of $24,903.66, the difference resulting from reduction of rates of depreciation as computed by petitioner and reduction of the basis upon which depreciation was computed by petitioner. (17) The aforementioned reduction in basis to be used in computing depreciation is in the amount of $73,421.65 and is represented by the difference between the book value of certain assets shown by the books of the predecessor company, the Fort Worth Record Company, and the recorded cost of the same assets included in the aforementioned detailed classified cost of $175,000 as spread upon the books of the petitioner on October 31, 1925. (18) The parties are in agreement that the sole controversy before this Board relates to the basis for computing depreciation, and the basis for computing gain or loss on subsequent disposition, 1182 of the physical assets acquired by petitioner from the Fort Worth Record Company on October 31, 1925, the petitioner having used as its basis the cost of $175,000 attributed to the physical assets the amount of which is not in controversy between the parties, whereas the respondent has determined that the purchase of the assets by the petitioner from the Fort Worth Record Company constituted a reorganization under the provisions of Section 204(a)(7) of the Revenue Act of 1926, and that thereunder the petitioner is limited to the use of the basis in the hands of the predecessor company. OPINION. LANSDON: In this proceeding we are required to decide only a question of law. The petitioner contends that in the circumstances set out in our findings of fact it purchased certain of the physical 164 assets of the Fort Worth Record Co. for $175,000 and, therefore, is entitled to compute gain or loss from the sale of such property and depreciation sustained in the use thereof on a cost basis of $175,000. The respondent has determined the transactions in question effected a reorganization as defined in section 203(h)(1) of the Revenue Act of 1924 and therefore that the basis for1183 computing gain or loss from sales or depreciation sustained in the use of assets so acquired is that to which the transferor was entitled under the provisions of section 204(a)(7) of the same act. The Fort Worth Record Co. distributed a part of its assets to its principal shareholder, thereafter sold the remainder to the petitioner and was at once dissolved. Instead of being a continuing reorganized corporation in any sense it ceased to exist, and from the date of its dissolution neither as a corporation nor through its stockholders dis it have any continued interest in or control over the corporation that had purchased a portion of its assets for cash. ; . It is equally difficult to see any reorganization of the petitioner, which merely bought some property and thereafter remained under and was operated for the same body of stockholders that controlled it prior to the transaction. In the circumstances herein some of petitioner's stockholders took legal title to the stock of the Fort Worth Record Co., but only for the purposes of carrying out the agreement1184 with Hearst. In their ad interim holding thereof, Carter and his associates were no more than trustees charged with the duty of accomplishing the terms of such agreement. Since none of such stockholders owned a majority of the Fort Worth Record Co. at the inception of this transaction, the procedure followed is not within the definition of a reorganization as contended by the respondent. The whole series of acts, corporate and otherwise, constituted only a single transaction in which the petitioner purchased certain tangible assets for cash. On this issue the determination of the respondent is reversed. ; ; ; ; ; . Cf. ; . The petitioner has abandoned its claim for a rate of depreciation higher than that allowed by the Commissioner. On this issue the1185 determination of the respondent is affirmed. Reviewed by the Board. Decision will be entered under Rule 50.GOODRICH and LEECH dissent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624606/	Estate of Stephen L. Richards, Deceased, Lynn S. Richards, Executor v. Commissioner.Estate of Richards v. CommissionerDocket No. 1608-63.United States Tax CourtT.C. Memo 1965-263; 1965 Tax Ct. Memo LEXIS 65; 24 T.C.M. (CCH) 1436; T.C.M. (RIA) 65263; October 4, 1965Harold H. Hart, Newhouse Bldg., Salt Lake City, Utah, for the petitioner. D. Lee Stewart for the respondent. DAWSONMemorandum Findings of Fact and Opinion DAWSON, Judge: Respondent determined a deficiency of $31,685.08 in estate tax against the Estate of Stephen L. Richards. The only issue for decision is whether the value of a trust, created by the decedent on January 31, 1942, is includable in his gross estate under the provisions of section 2036(a)(1) of the Internal Revenue Code of 1954. Findings of Fact Some of the facts have been stipulated and are so found. Stephen L. Richards, who was born June 18, 1879, died66 a resident of Salt Lake City, Utah, on May 19, 1959. He was survived by his wife, Irene, by three sons, Lynn, Philip, and Richard, and by four daughters, Irene, Lois, Alice, and Georgia. The Federal estate tax return for the Estate of Stephen L. Richards was filed with the district director of internal revenue, Salt Lake City, Utah. On January 31, 1942, Stephen L. Richards created a trust naming his three sons and his brother, G. Gill Richards, as trustees. The trust instrument provides, in pertinent part, as follows: SECOND: The Trustees shall collect and hold all income of every name and nature from the trust estate, together with the corpus thereof, in trust for Irene Merrill Richards, my wife, during her lifetime. THIRD: My Trustees shall pay unto my wife Irene Merrill Richards for her maintenance and support the net income from my trust estate at such times as they in their sole discretion shall determine. In the event the net income of this trust shall not be sufficient to support and maintain my wife the said Trustees may in their uncontrolled discretion pay to my wife out of the sale of the corpus of said trust estate any additional sums as may be necessary for her67 comfort and support. [Emphasis supplied.] FOURTH: The trust for the benefit of my said wife shall persist throughout her lifetime. Upon her death the said Trustees shall hold said trust estate in trust for my seven children Lynn Stephen Richards, Irene Louise Richards Covey, Lois Bathsheba Richards Hinckley, Alice Leila Richards Allen, Georgia Gill Richards Olson, Philip Longstroth Richards and Richard Merrill Richards. * * NINTH: (a) This is a trust for maintenance, and I direct that the payments to my said wife and children hereinbefore specified be made by my Trustees according to the foregoing terms and continuing until and including the time of the distribution of the trust estate by the Trustees. At the time the trust was created, Stephen L. Richards transferred to the trustees 3,800 of the 4,999 outstanding shares of the capital stock of Wasatch Land and Improvement Company (hereafter called Wasatch), a closely-held family corporation. Later Richards transferred to the trustees an additional 300 shares of Wasatch stock on March 3, 1945, and 890 shares on April 30, 1949. No other property was ever transferred to the trust. The trust had no gross or net income at68 any time in any year from its creation until the death of Stephen L. Richards. Wasatch, a Utah corporation organized about 1912, is the owner of the fee title in about 67 acres of land in Salt Lake City which had been developed as a cemetery called Wasatch Lawn Memorial Park. Corporate income is derived from the sale of gravesites and related activities within the cemetery. When Stephen L. Richards created the trust he was president and general manager of Wasatch. He continued to serve the corporation in these capacities until his death. The directors of Wasatch as of January 30, 1942, were as follows Lynn S. Richards Richard M. Richards Philip L. Richards Ralph Harvard Olson (son-in-law of Stephen L. Richards) Jay Knight Allen (son-in-law of Stephen L. Richards) Stephen G. Covey (son-in-law of Stephen L. Richards) Frederick R. Hinckley (son-in-law of Stephen L. Richards) Orval W. Adams (banker) The directors of Wasatch as of May 19, 1959, were as follows: Stephen L. Richards Irene M. Richards (wife of Stephen L. Richards) Lynn S. Richards Richard M. Richards Philip M. Richards Louise R. Covey (daughter of Stephen L. Richards) Lois R. Hinckley69 (daughter of Stephen L. Richards) Alice R. Allen (daughter of Stephen L. Richards) Georgia R. Olson (daughter of Stephen L. Richards) The assets and liabilities of Wasatch on December 31, 1958, were carried on its books as follows: ASSETS: Cash$ 18,584.91Stocks13,156.96Receivables (Accounts, mortgages,notes and contracts)37,941.08Real estate46,592.23Improvements - net8,359.54Buildings - less accumulated depre-ciation11,506.42Furniture - less accumulated de-preciation2,398.93Equipment - less accumulated de-preciation13,411.36Miscellaneous assets3,543.98Total assets$155,495.41LIABILITIES and EQUITY: Accounts payable$ 3,390.37Reserves (taxes, unrealized profit,open graves, etc.)15,209.93Capital stock50,000.00Retained earnings86,895.11$155,495.41Wasatch has never paid a dividend in any year from January 31, 1942, to May 19, 1959. Its business needs are such that it requires large sums of money for investment in capital assets and operating expenses. The amount spent for capital improvements between 1942 and 1959 exceeded $44,000. In addition, $117,000 was spent for equipment and maintenance70 of the cemetery. During such period Wasatch invested in real estate contiguous to its existing cemetery facilities and also made improvements in roads, lawns, shrubs, surveying, pipelines, water systems, and buildings. In 1958, Wasatch had 30 acres of undeveloped land. The corporation intended to incorporate this land into the cemetery proper. Wasatch also planned to construct an expensive north entrance to the existing cemetery facilities and to build garden crypts extending along the east border of the property. At the time the trust was created, Stephen L. Richards lived with his wife in a home which he owned at 254 Seventh Avenue, Salt Lake City, Utah. In November 1950, he and his wife moved to an apartment at 105 East South Temple in Salt Lake City where they resided until his death. Stephen L. Richards' income from 1942 until his death in 1959 was more than ample to support his wife and he did support her during such period. In these years he received salaries as an officer or director of several companies. Examples of his total income from all sources are as follows: 1942$19,690.85194722,929.27195240,519.34195749,767.44Richards' wife, Irene, 71 had no properties or income of her own during the period from January 31, 1942, to May 19, 1959. Stephen L. Richards' total gross estate was valued at the date of his death for estate tax purposes at $427,024.41. In addition, the assets in the trust of January 31, 1942, were valued as of the date of his death at $229,540. In its estate tax return no part of the assets of the trust were included by petitioner in the gross estate. Opinion Respondent contends that the value of the assets in the trust created by Stephen L. Richards on January 31, 1942, is includable in his gross estate under section 2036(a)(1) of the Internal Revenue Code of 1954, 1 because, under Utah law, 2 he was under a legal obligation to support his wife. 3 In support of this position respondent relies on the following cases: Commissioner v. Dwight's Estate, 205 F. 2d 298 (C.A. 2, 1953); Helvering v. Mercantile Commerce Bank and Trust Company, 111 F. 2d 224 (C.A. 8, 1940); First National Bank of Montgomery v. United States, 211 F. Supp. 403">211 F. Supp. 403 (M.D. Ala. 1962); and Estate of William H. Lee, 33 T.C. 1064">33 T.C. 1064 (1960). 72 Petitioner does not dispute the general principles of law set out in the cases cited by respondent, but argues that the facts of this case bring it within an exception carved out by our decisions in Estate of Jack F. Chrysler, 44 T.C. 55">44 T.C. 55 (1965), and Estate of Payson Stone Douglass, 2 T.C. 487">2 T.C. 487 (1943), affirmed sub nom Commissioner v. Douglass' Estate, 143 F. 2d 961 (C.A. 3, 1944). See also Lettice v. United States, 237 F. Supp. 123">237 F. Supp. 123 (S.D. Calif. 1964). In each of these cases trusts created for the maintenance and support of legal dependents were not includable in the settlors' estates because the trustees were given discretionary powers of distribution. Respondent argues that the Daoglass and Chrysler cases are distinguishable. In his brief he states: In Commissioner v. Douglass' Estate, supra, Lettice v. United States, supra, and Estate of Jack F. Chrysler, supra, the trustees had sole discretion as to whether any income of the trusts was to be applied for the maintenance and support of the beneficiaries. In the case at bar, the dispository paragraph of the trust instrument required that73 the trustees pay to the decedent's wife for her maintenance and support the net income from the trust estate. The trustees had discretionary power only as an invasion of the corpus in the event the net income of the trust was insufficient to support and maintain the wife and as to the time to make payment, i.e., weekly, monthly, or quarterly. We are thus faced with a very narrow question of interpretation: Does the language of the trust instrument operate to give the trustees discretion over the payment of trust income to Richards' wife so as to bring this case within Douglass and Chrysler? We think not. In our opinion Stephen L. Richards retained an enforceable right to have the trust income used to discharge his legal obligation to support his wife. Although we realize that the trust never had any income, the trust corpus was never used to support Irene Richards, and Stephen Richards did support his wife from 1942 until his death in 1959, it is our view that the trust agreement is the best index of the settlor's intent. The requirement as to the payment of trust income was not permissive or discretionary, but absolute. In plain and unequivocal language, the third dispository74 paragraph provides that the "Trustees shall pay unto my wife * * * for her maintenance and support" the net income from the trust. And, if the income was not sufficient, then the trustees could in their discretion invade the corpus for that purpose. Moreover, the ninth paragraph of the trust instrument expressly states that "This is a trust for maintenance." As we read the trust instrument, the only discretion given to the trustees was as to the times payments were to be made. There was no discretion as to the purpose for which payments were or were not to be made. Under these particular circumstances we think a court would have compelled the trustees to provide for the wife's maintenance and support out of trust income. Accordingly, we hold that the value of the trust is includable in the gross estate of the decedent. Decision will be entered for the respondent. Footnotes1. SEC. 2036. TRANSFERS WITH RETAINED LIFE ESTATE. (a) General Rule. - The value of the gross estate shall include the value of all property (except real property situated outside of the United States) to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money's worth), by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death - (1) the possession or enjoyment of, or the right to the income from, the property, or ↩2. Section 76-15-1, Utah Code: Any person who, without just cause, deserts or wilfully neglects or refuses to provide for the support and maintenance of his wife in destitute or necessitous circumstances * * * is guilty of a felony, and shall be punished by imprisonment in the state prison at hard labor for a period of not to exceed five years. ↩3. Section 20.2036-1(b)(2), Income Tax Regs.: The "use, possession, right to the income, or other enjoyment of the transferred property" is considered as having been retained by or reserved to the decedent to the extent that the use, possession, right to the income, or other enjoyment is to be applied toward the discharge of a legal obligation of the decedent, or otherwise for his pecuniary benefit. The term "legal obligation" includes a legal obligation to support a dependent during the decedent's lifetime.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624607/	Joseph C. Ruddy, Jr. v. Commissioner.Ruddy v. CommissionerDocket No. 6744-70 SC.United States Tax CourtT.C. Memo 1971-316; 1971 Tax Ct. Memo LEXIS 13; 30 T.C.M. (CCH) 1355; T.C.M. (RIA) 71316; December 20, 1971, Filed. Joseph C. Ruddy, pro se, 2818 64th Ave., Hyattsville, Md.John J. Weiler, for the respondent. INGOLIAMemorandum Findings of Fact and Opinion INGOLIA, Commissioner: Respondent determined a deficiency in petitioner's Federal income tax for 1968 in the amount of $257.27. Concessions having been made, the only issue for decision is whether expenses totalling $770.20 incurred by the petitioner in 1968 in attending Georgetown University Law Center are deductible as ordinary and necessary business expenses under section 162(a). 114 Findings of Fact Joseph C. Ruddy, Jr., (hereinafter referred to as "petitioner") was a legal resident of Hyattsville, Maryland, at the time his petition was filed. He filed his Federal income tax return for 1968 with the District Director at Baltimore, Maryland. Petitioner was graduated from Georgetown University in June of 1966 with a major in Public Administration and a minor in Economics. In September of 1966, he enrolled in a Master of Arts degree program in Government at George Washington University. He received his degree in August of 1968. While in the Master's program, the petitioner taught school in Prince George's County on a part-time basis. In December of 1967, the petitioner applied for a position at Federal City College (hereinafter referred to as FCC). It was a new school which was not to begin classes until September of 1968. He spoke with Dr. Irene Tinker Walker who was then the assistant provost for curriculum development. Since no teaching jobs were available, she referred the petitioner to the business manager. The petitioner was hired in February of 1968 and undertook administrative duties. On March 31, 1968, the petitioner applied for admission to the15 georgetown University Law Center in the Juris Doctor degree program. On his application, he listed himself as a substitute teacher and in a document attached to the 1356 application entitled "Some Plans And Why?", he made the following statement: * * * it seems that the means of affecting [sic] any degree of social progress is necessarily either directly or indirectly related to the law. Whether the social progress be civil rights, poverty, or a change in an unpopular national policy, the means by which this social change is eventually achieved can be categorized as either a positive or negative attempt to influence the law. Mass rallies, freedom marches, block voting, partisan politics, Congressional lobbying, and even lawless riots intend to influence a change in the law. After absorbing four years of rebellious, uncompromising undergraduate school, and two years of maturing graduate school, I am now prepared to work for change within the social system. Profoundly sure that social progress is possible, I intend to vigorously work towards affecting a small share of that progress. Education, politics, and the practice of law are my intended means of influence. The exact order16 and proportion each one of these will hold in my own social and self-progress, I do not know. However, whether my eventual concentration be education, politics, or law; the study, absorption, and understanding of the past, present, and future evolution of the law is a necessary prerequisite for my quest. In June of 1968, the petitioner had an interview with Dr. William L. Crump who had come to FCC that same month to develop a program for business and to recruit a faculty to execute the program. The petitioner told Dr. Crump he was completing his Master's in Business Administration and that he was interested in working in the Business program. Dr. Crump hired the petitioner to teach freshman courses in Business for September of 1968, in which month the petitioner also enrolled in the evening division of Georgetown University Law Center. He received instruction in Contracts, Torts, Procedure, and Criminal Law totalling 10 credits - the maximum amount allowable in evening school. In the fall of 1968, the petitioner taught five sections of Seminar in Business - three sections at night and two during the day. When Dr. Crump planned the winter quarter schedule, he assigned the petitioner17 to two sections during the day and two at night. The evening sections were to be conducted on Monday through Thursday beginning at 6:00 P.M. When he learned of the schedule, the petitioner told Dr. Crump he would not be able to teach the evening courses because they interfered with his studies. After the above conflict developed, the petitioner spoke with Valerie Simms in December of 1968. Miss Simms was an assistant professor of Political Science at that time as well as the "Convener" of the Political Science program. As such she was charged with the hiring of faculty in the social science program. Miss Simms ultimately hired the petitioner to assist in the Political Science program. She believed that since he was goint to law school the petitioner could help in planning the curriculum and in counseling students. While the record is devoid of any definitive evidence as to exactly when it began, FCC did develop a pre-law course in the Political Science division. Various courses were offered including Constitutional Law, Civil Rights and Civil Liberties, and Courts and Justice. For the winter quarter of 1970 - 1971, the petitioner taught The American Political System, which is a basic18 Political Science course, and Civil Rights and Civil Liberties, which comes under the heading of Law, Courts and Politics in the Political Science program. There is some evidence the petitioner taught similar courses as early as the fall of 1970. Opinion The question in issue is one that has often been presented to the Court; namely, whether a taxpayer's expenditures incurred in attending law school are deductible. Section 162(a) provides generally that, "There shall be allowed as a deduction all the ordinary and necessary expenses incurred during the taxable year in carrying on any trade or business." Section 262, which must be considered along with section 162(a), denies any deduction for "personal" expenses. Although the law itself does not specifically relate to educational expenses, the regulations deal directly with such expenses and, hence, take on added significance. Burke W. Bradley, Jr., 54 T.C. 216">54 T.C. 2161357 (1970). 2 These regulations 3 provide that educational expenses are deductible if they maintain or improve skills required by the individual in his employment or other trade or business or meet the express requirements of the employer for the taxpayer19 to retain his employment relationship, status, or rate of compensation. Sec. 1.162-5(a), Income Tax Regs. However, the above general rule applies only if the expenditures do not fall within specified nondeductible categories. The education must not be required of the taxpayer to meet the minimum educational requirements for qualification in his employment or other trade or business, Sec. 1.162-5(b)(2)(i), Income Tax Regs.; and they must not be "expenditures made by an individual for education which is part of a program of study being pursued by him which will lead to qualifying him in a new trade or business". Sec. 1.162-5(b) (3)(i), Income Tax Regs. Such expenditures are nondeductible "personal expenditures or constitute an inseparable aggregate of personal and capital expenditures". Sec. 1.162-5(b)(1), Income Tax Regs.20 In a well-ordered brief, the petitioner argues that his attendance at law school in 1968, (1) maintains or improves the skills required by him in his employment or other trade or business, (2) meets the express requirements of his employer to retain his employment relationship, status, or rate of compensation, (3) was not required by him to meet minimum education requirements, and (4) that his primary purpose in attending school was to maintain or improve his skills as a teacher and not to qualify him as a lawyer. He then argues that the 1967 regulations are invalid because they would deny the deduction where the education "will lead to qualifying him in a new trade or business". The petitioner submits that this objective test and the new regulations should be set aside and the old 1958 regulations containing the subjective "primary purpose" test should be reinstated. We believe that even if the 1967 regulation were invalid and we applied the 1958 regulation to the facts of this case, the petitioner would not be able to deduct the expenditures made for his education in 1968. Under the old regulations 4 the test is a subjective rather than an objective one in that a taxpayer's21 "primary purpose" in attending school must be to maintain or improve the skills required by the taxpayer in his employment or other trade or business. To determine the primary purpose of the taxpayer, we must consider all of the facts and surrounding circumstances. We have done so in the instant case and are compelled to hold that they do not convince us that the petitioner's primary purpose in attending law school was to maintain and improve his skills. First of all, the petitioner initially applied for admission to law school in April of 1968. At the time he was working for FCC but was not actually teaching any subjects. Consequently, it was difficult22 to know the exact nature of his "trade or business". Even more importantly, the statement made with his application indicates that he 1358 himself did not know whether his "eventual concentration" would be education, politics, or law. Therefore, we cannot conclude that when the petitioner enrolled in law school his primary purpose was to maintain or improve his skills. Sandt v. Commissioner, 303 F. 2d 111 (C.A. 3, 1962), affirming a Memorandum of this Court; N. Kent Baker, 51 T.C. 243">51 T.C. 243 (1968). Nor do the subsequent facts aid the petitioner. In June of 1968, he was hired in the Business program as a teacher and did not begin teaching until September. When a conflict arose between the business courses he was to teach in the evening during the winter term and his law school work - he stopped teaching in the Business program and secured a new post which did not conflict with his law school studies. This would indicate that at least in 1968 the petitioner did not consider his law school work primarily as a way of maintaining or improving his teaching skills. As to the point raised by the petitioner that the education "meets the express requirements of the23 individual's employer, imposed as a condition to the retention by the individual of an established employment relationship, status, or rate of compensation", we cannot conclude from the record that FCC required the petitioner to enter law school in 1968 for the above reasons. As we have noted, the petitioner shifted from one position to another in 1968 when he finally received a post with the Political Science Department in December. Prior to December of 1968, it is doubtful if anyone at FCC even knew the petitioner was attending law school much less required him to attend and certainly his initial employment as well as his retention by the Business Department was not predicated on his attending law school. Indeed, the differences he had with the head of the business course stemmed directly from the conflict between his attending law school at night and his teaching business courses in the evening. It may well be true, as some of the testimony indicates, that generally a teacher's contract may not be renewed if he does not "produce a book" or secure "an advanced degree". However, in the light of the facts of this case where the petitioner had only just begun to teach and obviously24 had not himself decided just what course he was going to ultimately pursue, we are not convinced that he attended Georgetown to meet the express requirements of his employer within the meaning of the applicable law and regulations. Additionally, we believe that in applying the 1967 regulations to the facts of this case, section 1.162-5(b)(3) need not be invoked in order to deny the deduction. The facts do not establish that the law courses taken by the petitioner actually maintained or improved his skills. As we have noted, the record shows that his job at FCC was his first full-time job at a school; that he did not begin teaching until September of 1968 in the Business program; that he quit that program in the latter part of 1968 and accepted a position in the Political Science Department. Nowhere in the record is there any evidence of any meaningful relation between what he taught at FCC and what he learned at Georgetown in 1968. The only connection is the remote and vague assumption that a background in law might aid any teacher generally. This does not satisfy the requirement that the education "maintain and improve" the skills required in an individual's employment or other25 trade or business as set down in the applicable law or regulations. We recognize that much of the petitioner's argument on brief is concerned with the invalidity of section 1.162-5(b)(3) of the regulations, which denies a deduction where the education expenses "will lead to qualifying him in a new trade or business". Those arguments are set forth clearly and effectively. However, we note that even if the validity of the regulations were the only issue involved, this Court has previously upheld them and found that where the education will lead to a new trade or business, the deduction will be denied. Ronald F. Weiszmann, 52 T.C. 1106">52 T.C. 1106 (1969), affirmed per curiam 443 F. 2d 29 (C.A. 9, 1971); Jeffry L. Weiler, 54 T.C. 398">54 T.C. 398 (1970); and David N. Bodley, 56 T.C. - (Sept. 23, 1971). Reviewed and adopted as the report of the Small Tax Case Division. To reflect the concessions of the parties, Decision will be entered under Rule 50. 1359 Footnotes1. All section references are to the Internal Revenue Code of 1954, unless otherwise noted.↩2. Since the tax year here in question is 1968, the current regulations issued in 1967 rather than the 1958 version are applicable, and petitioner is not entitled to the election accorded taxpayers for the years immediately prior to 1968. See, e.g., Burke W. Bradley, Jr., 54 T.C. 216">54 T.C. 216 (1970), and Ronald F. Weiszmann, 52 T.C. 1106">52 T.C. 1106↩ (1969), affirmed per curiam - F. 2d - (C.A. 9, 1971). 3. Income Tax Regs.: § 1.162-5 Expenses for education. (a) General Rule. Expenditures made by an individual for education * * * which are not expenditures of a type described in paragraph (b)(2) or (3) of this section are deductible as ordinary and necessary business expenses (even though the education may lead to a degree) if the education - (1) Maintains or improves skills required by the individual in his employment or other trade or business, * * * (b) Nondeductible educational expenditures - (1) In general. Educational expenditures described in subparagraphs (2) and (3) of this paragraph are personal expenditures or constitute an inseparable aggregate of personal and capital expenditures and, therefore, are not deductible as ordinary and necessary business expenses even though the education may maintain or improve skills required by the individual in his employment or other trade or busines * * * (3) Qualification for new trade or business. (i) The second category of nondeductible educational expenses within the scope of subparagraph (1) of this paragraph are expenditures made by an individual for education which is part of a program of study being pursued by him which will lead to qualifying him in a new trade or business. * * *↩4. Sec. 1.162-5 Expenses For Education. - (a) Expenditures made by a taxpayer for his education are deductible if they are for education (including research activities) undertaken primarily for the purpose of: (1) Maintaining or improving skills required by the taxpayer in his employment or other trade or business, or (2) Meeting the express requirements of a taxpayer's employer, or the requirements of applicable law or regulations, imposed as a condition to the retention by the taxpayer of his salary, status or employment.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624609/	KEYSTONE WOOD PRODUCTS CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Keystone Wood Products Co. v. CommissionerDocket No. 31420.United States Board of Tax Appeals19 B.T.A. 1116; 1930 BTA LEXIS 2260; May 26, 1930, Promulgated 2260 1. A valuation of the rights of one party to a bilateral contract based on promises to deliver and to receive and pay for raw material, which assumes the profit to be derived from the manufacturing business for the life of the contract based upon an estimate of the probable quantity of such raw material to be supplied, reduces such assumed profit to an average per unit of raw material, and attributes such profit to the supply contract, is unsound. 2. The opinions of witnesses as to the value of petitioner's rights in such a contract are not compelling evidence of such value when the method of reaching such opinions is fallacious. 3. Opinions as to value are not arbitrarily to be either rejected or accepted entirely but are reasonably to be weighed with all the other evidence in accordance with the demonstrated qualifications of each witness to form an opinion. 4. A contract providing for the supply of wood to which petitioner, a manufacturer of wood chemicals, became a party by assignment in September, 1912, held, on all the evidence, to have no premium value to eptitioner for invested capital or on March 1, 1913, for a basis for depreciation in 1918 and 1920. 2261 5. In determining invested capital under section 326, Revenue Act of 1918, a bilateral contract on promises, to which petitioner became a party by assignment from another corporation, not a stockholder, may not be included as paid-in surplus, notwithstanding partial identity of the stockholders of the two corporations. 6. Special assessment denied. John E. Hughes, Esq., and William Cogger, Esq., for the petitioner. James L. Backstrom, Esq., and P. A. Sebastian, Esq., for the respondent. STERNHAGEN 1117 The respondent determined deficiencies in income and profits taxes of $41,085.06 for 1918 and $12,639 for 1920. The petitioner claims that its invested capital should be increased by at least $800,000, alleged to be the value of a contract acquired by assignment shortly after organization in 1912, and that this figure should also be taken as the value of the contract on March 1, 1913, to support a depreciation deduction in the determination of net income of the years in question; that invested capital has been brought too low on account of taxes of 1917, and that its profits tax should be determined by special assessment under2262 sections 327 and 328. Petitioner, in brief, abandoned a claim that alleged capital items which had been charged off as expense should be restored to surplus and thus included in invested capital. The hearing was limited under Rule 62. FINDINGS OF FACT. The petitioner is a corporation of Pennsylvania with principal office at Olean, N.Y. It was organized in 1912 and is engaged in the manufacture of wood chemicals. In 1912 the Norwich Lumber Co., a Pennsylvania corporation, had rights in the timber, trees and wood suitable for the manufacture of chemicals on certain tracts of land in the counties of McKean, Cameron, and Elk, Pennsylvania. It was obligated to remove such timber, trees, and wood by 1922. It had previously arranged for the removal of wood other than chemical wood, and on June 21, 1912, it entered into a contract with the Lackawanna Chemical Co., a Pennsylvania corporation, whereby it agreed to cut all of the chemical wood on such lands and to deliver not less than 30,000 cords per year to the Lackawanna Co. at a factory to be built by the latter, at a price of $4.45 per cord, payable on the fifteenth day of the month following delivery. The contract provided, 2263 among other things, that the Lackawanna Co. should construct a chemical factory at or near Norwich, Pa., with a capacity sufficient to consume not less than 30,000 cords of chemical wood per year, and should be prepared to commence operations not later than April 1, 1913; that the contract should be assigned to a corporation to be formed under the laws of Pennsylvania with a capital stock fully paid in cash of not less than $250,000; that such corporation should not issue any bond or mortgage, or create any specific lien upon its property prior to the obligation imposed by the contract, without the consent of the Norwich Co.; that the Norwich Co. should not be liable for timber, trees, wood, or chemical wood which might be destroyed by forest fires, and, in the event of damage resulting from fire, it should not be bound to cut or deliver any wood in case the wood should be unsuitable for chemical wood, or in case the Norwich Co. after 1118 reasonable effort should be unable to contract for cutting, hauling, and loading at $3 per cord or less; and the obligation to deliver 30,000 cords per year should be reduced by the amount of wood which was eliminated from the contract by2264 the last mentioned provisions. The contract further provided that the Norwich Co. would drill for gas and if found the Lackawanna Co. would purchase such gas for fuel and lighting purposes at 10 cents per 1,000 cubic feet. At the time the contract was made, and on September 30, 1912, the Lackawanna Co. had outstanding 1,500 shares of capital stock, owned as follows: SharesT. H. Quinn500M. F. Quinn489M. M. Quinn20E. V. Quinn20E. H. Quinn20M. J. Collins1F. A. Sherman Estate450M. F. Quinn and T. H. Quinn were the principal officers of the Lackawanna Co. The contract of June 21, 1912, was consummated after negotiations extending over a period of six months. The Norwich Co. was a subsidiary of the Goodyear Lumber Co., and the owners of these companies had no interest whatever in either the Lackawanna Co. or the petitioner, nor were they associated in any way, in business affairs, with the Quinns and the Barclays. The contract was made by bargaining and was in arm's-length transaction. The petitioner was organized in 1912 with a capital stock of $250,000, which was paid in in cash, and the Lackawanna Co. assigned the contract to the2265 petitioner on September 30, 1912, with the consent of the Norwich Co. The officers of the petitioner at organization and during the taxable years were, W. L. Barclay, president; T. H. Quinn, vice president; M. F. Quinn, secretary and treasurer. The petitioner's capital stock at the time of organization was owned in equal proportions by the Quinn and the Barclay families. The petitioner commenced construction of a chemical factory at Betula, Pa., in 1912, and completed it in March, 1913. The factory had a capacity of 100 cords per day. A plant of this type is of very little value after being in use 10 or 12 years. Quinn and his associates had had a survey made of the lands described in the contract some time about 1907. The first delivery was made on October 8, 1912, and the last was made on October 31, 1922. The quantities delivered in each year during that period are as follows: YearCords19126,560191340,783191447,914191543,381191622,827191723,048191830,946191934,157192024,285192169,595192248,0091119 The number of cords of wood consumed by the petitioner, the net profit from operations, and the profit2266 per cord realized in each of the years 1913 to 1922, inclusive, were as follows: YearNumber or cordsNet profitProfit per cord191323,072$37,988.77$1.65191428,10016,294.92.58191540,850150,458.713.68191642,280350,536.498.29191739,409396,818.7910.07191836,387$208,601.58$5.7319198,750137,810.3315.75192025,980211,846.728.15192137,97634,869.11.92192241,218198,398.354.81There was no material change in the price of timber in this section between June 21, 1912, and March 1, 1913. The petitioner did not set up on its books any value for the contract of June 21, 1912, nor did it show any value therefor in the balance sheets attached to its capital-stock-tax returns for 1917, 1918, and 1919, and its income and profits-tax return for 1920. M. F. Quinn was an officer of and interested in numerous other companies during 1917, 1918, and 1920. He performed all the duties of secretary and treasurer for the petitioner, supervised the bookkeeping, and devoted the principal part of his time to its business. He was paid an annual salary of $2,000. He depended upon dividends for his compensation. 2267 No salaries were paid to the other officers. T. H. Quinn is the vice president of the petitioner and has held that office since organization. He was experienced in the wood chemical business and in 1917 and 1918 spent about two days a week at the plant. He was also interested in two other chemical companies at that time and spent part of his time visiting their plants and looking after their affairs. He received no salary for his services in 1917 and 1918. During 1912, 1913, and 1914 the petitioner did not pay any salaries to its officers. In 1915 the petitioner constructed an addition to its plant which increased the capacity from 100 to 140 cords. The masonry and foundation, representing about half of the cost, were let out on contract and the remainder of the plant was constructed by the petitioner. The construction took about eight months and twenty-five or thirty men were employed who devoted their entire time to the work. The original plant was operated at full capacity during that period and the construction of the addition was supervised by petitioner's general superintendent. He received no other salary than his regular salary of $150 per month. Barclay, 2268 at the time, was managing the plant of the Barclay Chemical Co., and visited the plant three or four times during construction. T. H. Quinn assisted in supervision 1120 and remained at the plant throughout the period, devoting his entire time to the business of the petitioner. M. F. Quinn participated in the planning of, and inspected, the work and contracted for the masonry and materials. He also managed the business and looked after the bookkeeping. He received only his regular salary. The amount of time devoted by the officers and superintendent to the new addition can not be accurately determined and no capital charge was made therefor. The petitioner had no cost-plus contracts. For the year 1917 the respondent determined the income and profits-tax liability of the petitioner to be $218,537.74, and based the deduction from invested capital for 1918 and 1920 on said tax. The pro rata portion of such tax deducted from invested capital for 1918 was $119,746.70. The income, invested capital, and profits tax of the petitioner and the per cent of its profits tax to net income, less $3,000, as determined by the respondent for 1918, are as follows: Net income (less $3,000)$265,018.15Profits tax166,331.50Invested capital291,907.77Ratio of profits tax to net income62.8%2269 OPINION. STERNHAGEN: The first question for decision is whether as a matter of law and by virtue of the facts in evidence the petitioner is entitled to include in its statutory invested capital as defined in sections 325 and 326, Revenue Act of 1918, any amount as the value of its rights as assignee of the contract of June 21, 1912. Two witnesses testified for petitioner that in their opinion the contract was at the time of assignment and on March 1, 1913, worth $800,000, and another testified to his opinion of a value of $1,300,000. There are, however, facts in evidence which we think seriously impair the weight of these opinions. The contract was made in June, 1912, by parties who on both sides were acting with full knowledge of the then known facts and were both apparently intelligently aware of the possibilities. After six months of negotiation they agreed upon terms as to price and other obligations, both having in contemplation the organization of petitioner, the construction of a plant, the precise use and purpose of the wood supply and the risks and hopes of the enterprise. Nothing occurred prior to March 1, 1913, which was not contemplated on June 21, 1912, to2270 change the relative advantages of the parties under the contract or to justify the belief that the net rights of the Lackawanna Co. could be sold to a willing and intelligent buyer for a 1121 premium. It it could have been so sold or were fairly worth a substantial premium above the assumption of its contractual obligations, it may be questioned why the Lackawanna Co., acting for its stockholders, sone of whom had no interest in the Keystone Co., assigned the contract without realizing upon this asserted increment in the value of its rights. The valuation asserted by the petitioner's witnesses is arrived at by attributing to the contract as assumed assurance of future profit of $3 or $4 to be derived from the manufacture and sale of each cord of wood supplied out of an assumed source of supply of 400,000 cords. It does not require expert intelligence or special experience in the manufacture of wood chemicals to perceive the fallacy of such valuation, even accepting it as fact that such assumed profits could be quite definitely foreseen. By such reasoning, the allocation of profits is confined to give value solely to the contract providing for the supply of one class of2271 raw material. No part of the profit is allocated to plant or other investment, to say nothing of other supplies or expenditures. Thus a steel business might attribute its profits as it chose to give value to contracts for ore, coke or limestone, or a motor manufacturer to any one of the numerous supply contracts it might have. This would be clearly unsound. Granted that the reasonably certain prospect of future earnings might in a proper case be translated into a present worth, and assuming that such worth may be treated as a present asset, like, say, good will or going-concern value, there is no authority in precedent and we think none in reason for carrying the process beyond its effect on the business as a whole and into an allocated valuation of each contract or other factor used in producing the expected estimated gains. . The opinion of the court in , does not compel a recognition of such a valuation merely because it is offered and because no countervailing witnesses have been brought forth to testify to the manifest unsoundness2272 of its method. Opinions are at best a weak form of evidence, although in some esoteric matters they may constitute the only method of proof. Their weight can not be the equal of fact, and, unlike factual evidence, they involve the play of reason and can not be blindly adopted as truth. Valuation is notably a matter of opinion and the force of the opinion is derived from the care and ability used in forming it. Historical experience alone lends no necessary authority to an opinion; but only when coupled with mental ability to give it significance, and in matters of valuation, to appreciate the nature of the problem. Thus opinions as to value are in each instance not arbitrarily to be either rejected or accepted entirely, but are reasonably to be weighed with all the other evidence in accordance with the demonstrated qualifications 1122 of each witness to form an opinion. ; ; ; 2273 . Nor can we accept the factors used in arriving at this valuation. To say that in 1912 and 1913 the profit would be at least $3 a cord was a speculation not supported by the then existing facts, for this plant had had no past experience and for the immediate future the profit per cord in 1913 was $1.65 and in 1914, 58 cents. Furthermore, the contract itself discloses a serious apprehension of a substantial risk, and it must be assumed that this was a factor embodied in its terms. We are of opinion that the evidence taken altogether does not justify a finding that the petitioner's contract rights were when acquired in September, 1912, of a value above the obligations which petitioner assumed. Hence, there is nothing, as a matter of fact, which has been omitted from invested capital. Since the evidence shows and the petitioner agrees that the value on March 1, 1913, was no greater than when acquired in September, 1912, it follows that there is no value on the later date to be used as a basis for a depreciation deduction in 1918 and 1920. Furthermore, there appears to be no support as a matter of law for including2274 the contract rights in invested capital, even if they be treated as tangible property under the statute. They were not, and it is not contended that they were, paid in for stock or shares. The shares were issued at par for $250,000 cash paid in by the Quinn and Barclay families. The contract was at that time between the Norwich Co. and the Lackawanna Co., whose shares were owned by the Quinns and the Shermans and not at all by the Barclays. The separate identity of the petitioner from that of the Lackawanna Co. was expressly provided for and can not be ignored. Indeed, if it were to be ignored and the two treated as the same, all semblance of claim to include the contract in invested capital would disappear; because it is only by positing the transfer from one to the other after a value has sprung up that invested capital can be claimed to be affected. The mere existence of a bilateral contract upon promises would not ordinarily affect invested capital. It is therefore claimed that the value of the contract rights above the burden of its obligations would be a paid-in surplus and therefore within statutory invested capital under section 326(a)(3). But the contract was not an2275 asset paid in by stockholders over and above the par value of their stock. The petitioner became a party to it by a valid assignment from another corporation which was not a stockholder, thus acquiring both the rights and obligations of the assignor. This is not paid-in surplus in the ordinary sense and we see no reason to suppose that it was 1123 within the term as used in the statute. . It is unlikely that Congress intended an evaluation of the rights and obligations of each taxpayer under its contracts so acquired, in order to determine surplus. See . The contract represented no investment either of the petitioner or its stockholders, and nothing which reasonably should be used in determining whether the ratio of its profits was greater or less than the standard prescribed by the statute to measure the profits tax. See . In our opinion, therefore, the contract may not be included in invested capital and the respondent's determination excluding it is sustained. The petitioner's next contention2276 is that its 1917 taxes have been overstated in computing invested capital for 1918 and 1920. Although though 1917 taxes are not directly in issue here, petitioner says that in order to determine invested capital for 1918 and 1920 it is necessary to determine the correct tax for 1917, and that such 1917 tax has not been correctly determined because in computing taxable net income for 1917 no deduction was allowed for exhaustion of the aforesaid wood supply contract of 1912 based upon its value on March 1, 1913. Whatever may be the merits of the theory generally that tax liabilities for years otherwise not before us for definitive determination are nevertheless in all respects open for consideration because of their effect upon invested capital in later years, the tax for which is under adjudication, we need not pass upon such theory here, because we have held that in fact the petitioner's contract rights had on March 1, 1913, no fair market value. Hence, as in 1918 and 1920, there was no basis for exhaustion thereof in 1917 and no necessary change in income or the resulting tax. Upon this point respondent's determination is sustained. The petitioner's last claim is that the facts*2277 shown by the evidence, which are in substance stated in the foregoing findings, establish such an abnormal condition of capital or income as under section 327(d) to entitle petitioner to special assessment under section 328, the amount of which is to be later determined under Rule 62. We are of opinion that the conditions are not within the special assessment sections. We can not say that the amount of the salaries paid, the prewar earnings, the exclusion of the contract from invested capital or its approaching end through complete performance, the relative amount of its income in the taxable years, or the method of accounting for the 1915 addition to its plant, taken separately or together, are abnormal conditions resulting in exceptional hardship. The respondent's denial of special assessment is sustained. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624611/	H. Lewis Brown, Petitioner, v. Commissioner of Internal Revenue, RespondentBrown v. CommissionerDocket No. 107266United States Tax Court1 T.C. 760; 1943 U.S. Tax Ct. LEXIS 209; March 16, 1943, Promulgated 209 Decision will be entered under Rule 50. Where petitioner, as a surviving partner, during the taxable year 1937 received a single check in payment of an attorney's fee for services rendered partly by a partnership which terminated in 1929 by the death of his copartner and partly by himself individually in years subsequent to the dissolution of the partnership, and during the taxable year petitioner paid the amount he determined as owing to the estate of his deceased partner and deposited the balance in his own business banking account, and during the taxable year the executor of the estate of the deceased partner orally informed petitioner that the estate would make a claim for more of the fee but did not state the amount of the claim until March of the following year, and in April of that year the parties agreed upon a division of the fee and the amount agreed upon as being the share of the deceased partner was paid over to the executor of his estate after taking into account the amount already paid in 1937, held:(1) Retroactive effect will be given to this agreement in determining petitioner's income tax liability for 1937. Lillie C. Pomeroy et al., Executors, 24 B. T. A. 488,210 affd., 68 Fed. (2d) 411, followed.(2) A part of the payment to the estate represented a capital expenditure by petitioner for the good will of the deceased partner in the practice and was income to petitioner. City Bank Farmers Trust Co., Executor, 29 B. T. A. 190, followed. Floyd F. Toomey, Esq., for the petitioner.James C. Maddox, Esq., for the respondent. Black, Judge. BLACK 761 The respondent determined an income tax deficiency of $ 25,774.81 against petitioner for the calendar year 1937. Instead of the deficiency petitioner claims a refund of $ 43,791.48.In the statement attached to the deficiency notice the respondent made two adjustments to petitioner's net income as disclosed by his 1937 income tax return. Adjustment (a) was labeled "Increase in income from former partnership $ 39,602.80" and was explained as follows:(a) The entire contingent fee of $ 228,068.44, less $ 6,816.15, the amount ultimately paid to the Estate of Ambrose H. Burroughs (Deceased) under a former partnership agreement for the period prior to his death, is held to constitute income to you for 1937 under section 22 (a) of211 the Revenue Act of 1936.Petitioner by appropriate assignments of error contests this adjustment and alleges that, instead of the determined increase in petitioner's net income, the respondent erred "in failing to reduce the net income reported in the petitioner's return for 1937 by the sum of $ 67,981.97 erroneously included by petitioner in his income tax return for 1937 on account of the said legal fee" and that in any event the respondent "in his attempted allocation of the sum of $ 14,995.50 that was paid by the petitioner in his trust capacity as surviving partner to the estate of his deceased partner on account of said legal fee, erred in assigning only 5/11 thereof or $ 6,816.15 to the period of joint interest prior to the death of the deceased partner and as much as 6/11 or $ 8,179.35 to the period of six months immediately after death."Adjustment (b) was a decrease in income of $ 550 and is not contested.FINDINGS OF FACT.Petitioner is a citizen of the State of New York and resides at 765 Fifth Avenue, New York City. He filed his Federal income tax return for the calendar year 1937 with the collector of internal revenue for the third district of New York.Petitioner kept212 his books of account and made his return on the basis of cash receipts and disbursements.Petitioner is a lawyer. On July 2, 1923, he and Ambrose H. Burroughs became associated as partners in the practice of law in New 762 York City under the firm name of Burroughs & Brown. Under that agreement the partners agreed to share equally in the income and expenses of the firm. The agreement provided in part as follows:VII. The death of either of the parties hereto at any time after the date of this agreement shall not effect a dissolution of the partnership, which shall on the contrary be continued for six months thereafter; and the estate of such deceased partner, for such period of six months, and as payment for the good will of the deceased partner in the practice, shall share in the income and expenses of the firm to the same extent that he would have done if he had lived.VIII. In case of the dissolution of the firm by the death of one of the partners, the survivor may continue the practice alone or in conjunction with others under the firm name of Burroughs & Brown, or under some other firm name in which that of the deceased partner may be a part, without paying anything 213 therefor to the estate of the deceased partner.On May 9, 1927, the original agreement of July 2, 1923, was amended in certain particulars not here material. It was further supplemented on March 19, 1929, by adding the following:As to work being done by the firm at the time of dissolution, whether pursuant to notice or six months after the death of one of the partners as provided in the contract, the fees and compensation for such work when and as collected shall be apportioned as follows: (1) to the firm such part thereof as will fairly represent the value of the service rendered during the existence of the firm, having in view the amount and character of such service as compared with the entire service; and (2) the rest to the partner completing the service after dissolution, or if both partners participate in the work after dissolution, then to each of them in proportion to the fair value of the service rendered by them respectively. This method of division shall be applicable whether the compensation be on a contingent basis or otherwise.Burroughs is the individual whose estate was involved in the case of City Bank Farmers Trust Co., Executor, 29 B. T. A. 190.214 At the time of the formation of the partnership of Burroughs & Brown, the members were representing the plaintiff in a patent infringement suit pending in the United States District Court for the District of New Jersey. A decision of the District Court rendered on August 14, 1925, in favor of the defendant in that suit was reversed by the Circuit Court of Appeals for the Third Circuit on March 1, 1927. 1 Under that decision the Southern Electro-Chemical Co., the client of Burroughs & Brown, became entitled to an accounting for profits and damages growing out of the patent infringement. During the period 1925 to 1929 the firm of Burroughs & Brown received a retainer from the Southern Electro-Chemical Co., principally for services in the litigation and in supervising and giving advice regarding the company's general affairs.215 On January 25, 1929, the firm of Burroughs & Brown entered into a fee agreement under which the firm became entitled to a contingent 763 interest in the ultimate recovery from the litigation. This agreement was with the Alper Chemical Corporation, whose interest in the matter arose from an agreement between it and the Southern Electro-Chemical Co. with respect to the conduct of the litigation. The agreement is in the form of a letter addressed to the Alper Chemical Corporation by the firm of Burroughs & Brown, the body of which is as follows:This confirms the arrangement arrived at in the course of the conference between Mr. Allen, Mr. Perkins and the writer at your offices yesterday with reference to the accounting now about to commence in the case of Southern Electro-Chemical Company vs. du Pont, namely:We will take active charge of the accounting and conduct the same and as occasion arises in this connection will seek the advice and guidance of Mr. Gifford and his firm. You will continue to pay us monthly at the rate of $ 10,000.00 per year, and in addition to that we will be entitled to the following percentages on any amount that the defendant may pay on account of216 the infringement involved, namely:(a) On such amount as will represent all expenses of the litigation, including what has already been charged on the books of the Southern Electro-Chemical Company and/or Alper Chemical Corporation, as well as expenses of the litigation that may arise or accrue hereafter, including bills for services that may hereafter be or already have been rendered, but bills for which have not been submitted, or if submitted, have not been paid, -- our firm will receive nothing;(b) On the next $ 500,000 ten per-cent to our firm;(c) On all amounts over the amounts specified in (a) and (b) above, twenty per-cent to our firm.You will pay all the expenses of the accounting, including fees of associate counsel, experts, stenographers' bills, and the like.Notwithstanding this arrangement you will have authority at any time to discontinue the accounting, or to make any compromise thereof that to you may seem best.If this accords with your understanding, will you kindly sign the memorandum at the foot, and return one part to us.Burroughs died June 19, 1929. At all times material herein the City Bank Farmers Trust Co. was the executor of his estate. Since the death217 of his partner, with the exception of an eight-month period not here material, the petitioner has continued the practice of law as sole proprietor under the firm name of Burroughs & Brown.Petitioner as surviving partner continued the accounting in the patent infringement litigation until September 21, 1937, when a final settlement was reached. The compensation (sometimes referred to as the Alper Chemical Corporation fee) owing under the terms of the contingent fee agreement of January 25, 1929, amounted to $ 228,068.44. On October 22, 1937, the Southern Electro-Chemical Co. delivered to petitioner its check for that amount payable to the order of Burroughs & Brown. Under the partnership agreement the Burroughs estate thereupon became entitled to participation in some part of one-half of that fee, depending upon an allocation thereof between the period of joint interest and the period thereafter.764 Upon receipt of the check for $ 228,068.44, petitioner deposited the same in an account with the Chase National Bank which he maintained under the name of Burroughs & Brown and used exclusively for the law office that he was conducting as an individual under that style. Moneys218 received by him which belonged to others were also deposited in that account. Generally the monthly balance therein was never more than $ 5,000. In addition to the petitioner, his wife and Clyde D. Sandgren, an employee, each had authority to draw against that account. From October 22, 1937, until December 31, 1937, the lowest balance in the Burroughs & Brown account was $ 117,930.41. Petitioner maintained such a high balance during that period because he and the executor of the Burroughs estate had not yet agreed upon the estate's share of the Alper Chemical Corporation fee.On October 28, 1937, petitioner forwarded to the executor of the Burroughs estate a check drawn on his Burroughs & Brown account in the sum of $ 7,982.40. The check was accompanied by a letter in which petitioner set forth his views concerning a division of the fee, which letter is in part as follows:The arbitration with reference to the fee of Burroughs & Brown under their contract of January 25, 1929, with Alper Chemical Corporation has been decided in favor of this office and distribution made accordingly.I have been over the record rather carefully and, after taking all the elements into consideration, 219 have reached the conclusion that the estate of Mr. Burroughs is fairly entitled to about 3 1/2% of the fee, and I am enclosing herewith a check made out on that basis, as per computation enclosed. * * I should like very much for you to have someone from the Trust Company come up to my office, by appointment, and go over the correspondence files and such other records as we have in the office bearing on the subject so that you may have a report from someone in your own organization which would be a basis for you to check the reasonableness of my conclusions.While the present check is sent as representing my idea of a fair division, it is not intended in any manner to bind the Trust Company because I recognize that you are not at this time in possession of sufficient information to form a judgment as to the correctness of my own conclusions, and I am very anxious indeed both that you should have this opportunity and that when the whole ground has been covered the ultimate figure will be one that is entirely acceptable to you, and more particularly the beneficiaries, as I am sure it will be to me, whatever that figure may turn out to be.At the time of the receipt of petitioner's220 check for $ 7,982.40 and his letter of October 28, 1937, the executor had assumed that the estate's share would be very much greater and felt that the beneficiaries of the Burroughs estate would expect a larger division. The beneficiaries were widely scattered. The executor called in its own counsel for assistance. The check tendered by petitioner was received and cashed without prejudice.From the outset of negotiations between petitioner and the representatives of the executor a real dispute existed between them with 765 respect to the period of joint interest. The petitioner contended that the period of joint interest in the fee covered only the eleven-month period from January 25, 1929, the date of the contingent fee agreement, to December 19, 1929, the end of the six-month period following the death of Burroughs. The executor contended that the fee represented compensation for the whole period of the infringement litigation and that, therefore, the period of joint interest extended from the inception of the litigation in 1920 until December 19, 1929, or a period of approximately ten years.By letter dated March 10, 1938, the executor claimed that the Burroughs estate221 was entitled to the total sum of $ 46,052.25 on account of the Alper Chemical Corporation fee. That was the first statement made by the executor in writing concerning the amount of its claim, and it confirmed the figure that had been communicated to the petitioner orally only a few days before. The difference between the total amount thus claimed by the estate ($ 46,052.25) and the amount previously paid to the estate on October 28, 1937, ($ 7,982.40), or $ 38,069.85, was withdrawn from the joint bank account of petitioner and his wife on March 14, 1938, and deposited with the National City Bank of New York in a joint account between the petitioner and the executor to await a final division after agreement of the parties. The signatures of both parties were required in order to draw against that account.Thereafter on April 27, 1938, petitioner and the executor agreed in writing that the Burroughs estate was entitled to the total sum of $ 14,995.50 on account of the Alper Chemical Corporation fee. In accordance with that agreement, the $ 38,069.85 fund on deposit in the joint account with the National City Bank of New York was thereupon divided, $ 7,013.10 ($ 14,995.50 minus the222 above amount of $ 7,982.40) to the executor, and the remaining $ 31,056.75 to the petitioner.In fixing the estate's total participation in the Alper Chemical Corporation fee at $ 14,995.50, the parties in their agreement of April 27, 1938, agreed that the period of joint interest extended from October 15, 1925, to December 19, 1929, or a period of approximately fifty months.In his allocation of the $ 14,995.50 payment between the period of joint interest prior to the death of Burroughs and the six-month period of joint interest after his death, the respondent treated the total period of joint interest as extending from January 25, 1929, to December 19, 1929, or a period of approximately eleven months. On a time basis he determined that five-elevenths, or $ 6,816.15 thereof, was applicable to services rendered prior to the death of Burroughs, and six-elevenths, or $ 8,179.35 thereof, was applicable to services rendered during the period of six months immediately after his death.In his Federal income tax return for the calendar year 1937 petitioner 766 included as income on account of the Alper Chemical Corporation fee the sum of $ 182,016.19, being the full amount of the 223 fee, $ 228,068.44, less the sum of $ 46,052.25, the amount first claimed on March 10, 1938, by the Burroughs estate as its share of the fee.The respondent determined that there should be included in petitioner's income for the calendar year 1937, on account of the Alper Chemical Corporation fee, the sum of $ 221,252.29, being the entire amount of said fee of $ 228,068.44 less the sum of $ 6,816.15 ultimately paid to the estate under the partnership agreement and allocated by him to the period of joint interest prior to Burroughs' death. 2On his Federal income tax return for 1937 which was filed on March 15, 224 1938, petitioner computed a tax liability of $ 101,921.32 which he paid in four installments as follows:Mar.15, 1938 $ 25,480.13June15, 1938 25,480.13Sept.20, 1938 25,480.13Dec.13, 1938 25,480.93On February 26, 1940, within three years after the payment of his taxes for 1937, petitioner filed with the collector for the third district of New York a claim for the refund of $ 43,450.48 (amount now claimed is $ 43,791.48) of the income taxes paid by him for that year. That claim is based upon the ground that in 1937 petitioner was taxable on only one-half of the total fee to which he was unqualifiedly entitled in that year; that he held the other half as trustee pending an agreement as to its allocation; and that since an agreement was not reached until 1938 his share of the remaining half is not taxable until that year.OPINION.The question in this proceeding is to determine how much of the $ 228,068.44 fee paid in 1937 to petitioner by the Alper Chemical Corporation is taxable to petitioner in that year. Petitioner in his return for that year reported $ 182,016.19 as taxable. This amount represented the difference between the full amount of the fee and $ 225 46,052.25 claimed by the Burroughs estate in the letter of its executor dated March 10, 1938, just five days before petitioner filed his return for 1937. Although the respondent has added $ 39,602.80 to the amount reported by petitioner in his return, we understand from 767 his brief that he does not now contend that any more than $ 221,252.29 of the entire fee is taxable to petitioner in the taxable year 1937. He arrives at this amount in the following manner. First, he treats the total period of joint interest in the fee as extending from the date of the agreement with Alper Chemical Corporation to six months after the death of Burroughs or from January 25, 1929, to December 19, 1929, a period of approximately eleven months. He then allocates five-elevenths of the $ 14,995.50 actually paid to the Burroughs estate, or $ 6,816.15, to the period of joint interest prior to Burroughs' death and six-elevenths thereof, or $ 8,179.35, to the period of joint interest after Burroughs' death. This latter amount the respondent determined was a payment by petitioner "for the good will of the deceased partner in the practice" and was income to petitioner upon the authority of City Bank Farmers Trust Co., Executor, supra.226 In other words, the respondent determined and contends that the entire fee, less the $ 6,816.15 he allocated to the period of joint interest prior to Burroughs' death, or $ 221,252.29, is taxable income to petitioner in 1937.Petitioner primarily contends that he erred in reporting $ 182,016.19 of the fee as taxable income in his 1937 return; that he should have reported only one-half of the fee or $ 114,034.22 as taxable income in 1937; that he held the other one-half of the fee in trust for himself and the estate of his deceased partner until the ownership thereof could be determined which determination did not occur until 1938. Petitioner in making this contention relies principally upon Sara R. Preston, 35 B. T. A. 312, and E. P. Madigan, 43 B. T. A. 549. The latter case, says petitioner, "is squarely in point, even as to all of the material facts." We think both cases are distinguishable upon their facts.In the Preston case, two lawyers received a check payable jointly to them. They could not agree as to the amount to which each was entitled; so the check was deposited in a bank to the joint account of both, 227 and there was drawn from the joint account during the taxable year such amount as each conceded the other entitled to, the balance to be drawn only upon final settlement of the differences between them. We held in that case that each attorney in the taxable year was taxable only on the amount withdrawn from the joint account for his respective use and that the balance was not taxable until there was a final settlement. There neither could draw on the joint account without the consent of the other. That situation is not present in the instant proceeding. All the money received by petitioner in the collection of the fee in 1937 was entirely under his control except the $ 7,982.40 which he paid to the Burroughs estate in October 1937.In the Madigan case, petitioner was the coach and athletic director of St. Mary's College. His compensation was $ 7,000 a year plus 10 768 percent of St. Mary's share of the football receipts. He reported his income on the cash basis. His share of the receipts of 1934 and 1935 amounted to $ 21,690.62, but prior to November 1936 he had not been paid. In November 1936 St. Mary's received a check for $ 38,324.15, as the result of a game played228 with Fordham University, which the president of St. Mary's endorsed to petitioner "with the stated understanding that petitioner was to take the $ 21,690.62 due him for 1934 and 1935 and was to hold the balance in trust until the accounting could be completed for the 1936 season." In March 1937 the accounting was completed and Madigan was permitted to keep all except $ 1,339.71, which he turned over to St. Mary's. The Commissioner determined that Madigan must return as income in 1936 the entire check for $ 38,324.15. We held Madigan taxable on only $ 21,690.62 and that the Commissioner was in error in adding any additional amount of the Fordham check. This case is clearly distinguishable from the instant proceeding. There the petitioner was to hold $ 16,633.53 "in trust until the accounting could be completed for the 1936 season." In the instant proceeding petitioner deposited the check which he received for the fee in question in the bank account which he used for his law business. He wrote a letter to the executor of the Burroughs estate in which he enclosed his check for $ 7,982.40 and gave it as his judgment that this amount represented the division of the fee to which the229 Burroughs estate was entitled and that he was entitled to keep the balance. In this connection petitioner stated in his letter of October 28, 1937, to the Burroughs estate, as follows:I have been over the record rather carefully and, after taking all the elements into consideration, have reached the conclusion that the estate of Mr. Burroughs is fairly entitled to about 3 1/2% of the fee, and I am enclosing herewith a check made out on that basis, as per computation enclosed.In the face of these circumstances it seems altogether unreasonable for petitioner to contend that under the doctrine of the Preston case and the Madigan case, both supra, that petitioner is taxable on only one-half of the fee in 1937 and that his part of the balance of the fee should be deferred for taxation until 1938. Moreover, the facts which are in evidence, oral and documentary, show that the bulk of the fee belonged to petitioner. It is perfectly clear that the greater part of the work for which the fee was paid was done after Burroughs' death. Just how much of the fee the Burroughs estate was entitled to receive was not easy to determine, but by no stretch of the imagination, we think, 230 could anyone contend that the Burroughs estate was entitled to one-half of the fee. The legal representatives of the Burroughs estate made no such contention at any time. Therefore, it is clear that petitioner's contention that he is taxable on only one-half of the fee in 1937 under the doctrine of the Preston case and Madigan case can not be sustained.769 If petitioner's contention in this respect is to be denied, then what is the amount of the fee upon which petitioner is taxable in 1937? We think there is some plausibility for the argument that he is taxable on all of it, except the $ 7,982.40 check which he sent to the executor of the Burroughs estate October 28, 1937. The balance of the fee was either transferred to the joint account of petitioner and his wife or left in petitioner's law firm account of which he was the sole proprietor and upon which he could check at will.Respondent contends that under North American Oil Consolidated v. Burnet, 286 U.S. 417">286 U.S. 417, petitioner was taxable on the entire amount except $ 6,816.15, the amount ultimately paid to the estate of Burroughs under the partnership agreement for the period prior231 to Burroughs' death. While, as above stated, we think there is some plausibility in this contention of respondent, nevertheless, there are important elements of distinction in the facts of the instant case and those present in the North American Oil Consolidated case, supra. In the latter case, as the Supreme Court pointed out in its opinion, the taxpayer had received the earnings in question under a claim of right, and in the taxable year was unrestricted in the disposition of such earnings. Under such circumstances the Supreme Court held that North American Oil Consolidated was taxable on the income so received, "even though it may be claimed that the taxpayer is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent." The instant case is different from the North American Oil Consolidated case, we think, in this important respect. Petitioner's claim to at least some indefinite part of the amount retained after sending the executor of the estate the check for $ 7,982.40 was a qualified claim of right, for in his letter transmitting the check, petitioner, among other things, wrote:While the present check232 is sent as representing my idea of a fair division, it is not intended in any manner to bind the Trust Company because I recognize that you are not at this time in possession of sufficient information to form a judgment as to the correctness of my own conclusions, and I am very anxious indeed both that you should have this opportunity and that when the whole ground has been covered the ultimate figure will be one that is entirely acceptable to you, and more particularly the beneficiaries, as I am sure it will be to me, whatever that figure may turn out to be.We have before us evidence as to what the division of the fee turned out to be. On April 27, 1938, an agreement was reached between petitioner and the legal representatives of the Burroughs estate under which the Burroughs estate's share of the fee was fixed at $ 14,995.50, and the remainder of the fee, it was agreed, belonged to petitioner. Now that we have that information at hand it would seem proper to use it in determining petitioner's income tax liability for 1937 rather than to make some kind of a theoretical allocation of the fee between the parties when it was received in 1937, for, as we have already said, 770 233 it was clear that petitioner was entitled to much more than one-half of the fee. We, of course, are well aware that the general principles of Federal income taxation require the determination of income at the close of taxable years without regard to the effect of subsequent events. Burnet v. Sanford & Brooks Co., 282 U.S. 359">282 U.S. 359; Penn v. Robertson, 115 Fed. (2d) 167. But there are exceptions. Cf. E. B. Elliott Co., 45 B. T. A. 82.There is precedent, we think, in the type of case we have here for using the actual figures agreed upon by the parties early in 1938 rather than to make some kind of theoretical allocation at the end of 1937. See Lillie C. Pomeroy et al., Executors, 24 B. T. A. 488; affd., 68 Fed. (2d) 411. In the Pomeroy case the taxable years which we had before us were the years 1922 and 1923. A small deficiency for 1924 was conceded. The sole issue was as to the correct allocation between Pomeroy and the estate of Josiah Dives of the net profits derived from the operation of a business conducted under the234 name of Dives, Pomeroy and Stewart for the periods September 21 to December 31, 1992, and January 1 to June 30, 1923. There were two partners, Dives and Pomeroy. Dives died September 21, 1922. The income from the business previously conducted as a partnership was as follows:Sept. 20 to Dec. 31, 1922$ 361,447.54Jan. 1 to June 30, 1923191,223.93Total 552,671.47On April 23, 1923, the executors of the Dives estate and Pomeroy agreed that $ 176,250 was to be paid to the Dives estate "in full settlement of any claim * * * for profits accrued to the partnership business from the date of the death of said Josiah Dives." The Board held that the amount of the earnings to be taxed to Pomeroy should be determined as follows:19221923Earnings of entire business$ 361,447.54$ 191,223.93Less 361,447.54/552,671.47 of 176,250115,267.63Less 191,223.93/552,671.47 of 176,25060,982.37Amount taxable to Pomeroy246,179.91130,241.56In affirming the Board the Court of Appeals of the District of Columbia said in part:While the agreement (of April, 1923) was made later than at the close of the first accounting period, it was made before the close235 of the second period, "when", as stated in petitioners' reply brief, "it could not be known whether there would be profits or not." This may have been the reason why the heirs were willing to accept 6 per cent, interest instead of sharing prospective profits. At all events, the good faith of the parties in entering into the contract is not impugned in any way. As it turned out, Pomeroy (who died September 13, 1925) made a good bargain. His estate should pay taxes on what he actually received.771 While in the instant case we do not have both the years 1937 and 1938 before us, as we had both the years 1922 and 1923 before us in the Pomeroy case, nevertheless, it is true that in the Pomeroy case retroactive application of an agreement made by the parties in 1923 was made in determining the taxpayers' income tax liability for the year 1922. In that important respect the two cases are similar.Since we now know what the facts are as to the division of the fee in question and since petitioner received all the money in 1937 and only disbursed $ 7,982.40 of it to the Burroughs estate, we shall tax petitioner in 1937 on the basis of the known facts as shown by agreement236 reached in the early part of 1938, under the doctrine of the Pomeroy case, supra. Cf. E. B. Elliott Co., supra.Having thus held, it becomes necessary to consider petitioner's alternative contention. In the alternative, petitioner contends that if the April 27, 1938, agreement between petitioner and the executor of the Burroughs estate be given retroactive effect, as respondent contends, then in any event the total period of joint interest in the fee as stated in the April 27, 1938, agreement "was from October 15, 1925, to December 19, 1929, or four years and two months"; that based upon a period of joint interest of 50 months instead of 11 months, 44/50 of the $ 14,995.50 actually paid to the Burroughs estate, or $ 13,196.04, should be allocated to the period of joint interest prior to Burroughs' death and 6/50, or $ 1,799.46, should be allocated to the period of joint interest after Burroughs' death; and that, therefore, no more than $ 214,872.40 ($ 228,068.44 less $ 13,196.04) is taxable to petitioner in the calendar year 1937. In this contention we think petitioner must be sustained.The agreement of April 27, 1938, which we are applying237 in reaching our decision, shows that there was a direct connection between the period of joint interest therein agreed upon and the amount of the estate's participation. In allocating the estate's share between the periods of joint interest before and after the death of Burroughs, the Commissioner had no more right to disregard the period of joint interest fixed in the agreement than he had to disregard the rest of the agreement. If any of the agreement is to be given effect, it seems to us that all of it must be given effect and that the Commissioner is inconsistent in doing otherwise in his determination of the deficiency. The Commissioner's allocation in his deficiency notice, based upon an eleven-month period of joint interest contrary to the agreement of the parties, it seems to us is clearly wrong and can not be sustained. We so hold.For the purpose of allocating the $ 14,995.50 payment to the Burroughs estate which was agreed upon in April 1938 between the 44-month period of joint interest prior to the death of Burroughs and the six-month period of joint interest after his death, the evidence convinces us that an allocation on a time basis would be reasonably 772 238 commensurate with the value of the services rendered during the two periods. Eighty-eight percent thereof, or $ 13,196.04, is, therefore, applicable to the 44-month period of joint interest prior to the death of Burroughs and the remaining 12 percent thereof or $ 1,799.64 is allocable to the six-month period of joint interest after his death. It is necessary to make this allocation because both parties agree that under our decision in City Bank Farmers Trust Co., supra, the amount of the fee which was paid the Burroughs estate for the six-month period after Burroughs' death was a capital payment in part for Burroughs' interest in the partnership and the parties are in agreement that this part of the payment is taxable income to petitioner. It probably should be pointed out that the above $ 1,799.64 is not the only capital payment that was made by petitioner for Burroughs' interest in the partnership. Other very considerable amounts were paid in prior years. Some of these are shown in the City Bank Farmers Trust Co. case, but they are not involved in any way in this proceeding and are, therefore, not set out here.The allocation which we have*239 made above should be used in a recomputation under Rule 50.Decision will be entered under Rule 50. Footnotes1. Southern Electro-Chemical Co. v. E. I. Du Pont De Nemours & Co., 9 Fed. (2d) 69; reversed at 20 Fed. (2d) 97↩; rehearing denied May 27, 1927.2. Although the parties have stipulated the figures found in this paragraph, there is an unexplained discrepancy of $ 366.70 illustrated as follows:↩Amount of fee reported on return by petitioner as stipulated$ 182,016.19Amount added by respondent in adjustment (a) above39,602.80Amount actually included by respondent221,618.99Amount stipulated as being included221,252.29Discrepancy366.70	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624612/	JOSEPH B. DURRETT, JR. AND CAROLYN C. DURRETT, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent.Durrett v. CommissionerDocket No. 21771-84United States Tax CourtT.C. Memo 1994-179; 1994 Tax Ct. Memo LEXIS 179; 67 T.C.M. (CCH) 2735; April 21, 1994, Filed 179 An appropriate order will be issued denying petitioners' motion for leave to amend petition and decision will be entered under Rule 155. The notice of deficiency in this case involving the taxable years 1979, 1980, and 1981 was mailed to Ps on April 3, 1984. The deficiencies resulted primarily from the disallowances of losses claimed with regard to straddle transactions with First Western Government Securities, Inc. This Court sustained the disallowance of similar losses in Freytag v. Commissioner, 89 T.C. 849">89 T.C. 849 (1987), affd. 904 F.2d 1011">904 F.2d 1011 (5th Cir. 1990), affd. on other grounds 501 U.S. , 111 S. Ct. 2631 (1991). Ps do not dispute the deficiencies and concede that the transactions involved here are indistinguishable from those in Freytag. Ps, however, contest the additions to tax for negligence and the increased interest under sec. 6621(c), I.R.C.Ps filed their petition in this case on June 29, 1984. Ps filed their 1983 Federal income tax return in October 1984. That return showed a "tentative regular investment tax credit" that was not used in the computation of the tax liability180 for that year. The credit is derived from the activities of a partnership subject to secs. 6221 through 6233, I.R.C., (the partnership provisions of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. 97-248, 96 Stat. 324). R did not commence an administrative proceeding with respect to the partnership and did not examine Ps' 1983 return. This case was calendered for trial on April 29, 1993. On April 21, 1993, Ps moved to amend their petition to raise for the first time an investment tax credit carryback from 1983 to 1980. Ps contend that the credit is an "affected item" that cannot be challenged in these proceedings. Held: 1. This Court has jurisdiction under sec. 6214(b), I.R.C., to consider whether there is an investment tax credit to be carried back to the 1980 year. Hill v. Commissioner, 95 T.C. 437 (1990); Mennuto v. Commissioner, 56 T.C. 910">56 T.C. 910, 922-923 (1971), followed. 2. Ps' motion to amend is untimely and will be denied. 3. R's determinations concerning increased interest under sec. 6621(c) and negligence under sec. 6653(a), I.R.C., are sustained. For petitioners: Thomas181 E. Redding, Paul J. Coselli, David C. Holland, Alan L. Tinsley, and Charles B. Koerth. For respondent: Paul J. Krug. DAWSON, POWEL DAWSONMEMORANDUM FINDINGS OF FACT AND OPINION DAWSON, Judge: This case was assigned to Special Trial Judge Carleton D. Powell pursuant to section 7443A(b)(4) and Rules 180, 181, and 183. 1 The Court agrees with and adopts the opinion of the Special Trial Judge which is set forth below. OPINION OF THE SPECIAL TRIAL JUDGE POWELL, Special Trial Judge: By notice of deficiency dated April 3, 1984, respondent determined deficiencies in petitioners' Federal income taxes and additions to tax as follows: Additions to TaxYearsDeficiencySec. 6653(a)(1) Sec. 6653(a)(2) 1979$ 68,279$ 3,414.00---1980858,19342,909.65---1981196,2209,811.001182 In an amended answer, respondent asserted that the deficiencies for all the years in issue were substantial underpayments due to tax-motivated transactions, and that the increased rate of interest under section 6621(c) was applicable. At the time the petition was timely filed petitioners resided in Houston, Texas. The issues are: (1) Whether petitioners may amend their petition to claim an investment tax credit carryback from 1983 to the 1980 taxable year; (2) whether the increased interest provisions of section 6621(c) apply; and (3) whether petitioners are liable for additions to tax under section 6653(a). FINDINGS OF FACT 1. Facts Concerning the Motion For Leave to Amend the PetitionPetitioners were represented by counsel at all relevant times. The notice of deficiency in this case was issued on April 3, 1984, and the petition was timely filed on June 29, 1984. Petitioners' 1983 Federal income tax return was filed on or about October 15, 1984. On that return petitioners showed a "tentative regular investment credit" in the amount of $ 95,766; they did not claim, however, any credit because of other limitations on credit arising from the alternative minimum tax. 183 This case was calendared for trial on the negligence and section 6621(c) issues commencing on April 29, 1993. On April 21, 1993, petitioners filed a Motion for Leave to Amend Petition, and lodged with the Court a proposed First Amendment to Petition. The proposed amendment states, inter alia: Petitioners are entitled in 1980 to a[n] * * investment tax credit carryback from 1983 based on their 1983 Form 1040 as originally filed.The 1983 investment tax credit arises from the activities of a partnership subject to sections 6221 through 6233 (the partnership provisions of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. 97-248, 96 Stat. 324). In addition to the potential credit, petitioners' 1983 return also claims substantial losses from other partnership and farming activities. Respondent did not commence an administrative proceeding with respect to the partnership and did not examine petitioners' 1983 return. Respondent opposes the motion for leave to amend. In so doing, respondent alleges that she would suffer prejudice because the files concerning the 1983 return are now unavailable. 2. Facts Concerning the Additions to Tax and Section184 6621The deficiencies in this case result, in part, 2 from the disallowance of partnership losses in the following amounts: OrdinaryShort Term CapitalPartnershipYearIncomeLossGainLoss101791979-0-($ 143,235)-0- -0- 101791980-0-(524)-0- -0- 51801 1980-0-(391,422)$ 962,962($ 964,061)51801981-0-(398,043)-0- -0- The partnership gains and losses arise from alleged straddle transactions of forward contracts for government-backed financial securities with First Western Government Securities, 185 Inc. (First Western). The First Western losses were the subject of this Court's opinion in Freytag v. Commissioner, 89 T.C. 849">89 T.C. 849 (1987), affd. 904 F.2d 1011">904 F.2d 1011 (5th Cir. 1990), affd. on other grounds 501 U.S. , 111 S. Ct. 2631 (1991). After a lengthy trial, this Court found, based on that record, inter alia, that "The transactions between First Western and its customers were illusory and fictitious and not bona fide transactions." Freytag v. Commissioner, 89 T.C. at 875. This Court alternatively held that, even if the transactions had substance, they "were entered into primarily, if not solely, for tax-avoidance purposes." Id. at 876. Based on the finding that the transactions were not bona fide, this Court concluded that additional interest under section 6621(c) was due on the underpayments. Id. at 886-887. In concluding that the transactions were not bona fide, this Court examined various aspects of the First Western program, including the risk of profit and loss, the hedging operation, the margins186 required and fees charged, the pricing of the forward contracts that were involved, and the manner in which the transactions were closed. In all of these areas we found that the First Western operations were deficient and not conducted as they should have been if bona fide financial transactions were being conducted. With respect to the losses, this Court noted: Petitioners' portfolios were constructed so as to achieve their desired tax losses. In this regard, the most important required data supplied by petitioners were their requested tax losses. Indeed, the program could not be implemented without the tax information. Thus, in analyzing the program for a profit standpoint, from the first, the tax tail wagged an economic dog. * * [Id. at 878.]We also pointed out that there were other "gremlins" in First Western's world that dispelled the notion that these transactions were bottomed in financial reality -- reversing transactions months later, confirmations being months late, transactions being made with no documentation, etc. . Id. at 882. In the case currently before the Court, petitioner 3 concedes187 that the transactions with First Western were conducted in the same way as the transactions discussed in Freytag, i.e., the same pricing algorithms were used, the transactions were closed in the same way, etc. He does not contest the disallowance of the losses claimed. He does, however, contest the increased interest under section 6621(c) and the additions to tax for negligence under section 6653(a). Petitioner has a degree in chemical engineering. In 1976 he started his own business, Chemical Exchange (Chemical). Chemical's (and petitioner's) primary business was buying and selling fuel oil. Petitioner was president of Chemical and information concerning the profitability of the corporation was available to him at all times. By 1979, the business had become very successful. Petitioner's compensations from Chemical were $ 333,562.50, 188 $ 516,987, and $ 605,658, respectively for the taxable years 1979, 1980, and 1981. Petitioner's withheld taxes for each year were $ 16,168, $ 16,546, and $ 26,953, respectively. Petitioner was introduced into First Western's world by Allen Daniels (Daniels). Daniels is an attorney with apparently a general business practice. He is not an expert in financial markets or in tax advantaged investments; he had, however, advised petitioner with respect to a truck leasing venture that was successful. Through Daniels, petitioner was introduced to Kenneth McCoin (McCoin) who was with Mosher, McCoin & Sims, Inc., a firm that provides investment advice. McCoin told petitioner and Daniels that he had reviewed the First Western operations and that they appeared to be a bona fide business. Although McCoin explained the First Western program to petitioner and Daniels, neither understood how the program worked. Petitioner testified that I don't think I had ever been acquainted with a straddle before, but he [McCoin] said that [is] what we would do -- what I understood to do -- and contrary to what everybody has been talking about, I had never heard of a formula. I thought we were buying189 some sort of a bond, and then we were buying bonds on the other side; buying Freddie Macs and selling Fannie Maes or vice versa. There was some difference in the interest [rates] between those two, and we could make some money on that. Frankly, I didn't understand.In short, both petitioner and Daniels relied on McCoin. McCoin was a so-called "finder" for First Western; he was paid by First Western for putting clients into the First Western program. He had approximately 100 clients in the First Western program and the firm was paid over $ 600,000 by First Western. Petitioner and Daniels were aware that McCoin was paid by First Western. McCoin also was an investor in the programs and claimed deductions from purported losses. Freytag v. Commissioner, 89 T.C. at 873-875. With regard to the firm of Mosher, McCoin & Sims, Inc., we noted: The corporation [Mosher, McCoin & Sims, Inc.] prepared various presentations of the First Western program for its customers in which it was pointed out that, even if the customer lost his entire margin, he would make a profit from tax savings. The following statement was made by the corporation: "Cash 190 deposit 17% of writeoff should expect to lose all of cash deposit any profit left at end of transaction is 'gravy'" * * . Mosher, McCoin & Sims had reviewed a pamphlet prepared apparently in 1978 by First Western * * that provided, inter alia: One time margin equal to 10% of the tax writeoff * * . * * No other cash or margin deposits are required. * * * If customer is correct in his interest rate direction, he will receive a check from First Western in the amount of up to 60% of his initial margin * * . Note that the tax writeoff could be as high as 25 to 1. [Id. at 875.]Daniels also suggested that petitioner get advice on the tax ramifications of the First Western transactions from Jerry Chambers (Chambers), a C.P.A. Chambers was not asked to give advice as to the bona fides of the transactions. Chambers reviewed the offering memorandum from First Western; as to the bona fides of the operations of First Western, however, he relied on McCoin and to some extent on Daniels. Chambers knew that there was no public market for these transactions. While he had some experience in straddle transactions involving transactions on191 the Chicago Board of Trade, Chambers had no experience with financial transactions of the type that were involved in the First Western programs. Chambers was also aware that McCoin was being paid by First Western. Chambers warned petitioner that there was a possibility that the deductions would be disallowed by respondent and that the disallowance "might" be sustained by the Tax Court. Petitioner's involvement in First Western was, as mentioned, through two partnerships. One of the partners was Leslie Jecko (Jecko) who also worked for Chemical as the "financial officer". Jecko was present when petitioner and Daniels met with McCoin and he knew that McCoin was paid by First Western. Jecko handled the transactions with First Western and prepared the partnership returns. Jecko understood that the loss leg of the straddle would be cancelled in the first year. He could not recall whether he requested a specific tax loss. The records of First Western show, inter alia, that the 1979 partnership requested a $ 300,000 ordinary loss in 1979 and a long-term capital gain of that amount in 1981. The 1979 loss from the First Western alleged trading was $ 303,000, and petitioner claimed192 a deduction of his aliquot share of the loss in the amount of $ 143,235. For the 1980 partnership, an ordinary loss in the amount of $ 525,000 in 1980 and a corresponding long-term capital gain in 1982 were requested. For 1981, a $ 600,000 ordinary loss and a 1983 long-term gain were requested. Petitioner claimed losses in the amounts of $ 391,422 and $ 398,043 arising from the 1980 partnership for the taxable years 1980 and 1981. OPINION 1. Motion for Leave to Amend PetitionRule 41(a) provides, in part: Amendments: A party may amend a pleading once as a matter of course at any time before a responsive pleading is served. * * Otherwise a party may amend a pleading only by leave of Court or by written consent of the adverse party, and leave shall be given freely when justice so requires. No amendment shall be allowed after expiration of the time for filing the petition, however, which would involve conferring jurisdiction on the Court over a matter which otherwise would not come within its jurisdiction under the petition as then on file. * * * In this case, the motion for leave was not filed before the responsive pleading, and respondent has not consented193 to the motion. The motion is addressed, therefore, to the sound discretion of the court. Avatar Exploration, Inc. v. Chevron, U.S.A., Inc., 933 F.2d 314">933 F.2d 314, 320 (5th Cir. 1991). In exercising that discretion, the courts consider various factors including the timeliness of the motion, the reasons for the delay, and whether granting the motion would result in issues being presented in a seriatim fashion. Daves v. Payless Cashways, Inc., 661 F.2d 1022">661 F.2d 1022, 1024 (5th Cir. 1981). Perhaps the most important consideration is whether undue prejudice would result to the other party. Evans Products Co. v. West American Ins. Co., 736 F.2d 920">736 F.2d 920, 924 (3d Cir. 1984); Russo v. Commissioner, 98 T.C. 28">98 T.C. 28, 31 (1992). As to the timeliness of the motion, petitioner contends that at the time that the petition was filed he had no reason to know that the carryback credit existed because he filed the petition before the 1983 return was filed. This may be so, but, when he filed the 1983 return in October, 1984, he knew of the 1980 deficiency, and he also had been warned by Chambers that194 he might not prevail on the First Western issue. By 1987, when our opinion in Freytag v. Commissioner, supra, was filed, he certainly knew that there was a problem with the 1980 liability. Furthermore, even if respondent's files concerning the partnership were available, a reconstruction of 10-year old transactions would be difficult, if not impossible, and prejudice to the other party is manifest. Finally, by waiting to the eve of trial, petitioner has presented a situation where, if an evidentiary hearing would be necessary, seriatim trials would be mandated. While tacitly recognizing these problems, petitioner contends that another trial is not necessary, and respondent would not be prejudiced because everything is in this record to decide the issue. This reasoning is predicated on a perceived relationship between the rules for deficiency litigation (subchapter B of chapter 63) and the rules governing so-called TEFRA partnership litigation contained in subchapter C of chapter 63. The partnership provisions of subchapter C of chapter 63 were added by section 402(a) of TEFRA, 96 Stat. 648. A "partnership item" is determined at the partnership level. Sec. 6221. A 195 "partnership item" is an item "more appropriately determined at the partnership level than at the partner level" to the extent prescribed by the regulations. Sec. 6231(a)(3). Subchapter C also uses the concept of an "affected item", which is defined as "any item to the extent such item is affected by a partnership item." Sec. 6231(a)(5). Although an investment credit is taken into account separately by each partner, sec. 702(a); Southern v. Commissioner, 87 T.C. 49">87 T.C. 49, 53 (1986), under the regulations investments "necessary to enable the partnership or partners to determine" investment credits from the partnership are considered partnership items. Sec. 301.6231(a)(3)-1(a)(1)(vi), Proced. & Admin. Regs. The carryback of an investment tax credit, however, is an affected item. Maxwell v. Commissioner, 87 T.C. 783">87 T.C. 783, 790 (1986). Petitioner contends that the 1983 investment tax credit arises from investments made by a TEFRA partnership and that the credit is a "partnership item" properly determined at the partnership level. Petitioner reasons that, because respondent has not challenged the partnership return and the period196 of limitations under section 6229 has expired, the partnership item of that return cannot be challenged in a TEFRA proceeding. Furthermore, because the carryback of the credit is an affected item, this Court has no jurisdiction to consider a challenge to the claim with respect to the 1980 taxable year. Respondent, relying on section 6214(b), disagrees. Section 6214(b) provides: Jurisdiction Over Other Years and Quarters. -- The Tax Court in redetermining a deficiency of income tax for any taxable year * * * shall consider such facts with relation to the taxes for other years * * * as may be necessary correctly to redetermine the amount of such deficiency, but in so doing shall have no jurisdiction to determine whether or not the tax for any other year * * * has been overpaid or underpaid.Section 6214(b) is a subject matter jurisdictional statute. In dealing with items from a later year where no notice of deficiency had been issued for that year, this Court is without jurisdiction to redetermine whether a tax liability for that year has been underpaid or overpaid. Notwithstanding this, under the first part of section 6214(b), in redetermining the tax liability for the197 year properly before this Court, Congress instructs that this Court "shall consider such facts with relation to the taxes for other years * * as may be necessary correctly to redetermine the amount of such deficiency". This Court has long held that we have jurisdiction to consider the claim of an investment tax credit carryover or carryback to a year that is before this Court where the credit arises in a year that is not before this Court and would otherwise be barred by the period of limitations. Hill v. Commissioner, 95 T.C. 437 (1990); Mennuto v. Commissioner, 56 T.C. 910">56 T.C. 910, 923 (1971); Brock v. Commissioner, T.C. Memo 1982-335">T.C. Memo. 1982-335; see also Lone Manor Farms, Inc. v. Commissioner, 61 T.C. 436">61 T.C. 436, 439-441 (1974), affd. without published opinion 510 F.2d 970">510 F.2d 970 (3d Cir. 1975) (same with regard to net operating loss carrybacks and carryovers). 4 This is true even if it would involve recomputing the tax liability in the other year to determine whether credit could be carried back or over. Hill v. Commissioner, supra at 441-442.198 Respondent argues that there is nothing in either the statutory framework of the TEFRA provisions or its legislative history indicating that Congress intended to repeal section 6214(b) and the case law based thereon. We agree. In Roberts v. Commissioner, 94 T.C. 853">94 T.C. 853 (1990), the taxpayers claimed deductions from losses from three TEFRA partnerships. There were no partnership administrative actions commenced with respect to those partnerships, and the period of limitations with respect to the partnerships had expired. Respondent issued a notice of deficiency disallowing a carryback of an investment credit from the partnerships, inter alia, on the ground that199 the taxpayers were not "at risk" under section 465. Taxpayers moved to dismiss on the ground that such an "affected item" could not be litigated in a deficiency proceeding. Taxpayers relied "on our statement in Maxwell that 'Affected items depend on partnership level determinations, [and] cannot be tried as part of the personal tax case, and must await the outcome of a partnership proceeding.' Maxwell v. Commissioner, supra at 792." Id. at 860. This Court stated: However, the "outcome of the partnership proceeding" may be acceptance of the partnership return as filed as a result of the fact that there was no partnership proceeding and there can no longer be a partnership proceeding under the normal statute of limitations. We do not read section 6230(a)(2)(A)(i) to mean that a partnership proceeding must be opened and closed in order for there to be a determination with regard to an affected item. We also find no requirement in the statute or regulations that prohibits affected items from being considered in a proceeding involving a personal tax case, providing subject matter jurisdiction exists. [200 Roberts v. Commissioner, supra at 860-861; emphasis added.]In the instant case, respondent does not contend that she can reopen the 1983 taxable year. Nonetheless, in redetermining the correct tax for the 1980 taxable year, respondent insists that, if petitioner is allowed to amend the petition to raise the carryback, then under section 6214(b), this Court has jurisdiction to consider whether the carryback is proper. Petitioner does not directly address this argument. Rather, petitioner contends that our opinion in Harris v. Commissioner, 99 T.C. 121 (1992), affd. 16 F.3d 75">16 F.3d 75 (5th Cir. 1994), directs that we must allow the claimed carryback as set forth on the 1983 return. 5 In Harris the taxpayer was before this Court in a deficiency proceeding. During the Rule 155 computation petitioner sought to amend the petition and raise net operating loss carrybacks from two classes of TEFRA partnerships. In one class, there was a settlement of the TEFRA partnership items reached between respondent and the partnership. In the other class, settlement of the administrative proceedings was201 under consideration; no settlement, however, had been reached. With regard to the settled partnership items, we noted when the Commissioner and a partner enter into a settlement those items become nonpartnership items under section 6231(b)(1)(C). Respondent contended, however, that the procedure for taking into account TEFRA partnership carrybacks was governed by the TEFRA procedures and "not by the provisions ordinarily governing the redetermination of deficiencies, such as section 6214(b)." Harris v. Commissioner, supra at 125. Respondent argued that under section 6230(a)(2)(A)(ii) a settlement is applied to a partner by a computational adjustment and not under the ordinary deficiency and refund procedures. We rejected202 this argument stating We, however, do not read the provisions of section 6230(a)(2)(A)(ii) * * as depriving us of jurisdiction to take account of the settled items pursuant to section 6214(b). The purpose of section 6230(a)(2)(A)(ii) is to enable the Commissioner to collect amounts due as a result of settlements without the necessity of issuing a statutory notice of deficiency, and we find no suggestion that such provision was intended to restrict the jurisdiction of this Court in the situation present in the instant case. * * * [Id. at 126.]As to the other partnerships, we concluded that "prior to the resolution of partnership level proceedings, partnership and affected items may not be taken into account in a partner's personal tax case." Id. at 127 (citations omitted). In Harris we commented that such cases as Hill and Lone Manor Farms, Inc. "did not involve the TEFRA partnership provisions and, consequently, do not resolve the issue before us." Id. at 125. As we understand petitioner's contention, the Court thereby rejected the rationale of these cases in any203 situation where a carryback or carryover emanates from a TEFRA partnership regardless of whether there is or was a partnership administrative proceeding. See sec. 6223. This states too much. In Harris, there were pending or settled administrative proceedings, and the rationale of Hill and Lone Manor Farms, Inc. did not apply. But it is vastly a different matter to say that in situations where there has been no partnership administrative proceeding, the TEFRA partnership rules prohibit this Court from examining the merits of a claimed carryback or carryover in conjunction with determining the correct tax liability in an individual's case under section 6214(b). Indeed, as noted supra, this Court rejected the contention that the partnership provisions restricted our jurisdiction under section 6214(b) where the partnership items had been settled. In short, the Harris case, to the extent that it is apposite, supports respondent's position. If we were to allow petitioner to amend his petition to raise the carryback, we then would have to consider all of the attendant questions involving the availability of that credit to be carried back including not only the 204 bona fides of the credit but the correct tax liability for 1983. 6Hill v. Commissioner, 95 T.C. 437">95 T.C. 437 (1990). This involves the probability of another trial in this case. Furthermore, it is difficult to imagine a situation where an opposing party could be more prejudiced. Petitioners had ample time to raise this issue, and they failed to do so. In these circumstances, justice would not be served by allowing petitioners to amend the petition at this late date. The motion for leave to file will be denied. 7205 2A. Section 6621(c)Petitioners contend that the increased interest under section 6621(c) is inapplicable to them, relying on Heasley v. Commissioner, 902 F.2d 380">902 F.2d 380 (5th Cir. 1990), revg. T.C. Memo. 1988-408. 8Section 6621(c)(1) provides that, if there is a "substantial underpayment attributable to tax-motivated transactions," the interest payable under section 6601 "shall be 120 percent of the underpayment rate". A substantial underpayment attributable to a tax-motivated transaction means "any underpayment of taxes * * attributable to 1 or more tax-motivated transactions if the amount of the underpayment for such year * * * exceeds $ 1,000." Sec. 6621(c)(2). The term "tax motivated transactions" means, inter alia, "any sham or fraudulent transaction." Sec. 6621(c)(3)(v). From a literal reading of the statute, if a transaction is determined to be a "sham", the increased interest applies. 206 In Freytag v. Commissioner, 89 T.C. 849">89 T.C. 849, 887 (1987), affd. 904 F.2d 1011">904 F.2d 1011 (5th Cir. 1990), affd. on other grounds 501 U.S. , 111 S. Ct. 2631 (1991), we sustained respondent's determinations that section 6621(c) applied to the First Western underpayments based on our finding that the transactions were "shams." Because petitioners concede that their transactions with First Western were identical to those in Freytag, additional interest under section 6621(c) is applicable here. 9 See Howard v. Commissioner, 931 F.2d 578">931 F.2d 578, 582 (9th Cir. 1991), affg. T.C. Memo. 1988-531. 207 Heasley v. Commissioner, supra, is inapposite. In Heasley v. Commissioner, T.C. Memo. 1988-408, this Court found that the transactions entered into were not entered into for profit, and, therefore, under section 301.6621-2T, Q&A-4, Temporary Proced. & Admin. Regs., 49 Fed. Reg. 50392 (Dec. 28, 1984), the increased interest under section 6621(c) was applicable. The Court of Appeals for the Fifth Circuit concluded, however, that the taxpayers had "the requisite profit motive." Heasley v. Commissioner, 902 F.2d at 386. While it is true that in Freytag v. Commissioner, 89 T.C. at 882-886, we held, in the alternative, that the transactions were not entered into for profit, we sustained the additional interest under section 6621(c) on the ground that the alleged transactions factually were illusory and fictitious, i.e., "shams", a finding affirmed by the Court of Appeals for the Fifth Circuit in Freytag v. Commissioner, 904 F.2d at 1015-1016">904 F.2d at 1015-1016, and it is upon that ground that we sustain respondent's determination here. Petitioners, 208 however, contend that for a transaction to be considered a sham under section 6621(c)(3)(v) the transaction must be without economic substance and be entered into without a profit objective, citing Heasley v. Commissioner, supra. While, as discussed infra, we reject their contention that there was a profit motive, we do not read the Fifth Circuit Court of Appeals' opinion in Heasley, not its opinion in Lukens v. Commissioner, 945 F.2d 92">945 F.2d 92, 99-100 (5th Cir. 1991), affg. Ames v. Commissioner, T.C. Memo. 1990-87, to stand for this proposition. When a transaction is the simple product of smoke and mirrors, it is a factual sham, regardless whether the taxpayer may have thought that a profit might have been made. See Cherin v. Commissioner, 89 T.C. 986">89 T.C. 986, 993-994 (1987). This is all that section 6621(c)(3)(v) requires. See Statement of the Managers attached to the conference report, H. Conf. Rept. 99-841. II-796 (1986), 1986-3 C.B. (Vol. 4) 796. 2B. NegligenceRespondent determined that additions to tax under section 6653(a) are due for negligence. 209 Section 6653(a) provides in relevant part that "If any part of any underpayment * * * is due to negligence or intentional disregard of rules and regulations * * * there shall be added to the tax an amount equal to 5 percent of the underpayment." "'Negligence is a lack of due care or the failure to do what a reasonable and ordinarily prudent person would do under the circumstances.'" Freytag v. Commissioner, 89 T.C. at 887 (quoting Marcello v. Commissioner, 380 F.2d 499">380 F.2d 499, 506 (5th Cir. 1967), affg. on this issue 43 T.C. 168">43 T.C. 168 (1964)); see also Zmuda v. Commissioner, 731 F.2d 1417">731 F.2d 1417, 1422 (9th Cir. 1984), affg. 79 T.C. 714">79 T.C. 714 (1982). Petitioners have the burden of establishing that their actions were not negligent. Freytag v. Commissioner, 904 F.2d at 1017">904 F.2d at 1017. The negligence question focuses on petitioner Joseph B. Durrett, Jr. He entered into the transactions with First Western. Petitioner contends that the addition to tax under section 6653(a) is unwarranted because he had a reasonable expectation for profit, and210 he exercised due care when he entered into the transactions with First Western. The gravamens of his contention are that he relied on expert advice and that his motive for entering into the transactions was not to avoid taxes. With regard to petitioner's reliance on experts, such reliance, standing alone, will not insulate a taxpayer from the addition to tax for negligence. It must be shown that the expert had the expertise and knowledge of the pertinent facts to render such an opinion on the subject matter. Freytag v. Commissioner, 849">89 T.C. at 888. Furthermore, it must be established that the person rendering the advice is independent and does not have an economic interest in giving the advice. Rybak v. Commissioner, 91 T.C. 524">91 T.C. 524, 565 (1988). Petitioner has a background in engineering and petroleum sales. Prior to 1979, he had made no investments in any transactions of this nature. He was told about the First Western program by Daniels. Daniels had no expertise in dealing with straddles in forward contracts that were the heart of the First Western program. Neither petitioner nor Daniels understood how the program211 worked. Rather, Daniels relied upon McCoin and Chambers, and the latter relied on Daniels and also on McCoin. According to petitioner's version of what happened, there were four blind mice, 10 all duped by one slick cat, McCoin. We believe that the mice, rather than being blind, suffered more from tax-motivated myopia and they stand in pari delicto with the cat. Cf. Horn v. Commissioner, 90 T.C. 908">90 T.C. 908, 941 (1988). All knew that McCoin had a direct relationship with First Western and was paid by First Western. While the facts here are somewhat more convoluted, our words in Rybak v. Commissioner, supra at 565, apply: In these circumstances, petitioners did not rely on competent, independent parties; they did no more than inquire of the promoter if the investment was sound. Such reliance is not the type of activity which will overcome the addition to tax for negligence or intentional disregard of the rules and regulations.212 See also Marine v. Commissioner, 92 T.C. 958">92 T.C. 958, 992 (1989), affd. without published opinion 921 F.2d 280">921 F.2d 280 (9th Cir. 1991); Patin v. Commissioner, 88 T.C. 1086">88 T.C. 1086, 1130 (1987), affd. without published opinion 865 F.2d 1264">865 F.2d 1264 (5th Cir. 1989), affd. without published opinion sub nom. Hatheway v. Commissioner, 856 F.2d 186">856 F.2d 186 (4th Cir. 1988), affd. sub nom. Skeen v. Commissioner, 864 F.2d 93">864 F.2d 93 (9th Cir. 1989), affd. sub nom. Gomberg v. Commissioner, 868 F.2d 865 (6th Cir. 1989). It must be noted that these transactions could hardly be described as being run-of-the-mill, and petitioner admits that he did not understand the transactions. They involved alleged forward contracts to purchase and sell millions of dollars of mortgage-backed securities. See Freytag v. Commissioner, 849">89 T.C. at 862-863. There was no market for these contracts, and First Western was on both sides of the transactions. In discussing the First Western transactions, the Court of Appeals213 for the Fifth Circuit noted: "no reasonable investor would surrender total control of his or her ability to profit or lose unless satisfied that the risk of loss had been greatly diminished or eliminated." [Freytag v. Commissioner, 904 F.2d at 1016">904 F.2d at 1016 (quoting Sochin v. Commissioner, 843 F.2d 351">843 F.2d 351, 356 (9th Cir. 1988).Furthermore, the ratio of the tax losses compared with the payments was huge, between 8:1 and 10:1. This latter fact was particularly important because, as the Court of Appeals for the Ninth Circuit recognized in Zmuda v. Commissioner, 731 F.2d at 1422, during this period there was "extensive continuing press coverage of questionable tax shelter plans." As we noted in our opinion in Freytag v. Commissioner, 89 T.C. at 888, given this scenario, a taxpayer could not merely rely on the documents supplied by First Western, and further investigation was clearly mandated. If there had been any serious examination of the program, "No reasonable person would have expected * * * [the] scheme to work." Freytag v. Commissioner, 89 T.C. at 889.214 Cf. Hanson v. Commissioner, 696 F.2d 1232">696 F.2d 1232, 1234 (9th Cir. 1983), affg. per curiam T.C. Memo. 1981-675. Finally, we note that petitioner's alleged profit motive for the First Western transactions is simply cut from whole cloth. The raison d'etre of the program was to convert ordinary income into long-term capital gains and defer the payment of taxes. Jecko understood this. Nonetheless, petitioner steadfastly contends that this was not the reason for his investment and denies that he knew anything about the requests for tax losses that were supplied to First Western. This has a decidedly hollow ring. First, without the losses from First Western, petitioner faced substantial tax liabilities in each of the years arising from his salary because of the underwithholding on his salary." 11 Second, if we were to accept petitioner's argument, we would have to accept that the requests for tax losses, which appear to be well tailored to his situation, materialized out of thin air for all 3 years. We decline that invitation. Third, it is inconceivable to us, given the relationship that McCoin had with First Western and the internal215 documents that his firm had and produced, that the profit potential of First Western played any significant part of McCoin's discussion with petitioner or petitioner's decision to invest. 12 Fourth, it is also unlikely that anyone whose primary purpose was to make a profit would enter into a transaction when he lacked any understanding of what was going on. The only rational explanation for any of this is that petitioner entered into these transactions with the primary, if not sole, objective of obtaining the tax losses. 216 Petitioner, relying again on Heasley, suggests that he did all that was necessary because he was an "unsophisticated" investor. It is true that the Court of Appeals for the Fifth Circuit in Heasley found that "moderate-income" and "unsophisticated" investors were not negligent when they failed to do more to investigate an investment in a tax shelter. Heasley v. Commissioner, 902 F.2d at 383-384. That case is distinguishable, however, from the one before us here. In this regard, we are continually surprised to discover, after Heasley, how the definition of an "unsophisticated" and "moderate-income" investor has been expanded to include well educated persons who have established or been engaged in lucrative businesses for many years. Indeed, if petitioner fits within that description, it would appear that at least some of the taxpayers in Freytag were similarly situated. But, in Freytag the additions to tax for negligence were affirmed by the same court that had decided Heasley just a month before. Heasley does not shield petitioner from additions to tax for negligence. Petitioners have not shown that they used due 217 care, and respondent's determinations with respect to the additions to tax under section 6653(a) are sustained. An appropriate order will be issued denying petitioners' motion for leave to amend petition and decision will be entered under Rule 155. Footnotes1. Unless otherwise indicated, section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩1. 50 percent of the interest due on the underpayment.↩2. In the notice of deficiency, respondent made other adjustments. By stipulation, the parties have resolved these issues. The other adjustments are mathematical and will be resolved during the Rule 155 computations.↩1. For 1980, respondent disallowed all losses but did not take the short term capital gain out of the computation of the deficiency for that year. The parties have stipulated that neither the gains nor losses will be recognized.↩3. The deficiencies and additions to tax focus on the activities of petitioner Joseph B. Durrett, Jr. with First Western, and for convenience he will be referred to as petitioner.↩4. See also Phoenix Coal Co. v. Commissioner, 231 F.2d 420 (2d Cir. 1956), affg. T.C. Memo 1955-28">T.C. Memo. 1955-28; Calumet Ind., Inc. v. Commissioner, 95 T.C. 257">95 T.C. 257 (1990); State Farming Co. v. Commissioner, 40 T.C. 774">40 T.C. 774↩ (1963).5. Although petitioner does not expressly concede the point, he apparently acknowledges that, if the rationale of Hill v. Commissioner, 95 T.C. 437">95 T.C. 437↩ (1990), and its antecedents apply, the motion for leave to file should be denied.6. Putting aside the investment tax credit issue, respondent would be entitled to question all items on petitioners' 1983 return to determine whether there was an investment tax credit to be carried back.↩7. Petitioner suggests that the Court applied a different standard when it allowed respondent to file an amended answer raising the increased interest under sec. 6621(c). In 1985, this Court issued guidelines for raising the increased interest under sec. 6621(c) in cases that were currently before this Court. See Cinman v. Commissioner, T.C. Memo. 1991-192. Under those guidelines, the basic concern as to the timeliness of respondent's motion was whether the petitioners were afforded time to prepare for trial. Id. This case was calendared for a pretrial hearing on Oct. 5, 1992. On Aug. 31, 1992, respondent filed a Motion for Leave to File First Amendment↩ to Answer and lodged with the Court a proposed amended answer raising the increased interest issue. At that hearing the Court gave notice that the case would be calendared for trial during the week of Apr. 26, 1993, and subsequently the case was calendared for trial commencing Apr. 29, 1993. When we granted respondent's motion for leave on Oct. 5, 1992, there was ample time for petitioners to prepare the issue for trial. The same cannot be said of the motion that is currently before the Court.8. Petitioners also raised but have not pursued the constitutionality of sec. 6621(c). We have rejected that argument. Solowiejczyk v. Commissioner, 85 T.C. 552">85 T.C. 552 (1985), affd. without published opinion 795 F.2d 1005">795 F.2d 1005↩ (2d Cir. 1986).9. Because the increased interest under sec. 6621(c) was raised for the first time in the amended answer, the burden of proof is on respondent to establish that the provision applies. While petitioners have not conceded that the First Western transactions were "shams", they conceded that the transactions were the same as involved in Freytag v. Commissioner, 89 T.C. 849">89 T.C. 849 (1987), affd. 904 F.2d 1011">904 F.2d 1011 (5th Cir. 1990), affd. on other grounds 501 U.S. , 111 S. Ct. 2631 (1991), and we held that the transactions in Freyteg were shams within the meaning of sec. 6621(c)(3)(v). Our findings in Freytag↩ were not based on a failure of proof, but rather affirmative evidence that was in the record. Which party bears the burden of proof is, therefore, not relevant here.10. Petitioner claims that he relied on Daniels, Jecko, and Chambers. Jecko relied on McCoin. Daniels relied on McCoin and Chambers. Chambers claimed that he relied on Daniels to some extent. It is peculiar that Chambers would rely on Daniels' advice when Daniels recommended that they seek Chambers' advice in the first place. We have a circle of the blind leading the blind.↩11. Petitioner claims that because a large part of his salary was from bonuses based on Chemical's profits, he did not know what, if any, bonuses would be paid. Petitioner was president of Chemical, had access to all financial information, and surely knew at any time where Chemical stood. Despite denials, he clearly knew that Chemical was making substantial profits.↩12. We recognize that McCoin denied knowledge of his firm's statements concerning the First Western program. We do not believe that is the case.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624615/	Little Rock Towel & Linen Supply Company v. Commissioner.Little Rock Towel & Linen Supply Co. v. CommissionerDocket No. 24230.United States Tax Court1952 Tax Ct. Memo LEXIS 351; 11 T.C.M. (CCH) 36; T.C.M. (RIA) 52010; January 18, 1952351 Petitioner is a corporation engaged in furnishing clean towels and linens to business establishments. During the war years, it was unable to replace any of its delivery equipment and in 1946 placed orders for six new trucks, estimated to cost about $8,100. Petitioner paid no dividends during 1946, retaining its earnings to finance such purchase. None were obtained until 1948, due to post-war conditions. Held, during the taxable year, petitioner's earnings and profits were not permitted to accumulate beyond the reasonable needs of the business, and petitioner was not availed of for the purpose of preventing the imposition of surtax upon its stockholders. E. C. Eichenbaum, Esq., Bolye Bldg., Little Rock, Ark., for the petitioner. John W. Alexander, Esq., for the respondent. RICEMemorandum Findings of Fact and Opinion Respondent determined a deficiency in income tax for the year 1946 in the amount of $2,948.12. The sole issue is whether petitioner was availed of during the taxable year for the purpose of preventing the imposition of surtax upon its stockholders so as to subject petitioner to the surtax provided for by section 102 of the Internal Revenue Code. Findings of Fact Petitioner, 352 an Arkansas corporation with its principal place of business in Little Rock, Arkansas, is engaged in furnishing clean towels and linens to business houses. Its income tax return for the year in question was filed with the collector of internal revenue at Little Rock, Arkansas. Prior to December, 1941, Lasker's Imperial Laundry & Cleaners, Inc., (hereinafter referred to as Lasker's) carried on a laundry, dry cleaning, and linen-supply business. Its offices were located in buildings owned and leased from Minnie F. Lasker (hereinafter referred to as Minnie), the principal and almost sole stockholder. The Towel and Linen Department was located in a separate building from the one housing the laundry and consisted of about 10 or 12 employees who were truck drivers and clerical help. Myron B. Lasker, Jr., (hereinafter referred to as Myron) the only son of Minnie, was general manager of the corporation. On or about December 31, 1941, petitioner was incorporated with a capitalization of 300 shares of $1 par stock. Minnie owned all of the stock but two qualifying shares. On or about January 1, 1942, Lasker's transferred the following assets related to its Towel and Linen Department to petitioner: 353 Cash$ 781.43Accounts Receivable2,511.25Linen Supplies14,452.64Prepaid Expenses55.30Miscellaneous Cabinets3,033.97Furniture & Fixtures748.04Delivery Equipment4,694.02$26,276.65Less: Reserve for Depreciation$ 3,348.81Accrued Taxes - Other than income254.783,603.59Total$22,673.06 In return for these assets, Lasker's received $300 in cash and a note in the amount of $22,373.06. As of January 1, 1946, petitioner still owed $14,000 on the obligation, which was paid in the latter part of 1946. Petitioner paid no dividends for the years 1942 through 1946. Its gross receipts and net income before taxes for these years were as follows: IncomeYearGross ReceiptsBefore Taxes1942$80,480.83$12,836.33194374,699.396,358.43194477,848.4410,454.90194578,980.8411,609.02194683,855.2313,792.76Petitioner's financial statements from January 1, 1942, through December 28, 1946 were as follows: 1/1/4212/31/4212/31/4312/30/44ASSETS: Current Assets: Cash$ 781.43$ 6,937.74$ 4,888.68$11,094.64U.S. Bonds3,000.005,000.00Accounts Receivable2,511.253,138.972,144.532,126.68Linen Supplies14,452.6417,314.2116,423.7616,963.39TOTAL CURRENT ASSETS$17,745.32$27,390.92$26,456.97$35,184.71Fixed Assets: Total Cost$ 8,476.03$ 8,413.83$ 7,948.72$ 7,730.72Less: Reserve for Depreciation3,348.814,437.915,256.846,231.84NET FIXED ASSETS$ 5,127.22$ 3,975.92$ 2,691.88$ 1,498.88Deferred Charges$ 55.30$ 172.16$ 103.36$ 194.99TOTAL ASSETS$22,927.84$31,539.00$29,252.21$36,878.58LIABILITIES: Current Liabilities: Notes Payable -Imperial Laundry$22,373.06$15,723.06$14,500.00$14,000.00Accrued Income Taxes7,455.471,991.302,867.32Accounts Payable andOther Liabilities254.782,598.762,639.052,157.32TOTAL CURRENT LIABILITIES$22,627.84$25,777.29$19,130.35$19,024.64Capital and Surplus: Capital Stock$ 300.00$ 300.00$ 300.00$ 300.00Surplus5,461.719,821.8617,553.94TOTAL CAPITAL & SURPLUS$ 300.00$ 5,761.71$10,121.86$17,853.94TOTAL LIABILITIES$22,927.84$31,539.00$29,252.21$36,878.58354 12/29/4512/28/46ASSETS:Current Assets:Cash$14,476.21$ 7,872.76U.S. Bonds10,000.0010,000.00Accounts Receivable2,060.472,342.90Linen Supplies18,464.3922,175.51TOTAL CURRENT ASSETS$45,001.07$42,391.17Fixed Assets:Total Cost$ 7,642.65$ 7,655.53Less:Reserve for Depreciation6,558.456,600.32NET FIXED ASSETS$ 1,084.20$ 1,055.21Deferred Charges$ 119.96$ 46.44TOTAL ASSETS$46,205.2343,492.82LIABILITIESCurrent Liabilities:Notes Payable -Imperial Laundry$14,000.00Accrued Income Taxes3,201.99$ 3,304.54Accounts Payable andOther Liabilities2,574.713,039.33TOTAL CURRENT LIABILITIES$19,776.70$ 6,343.87Capital and Surplus: Capital Stock$ 300.00$ 300.00Surplus26,128.5336,848.95TOTAL CAPITAL & SURPLUS$26,428.53$37,148.95TOTAL LIABILITIES$46,205.23$43,492.82Its net income before taxes, net income after taxes, and dividends paid for the years 1947 through 1950 were as follows: Net IncomeNet IncomeBeforeAfterDividendsYearTaxesTaxesPaid1947$20,666.28$15,999.71$ 6,000.00194819,199.8714,881.926,000.00194918,667.4614,473.4412,000.00195019,166.6314,758.3112,000.00 Linen supplies listed in petitioner's financial statements as current assets were not assets available for sale, but were necessary for the performance 355 of petitioner's services. During the year 1947, petitioner declared stock dividends in the amount of $27,700 thereby increasing its capital stock to $30,000. At a meeting of the Board of Directors of petitioner on December 19, 1946, the following letter from Myron was read: "November 7, 1946 "Board of Directors Little Rock Towel & Linen Supply Company, Inc. Little Rock, Arkansas"Dear Madam & Sir: "This letter will constitute my report to you as of September 28, 1946, together with certain recommendations for which I request your approval. "As of that date our statement of Assets and Liabilities reflected the following cash position: War Saving Stamp Fund$ 50.00Petty Cash100.00W. B. Worthen Co.20,266.77U.S. Bonds10,000.00$30,416.77"Against this balance we have current liabilities of $20,571.69 of which $14,000.00 is a note payable to Lasker's Imperial Laundry & Cleaners, Inc. I recommend the immediate payment of this note, and this will leave us a cash position of $9,845.08, which I believe is sufficient operating capital to take care of our usual needs, but may not be adequate for the replacement of the delivery equipment of the company, which is fully depreciated. Six of our present 356 models are of the year 1940, and one is a 1938 model and all need replacing as soon as new pieces are available. A quotation has just been furnished by a local truck sales company and according to present day selling prices this replacement will entail an investment of $8,091.65. "I think that this expenditure can be made from future operating profits, but should a debit financing program be necessary in order to accomplish this replacement, your authority and cooperation is hereby requested. "I, therefore, request your approval of the matters discussed in this letter, and trust that you will act favorably on these request before December 31, 1946. "Respectfully submitted Sgd: Myron B. Lasker, Jr. Myron B. Lasker, Jr., Gen'l Manager" MBL:ce The minutes of this meeting were as follows: "MINUTES OF MEETING OF THE DIRECTORS OF THE LITTLE ROCK TOWEL & LINEN SUPPLY COMPANY, HELD IN LITTLE ROCK, ARKANSAS, DECEMBER 19, 1946 "A meeting of the Directors of the Little Rock Towel & Linen Supply Company was held in Little Rock, Arkansas, December 19, 1946, at which all of the Directors were present. "A report of the financial condition of the Company as of September 28, 1946, was submitted to 357 the Directors and also a letter dated November 7, 1946, from Mr. Myron B. Lasker, Jr., General Manager of the Company. Said letter is attached to and made a part of the Minutes of this meeting. "The financial condition of the Company and the recommendations made by Mr. Lasker were discussed. "After considering the financial condition of the Company, the Directors passed a resolution authorizing the officers of the Company to make immediate payment of the $14,000.00 note in favor of Lasker's Imperial Laundry & Cleaners. "The Officers of the Company were instructed to buy new delivery equipment as soon as the same is available, at a cost of not exceeding $8,100.00. "It was considered that the expenditures above authorized might leave the Company without adequate reserves but the Directors considered the purchase of the new equipment as absolutely necessary, and the payment of the note to be to the best interests of the Company, realizing, however, that it may be necessary for the Company to borrow some money until the cash position can be improved. "There being no further business to come before the meeting it was adjourned subject to the call of the President. "Sgd: Minnie F. Lasker 358 President "Sgd: M. M. Overton Secretary" Immediately after this Board meeting, petitioner placed orders for the trucks, and delivery would have been taken at once had they been available. Due to the difficulty in obtaining trucks, none were received until 1948, when about one truck every other month was obtained until the petitioner's needs were met. U.S. Government Bonds had been purchased in 1943, 1944, and 1945 in order that funds might be available after the war with which to replace the worn-out delivery equipment. At the end of 1946, petitioner paid off the $14,000 it still owed Lasker's. After payment of this note, petitioner had cash on hand of $7,872.76, but accrued taxes and bills payable totaled $6,343.87. While the $10,000's worth of Government Bonds was available, it had been estimated that the cost of the needed delivery trucks was over $8,000. In the light of these facts, the Board determined that it was not possible to pay dividends. By the time the trucks became available in 1948, petitioner had sufficient money on hand to pay for such equipment without using the Government Bonds. There were no loans outstanding to petitioner's major stockholder. Petitioner's majority 359 and practically sole stockholder had sufficient income during 1946 to place her in the surtax brackets. Respondent determined that petitioner had undistributed section 102 net income for the year 1946 in the amount of $10,720.42. During the year 1946, the earnings and profits of petitioner were not permitted to accumulate beyond the reasonable needs of the business, and petitioner was not availed of for the purpose of preventing the imposition of surtax upon its shareholders through the medium of permitting its earnings and profits to accumulate instead of being divided or distributed. Opinion RICE, Judge: The sole issue is whether petitioner is subject to the surtax under section 102 of the Internal Revenue Code1361 for the year 1946 by reason of having been availed of for the purpose of preventing the imposition of surtax upon its stockholders. Whether section 102 surtax will apply is a question of fact to be determined from all the facts and circumstances of the record. No one criteria is controlling. Helvering v. Chicago Stock Yards Co., 318 U.S. 693">318 U.S. 693 (1943); The Whitney Chain & Manufacturing Co., 3 T.C. 1109">3 T.C. 1109 (1944), aff'd 149 Fed. (2d) 936 (C.A. 2, 1945); Cecil B. DeMille et al., 31 B.T.A. 1161">31 B.T.A. 1161 (1935), 360 aff'd 90 Fed. (2d) 12 (C.A. 9, 1937), cert. denied, 302 U.S. 713">302 U.S. 713 (1937). Under section 102 (c), 2 if earnings or profits are accumulated beyond the reasonable needs of the business, the petitioner must by a clear preponderance of evidence prove that such retention was not to avoid surtax upon its shareholders. During the taxable year, petitioner paid a $14,000 debt which it owed Lasker's for acquisition of its assets. The debt originally had been over $22,000, and between the years 1942 through 1945 was reduced to this amount. In addition, petitioner at the suggestion of its general manager and with the approval of its Board of Directors attempted to obtain delivery trucks, since those on hand were old and in bad condition. It was estimated that the cost of such equipment would be about $8,100. Post-war conditions made it difficult to get delivery trucks, and as a result none were obtained until 1948. After setting aside the $14,000 to pay off the note to Lasker's and the $8,100 estimated to be necessary to purchase the vehicles and eliminating from 362 current assets the linen supplies (which were a necessary part of petitioner's business and not held for sale), petitioner would have had current assets of a little over $12,000 and current liabilities of over $6,000. Retention of such amount under the facts of this case cannot be said to be beyond the reasonable needs of petitioner's business. Respondent relies on cases such as KOMA, Inc., et al. v. Commissioner, 189 Fed. (2d) 390 (C.A. 10, 1951) and McCutchin Drilling Co. v. Commissioner, 143 Fed. (2d) 480 (C.A. 5, 1944). In his brief, respondent states, in citing such cases: "Similar arguments regarding the necessity of retaining accumulated surplus for the purpose of buying necessary machinery at some future indefinite date have frequently been advanced by other taxpayers in Section 102 cases, and just as frequently have been considered wholly lacking in merit, when as here, the taxpayer failed to establish the immediate need of such surplus." The above-cited cases are distinguishable from the instant case. Here, the intention of petitioner was not to purchase the trucks at some future indefinite date, but to purchase them as soon as possible. Petitioner's evidence established 363 the immediate need of such trucks. Petitioner's entire business was based upon the delivery of linens to business establishments, and delivery equipment was essential. During the war, trucks were unavailable for civilian purposes; and, therefore, as soon as the war was over, it was necessary to replace the pre-war equipment as soon as possible. In the McCutchin case, the court said: "The statute, we think, contemplates immediate need, need associated with business in hand * ." Such language is applicable in the instant case, and we feel that here petitioner has established the immediate necessity which was its purpose for retaining the money. Petitioner paid dividends in the amounts of $6,000 for 1947 and 1948 and the amounts of $12,000 for 1949 and 1950. While such evidence of happenings in years after the taxable year in question is not controlling, it is corroborative of the problem existing in section 102 cases; namely, the motive for retention of income. While it might be argued that dividends in 1949 and 1950 are self-serving, since by that time petitioner was aware of the pendency of this case, such argument cannot be made as to the dividends paid in 1947 and 1948. This is 364 not a case where money passed from a corporation to a stockholder by some method other than by declaration of a dividend. No loans were made to Minnie, no stock was retired, nor was any other means employed such as are used at times in this type of case. Because of the foregoing reasons plus all other facts appearing in the record, we hold that petitioner was not availed of in 1946 for the purpose of preventing the imposition of the surtax upon its stockholders by permitting its earnings or profits to accumulate instead of being distributed, and that the respondent erred in the imposition of section 102 surtax on petitioner for the year 1946. Decision will be entered for the petitioner. Footnotes1. SEC. 102. SURTAX ON CORPORATIONS IMPROPERLY ACCUMULATING SURPLUS. (a) Imposition of Tax. - There shall be levied, collected, and paid for each taxable year (in addition to other taxes imposed by this chapter) upon the net income of every corporation (other than a personal holding company as defined in section 501 or a foreign personal holding company as defined in Supplement P) if such corporation, however created or organized, is formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders or the shareholders of any other corporation, through the medium of permitting earnings or profits to accumulate instead of being divided or distributed, a surtax equal to the sum of the following: 27 1/2 per centum of the amount of the undistributed section 102 net income not in excess of $100,000, plus 38 1/2 per centum of the undistributed section 102net income in excess of $100,000. * * ↩2. SEC. 102. SURTAX ON CORPORATIONS IMPROPERLY ACCUMULATING SURPLUS. * *(c) Evidence Determinative of Purpose. - The fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid surtax upon shareholders unless the corporation by the clear preponderance of the evidence shall prove to the contrary.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624616/	CHARLES J. TOBIN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Tobin v. CommissionerDocket No. 25922.United States Board of Tax Appeals17 B.T.A. 1261; 1929 BTA LEXIS 2158; November 6, 1929, Promulgated 2158 The compensation received by the petitioner during the year 1923 as counsel of the New York State Commission to Examine Laws Relating to Children, in which capacity he was an employee of the State of New York, was not subject to Federal income tax. Lawrence Graves, Esq., for the petitioner. R. Ritterbush, Esq., for the respondent. MURDOCK 1261 The Commissioner determined a deficiency of $203.21 in the petitioner's income tax for the calendar year 1923. The petitioner alleges that the Commissioner erroneously included in his taxable income for the year 1923, $2,250 received as compensation for services rendered as counsel of the New York State Commission to Examine Laws Relating to Children. FINDINGS OF FACT. The petitioner is an attorney at law residing at Albany, N.Y.In 1920 a bill was enacted in New York State which provided for the creating of the "New York State Commission to Examine Laws Relating to Children." This commission consisted of three senators, appointed by the temporary president of the senate; three members of the assembly, appointed by the speaker of the assembly; five persons to represent the public at large, 2159 appointed by the governor; and five persons to represent respectively the following five state departments or commissions, the head of each such department or commission appointing one such person: department of education, department of labor, department of health, state board of charities and state probation commission. The general purpose of the commission was to study all laws relating to child welfare, investigate the operation and effect of such laws upon children, ascertain any overlapping or duplication of laws and the activities of any public office, department or commission thereunder, and make recommendations to the legislature of remedial legislation which it might deem proper as a result of its investigations. The act authorized the commission to employ necessary assistants, as a part of its expenses. In February, 1922, the commission appointed the petitioner as its counsel. The appointment was made by the commission itself and was communicated to the petitioner merely by calling him to one of its meetings. There was no written contract 1262 of employment. The petitioner's appointment was not for any fixed period. The services rendered by the petitioner2160 during 1923 consisted of attending meetings of the commission which were held in various parts of the State, appearing before legislative committees and the governor in regard to proposed remedial legislation, and drafting bills. In all his work he acted under the direction of this committee. He received aid in the drafting of bills by conferring with the heads of the various departments represented on the commission and with other persons who he thought might be of particular aid to him, including his law partners. The original act creating the commission called for a report to the state legislature at its next session. In 1921, however, the act was amended so as to read, "The commission shall make reports of its proceedings annually to the legislature." The commission made reports down to and including the year 1926. After that time, the legislature failed to make any further appropriation, although the act under which the commission was created was not repealed. The petitioner's salary was fixed by the commission at $2,500 per year. During the taxable year in question, 1923, the petitioner's income from the commission was $2,250. The commission's pay roll was first approved2161 by its chairman, then by the state comptroller, and finally was paid by check from the state treasurer. During 1923 while the petitioner was acting as counsel for the commission, he was free to accept other employment. He was not required by the commission to spend any specific number of days or hours on its work, but merely to perform his required duties in a reasonable time. The commission did not instruct the petitioner how he should perform his work, but rather they merely assigned him the work and he had the general task of doing it. OPINION. MURDOCK: The petitioner contends that he was an employee of the State of New York, and that therefore his salary received as such employee was not subject to Federal income tax. For a history of the provisions of the various revenue acts relating to the taxability of the compensation of state employees, see . It will be noted that the petitioner was engaged to do certain routine work for the commission. He was not to perform any specific task or to accomplish any definite result. Rather, he was to do whatever work was assigned to him by the commission. 2162 His work was continuous and in a sense was permanent. Clearly, he was subject to the control of the commission, and although he 1263 was to use his skill in performing the various duties assigned to him, under the circumstances we hold that he was an employee of the State and not an independent contractor, and therefore, the salary which he received from the State is not subject to Federal income tax because to tax such income would be contrary to the law that the Federal Government may not tax the instrumentalities of a State. ; affirmed in principle, ; ; ; . There is no deficiency. Judgment will be entered for the petitioner.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624618/	Staked Plains Trust, Limited, Henry F. Whitney, Hugh R. Partridge and William F. Feeney, Trustees v. Commissioner.Staked Plains Trust, Ltd. v. CommissionerDocket No. 109202.United States Tax Court1943 Tax Ct. Memo LEXIS 164; 2 T.C.M. (CCH) 566; T.C.M. (RIA) 43381; August 5, 1943164 J. P. Jackson, Esq., P. B. Randolph, Esq., and W. G. Peavy, C.P.A., 711 Santa Fe Bldg., Dallas, Tex., for the petitioner. Sam G. Winstead, Esq., for the respondent. HILL Memorandum Findings of Fact and Opinion HILL, Judge: This proceeding involves deficiencies in income and excess-profits tax for the year 1937 in the amounts of $12,695.76 and $3,013.23, respectively. In its petition, petitioner claimed an over payment of $729.68 and assigned numerous errors arising from respondent's adjustments. The parties have resolved the majority of their differences by abandonment or agreement and effect will be given thereto in the recomputation under Rule 50. Remaining in controversy are the following issues: (1) Is the sum of $29,750 accrued by petitioner as interest on its Liquidation Rights (Class B) deductible as interest on indebtedness under section 23 (b) of the Revenue Act of 1936? (2) If the first question be answered in the negative, is petitioner entitled to a dividends paid credit by reason of its payment of $72,293.78 on Liquidation Certificates (Class A)? (3) For the purpose of computing surtax on undistributed profits, is petitioner entitled to a credit in the full amount165 of its adjusted net income under section 26 (c) (1) of the Revenue Act of 1936, the amendment to section 26 (c) as provided by section 501 (a) (2) of the Revenue Act of 1942 or section 26 (f) as added by section 501 (a) (3) of the Revenue Act of 1942? The case was submitted upon oral testimony, documentary evidence and a stipulation of facts which we adopt and incorporate herein by reference. Petitioner's tax returns were filed with the collector of internal revenue for the second collection district of Texas at Dallas on an accrual basis of accounting. Findings of Fact Texas Prairie Lands, Ltd., a Canadian corporation, now wholly owned by petitioner, was organized in 1912. It acquired 60,000 acres of unimproved Texas land for the purpose of development and resale thereof in small tracts. On November 20, 1912, it issued First Mortgage Six Per cent Five-Year Bonds in the sum of [] 500,000 ($2,433,333.33) and on December 12, 1914, it issued Prior Lien Notes in the sum of $500,000, both issues being secured by mortgages on the land. The Five-Year Bonds were subordinated to the Prior Lien Notes. The noteholders also became owners of three classes of Profit Sharing Certificates. 166 Petitioner is a trust and was formed under a declaration of trust dated December 12, 1914, to take over and manage, operate and develop the property. The beneficial interest in petitioner's assets was divided into 35,000 shares, all of which were issued to Texas Prairie Lands, Ltd. and immediately deposited as additional security for the payment of the Five-Year Bonds. Petitioner also assumed the corporation's above mentioned liabilities. The declaration of trust authorized petitioner's trustees to borrow money for the purposes of the trust, to place a floating charge upon its assets, and to issue shares in addition to the original 35,000. Such new shares might be issued as preferred or common; for money, property or in payment of liabilities; and could contain any preferences or advantages which the trustees, in their discretion, might designate. The trustees also were given the power "To employ such agents as they shall think proper for the sale or management of any of the said property or in conducting the business of the said trusts * * ." The shareholders were given no right to any distribution except when and as declared by the trustees. Every shareholder was given one vote167 for each share held by him. The duration of petitioner was declared to be 13 years, after which its assets were to be converted into money and, after the discharge of debts, apportioned among the shareholders. In September 1916 petitioner borrowed $100,000 on a note due in December of the same year, which sum was used in the operation and development of the 60,000 acres as had been the funds borrowed by the corporation. To secure further financial aid for the enterprise, a second trust, Prairie Lands Trust, Ltd., was formed under indenture dated December 1, 1916. Petitioner thereupon transferred to it certain contracts of purchase and vendor's lien notes, promised to convey additional assets, guaranteed payment of Texas Prairie Lands, Ltd's Prior Lien Notes, guaranteed a return of $375.000 plus six percent interest to the shareholders of Prairie Lands Trust, Ltd., assigned its accounts receivable and transferred to it a portion of its physical equipment. In consideration therefor, Prairie Lands Trust, Ltd. agreed to carry out certain of petitioner's commitments and obligations, including the payment of the $100,000 note. Prairie Lands Trust Ltd. then borrowed a sum with which to168 perform its agreement and, as security therefor, pledged the subscriptions for its entire beneficial interest which was divided into 4,250 shares. The subscribers were required to pay this loan and the shares were, thereupon, issued to them. In 1919 a plan was conceived envisaging the reorganization of the entire enterprise. This plan was incorporated in a "Reorganization Agreement" dated December 1, 1919, and executed by the three reorganization managers, two of whom were also trustees of petitioner. Among the provisions of the agreement was the following: (e) The Staked Plains Trust Limited shall make one issue of Liquidation Certificates (Class A) and one issue of Liquidation Rights (Class B) and shall provide in effect that, the certificates of Class A shall be paid in full both principal and interest before any payments in respect of the liquidation rights (Class B) and that the liquidation rights (Class B) shall be redeemed in full with interest before any payments shall be made in respect of the shares of the Staked Plains Trust Limited. The plan of reorganization was made known to the holders of the bonds, notes and certificates of Texas Prairie Lands, Ltd. and169 the shareholders of Prairie Lands Trust, Ltd. by means of a printed notice. In connection with this plan, petitioner's trustees met on December 11, 1919, and adopted certain resolutions and records. They were reduced to writing and signed by the trustees. Included therein was the following: And Whereas the proposed reorganization is set forth in the agreement a copy of which appears at the end of these records and immediately following page 38 of this record book Resolved that the Staked Plains Trust Limited hereby accepts and agrees to the plan of reorganization set forth in the said reorganization agreement and the trustees and officers of the said trust are hereby authorized to sign all deeds and instruments and do all things necessary or expedient in order to carry out the said plan and agreement of reorganization and to comply with all directions of the Reorganization Managers therein named Resolved to authorize an issue of Liquidation Certificates (Class A) in the principal sum of $625,000 in the form contained in Schedule A annexed to the said reorganization agreement Resolved to authorize an issue of Liquidation Rights (Class B) to the number of 4,250170 and to issue certificates representing the same in the form contained in Schedule A annexed to the said reorganization agreement Thereafter, the reorganization was effectuated in accordance with the plan. Prairie Lands Trust, Ltd. retransferred to petitioner all remaining assets previously received and all bonds and profit sharing certificates of Texas Prairie Lands, Ltd. were retired as were the shares of Prairie Lands Trust, Ltd. To the former holders of Prior Lien Notes and Class A Profit Sharing Certificates were issued petitioner's Liquidation Certificates (Class A) in the aggregate amount of $625,000, such certificates being in words and figures as follows: Liquidation Certificate (Class A) This is to certify that the registered holder hereof is entitled to receive from time to time payments aggregating $ with interest thereon at the rate of (7 per cent per annum from 1st July 1918 or) (5 per cent per annum from 1st January 1923) funds of Staked Plains Trust Limited as and when such payment shall be authorized by the Trustees of the said trust and that the total amount above mentioned including both principal and interest shall be paid before any payments shall be made171 either from income or distribution of capital by the Trustees in respect of the liquidation rights or the shares of the said Trust This liquidation certificate is one of a series aggregating $625,000 in amount of which $500,000 carry interest at the rate of 7 per cent per annum from 1st July 1918 and $125,000 carry interest at the rate of 5 per cent per annum from 1st January 1923. All payments upon or in respect of the said series shall be made equally and proportionately upon all certificates thereof Payments shall be made only upon presentation of this certificate to the Old Colony Trust Company in Boston or to its representative in New York or Lodon for proper notation hereon. This certificate is transferable only by written assignment noted on the books of the Old Colony Trust Company in Boston or of its representative in London and endorsed hereon IN WITNESS WHEREOF the said Staked Plains Trust Limited has caused this certificate to be duly signed in its name by the said Old Colony Trust Company as its agent this For the STAKED PLAINS TRUST Limited OLD COLONY TRUST COMPANY, Agent By Vice-President To the former holders of shares in Prairie Lands Trust, 172 Ltd. were issued petitioner's Liquidation Rights (Class B), the liquidation rights being divided in the same proportion as were the shares. These certificates were in words and figures as follows: Liquidation Rights Certificate (Class B) This is to certify that the registered holder hereof is entitled to liquidation rights of the Staked Plains Trust Limited. The said rights are redeemable by payments to be made out of the funds of the said trust from time to time when and as authorized by the Trustees of the said trust for the total sum of $160 plus interest at the rate of 7 per cent per annum from 1st January 1920 for each right. The liquidation rights represented by this certificate are part of a total number amounting but limited to 4,250 liquidation rights all of which are similar and equal All payments in respect of the said liquidation rights shall be made equally and proportionately upon all the said series. No payments shall be made thereon until after the total amount of Liquidation Certificates (Class A) of the said trust aggregating $625,000 and interest shall have been paid. No payments in liquidation or otherwise shall be made in respect of the shares of the 173 said trust until all of the liquidation rights shall have been redeemed at and for the amounts above stated. Payments shall be made only upon presentation of this certificate to the Old Colony Trust Company in Boston or to its representatives in New York or London for proper notation thereof. The liquidation rights represented by this certificate are transferable only by written assignment noted on the books of the Old Colony Trust Company in Boston or its representatives in London and endorsed hereon IN WITNESS WHEREOF the said Staked Plains Trust Limited has caused this certificate to be duly signed in its name by the said Old Colony Trust Company as its agent this For the STAKED PLAINS TRUST LIMITED OLD COLONY TRUST COMPANY. Agent By Petitioner's 35,000 shares were divided among the former holders of Texas Prairie Lands, Ltd.'s First Mortgage Bonds at the rate of seven shares for each bond. Each former bondholder was also entitled to obtain Liquidation Rights (Class B) at a price of $110 plus interest, the subscription being limited to 85/100 of one right for each [] 100 bond. Petitioner has since operated and continues to operate the properties under the174 agreement of December 1, 1919. No change has been made in the terms of the trust agreement by which petitioner was formed or in the rights and interests of the parties acquired pursuant to such agreement of December 1, 1919. By means of several partial payments, the principal amount called for under the Liquidation Certificates (Class A) was paid by August 31, 1930, petitioner, in the meantime, having accrued and deducted on its tax returns the so-called interest on such certificates in a total amount of $289,175.12. In 1937 $72,293.78 of this previously accrued sum was paid the holders of such certificates leaving $202,422.58 the balance due as of December 31, 1937. All such payments were made partly from receipts from land sales and partly from income arising from operations. Through 1937 no payment of any kind had been made to the holders of the Liquidation Rights (Class B). From its formation to January 1, 1937, petitioner had sustained net operating losses of approximately $1,800,000. Its adjusted net income for 1937 was $39,330.76. At the end of 1937 petitioner owned 46,100.15 acres of land in various stages of development with its value per acre ranging from $29 to $64. 175 The book value of improvements at that time was $297,167.67. Petitioner accrued interest on the Liquidation Rights (Class B) for the year 1937 of $29,750 and in its income tax return for that year deducted the amount of such accrual from gross income. Respondent disallowed the deduction. It is stipulated that for the purposes of this proceeding petitioner is to be considered an association properly taxable as a corporation. Opinion The first two questions involve the nature of the "interest" payments in respect of petitioner's so-called Liquidation Certificates (Class A) and Liquidation Rights (Class B). Petitioner contends that $29,750 accrued on its books in 1937 as interest on Liquidation Rights (Class B) is deductible under authority of section 23 (b) of the Revenue Act of 1936 1 or, in the alternative, that a dividends paid credit should be allowed since $72,293.78 in "interest" was distributed in the taxable year to the holders of Liquidation Certificates (Class A). In short, it is petitioner's position that the two issues of certificates must be treated similarly; that in both cases the payments are either interest or dividends within the meaning of the revenue act. The176 legal effect of the "interest" payments called for by each issue must depend upon the circumstances relating to that issue alone. Because payments under one class may be denoted dividends, it does not follow that payments under the other are also dividends. The question of whether payments called for under the terms of a corporate certificate are interest on an indebtedness or dividends on an investment has been an issue in numerous decided cases. See ; ; ,177 and cases cited therein. Such authorities are not of great help however, since the question is one of fact and the facts in each case are so variant as to make almost every decision distinguishable on some ground. Moreover, distinguishing criteria held significant in other situations are not necessarily determinative here because of the singular character and purpose of the instant entity. Petitioner, though treated as a corporation for the purpose of this proceeding, is a trust and, consequently, the form, nature and incidents appertaining to its certificate do not approximate those of analogous corporate issues. Moreover, as opposed to the usual business enterprise which contemplates an indefinite continuation of operations, petitioner was formed for the very purpose of liquidating its assets and this plan was promoted by the reorganization agreement. This purpose is reflected in the form, terminology and rights granted in certificates, and particularly those issued pursuant to the reorganization. Hence, factors such as the existence of maturity dates, which in a less unique situation might be indicative of the relationship established between the issuer and certificate holder, 178 here are of little probative value. The ultimate fact to be found with regard to the status of the holders of the two classes of certificates here involved is, of course, whether such holders are, in fact, creditors of petitioner with a right to interest on their loan or simply the owners of a beneficial interest thereof hoping for a return on their investment. This determination must be made with an eye to the whole record. Of real significance is the intent of the parties as evidenced by their conduct, statements and the circumstances attending the issuance of the certificates, with all reasonable inference to be drawn from these acts and circumstances. ; . The evidence here shows that all the endeavors of the interested parties were directed toward the irrigation, development, improvement, division and resale of a large tract of Texas land. The tremendous cost of the development plus the dearth of buyers resulted in 179 a need for working capital beyond that which had been anticipated, and, hence, brought about certain financial proceedings. Among them was one which enabled petitioner to obtain $500,000 in exchange for Prior Lien Notes secured by a mortgage on petitioner's assets. These notes, originally issued by Texas Prairie Lands, Ltd., were interest bearing and the holders were unquestionably superior lien creditors. To these creditors were also issued Class A-Profit Sharing Certificates entitling them to receive an additional $125,000 before any payments of principal and interest were made on an existing [] 500,000 bonded indebtedness. A further effort to continue the original enterprise resulted in the formation of a second trust, Prairie Lands Trust, Ltd., which took over a portion of petitioner's assets and obligationsc This trust issued 4,250 beneficial shares and the holders thereof comprised another class of parties in interest, beneficial owners of Prairie Lands Trust, Ltd. Petitioner's guaranty that the assets transferred to Prairie Lands Trust, Ltd. would enable it to redistribute $375,000 to its shareholders did not, under the evidence here, make these shareholders petitioner's creditors. 180 The reorganization plan adopted in 1919 envisaged a merger of the assets owned by petitioner and Prairie Lands Trust, Ltd., as well as the retirement of securities issued by Texas Prairie Lands, Ltd. Thereafter, all parties were to hold certificates issued by petitioner. On the other hand, existing priorities as between the holders were to be unchanged. Pursuant to this agreement and a subsequent resolution of petitioner's trustees, the two instant issues were authorized in the form which they respectively possess. The so-called Liquidation Certificates (Class A) were exchanged for Prior Lien Notes and Class A-Profit Sharing Certificates while the so-called Liquidation Rights (Class B) were issued to Prairie Lands Trust, Ltd. in exchange for its assets and by it distributed to its shareholders. The circumstance that the two types of certificates, though issued simultaneously and as a part of a sigle plan, differed substantially in form is evidence of an intent that they should represent different types of obligations. This is supported by the fact that the Liquidation Certificates (Class A) replaced what previously had been evidences of debt whereas the Liquidation Rights (Class 181 B) were issued to the former shareholders in the trust merged with petitioner in exchange for their trust shares. The combination of these circumstances suggests the intent that the holders of the Class A Certificates should continue as creditors while the holders of Class B Rights should have only a beneficial interest in the trust returns. In form the Liquidation Certificates (Class A) more nearly approximate an interest bearing note than a preferred share in the trust whereas just the reverse is true of the Liquidation Rights (Class B). While form is not conclusive, still the parties must be presumed to know the differences between bonds and shares and when they adopt a form of certificate incorporating elements of one or the other, their acts must be given the intended effect, unless there is evidence that the certificates did not recite what they were intended to mean. . Here the intent and form are in accord. An examination of the Liquidation Certificate (Class A) discloses that the holder is entitled to receive out of petitioner's funds a specific amount with interest at a given rate per year and that182 this amount shall be paid before any payments shall be made either from income or distribution of capital in respect of the Liquidation Rights (Class B) or the shares of the trust. A note need not be in any special form. These words sufficiently show a promise to pay a sum certain plus interest in all events and regardless of the character of the funds from which either principal or interest is to be paid. True, no maturity date is fixed. However, since available funds depended upon the speed with which the sale of the farms could be accomplished, we do not consider this to have conditioned the payment. The certificate holders could not have obtained payments faster than cash was received regardless of the maturity date. On the other hand, doubtless they could have forced payment should none have been forthcoming within a reasonable period after cash was realized from the assets. Moreover, consistent with an indebtedness, the entire issue of the Liquidation Certificates (Class A) aggregated a sum certain, $625,000, and this figure was identical with the principal amount of the obligations which this issue replaced. Conversely, the so-called Liquidation Rights (Class B) did not purport183 to represent an obligation in a specific sum. On the contrary, this issue was divided into 4,250 similar and equal "rights". The word "right" denotes an interest or title in an object of property and, thus, the very terminology of this issue displays the intent that its holders should share in the ownership of the trust. Ownership, obviously, is incompatible with the relationship of creditor-debtor. ; . Furthermore, the certificates did not call for the payment of a sum certain but simply provided that the rights were redeemable at the option of petitioner's trustees. The reciation of the amount for which each right may be redeemed merely defined the maximum monetary value of the holder's beneficial interest and this is consonant with the usual corporate preferred stock which generally limits participation but places it ahead of common stockholders. Moreover, the so-called "interest" payments were not due or payable annually, but merely increased the value of the holder's right as and when it was redeemed. Not only could no payments184 whatever be made with respect to these certificates until the $625,000 and interest, represented by the Liquidation Certificates (Class A), were paid, but even thereafter the so-called "interest" did not become due. This is inconsistent with the concept of debt. The accrued amount more nearly approximates an anticipated dividend on preferred stock. ; ; , (on appeal, CCA-3rd).1This conclusion is substantiated by a resolution appearing in petitioner's "Records of Trustees adopted 11th December 1919". We quote therefrom: And Whereas at the time of the formation of the Prairie Lands Trust Limited it was intended that every holder of bonds of Texas Prairie Lands Limited should have an equal opportunity to subscribe to and become interested in the Prairie Lands Trust Limited on the same terms as all other subscribers but during the war it was found 185 impossible to communicate with all of the bondholders and it was also impossible for many of those with whom communications were held to avail themselves of the opportunity on account of restrictive laws in foreign countries. And Whereas it is now desired to afford all such bondholders the opportunity to place themselves in the same position as they would have occupied if they had subscribed to their proportionate interest in Prairie Lands Trust Limited. Now Therefore in order to accomplish the foregoing objects the following resolutions are hereby adopted: * * * * Resolved that as a part of the consideration of the foregoing purchase and in order to give the holders of all the 5000 first mortgage bonds of the Texas Prairie Lands Limited (of the par value of [] 100 each) an opportunity to acquire the said 4,250 liquidation rights on an equal and proportionate basis at a price equal to cost to the subscribers to Prairie Lands Trust Limited the trustees of the last mentioned trust shall agree to offer through the Reorganization Managers under the plan or reorganization of Texas Prairie Lands Limited in such manner and under such conditions as the said Reorganization186 Managers may fix to each of the holders of first mortgage bonds of the said company an opportunity to purchase eight-five one hundredths (85/100) of one liquidation right for each bond of [] 100 held by such bondholders at and for the price of $110 plus interest at the rate of 6 per cent. per annum from 1st January 1920 in cash for each liquidation right. No such opportunity was presented with respect to Liquidation Certificates (Class A). It is apparent that a principal purpose for the formation of Prairie Lands Trust, Ltd., and the subsequent issuance of Liquidation Rights (Class B), was to enable all the original bondholders, if they so chose, to enter into a joint venture with a view to minimizing the loss which, from all appearances, they were bound to sustain. The fact that these parties were permitted to subscribe for the rights; that they were required to pay only $110 for certificates redeemable at a minimum of $160; that advantages superior to those of the holders of the common shares were granted, and that all rights were subordinated to the payment of principal and interest under the Liquidation Certificates (Class A), show that the Liquidation Rights (Class B) were 187 regarded as preferred shares in the enterprise and not as evidence of an absolute debt. The holders thereof were adventurers in a business and they were no less adventurers because their hope was recoupment rather than profit. Considering the entire record we are of the opinion and it is, therefore, held that the accrual account in respect of the socalled Liquidation Rights (Class B) does not represent interest due on an indebtedness. Respondent properly disallowed such a deduction from 1937 income. We hold, further, that the so-called Liquidation Certificates (Class A) did represent an indebtednes of petitioner and that the amounts distributed to the holders thereof in 1937, accordingly, were not dividends on an investment. In view of these conclusions it becomes unnecessary to discuss alternate contentions urged by respondent respecting the non-deductibility of both petitioner's $29,750 acrual and its $72,293.78 payment. The next issue is whether petitioner is entitled to a credit under section 26(c)(1) of the Revenue Act of 1936 2 by reason of a provision of a written contract executed prior to May 1, 1936, 188 expressly dealing with and restricting the payment of dividends. Petitioner contends that the reorganization agreement of December 1, 1919, under which it has since operated, constitutes such a contract. Respondent, in his brief, does not allude to the reorganization agreement or petitioner's argument in that connection. Rather, he reasserts his position that the Liquidation Certificates (Class A) and Liquidation Rights (Class B), which contained restrictive language, are not debts. Consequently, he urges, they are not contracts within the meaning of section 26(c)(1). Obviously, this contention is weakened by our conclusion that the Liquidation Certificates (Class A) do represent an indebtedness. 189 By 1919 three entities and numerous individuals were interested in the enterprise involving the development and sale of the Texas Land first acquired by Texas Prairie Lands, Ltd. In addition to this corporation, petitioner and Prairie Lands Trust, Ltd. were concerned with the original purpose. Moreover, several classes of note, bond and shareholders had a stake in the undertaking of one sort or another. The project was so burdened with financial obligations, as to make an orderly liquidation of the assets in accordance with the original purpose virtually an impossibility. To remedy this difficulty a plan was proposed, such plan being set forth in a written reorganization agreement. In principle it contemplated the surrender of pre-existing securities and shares in exchange for certain new issues to be authorized by petitioner. The palpable intention was, however, that preferences then existing between the holders of the several kinds of securities should not be altered. It was provided that the Prior Lien Notes should be retired in exchange for Liquidation Certificates (Class A) and that, "The Staked Plains Trust Limited shall make one issue of Liquidation Certificates (Class190 A) and one issue of Liquidation Rights (Class B) and shall provide in effect that the certificates of Class A shall be paid in full both principal and interest before any payments in respect of the liquidation rights (Class B) * * ." The Liquidation Rights (Class B) are in the nature of preferred shares representing an investment in the enterprise as we have shown above. Hence it is apparent that this provision expressly deals with the payment of dividends. Furthermore, annexed to the agreement was a proposed form of the Liquidation Certificates (Class A), such form containing a restriction upon payments in respect of the liquidation rights or petitioner's shares until the full amount of principal and interest was paid on the certificates. The plan so set forth in the reorganization agreement was specifically accepted and agreed to by resolution of petitioner's trustees which incorporated therein a copy of the agreement and which was adopted December 11, 1919, reduced to writing and by them signed. Moreover, it was also resolved that the Liquidation Certificates (Class A) be issued in the form suggested in the schedule to the reorganization agreement. The original trust indenture191 reposed in the trustees the power to act for the trust. The adoption of the agreement by written resolution signed by them was the adoption of such by petitioner. Pursuant thereto the Liquidation Certificates (Class A) were issued and, as is stipulated by the parties, petitioner since has operated under the agreement at all times. The written acceptance and adoption of the agreement signed by the trustees and incorporating therein the agreement constituted a written contract executed by petitioner. Cf. . As we have pointed out, the agreement contained a provision expressly dealing with the payment of dividends and this, of course, is included in the ratification. The contract was executed prior to May 1, 1936. Hence, the petitioner was subject to a contract restricting the payment of dividends within the meaning of section 26 (c) (1). Petitioner's contention may be sustained by reason of another contract, the Liquidation Certificates (Class A). For reasons previously set forth we concluded that these certificates were, in fact, notes representing debt. Unquestionably such note is a contract. Williston192 on Contracts, [] 7. See . Cf. , certiorari denied , (42 P-H [] 63036): , certiorari denied . Each Liquidation Certificate (Class A) contained a clause expressly restricting the payment of dividends until the face amount thereof plus interest was paid and each was signed for the petitioner by its agent. Petitioner's trustees were authorized to act through agents. Such certificates were also contracts falling within section 26 (c) (1). During the year 1937 there remained a balance due in respect of Liquidation Certificates (Class A). Petitioner, in compliance with its agreement, made no payments on its Liquidation Rights (Class B) or on its original shares. We hold that petitioner, in computing its undistributed profits tax for 1937, is entitled to a credit in the full amount of its adjusted net income by reason of a contract restricting the payment of 193 dividends within the meaning of section 26 (c) (1), supra. ; . The application of this credit would relieve petitioner of liability for tax on undistributed profits and respondent erred in not so determining. In view of this conclusion it becomes unnecessary to consider whether a credit might equally be available under the provisions of section 501 (a) (2) and (3) of the Revenue Act of 1942 amending section 26 of the Revenue Act of 1936. Decision will be entered under Rule 50. Footnotes1. SEC. 23. DEDUCTIONS FROM GROSS INCOME. In computing net income there shall be allowed as deductions: * * * * (b) Interest. - All interest paid or accrued within the taxable year on indebtedness, except on indebtedness incurred or continued to purchase or carry obligations (other than obligations of the United States issued after September 24, 1917, and originally subscribed for by the taxpayer) the interest upon which is wholly exempt from the taxes imposed by this title.↩1. Subsequently affirmed by CCA-3, .↩2. SEC. 26. CREDITS OF CORPORATIONS. In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax - * * * *(c) Contracts Restricting Payment of Dividends. - (1) Prohibition on Payment of Dividends. - An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. If a corporation would be entitled to a credit under this paragraph because of a contract provision and also to one or more credits because of other contract provisions, only the largest of such credits shall be allowed, and for such purpose if two or more credits are equal in amount only one shall be taken into account.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624619/	LELAND L. AND ROSANNE M. SPRAGUE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentSprague v. CommissionerDocket No. 16043-86.United States Tax CourtT.C. Memo 1989-117; 1989 Tax Ct. Memo LEXIS 117; 56 T.C.M. (CCH) 1511; T.C.M. (RIA) 89117; March 23, 1989F. T. Muegenburg,118 Jr., for the petitioner. Elizabeth Rawlins, for the respondent. FAYMEMORANDUM FINDINGS OF FACT AND OPINION FAY, Judge: This case was assigned to Special Trial Judge Larry L. Nameroff pursuant to section 7456(d) (redesignated as section 7443A(b) by the Tax Reform Act of 1986, Pub. L. 99-514, section 1556, 100 Stat. 2755) of the Code 1 and Rule 180 et seq. The Court agrees with and adopts the opinion of the Special Trial Judge, which is set forth below. OPINION OF THE SPECIAL TRIAL JUDGE NAMEROFF, Special Trial Judge: Respondent determined deficiencies in petitioners' income tax and additions to tax as follows: YearDeficiencySec. 6653(a)1979$ 15,691.64$ 784.5819807,562.00499.00198113,793.00 690.00119 The issues for decision are: 1) whether Leland L. Sprague received constructive dividends between 1979 and 1981 totalling $ 76,000.00 from Leland L. Sprague, M.D., Inc., his wholly-owned corporation; and 2) whether petitioners are liable for additions to tax due to negligence or intentional disregard of rules and regulations. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and exhibits are incorporated herein by this reference. Petitioners are husband and wife who resided in Ventura, California at the time their petition was filed in this case. Hereinafter, Dr. Sprague will be referred to as petitioner. Petitioner has been an anesthesiologist since 1960. He has resided in Ventura, California since 1979 and has maintained a practice in Ventura since 1964. Petitioner also invests in real estate. Petitioner's business, Leland L. Sprague, M.D., Inc., (hereinafter referred to as the corporation) is a professional corporation organized under the laws of the State of California in 1971. Prior to 1971, petitioner operated his business as a sole proprietorship. Petitioner has been the corporation's sole director and shareholder120 since its formation. Moreover, petitioner and his wife have been the corporation's only officers. Specifically, petitioner has served and continues to serve as the corporate president and treasurer. Rosanne M. Sprague has served and continues to serve as the corporate vice president and secretary. At all times relevant herein, the corporation has filed its Federal income tax returns using a fiscal year ending September 30. Between May 25, 1979 and June 4, 1981, petitioner made nine withdrawals from the corporation. 2 Eight of these withdrawals were repaid. The relevant transactions occurred as follows: Date Of WithdrawalAmountDate Of RepaymentMay 25, 1979$ 5,000.00 December 17, 1981June 7, 19795,000.00 December 17, 1981August 21, 197910,000.00 August 15, 1983December 28, 197910,000.00 December 28, 1983February 10, 19805,000.00 April 9, 1984March 11, 19805,000.00 May 17, 1984May 26, 19805,000.00 May 17, 1984April 30, 198111,000.00 April 21, 1985June 4, 198120,000.00 -121 Petitioner regularly received correspondence from his legal counsel, F. T. Muegenburg, Jr., Esq., or Mr. Muegenburg's assistant. These letters notified petitioner that the corporate bylaws required him to convene a meeting of either the corporate shareholders or the corporate directors by a prescribed date. Upon receipt of such notices, it was petitioner's practice to hold the appropriate corporate meeting with petitioner and his wife in attendance. It was also petitioner's practice to transcribe the minutes of these meetings in longhand. He would then send the handwritten minutes to Mr. Muegenburg's office, where they were typed. Thereafter, the minutes were returned to petitioner and were placed in the corporation's permanent records. One of these handwritten minutes, from a director's meeting on April 20, 1979, contains the following: "resolved -- that the officers of the corp. be authorized to loan [petitioner] from time to time money at the prevailing rate of interest in a total amount not to exceed 1 years [sic] salary at any given time." Thereafter, the corporation issued a check to petitioner, dated May 25, 1979, in the amount of $ 5,000.00. The check, which was122 signed by Dr. Sprague, contained the notation "1 yr. loan." The withdrawal was used by petitioner to invest in a movie. On June 7, 1979, the corporation issued a second check to petitioner in the amount of $ 5,000.00. Again, the check contained a notation "Loan - 1 yr." This withdrawal was used by petitioner to pay an obligation on a second trust deed on a rental property. On August 21, 1979, the corporation issued a check to petitioner in the amount of $ 10,000.00. The notation on the check read "Transfer." The $ 10,000.00 was transferred to the Spragues' personal checking account and was eventually used to pay a note on a trust deed on commercial property. On November 15, 1979, petitioner received a letter from his attorney's assistant transmitting the typed minutes of previous meetings. The letter also stated: "In your April 20 minutes, where the corporation is authorized to loan money to you individually, please be aware that if such a loan is made to you, it must be substantiated by a demand note and a resolution of the director. Also, pursuant to a recent tax court ruling, interest-free loans may be made from the corporation to you as a shareholder." On December 28, 1979, petitioner123 withdrew another $ 10,000.00 from the corporation. The money was used in part to pay an obligation on a second trust deed and in part to finance the reconstruction of some rental property. Withdrawals of $ 5,000.00 each were made from the corporation by petitioner on February 10, 1980, March 11, 1980 and May 26, 1980, to finance the reconstruction of rental property. The checks issued by the corporation to petitioner all contained notations stating either "Demand Loan" or "Loan, demand." In a letter dated May 13, 1980, Mr. Muegenburg advised petitioner that the interest-free loans made by the corporation constituted a "Tax Court approved employee-shareholder benefit." 3 In a letter dated June 12, 1980, Mr. Muegenburg further advised petitioner to refine the existing promissory notes and corporate resolutions to reflect a more formalistic style. Revised promissory notes were enclosed. We presume that the executed, demand interest-free notes stipulated by the parties are these revised notes, even though dated as of each transaction, and that the "original" notes were then destroyed. 124 The last two withdrawals from the corporation by petitioner were in the amounts of $ 11,000.00 and $ 20,000.00, and were made on April 30, 1981 and June 4, 1981, respectively. Promissory notes and corporate resolutions were issued to support the loans. In addition, the corporate check for the April 30, 1981 withdrawal contained the notation "Loan." The $ 11,000.00 was used to purchase a mobile home for petitioner's mother, while the $ 20,000.00 was placed in a money market investment account. Until December 17, 1981, petitioner failed to repay any of the notes outstanding. The corporation received an audit notice dated November 5, 1981 from I.R.S. Revenue Agent Michelle Rosenthal. The notice informed the corporation that its tax returns would be audited for the fiscal years ending September 30, 1980 and September 30, 1981. On December 17, 1981, petitioner repaid $ 10,000.00 and the notes for the loans dated May 25, 1979 and June 7, 1979 were marked "paid." Other repayments were made as indicated above. In the summer of 1984, petitioner was advised by his attorney that it would be necessary to pay interest on the loans then outstanding. At that time, the remaining interest-free125 demand notes were cancelled and new, interest-bearing notes were issued. On or about February 22, 1981, petitioner applied for a $ 120,000.00 residential loan from the Bank of A. Levi of Ventura, California. At the time petitioner applied for the loan, seven of the nine shareholder advances at issue were outstanding. As part of the loan application, petitioner submitted a financial statement to the bank. On the financial statement, petitioner failed to list the seven advances as liabilities. However, petitioner also failed to list other assets on the financial statement including automobiles, jewelry, art work and Krugerrands. By April 1985, petitioner had repaid all of the outstanding debts at issue except for the withdrawal on June 4, 1981. All nine withdrawals were appropriately reflected in Schedules L of the corporation's various income tax returns. At all times relevant, the corporation had earnings and profits in excess of the amounts at issue. All the notes at issue were unsecured and no repayment schedule was ever drawn up by the corporation during the years at issue. However, the record indicates that petitioner always possessed the ability to repay the loans. 126 The following schedules reflect the corporation's gross income, the compensation paid to petitioner, and retained earnings for the corporation's fiscal years ending September 30, 1979, September 30, 1980, September 30, 1981, and September 30, 1982. YearGross IncomePetitioner's SalaryRetained Earnings1979$ 210,322.30$ 96,000.00$ 50,368.151980$ 234,312.12$ 96,000.00$ 50,671.121981$ 270,188.48$ 96,000.00$ 101,400.261982$ 288,394.13$ 116,000.00$ 163,111.69Since the corporation's inception, it has never issued a dividend. Petitioner stated that the lack of dividends was due to his desire to keep funds available in case a malpractice judgement was entered against the corporation in excess of its $ 500,000 liability coverage. Petitioner also wished to keep money in the corporation because he was contemplating acquiring additional office space for his billing operations. Petitioner was in fact considering the purchase of several different properties for that purpose, although no such purchase was actually made. Petitioner stated that he viewed the interest-free portions of the loans as an employee benefit. OPINION127 Section 61(a)(7) provides that gross income includes dividends. Section 301 provides that a distribution of property by a corporation to a shareholder with respect to its stock is includable in gross income to the extent the distribution is a dividend as defined by section 316. Section 316 defines a dividend as any distribution of property made by a corporation to its shareholders out of its earnings and profits accumulated after February 28, 1913. Section 317 defines "property" as including money, securities and any other property. The determination of whether a withdrawal from a wholly-owned corporation constitutes a loan or a dividend depends upon petitioner's intent at the time the withdrawal is made. If petitioner's intent was to repay, the withdrawal will be treated as a loan. However, if petitioner's intent was to retain the advanced funds, the withdrawal will be treated as a constructive dividend. Berthold v. Commissioner,404 F.2d 119">404 F.2d 119, 122 (6th Cir. 1968), affg. a128 Memorandum Opinion of this Court; Haag v. Commissioner,88 T.C. 604">88 T.C. 604 (1987). Such intent is a question of fact to be determined upon a thorough evaluation of all the circumstances in each case. Haag v. Commissioner, supra.Establishing the taxpayer's intent by direct evidence is extremely difficult. Dean v. Commissioner,57 T.C. 32">57 T.C. 32, 43 (1971). Consequently, the Court must utilize several objective criteria to determine whether a withdrawal constitutes a loan or a dividend. These objective criteria include: the extent of shareholder control of the corporation; the retained earnings and dividend history of the corporation; the size of the withdrawals; the presence of conventional indicia of debt, such as promissory notes, collateral, and provision for interest; treatment of advances in corporate records; the history of repayment; and the taxpayer's use of the funds. Busch v. Commissioner,728 F.2d 945">728 F.2d 945, 948 (7th Cir. 1984). Other objective criteria include "whether the corporation imposed a ceiling on the amounts129 that might be borrowed, whether [there] were definite maturity dates, attempts to force repayment, intention or attempts to repay, and the shareholder's ability to liquidate the loan." Williams v. Commissioner,627 F.2d 1032">627 F.2d 1032, 1035 (10th Cir. 1980). None of these factors, standing alone, is determinative of the issue before us. Alterman Foods, Inc. v. United States,505 F.2d 873">505 F.2d 873, 876-877 n.6 (5th Cir. 1974). However, these factors are useful in determining whether there is a true intention to repay. Some of these factors favor respondent, while others favor petitioners. Based upon an analysis of the foregoing factors as they apply to this case, we conclude petitioner has not demonstrated that he intended to repay the withdrawals when they were made. First, we note that there has been no showing that petitioner needed the withdrawn funds. The use to which the funds were put indicates that petitioner regarded the corporation as another "pocket" or personal source of funds, rather than an arm's-length lender. The withdrawn funds were used for personal investments or, on one occasion, a mobile home for petitioner's mother. The initial withdrawal,130 as well as all subsequent withdrawals, were made under a corporate resolution permitting the loans without any showing of need or other restriction, except that the total borrowings not exceed petitioner's annual salary. Of course, petitioner's salary was a matter over which he had total control as sole shareholder of the corporation. Therefore, the resolution had very little significance. We think petitioner regarded these loans as a right attributable to the form of business that he utilized. Petitioner admits he failed to initiate repayment of any of his debts to Leland L. Sprague, M.D., Inc., during 1979, 1980 and from January to November 1981, even though the early withdrawals were initially supposed to be repaid within one year. Petitioner's first repayment occurred on December 17, 1981, when he purportedly paid off the May 25, 1979 note and the June 7, 1979 note. Significantly, these repayments occurred shortly after the IRS had notified petitioner of its intention to audit LeLand L. Sprague, M.D., Inc., in a letter dated November 5, 1981. We believe that there is a strong cause and effect relationship between the receipt of the audit letter by petitioner and his commencement131 of repayments. Subsequent to the inception of the audit, further repayments were made. Petitioner claimed that he was motivated to make the first repayment because he "had a little extra money" and "it seemed prudent to go ahead and repay it at that time." We are not persuaded that petitioner was particularly "flush" at that time. Indeed, we believe these repayments would not have been made but for the receipt of the audit notice. In O'Connor v. Commissioner,T.C. Memo. 1985-616, we accorded little probative value to impromptu repayments made by taxpayers under notice of audit. "Use of the withdrawals for personal interests and repayment after the start of an audit are incompatible with an intent to repay when the withdrawals were made." Williams v. Commissioner,627 F.2d 1032">627 F.2d 1032, 1035 (10th Cir. 1980), affg. a Memorandum Opinion of this Court. Petitioner's intention not to repay the corporate withdrawals is further demonstrated by his failure to list the then-outstanding withdrawals at issue as debts on a bank loan application wherein petitioner listed132 fourteen other real estate loans as debts. Petitioner's failure to list these withdrawals on the bank loan application indicates he did not view them as bona fide loans. Additional factors indicating the withdrawals were dividends include: (1) all nine promissory notes specifically provided that the borrowed amounts were interest free and payable on demand; (2) none of the loans were either secured by collateral or supported by written repayment schedules; (3) the corporation apparently had little concern regarding repayment; (4) none of the loans had a business purpose directly related to petitioner's practice, but were instead used for petitioner's real estate investments or for personal purposes; and (5) significantly, the corporation never issued a dividend notwithstanding substantial retained earnings. The only credible evidence presented by petitioner which would indicate that these withdrawals were loans are the promissory notes, loan authorizations and corporate tax returns which characterize these withdrawals as loans. However, while this evidence is to be considered, it is not controlling. 133 "Book entries and records may not be used to conceal a situation which is not in reality what it is made to appear." Fenn v. Commissioner,T.C. Memo. 1980-229, 40 T.C.M. 559 at 561. Based upon the foregoing considerations, we must reject petitioner's contention that the withdrawals at issue were bona fide loans. We conclude that such amounts should be treated as dividends distributed to petitioner from his wholly-owned corporation. Petitioner has failed to carry his burden of demonstrating that the amounts at issue were bona fide loans. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rule 142 (a). We now consider respondent's determination of additions to tax under sections 6653(a)(1) and 6653(a)(2). Petitioners have the burden of proof to show that the underpayments were not due to negligence or the intentional disregard of rules or regulations. Enoch v. Commissioner,57 T.C. 781">57 T.C. 781, 802 (1972). After a review of the facts and circumstances presented, we hold that petitioners are not liable for the additions to tax set forth in the notice134 of deficiency. Decision will be entered for respondent, except for the additions to tax.Footnotes1. Hereinafter, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the years at issue, unless otherwise indicated. All Rule references are to the Tax Court Rules of Practice and Procedure.↩*. For 1981, this addition to tax was determined under section 6653(a)(1); respondent also determined an addition to tax for 1981 under the provisions of section 6653(a)(2) in an amount equal to 50% of the interest due on the total underpayment.↩2. Our use of the terms "loan", "repayment", "note", "promissory note" and other similar terms for for convenience only and do not impart any legal conclusion or significance.↩3. The letter cited Crown v. Commissioner67 T.C. 1060">67 T.C. 1060 (1977), affd. 585 F.2d 234">585 F.2d 234 (7th Cir. 1978), and Suttle v. CommissionerT.C. Memo. 1978-393, affd. 625 F.2d 1127">625 F.2d 1127 (4th Cir. 1980). Crown held that no gift was occasioned by a tax-free loan, while Suttle refused to reconsider our previous opinion in Dean v. Commissioner,35 T.C. 1083">35 T.C. 1083↩ (1961), to the effect that the interest-free portion of a loan does not generate gross income (i.e., imputed interest income). None of these cases held that a loan to a shareholder or employee of a closely-held corporation was not a dividend as a result of, or in spite of, the interest-free feature.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624620/	Southwest Natural Gas Company, Petitioner, v. Commissioner of Internal Revenue, RespondentSouthwest Natural Gas Co. v. CommissionerDocket No. 15243United States Tax Court14 T.C. 81; 1950 U.S. Tax Ct. LEXIS 293; January 27, 1950, Promulgated 293 Decision will be entered under Rule 50. Reorganization -- Statutory Merger -- Section 112 (g) (1) (A), I. R. C. -- In a statutory merger pursuant to state law, corporation A acquired all the assets of corporation B in exchange for a total consideration of $ 663,393.01, consisting of 16.4 per cent of A's common stock having a market value of $ 5,592.50 and a certain amount of A's bonds, cash, and the assumption of B's liabilities.(1) Held, on authority of Roebling v. Commissioner, 143 Fed. (2d) 810, that in addition to the statutory merger and to constitute a "reorganization" within the Federal income tax statutes, the transaction must meet the test of the "continuity of interest" doctrine enunciated by the courts.(2) Held, further, on authority of Le Tulle v. Scofield, 308 U.S. 415">308 U.S. 415, that the bonds involved in the exchange did not represent a retained proprietary interest and that for purposes of this opinion the bonds are to be considered as the equivalent of cash.(3) Held, further, on authority of Helvering v. Minnesota Tea Co., 296 U.S. 378">296 U.S. 378, that the shares294 of stock involved representing the retained proprietary interest having a value of only $ 5,592.50 did not constitute a substantial part of the value of the assets transferred by corporation B and that accordingly there was no statutory merger within the meaning of the term "reorganization" as defined by section 112 (g) (1) (A), I. R. C.A. O. Dawson, Esq., and Paul Smith, Esq., for the petitioner.John W. Alexander, Esq., for the respondent. Tyson, Judge. TYSON 81 This proceeding involves deficiencies for the years and in the amounts as follows:YearTaxAmount1941Income tax$ 22,475.331942Declared value excess profits tax1,452.241942Excess profits tax112,347.9582 The only contested issue is whether respondent erred in his determination that a transaction alleged to have been a statutory merger, whereby the petitioner acquired all the assets and assumed all liabilities of the Peoples Gas & Fuel Corporation on December 28, 1940, did not constitute a "reorganization" within the meaning of section 112 (g) of the Internal Revenue Code.The parties have stipulated the figures to be used for computing petitioner's depreciation deductions and equity invested capital for the years in question, dependent upon the decision herein on the above mentioned reorganization issue, and, further, certain other assignments of error have been settled by stipulation to be given effect in a recomputation under Rule 50.The proceeding has been submitted upon the pleadings, 296 testimony, and a stipulation of facts, with appended exhibits.FINDINGS OF FACT.The facts as stipulated are so found.Petitioner is a corporation, duly organized and existing under the laws of the State of Delaware. It was incorporated on April 17, 1928, under the name of Southwest Gas Utilities Corporation of Oklahoma, and subsequently, on April 23, 1937, its name was changed to Southwest Natural Gas Co. Petitioner is engaged in business as a natural gas operating public utility, with its principal office at Shreveport, Louisiana. For the calendar years 1941 and 1942, respectively, petitioner duly filed its corporation income and declared value excess profits tax returns, on Form 1120, and its corporation excess profits tax returns, on Form 1121, with the collector of internal revenue at New Orleans for the district of Louisiana.Prior and leading up to the December 28, 1940, transaction here in question, certain undisputed transactions occurred involving petitioner and three other similar utility companies. As subsidiaries of the same parent holding company, which owned 100 per cent of the stock of petitioner and two others and 80 per cent of the stock of another, those four297 operating utility companies occupied the same office space in Shreveport and their business affairs were conducted by the same group of persons serving in the capacities of directors, officers, attorneys, accountants, and engineers. On September 30, 1935, the parent holding company distributed pro rata to its own stockholders all of the shares of stock held in the four subsidiaries, which continued operations as theretofore conducted, and the new stockholders of the four companies gave consideration to merging or consolidating them into one company. On April 22, 1937, one of those companies, the Southwest Gas Co. of Oklahoma, was merged with petitioner, which continued doing business at the Shreveport office and operated properties located in Texas and Oklahoma. Due 83 to financial difficulties the other two companies, Northwest Louisiana Gas Co. and Peoples Gas & Fuel Co., were involved in proceedings under section 77-B of the Bankruptcy Act and, pursuant to an order of the court in such proceeding, were merged on November 30, 1938, into a new Delaware corporation duly organized in November, 1938, under the name of "Peoples Gas and Fuel Company, Inc." (hereinafter referred298 to as Peoples). The latter thereupon operated Louisiana properties from the Shreveport office.At meetings held on December 5, 1940, the board of directors of petitioner and the board of directors of Peoples, respectively, unanimously adopted a resolution approving and authorizing the execution of a proposed agreement of merger, dated December 5, 1940, which provided the terms of a merger of Peoples with and into petitioner as the continuing corporation pursuant to chapter 65 of the Revised Code of Delaware. At the same meetings there were adopted resolutions calling for due notices of special meetings of the stockholders of the two corporations to vote thereon. Following those meetings and under date of December 5, 1940, the directors of petitioner and the directors of Peoples, respectively, made and entered into the agreement of merger. At special meetings of the stockholders of petitioner and of Peoples, held on December 28, 1940, respectively, more than two-thirds of the common and preferred stock of petitioner and of the common stock of Peoples, issued, outstanding, and entitled to vote, voted in favor of the agreement of merger and authorized the officers to do all acts 299 necessary to consummate it.On December 28, 1940, the agreement of merger between petitioner and Peoples was duly executed on behalf of each corporation by the proper officers and under the corporate seal thereof, together with certifications as to the adoption thereof by the stockholders of each corporation, and the agreement was filed in the office of the Secretary of State of Delaware and recorded in the office of the Recorder of the County of New Castle, Delaware, in which petitioner and Peoples had their original certificates of incorporation recorded. On February 3, 1941, such agreement of merger was filed in the office of the Secretary of State of Louisiana and recorded in the record of charters of that state.Prior to the statutory merger of petitioner and Peoples pursuant to the laws of Delaware as above mentioned, petitioner was the larger of the two companies. Their respective balance sheets as of October 31, 1940, show total assets and liabilities in the amounts of $ 4,352,033.26 for petitioner and $ 1,682,008.91 for Peoples. The assets of both companies shown on those balance sheets consisted principally of tangible property, plant, equipment, etc. In the prior 77-B300 proceeding which resulted in the organization of Peoples, the holders of all types of stocks, bonds, and other securities of Peoples' predecessors received 84 shares of common stock of Peoples which remained free of any bonded indebtedness, and its liabilities shown on its balance sheet embraced, inter alia, an authorized 25,000 shares of common stock, par value $ 1 each, not all of which were issued and outstanding, and a paid-in and earned surplus of $ 1,438,020.69. Petitioner's liabilities as shown on its balance sheet embraced, inter alia, Southwest Gas Co. of Oklahoma 6 per cent first mortgage bonds due May 1, 1954, in the amount of $ 1,419,150, less treasury bonds amounting to $ 376,000, which bond issue had theretofore been assumed by petitioner; certain other long term debts; an authorized capital stock of 20,000 shares of $ 6 dividend cumulative preferred stock, series A, par value $ 10 each, and 1,200,000 shares of common stock, par value 10 cents each, not all of which preferred and common stock was issued and outstanding; and a paid-in and earned surplus of $ 324,243.50.As of December 7, 1940, the petitioner had issued and outstanding in the hands of the301 public 9,590 shares of preferred stock which was $ 12.75 per share in arrears on dividends, and also 566,150 shares of common stock, which had a market value of 5 cents a share. As of the same date, Peoples had issued and outstanding in the hands of the public 17,769 shares of common stock which had a market value of $ 30 a share. Of such 566,150 shares of common stock of petitioner, 480,813 shares were held by persons who also owned 6,291 shares of common stock of Peoples, that is, the same group of people owned approximately 85 per cent of the common stock of petitioner and 35 per cent of the common stock of People. There was no substantial change in the record of stockholders of either company between December 7 and December 28, 1940.In connection with the drafting of the proposed agreement of merger, it was necessary to consider the difficulties presented by the variation in the capital structure and in the market value of the common stock of the two companies. An exchange of common stock for common stock was not feasible because on the basis of market value it would have required 600 shares of petitioner's to equal in value one of Peoples' and, further, petitioner's common302 stock was subordinate to its long term debt and preferred stock outstanding. Accordingly, the plan devised and incorporated in the terms of the agreement of merger was that the common stockholders of Peoples would have the option to receive in exchange for each share of Peoples either (A) 10 shares of petitioner's common and $ 33 principal amount of petitioner's bonds, with a cash adjustment equivalent to 90 per cent of the principal amount of bonds of less than $ 50 denomination, or (B) cash in the amount of $ 30 per share. All shares of stock of petitioner outstanding at the time of the agreement were to remain outstanding; and no new securities were to be issued to the then holders thereof in connection with the merger. In addition the group of persons who 85 held substantial amounts of common stock in and exercised actual control over the operations of both companies agreed among themselves that they would exercise their respective options in such manner that the total exchanges consummated in the merger would come within the respective amounts of petitioner's common shares, bonds, and cash available therefor.On December 28, 1940, there was a total of 18,875 shares of303 common stock of Peoples entitled to participate under the agreement of merger. The holders of 7,690 of such shares exercised option B of that agreement and received $ 30 in cash for each share, or a total of $ 230,700. The holders of 11,185 shares of Peoples' common stock (or 59.2 per cent of the total outstanding) exercised option A and received in exchange therefor under the agreement of merger, the following: $ 349,350 principal amount of petitioner's 6 per cent first mortgage bonds of the market value of 90 cents on the dollar, or a total value of $ 314,415; $ 17,779.50 cash for fractional bond interests; and 111,850 shares of petitioner's common stock having a market value of 5 cents per share, which shares represented 16.4 per cent of petitioner's outstanding common stock immediately after the merger transaction was consummated.On December 28, 1940, all of Peoples' assets were transferred to petitioner and the liabilities of Peoples, amounting to $ 94,906.01, were assumed by petitioner in connection with the merger. On the same date all of Peoples' assets, depreciable and undepreciable, in its hands had an unadjusted basis of $ 1,724,468.62 and an adjusted basis of $ 938,912.68. 304 The parties have stipulated the adjusted basis for depreciation in the hands of Peoples of its depreciable property on December 28, 1940, and they have further stipulated with respect to Peoples' property in the hands of petitioner, and, if the merger transaction on that date was a reorganization within the meaning of the Internal Revenue Code, the amounts of depreciation deductions allowable to petitioner for each of the years 1941 and 1942, and also the amounts, respectively, to be used in determining petitioner's equity invested capital for 1941 and 1942 and borrowed invested capital for 1941.Prior to the transaction on December 28, 1940, petitioner and Peoples maintained a common principal place of business at Shreveport, had the same four men as their respective officers, had the same men as principal employees, and conducted their affairs as an integrated business, and those circumstances constituted the reasons for the statutory merger of the two companies, under the laws of Delaware, for the purpose of better integration and greater efficiency. Following the transaction, the petitioner conducted the business as it had been previously conducted, petitioner's officers and305 principal employees were the same persons as previously employed, and petitioner's 86 board of directors was substantially an amalgamation of the prior boards of directors of petitioner and Peoples. After the transaction, individuals who had theretofore owned a substantial amount of stock in Peoples owned approximately 88 per cent of petitioner's outstanding common stock as a result of the stock they received in the merger transaction plus their prior stockholdings in petitioner, and those same individuals continued in active control of the merged business enterprise.In asserting the deficiencies involved herein, the respondent determined that the transaction of December 28, 1940, whereby petitioner acquired the assets of Peoples, did not constitute a reorganization within the meaning of section 112 (g) of the Internal Revenue Code and that the basis of such assets was the cost thereof to petitioner, as follows:Cash paid$ 248,479.50Liabilities assumed94,906.01Bonds issued (principal amount)349,350.00Stock issued (market value 5 cent per share)5,592.50Total 698,328.01The parties have stipulated that if the December 28, 1940, transaction between306 petitioner and Peoples was not a reorganization within the meaning of the Internal Revenue Code the petitioner's cost basis for depreciable assets acquired therein and allowable depreciation deductions thereon for 1941 and 1942 are in the respective amounts as determined by respondent in the deficiency notice.OPINION.The only contested issue presented for decision is whether the statutory merger of Peoples with petitioner on December 28, 1940, constituted a purchase by petitioner of the assets of Peoples as determined and herein contended by respondent, or, as contended by petitioner, constituted a "reorganization" within the meaning of that term as defined by subsection (g) (1) (A) of section 112 of the Internal Revenue Code, 1 which section provides the general rule for the recognition of gain or loss upon the sale or exchange of property and for the exceptions thereto in specifically described exchanges incident to readjustments of corporate structures or corporate reorganizations.307 87 The facts herein establish, and the respondent does not contend otherwise, that the petitioner and Peoples, both Delaware corporations, duly complied with the provisions of the Revised Code of Delaware of 1935, chapter 65, section 59, pertaining to the procedure for consolidation or merger of corporations and pursuant thereto duly effectuated a statutory merger of Peoples with and into the petitioner as the continuing corporation, on December 28, 1940. Accordingly, in the instant proceeding we have a statutory merger of Peoples with petitioner under state law and a compliance with the literal language of the above definition of the term "reorganization." However, the parties are in agreement on the established principle that such literal compliance alone is not sufficient, and both cite Roebling v. Commissioner, 143 Fed. (2d) 810; certiorari denied, 323 U.S. 773">323 U.S. 773, as authority that, in addition thereto and to constitute through merger a "reorganization" within the meaning of the Federal income tax statutes, the transaction must meet the test of the "continuity of interest" doctrine enunciated in numerous decisions308 of the Supreme Court of the United States to distinguish a transaction which, though taking the form of a reorganization, constitutes a taxable sale or exchange from a transaction which in fact as well as in form constitutes a tax-free reorganization within the intendment of the Federal statute. The parties differ only with regard to whether the "continuity of interest" test has been met under the facts of this case.In the Roebling case, supra, two corporations complied with state law providing for mergers, but, since the stockholders of the merged corporation received in exchange therefor only long term bonds of the continuing corporation, the court held that they thereby surrendered their former proprietary interest in certain property and simply became creditors of the continuing corporation, and that the transaction was not a "reorganization" within the meaning of section 112 (g) (1) (A) of the Revenue Act of 1938, which provided, "(1) The term 'reorganization' means (A) a statutory merger or consolidation." In reaching its conclusion the court relied upon the "continuity of interest" doctrine first introduced in Supreme Court decisions in Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U.S. 462">287 U.S. 462,309 and as applied in Le Tulle v. Scofield, 308 U.S. 415">308 U.S. 415, and other cited cases.In the instant case and under the agreement of merger, all of Peoples' assets were acquired by petitioner in exchange for certain amounts of stock, bonds, cash, and the assumption of debts. As to the stock involved, the owners of 59.2 per cent of Peoples' common shares received 16.4 per cent of petitioner's outstanding common stock, representing their continuing proprietary interest in the enterprise after the merger. The question here is thus narrowed to one of whether such retained proprietary interest was sufficient to satisfy the test of 88 the "continuity of interest" doctrine enunciated by court decisions.An examination of numerous Supreme Court decisions involving application of the "continuity of interest" test leads to the conclusion that there is no precise formula for that test, but, instead, different language has been used to express a meaning of the phrase "continuity of interest" as applied to the facts involved in each particular case. In cases involving an exchange in a merger or consolidation alleged to constitute a "reorganization" as defined310 by the tax statutes, it has been held, in Pinellas Ice & Cold Storage Co. v. Commissioner, supra (1933), that an exchange for cash and promissory notes constituted a sale because such notes were the equivalent of cash and the transferor did not acquire a sufficiently definite "interest in the affairs of the purchasing company"; in Helvering v. Minnesota Tea Co., 296 U.S. 378 (Dec. 16, 1935), that an exchange for $ 426,842.52 in cash and 18,000 shares of common stock valued at $ 540,000 constituted a merger "reorganization" because the statute does not inhibit a substantial change in the relationship of the transferor to the assets conveyed and the transferor acquired a "definite and material" interest in the affairs of the transferee, represented by a "substantial part of the value of the thing transferred"; in Nelson Co. v. Helvering, 296 U.S. 374 (Dec. 16, 1935), that an exchange for $ 2,000,000 cash and the entire authorized issue of 12,500 shares of nonvoting preferred stock constituted a merger "reorganization" because the transferor acquired "a definite and substantial interest311 in the affairs of the purchasing corporation," represented by ownership of the preferred stock, although denied voting rights, since neither participation in the management of nor a controlling stock interest in the transferee is requisitee; and in Le Tulle v. Scofield, supra (1940), that an exchange for cash and bonds constituted a sale because the transferor became solely a creditor of the transferee and did not retain "any proprietary interest in the enterprise"; and, further, that the statute is "not satisfied unless the transferor retained a substantial stake in the enterprise," as for instance, such a stake as was thought to be retained in the Minnesota Tea and Nelson Co. cases, supra.Since the types of exchanges in different mergers or consolidations of necessity vary considerably one from the other in order to meet the widely varying circumstances as to capital structure, etc., involved in different transactions of that character, and in the light of the pronouncements in the above cited cases, we conclude that the basic test is whether, under all the facts and circumstances involved in a particular merger or consolidation, it312 can be said that the transferor corporation or its stockholders retained a proprietary stake in the enterprise represented by a definite and material interest in the affairs 89 of the transferee company and, as was said in the Minnesota Tea case, supra, that such retained interest represents "a substantial part of the value of the thing transferred," so that the transaction genuinely partakes of the true nature of a merger or consolidation and, further, that, other than being "substantial," there is no precise measure of the extent of such proprietary stake requisite to satisfy the "continuity of interest" test laid down by court decisions. Each case must rest upon its own facts in the light of prior decisions.In the instant case that part of the consideration consisting of bonds did not represent a proprietary interest in the assets transferred, Le Tulle v. Scofield, supra, and for the purposes of this opinion may be considered as being in the same category as the cash consideration, thus in effect treating the transfer as one for cash and stock, as was true in the Minnesota Tea case, supra. Accordingly, the principle enunciated313 and as applied in deciding the last cited case is determinative of the instant case.In the Minnesota Tea case, supra, the assets of one corporation were transferred to another corporation and, as more particularly shown in the Circuit Court's opinion in 76 Fed. (2d) 797, for a total consideration of $ 966,842.52, consisting of $ 426,842.52 cash and 18,000 shares of the transferee corporation's stock, which stock had a value of $ 540,000. In deciding that there was a reorganization, the Supreme Court enunciated the principle that the retained definite and substantial interest represented by stock in a transferee corporation "must represent a substantial part of the value of the thing [assets] transferred. * * in order that the result accomplished may genuinely partake of the nature of merger or consolidation," and it concluded that the proportion of the total consideration there paid for the transferor corporation's assets represented by the value of the stock of the transferee corporation satisfied the requirement of the principle enunciated.In the instant case, as in the Minnesota Tea case, supra, the record discloses no value of the314 assets transferred other than as evidenced by the consideration paid therefor. Here, the total consideration paid amounted to $ 663,393.01, consisting of cash and its equivalent amounting to $ 657,800.51 and common stock of petitioner having a market value of $ 5,592.50. Such a small fractional portion of the total value of the assets transferred as is represented by the value of the common stock can not in our opinion be said to represent a substantial part of the value of the assets transferred, as is required under the principle enunciated in the Minnesota Tea case, supra, and we hold that the transaction here involved did not constitute a statutory merger within the provisions of section 112 (g) (1) (A), supra, and, therefore, was not a reorganization. On this issue the respondent is sustained.90 The petitioner points to the various facts as to continuity of the business enterprise, directors, officers, employees, etc., and particularly to the fact that after the exchange those persons who had owned 59.2 per cent of Peoples' common stock owned 16.4 per cent of petitioner's outstanding common stock, as representing their continuing proprietary interest. Petitioner315 contends that such continuing proprietary interest in the transferee corporation measured by the 16.4 per cent of its common stock should be regarded as substantial enough to meet the continuity of interest test. We think it should not be so regarded, if for no other reason, than that such method gives no consideration to the value of petitioner's outstanding preferred stock, which is not shown and which, as well as did the common stock, represented an interest in the value of all of petitioner's assets, including those transferred by Peoples, after the consummation of the transaction involved; and it would be necessary to know the value of this outstanding preferred stock in order to arrive at the proper proportion of the interest of the holders of the 16.4 per cent of common stock in the assets transferred by Peoples. And in this connection it may be noted that, while the value of the outstanding preferred stock is not shown, it is obvious that it represented a vastly more valuable interest in petitioner and its assets than did the entire outstanding common stock, since after the transaction was completed petitioner's outstanding 678,000 shares of common stock had a market value316 of only 5 cents per share or a total of $ 33,900, while petitioner's outstanding 9,590 shares of preferred stock of $ 10 par value per share bore an annual dividend rate of $ 6 per share, or the equivalent of 6 per cent on a $ 100 per share valuation, and, as shown by an exhibit to the stipulation, was entitled to receive in preference to the common stock, upon any distribution of assets other than dividends from surplus or profits, $ 100 per share plus any accumulated and unpaid dividends thereon.Decision will be entered under Rule 50. Footnotes1. SEC. 112. RECOGNITION OF GAIN OR LOSS.* * * (g) Definition of Reorganization. -- As used in this section (other than subsection (b) (10) and subsection (l)) and in section 113 (other than subsection (a) (22)) --(1) The term "reorganization" means (A) a statutory merger or consolidation * *.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/1359007/	237 Kan. 807 (1985) 703 P.2d 818 THE WESLEY MEDICAL CENTER, Plaintiff-Appellee, v. THE CITY OF WICHITA, KANSAS, Defendant-Appellant, and THE BOARD OF COUNTY COMMISSIONERS OF THE COUNTY OF SEDGWICK, Defendant/Appellee, and GEORGE E. RAINEY, Defendant. No. 57,546 Supreme Court of Kansas. Opinion filed July 26, 1985. Douglas J. Moshier, assistant city attorney, argued the cause and was on the brief for appellant. Michael L. North, of Boyer, Donaldson & Stewart, of Wichita, argued the cause and was on the brief for appellee, Wesley Medical Center. Edward L. Keeley, of Crockett & Gripp, of Wichita, argued the cause and was on the brief for appellee, Board of County Commissioners of Sedgwick County. The opinion of the court was delivered by PRAGER, J.: This is an action brought by Wesley Medical Center of Wichita to recover the value of medical expenses furnished by that hospital to George E. Rainey following a gun battle and Rainey's subsequent arrest by Wichita police officers. The defendants in the case were George E. Rainey, the City of Wichita, the Board of County Commissioners of Sedgwick County, and the Board of County Commissioners of Butler County. The district court found that Butler County was not 808 liable for the medical services, and that judgment is not questioned on this appeal. The controversy in the trial court and on this appeal is whether the City of Wichita or Sedgwick County is liable to Wesley Medical Center for the medical services it provided George E. Rainey. The case was submitted to the trial court on a stipulation of facts which may be summarized as follows: On July 11, 1981, in Butler County, the defendant, George E. Rainey, shot and killed a highway patrolman who had stopped him on the Kansas Turnpike. Rainey continued south on the turnpike and got off at the east Wichita exit. Word of the shooting reached the Wichita police before Rainey's arrival in Wichita. Shortly after entering the city limits, Rainey was stopped by Wichita police officers and a gun battle resulted. In the course of the gun battle, Rainey was seriously wounded. At the instance of the Wichita officers, an ambulance was dispatched to the scene. The emergency medical personnel on the ambulance then determined that Rainey would be transported to Wesley Medical Center for treatment of his wounds. On the trip to the hospital and for six days thereafter, until July 17, 1981, Rainey was under guard by Wichita police officers. Defendant Rainey was charged with attempted first-degree murder in Sedgwick County. His first appearance before a magistrate in Sedgwick County took place on July 17, 1981, at the hospital. Rainey was guarded in the hospital by officers of the Sedgwick County sheriff's department from July 17, 1981, until July 31, 1981. Rainey was also under guard at times during that period by officers of the Butler County sheriff's department. On July 31, 1981, Rainey was released from the hospital and transferred to the Sedgwick County jail. After approximately one hour in the jail, he was released to the custody of the Butler County sheriff and taken to Butler County and jailed. Subsequently, he was arraigned, stood trial, and was convicted of the murder of a state highway patrolman. Rainey was returned to the Sedgwick County jail on December 29, 1981, for disposition of the felony charges pending against him in Sedgwick County District Court. These matters were concluded and he was sent to the Kansas State Penitentiary on January 12, 1982. It was undisputed that defendant Rainey was an indigent within the meaning of K.S.A. 22-4501 et seq. The claim for medical treatment supplied to 809 defendant Rainey by Wesley Medical Center from July 11, 1981, to July 31, 1981, amounted to $19,071.66. On February 5, 1982, Wesley Medical Center filed this action against Rainey, Butler County, and Sedgwick County. After discovery and several hearings, Wesley Medical Center moved for leave to add the City of Wichita as a party defendant, which motion was granted. The basic dispute in the case was whether the City of Wichita or Sedgwick County was responsible for Rainey's medical expenses. On August 23, 1984, the case proceeded to trial upon facts stipulated or admitted by all the parties involved. The trial court held that the City of Wichita was liable for Rainey's medical expenses from July 11, 1981, to July 17, 1981, during which period Rainey was under guard by the Wichita police. The trial court held that Sedgwick County was liable for the medical expenses from July 17, 1981, to July 31, 1981, during which period Rainey was under guard by the Sedgwick County sheriff's office. The City of Wichita appealed and the case was transferred to the Supreme Court. Wesley Medical Center filed a cross-appeal. The basic issue presented in the case is this: Is a city responsible for the payment of medical expenses incurred by an indigent person who is arrested by city police and subsequently charged with and convicted of a violation of state law, who before being physically transported to the county jail, is taken to a hospital for necessary medical treatment? Before considering the specific issue presented, it would be helpful to review some of the basic legal principles which are applicable where a person, who is arrested by law enforcement officers or confined in a jail, requires medical services. It has long been the statutory law of Kansas that it is the duty of all keepers of jails and prisons to treat their prisoners with humanity. K.S.A. 19-1919, which specifically so provides, was enacted as a part of the General Statutes of 1868 in Chapter 53, Section 19. The later Kansas cases have consistently held that a prisoner's rights include entitlement to medical care at the governmental agency's expense, if the prisoner is indigent and no other source of funds is available. Levier v. State, 209 Kan. 442, 497 P.2d 265 (1972); Pfannenstiel v. Doerfler, 152 Kan. 479, 483, 105 P.2d 886 (1940); Dodge City Med. Center v. Board of Gray County Comm'rs, 6 Kan. App. 2d 731, 634 P.2d 163 (1981); Mt. 810 Carmel Medical Center v. Board of County Commissioners, 1 Kan. App. 2d 374, 566 P.2d 384 (1977). It should be noted that several earlier Kansas cases held that a county is not bound to pay a physician for medical services rendered by him to prisoners in the county jail unless such services are authorized by the county. Hendricks v. Comm'rs of Chautauqua Co., 35 Kan. 483, 11 P. 450 (1886); County of Smith v. County of Osborne, 29 Kan. 72 (1882); Roberts v. County of Pottawatomie, 10 Kan. 29 (1872). The later cases, however, place a positive duty upon the county to furnish medical attention to a prisoner in custody who is in need of medical attention, if the prisoner is indigent and no other source of funds is available. In Mt. Carmel Medical Center v. Board of County Commissioners, 1 Kan. App. 2d 374, a county prisoner, in an attempt to escape from jail, jumped out of an unlocked window and dropped four stories to the ground, causing him to break a leg. A neighbor heard his screams and called the Oswego police. The police arrived and called an ambulance. The ambulance, a doctor, and a sheriff's deputy arrived at the scene. The doctor recommended hospitalization where orthopedic care was available. The deputy sheriff concurred with the decision to send the escapee to the hospital where he was provided medical treatment. It was held that the fact that the injured man was an escaped man when he received treatment was not determinative of the sheriff's responsibility to provide medical attention. The determinative factor was whether he was in custody when the decision was made to transport him to the hospital. The county was held liable for the medical care provided. Dodge City Med. Center v. Board of Gray County Comm'rs, 6 Kan. App. 2d 731, presents a factual situation comparable to that in the case now before us. In that case it was held that, where a suspect is apprehended in the commission of a felony, felled by an officer's gunshots, and taken to the hospital by the sheriff, the suspect is "in custody" while hospitalized, for the purpose of determining the county's liability for his medical expenses, even though he has not been formally arrested or kept under guard. In the present case, the City of Wichita and Sedgwick County agree that one of those two political subdivisions is responsible for the medical expenses incurred in the treatment of George E. Rainey. The dispute is over which entity is responsible for them. 811 In the state of Kansas, there are a number of cities that have no municipal jail facilities. It is quite customary for the city police of those cities to take city prisoners to the county jail for incarceration. For a number of years, this has been true in Sedgwick County where persons arrested by Wichita police officers are taken to the county jail. In 1963, the Kansas legislature enacted K.S.A. 19-1930, which provided for compensation to the county for the maintenance of United States prisoners and city prisoners held in county jails. The statute was later amended in 1981 and 1984 and now appears at K.S.A. 1984 Supp. 19-1930, which provides in part as follows: "(a) The sheriff or the keeper of the jail in any county of the state shall receive all prisoners committed to the sheriff's or jailer's custody by the authority of the United States or by the authority of any city located in such county and shall keep them safely in the same manner as prisoners of the county until discharged in accordance with law. The county maintaining such prisoners shall receive from the United States or such city compensation for the maintenance of such prisoners in an amount equal to that provided by the county for maintenance of county prisoners and provision shall be made for the maintenance of such prisoners in the same manner as prisoners of the county. The governing body of any city committing prisoners to the county jail shall provide for the payment of such compensation upon receipt of a statement from the sheriff of such county as to the amount due therefor from such city. "(b) The sheriff or the keeper of the jail in any county of the state shall receive all prisoners committed to the sheriff's or jailer's custody pursuant to K.S.A. 75-5217, and amendments thereto, and shall keep them safely in the same manner as prisoners of the county until discharged in accordance with law or until otherwise ordered by the secretary of corrections. The cost of maintenance of such prisoners, including medical costs of such prisoners shall be paid by the department of corrections in an amount equal to that provided by the county for maintenance of county prisoners. "(c) In lieu of charging city authorities for the cost of maintenance of prisoners as provided by subsections (a) and (b), the board of county commissioners of Sedgwick county may levy a tax not to exceed 1 mill upon all tangible taxable property of the county to pay such costs and the costs of maintaining county prisoners. Any such levy shall not be subject to the provisions of K.S.A. 79-5001 et seq., and amendments thereto. No revenue derived from such levy shall be used to pay the costs of maintenance of prisoners committed to the jail by federal or state authorities, or authorities of other counties or cities in other counties. For the purpose of this subsection, if any portion of a city is located within a county levying a tax hereunder, all prisoners of such city shall be deemed prisoners of such county." (Emphasis supplied.) It should be noted that under K.S.A. 1984 Supp. 19-1930(a) the sheriff or the keeper of the jail in any county is required to receive all prisoners committed by the authority of the United 812 States or by the authority of a city and to keep them as prisoners of the county. The county maintaining such prisoners is entitled to receive from the United States or such city compensation for the maintenance of such prisoners in an amount equal to that provided by the county for the maintenance of county prisoners. Section (b) was added by the 1981 legislature to cover situations where a county sheriff receives into his custody a person who has violated the conditions of his parole or conditional release and a warrant for his arrest has been issued by the secretary of corrections. The cost of maintenance of such prisoners is to be paid by the department of corrections. In 1984, the legislature enacted section (c) to authorize the board of county commissioners of Sedgwick County to levy a tax on all tangible property of the county to pay the costs of maintaining county prisoners and also prisoners of cities located within Sedgwick County, including the city of Wichita. From time to time in the past, disputes have arisen as to which governmental subdivision is responsible for medical services provided a prisoner who is in the custody of the county. The attorney general of Kansas has held on three separate occasions that, under K.S.A. 19-1930, the cost of medical treatment provided a prisoner arrested for violation of a state statute is the responsibility of the county, and the cost of medical treatment provided a prisoner arrested for the violation of a local municipal ordinance is borne by the city. In this regard see attorney general opinions Nos. 77-286, 78-66, and 83-93. It appears that this is a case of first impression involving a controversy between a county and city as to which entity has the obligation to pay the medical expenses of a person who has been arrested by city police officers for violation of a state law but who was taken to a hospital before being delivered to county officers. Simply stated, it is the position of Sedgwick County that a governmental entity is liable for the medical expenses of a person who is indigent and where no other source of funds is available, if the person is in the "custody" of that governmental entity's representatives. The county argues that, in the present case, the county sheriff never obtained custody of George E. Rainey until July 17, 1981, when the sheriff's deputies began guarding Rainey in the hospital. Sedgwick County maintains that, until a prisoner has been physically turned over to the 813 sheriff's custody or arraigned for state felony charges, the county has no responsibility or liability for any necessary medical expenses incurred on behalf of an indigent prisoner. Hence, the county maintains the trial court correctly held that the City of Wichita was responsible for Rainey's medical care from July 11, 1981, to July 17, 1981, during which period the city police officers were guarding the prisoner. It is the position of the City of Wichita that a county should be held liable for the medical expenses provided a prisoner is arrested for a violation of a state statute, even though the prisoner was arrested by city police officers and taken directly to a hospital for medical care. Simply stated, it is the City's position that the obligation to pay medical expenses of an indigent prisoner depends upon whether the person has been arrested for a violation of state law or a violation of a city ordinance. There are a number of cases from other jurisdictions where the issue has arisen and, although there is a split of authority, the majority of the cases hold that a county's liability for medical expenses furnished a prisoner should not depend on which governmental law enforcement agency happens to be called to the scene of the alleged crime or whether the prisoner is hospitalized before or after he is placed in the county jail. The important factor is whether the offender was arrested for a violation of a state law or for a violation of a municipal ordinance. Two Oregon cases in point are Bd. of Higher Educ. v. Wash. Co., 52 Or. App. 369, 629 P.2d 373, rev. denied 291 Or. 368 (1981); and Rogue Valley Memorial Hosp. v. Jackson Cty., 52 Or. App. 357, 629 P.2d 377, rev. denied 291 Or. 368 (1981). Both of these cases hold, so long as an offender is arrested for violation of state law and in due course is ultimately delivered to a local correctional facility for confinement and trial, the medical expenses incurred as a consequence of and following his arrest, and until his transfer to the county facility, are chargeable to the county. A county's liability for charges and expenses for maintaining prisoners, including medical expenses, should not depend on which police agency is called to the scene of the alleged crime or whether such person is hospitalized before or after he is placed in the county jail. A similar result was reached in St. Mary of Nazareth Hospital v. City of Chicago, 29 Ill. App. 3d 511, 331 N.E.2d 142 (1975). An Illinois appellate court in a different 814 division criticized that opinion and held to the contrary in Sisters of Third Order, Etc. v. Tazewell Cty., 122 Ill. App. 3d 605, 78 Ill. Dec. 230, 461 N.E.2d 1064 (1984), on the basis that the person was not charged with a state offense prior to or during hospitalization. That court held that the charging of the patient while hospitalized is the catalyst which results in the liability of the county for incurred medical expenses. Another case in point is Washington Township Hosp. Dist. v. County of Alameda, 263 Cal. App. 2d 272, 69 Cal. Rptr. 442 (1968), where a California appellate court held that where a prisoner is confined in the county jail after having been charged with or convicted of violating a state law or county ordinance, the expense of his care and maintenance must be paid by the county even though the prisoner may have been arrested by a city police officer and temporarily confined in the city jail. In City of Plantation v. Humana, Inc., 429 So. 2d 37 (Fla. Dist. App. 1983), it was held that a city was not liable for the medical expenses of a prisoner because there was no showing of statutory authority establishing such liability or a showing of a contractual relationshp or implied promise to pay by the city, even though the prisoner was arrested and charged with a violation of Florida state statutes. There are a number of Kansas statutes which indicate a legislative policy that the liability for care and maintenance of a prisoner, including medical expenses, should be the responsibility of the governmental entity, the violation of whose criminal statutes was the basis for the arrest. As noted heretofore, K.S.A. 1984 Supp. 19-1930 clearly expresses a legislative policy that the cost of maintenance of a prisoner in a county jail who was taken into custody under the authority of the United States should be paid by the United States government, while the cost of maintenance of a prisoner arrested and taken into custody under the authority of a city should be paid by the city. Likewise, the cost of maintenance, including medical costs, of a prisoner delivered to a county jail under the authority of the secretary of corrections for a parole violation should be paid by the department of corrections. Other Kansas statutes express a similar legislative policy. K.S.A. 19-1916 governs situations where a prisoner who is charged with crime in one county is placed in the physical 815 custody of the jailer of another county. That statute authorizes a judge of a county in which there is no sufficient jail to order a prisoner confined in the jail of the nearest county having a sufficient jail. The sheriff of the county having the jail is required to receive and keep in his custody such a prisoner "at the expense of the county from which such person was sent." Another example is K.S.A. 19-1917, which provides that any county jail may be used for the safekeeping of any fugitive from justice from another state, and the jailer shall be entitled to reasonable compensation for the support and custody of such fugitive from justice, to be paid by the officer demanding the custody of the same. Thus, the legislative policy is again expressed that the cost of maintenance of a prisoner, including medical expenses should not be placed upon the county whose jail has physical custody of the prisoner, but on the governmental entity whose laws have been violated and under whose authority the person is actually being held as a prisoner. After carefully considering all of the above authorities and the arguments of counsel who have briefed their respective positions in a highly professional manner, we have concluded that a city is not responsible for the payment of medical expenses incurred by an indigent person who is arrested by city police and subsequently charged with a violation of state law and who, before being physically transferred to the county jail, is taken to a hospital for necessary medical treatment. We hold that so long as an offender is arrested for violation of a state law and in due course is charged with a state crime and delivered to the county jail for confinement, the medical and other incidental expenses incurred as a consequence of and following his arrest, and until his transfer to such facility, are chargeable to the county. We further hold that a county's liability for charges and expenses for safekeeping and maintenance of the prisoner, including medical expenses, does not depend on which police agency happens to be called to the scene of the alleged crime or whether such expenses were incurred before or after he is placed in a county jail. The controlling factor is that the prisoner was arrested and subsequently charged with violation of a state law. Thus, under the factual circumstances present in this case, the obligation to pay the medical expenses involved here is that of Sedgwick *816 County and not the City of Wichita. The judgment of the trial court holding to the contrary must be reversed. We note that in the brief filed by Sedgwick County it is stated there is a factual dispute as to the reasonable value of the medical expenses furnished by Wesley Medical Center during the period from July 11, 1981, to July 17, 1981. The county maintains that it did not admit the amount and reasonableness of the medical charges claimed by Wesley Medical Center for that period. Because there may be an issue of fact in that regard, the case must be remanded to the trial court to determine that issue. As noted earlier, a cross-appeal was taken by Wesley Medical Center in which it is claimed that Wesley Medical Center's petition states a cause of action against the City on the theory of express or implied contract. We have examined the record in this case and concluded that there is no evidentiary basis in the record to show that the City of Wichita's agents ever expressly or impliedly agreed to pay for the medical expenses of George E. Rainey. For this reason, the plaintiff's cross-appeal is denied. The judgment of the district court is reversed on the appeal and the case is remanded to the district court with directions to determine any remaining issues as to the reasonableness of the charges for medical services provided by the plaintiff. The cross-appeal of the Wesley Medical Center is denied.	01-04-2023	10-30-2013
https://www.courtlistener.com/api/rest/v3/opinions/4624653/	Norma Mathews Lauer v. Commissioner.Lauer v. CommissionerDocket No. 81662.United States Tax CourtT.C. Memo 1961-208; 1961 Tax Ct. Memo LEXIS 141; 20 T.C.M. (CCH) 1038; T.C.M. (RIA) 61208; July 14, 1961141 Held, that petitioner was engaged during each of the taxable years in carrying on a business of breeding, buying, selling, and exhibiting horses, with a view to profit; and accordingly, that the losses which she sustained therefrom are deductible from her gross income for said years. William F. Roberts, Esq., for the petitioner. Timothy T. Tuerck, Esq., for the respondent. PIERCE Memorandum Findings of Fact and Opinion PIERCE, Judge: The respondent determined deficiencies in petitioner's income taxes for the calendar years 1955, 1956, and 1957, in the respective amounts of $2,476.84, $3,058.51, and $1,526.76. The sole issue presented for decision is, whether petitioner was engaged during the taxable years in a trade or business of breeding, raising, buying, selling and exhibiting horses. If she was so engaged, then she correctly deducted a loss which she suffered in each of the taxable years, measured by the excess of her expenses in connection with such activities over the income which she derived therefrom. The respondent disallowed deductions for such losses which petitioner claimed on her returns. Findings of Fact Petitioner is a married woman, 142 residing in Sacramento, California. She filed a separate individual Federal income tax return for each of the taxable calendar years 1955, 1956, and 1957, with the district director of internal revenue at San Francisco, California. Since early in her childhood, petitioner has owned and been fond of horses. Petitioner was given her first horse when she was 9 years old, and ever since that time (with the exception of a "few years" when she resided in Montana), she has always owned horses. When she was in high school, she followed a practice of acquiring a horse, training it, exhibiting it, and then selling it; and thereafter acquiring another horse and following the same cycle. During the period up to 1946, petitioner kept her horses in a public stable in Sacramento or on a ranch in which her mother had an interest. Beginning in 1947 petitioner began to acquire "quarter horses" 1 with a view to exhibiting them at horse shows, breeding the mares, and then selling some of the colts and retaining others. Petitioner at about the same time began keeping her horses on premises at 640 Howe Avenue in Sacramento, which were owned by her mother and which also served as the residence of petitioner143 and her husband. The Howe Avenue premises consisted of a residence house, barn, paddocks and fenced-in pasture land. Petitioner inherited the Howe Avenue property in 1955, upon the death of her mother, During the period from 1947 through 1954, petitioner raised and sold 3 colts which were foaled by her mares. Throughout this same 1947-1954 period, petitioner also made purchases and sales of quarter horses. The following table shows the number of horses in petitioner's herd, the number of horses acquired, and the number disposed of by sale or exchange or by death, for each of the years 1947 through 1954: Numberof HorsesNumberin HerdofNumber ofDuringHorsesHorses Dis-YearYearAcquiredposed Of19473301948520194950219504101951623195240119535221954630Beginning in 1952, petitioner began to purchase significant amounts of equipment for144 her horse breeding, raising, and showing activities (hereinafter, for simplicity, called collectively "horse-breeding activities"). In 1952, she purchased two horse trailers and sundry items of equipment at a total cost of $1,365.07. In 1954, she purchased a station wagon and trailer at a total cost of $1,800 and additional saddles and other equipment costing $263.09. In 1955, she purchased a 3/4-ton pickup truck at a cost of $2,727. And in 1957, miscellaneous items of equipment costing $100.88 were purchased. During the taxable years involved, the number of horses in petitioner's herd, the number of horses acquired, the cost thereof, and the number of horses sold or traded were as follows: NumberofNumberCostNumberhorsesofofofinhorses ac-horseshorsesYearherdquiredacquireddisposed of1955104$5,500 1None19561442,500 2419571333,000 34145 Petitioner did not employ magazines or newspapers as media for advertising her horses for sale during the taxable years, or at any other time. Rather she chose for this purpose to exhibit her horses in shows throughout the State of California and also in the State of Oregon. Petitioner always followed the practice of informing spectators at these horse shows that she had horses for sale; and she was able to effect sales of horses by this means. Regarding the records kept by petitioner of her activities in connection with horses, she always retained all of her invoices and cancelled checks for her expenditures; and she also kept copies of bills of sale of horses sold, as well as a record of prizes which her horses won at the shows. She inquired of her accountant in 1953 if she should set up a regular set of books; and the accountant advised petitioner that this would not be necessary. Petitioner performed most of the work in connection with the carrying on of her horse-breeding activities during the taxable years. She devoted all of the time that her health and family circumstances permitted, to such activities during said years. In 1957, her husband withdrew from a motorcycle146 sales business which he had been operating, in order to help petitioner with her horse-breeding activities. Also, her 1957 Federal income tax return shows the payment of $1,200 of wages in connection with said activities. (The recipient of such wages is not identified in the record.) Besides hauling her horses to shows and there exhibiting them, petitioner transported her mares to farms operated by owners of the stallions to which her mares were bred. Petitioner also attended to the feeding of the horses in her herd, and to their care in such matters as veterinary services and shoeing. The quarter horse became increasingly popular and sought after during the period from 1950 to 1960. Along with this increase in demand, there was an increase in the price which such animals brought when sold. Among the quarter horses most sought after were those descended from a quarter horse stallion, not owned by petitioner, named Driftwood. Beginning early in the 1950's, petitioner sought to perpetuate the Driftwood line in her herd. To this end, in 1954 petitioner purchased Buckwood, a mare descended from Driftwood; and also petitioner bred her other mares to stallions descended from Driftwood. 147 Horses descended from Driftwood were in especially high demand by persons who participated in rodeos. Petitioner is and was during the taxable years, a member of four associations of horsemen: American Horse Shows Association, Inc.; American Quarter Horse Association; Pacific Coast Quarter Horse Association; and Pacific Coast Hunter, Jumper and Stock Horse Association. In 1960, she made application for issuance to her of an amateur status membership card by the above-named American Horse Shows Association, Inc. In the application blank which she signed, the following statements appeared: I have not engaged in any of the following categories either as a method of support or as a method of increasing my personal income in any substantial degree: a. breeding, riding, driving, schooling, training or boarding horses, or * c. buying, selling or dealing in horses; Petitioner was issued an amateur's card in response to her said application. From 1947 up to July 1960, petitioner exhibited her horses in shows as an amateur. Petitioner is a woman with independent means of support. During the taxable years involved, as well as prior and subsequent thereto, petitioner received148 income from a trust established by her parents, and also from annuities, dividends, rent, and interest. Petitioner's horse-breeding activities did not, in any year from 1952 through 1959 yield a profit but rather they were operated at a loss. On petitioner's Federal income tax return for each of the taxable years, she reported the following income, expenses and losses from her activities in connection with horses: 195519561957Income$1,921.47$ 2,867.79$3,759.45Expenses8,175.4111,353.249,798.57Net Operat-ing Loss($6,253.94)($ 8,485.45)($6,039.12)None of the expenses in the foregoing table were related to the upkeep and maintenance of the residence house occupied by petitioner and her family. All of the income items in the foregoing table represent prizes won by petitioner from exhibiting her horses at shows, with the exception of $550 in 1955 which was described as being from the "sale of horse." (The record does not reveal the identity of this horse.) In addition, petitioner reported capital gains from the sales of horses during the taxable years, as follows: PriorGrossdepre-salesciationYearpricetakenBasisGain1956$2,200$ 400.00$1,600$1,000.0019575,0003,808.844,2504,558.84149 On petitioner's return for each of the taxable years, the amounts shown above as net operating losses were deducted from her income from other sources. Respondent, in his statutory notice of deficiency, disallowed the losses so claimed by petitioner; and he gave the following explanation for his action: It is held that your activities in connection with the exhibition and breeding of horses do not constitute a bona fide business venture or a transaction entered into for profit. The loss claimed as a business loss * * representing the excess of expenses claimed over receipts reported from the exhibition and sale of horses, has therefore been disallowed as a nondeductible personal loss. Ultimate Fact During each of the taxable years 1955, 1956 and 1957, petitioner intended to be, and was, engaged in the trade or business of breeding, raising, buying, selling, and exhibiting horses, with a view to profit. Opinion There is no question but that petitioner bought, sold, bred, raised and exhibited horses during each of the taxable years involved. There also is no dispute that she derived income from these activities; that she incurred and paid expenses in connection therewith; 150 and that the expenses of each year exceeded the income, thus giving rise to a loss for each year. Nor is there any dispute as to the amounts of the income, expenses and losses involved. The sole and narrow question presented for decision in the instant case is: Was petitioner engaged in a trade or business with a view to profit, insofar as the abovementioned horse activities are concerned (as she contends she was); or was she, in connection with said activities, merely pursuing a hobby for pleasure (as the respondent determined and here contends to be the case). Such question is one of fact, to be determined in the light of all the facts and circumstances of the particular case. The burden of proof is, of course, on the petitioner to establish that she engaged in the trade or business that she contends she was in. We are satisfied, after seeing the witnesses testify and listening to their testimony, and after considering all the facts and circumstances of the instant case, that petitioner has established by the preponderance of the evidence, that she was in the trade or business of breeding, raising, buying, selling, and exhibiting horses with a view to profit, during each of the151 taxable years - and we have hereinabove so found as an ultimate fact. In conection with what is sufficient to cause an occupation to constitute a "trade or business," we said in Kerns Wright, 31 T.C. 1264">31 T.C. 1264, 1267, affd. (C.A. 6) 274 F. 2d 883: Business has been defined as including "that which occupies the time, attention, and labor of men for the purpose of livelihood or profit." Flint v. Stone Tracy Co., 220 U.S. 107">220 U.S. 107, 171. But it is recognized that whether an occupation constitutes a trade or business must be decided on the facts in each case, Frederick A. Purdy, 12 T.C. 888">12 T.C. 888, and the intent of the taxpayer has a material bearing on the issue, Morton v. Commissioner, 174 F. 2d 302, certiorari denied 338 U.S. 828">338 U.S. 828, although it is not conclusive. While profits and losses are factors to be considered in determining whether a taxpayer's intention is to engage in a busines for a livelihood or profit, Thacher v. Lowe, 288 F. 994">288 F. 994, the fact that the activity is conducted at a loss does not itself preclude its being considered a business. Doggett v. Burnet, 65 F. 2d 191. * * * "Intention, 152 " we said in American Properties, Inc., 28 T.C. 1100">28 T.C. 1100, 1111, affd. (C.A. 9) 262 F. 2d 150, "is a question of fact to be determined not only from the direct testimony as to intent, but from a consideration of all the evidence, including the conduct of the parties. The statement of an interested party of his intention and purpose is not necessarily conclusive." The respondent has recognized that the operation of horse breeding farms may constitute a trade or business. See G.C.M. 21103, 1 C.B. 164">1939-1 C.B. 164, wherein it is stated, in part, as follows: Numerous cases have been decided by the Courts and by the Board of Tax Appeals involving the question of whether horse breeding and racing activities constitute a trade or business. In a few cases such activities have been held not to constitute a trade or business. * * [Citations.] In other cases, which are much more numerous, the decision has been to the contrary. * * * [Citations.] An analysis of the above-cited cases discloses that the operation of horse breeding farms and racing stables may constitute a trade or business; that the question of whether or not such operations constitute a trade153 or business depends upon whether the activities are for the purpose or with the intention of making a profit, provided the expectation of profit is reasonable; that the question of intention is a question to be determined in each case upon the particular facts presented; that the taxpayer's intention or purpose of making a profit, as disclosed by his own testimony and by other evidence, is sufficient to establish the business character of the enterprise, provided the expectation of profit is reasonable; and that the fact that losses are incurred year after year does not necessarily indicate that the prospect of profit is not reasonable or that the taxpayer's intention is not to make a profit. * * The record in the instant case leaves no room for doubt that petitioner's activities were sufficient to constitute a business, if she had the requisite intention to make a profit from those activities. Our Findings of Fact amply demonstrate that she gave her time, attention, and labor to her horsebreeding activities, and that she also invested considerable amounts of her money therein. Our findings also show that she had made numerous purchases and sales of horses, and that she promoted154 her sales through a method which she deemed and found to be effective, i.e., exhibiting her horses at shows where she contacted prospective purchasers. The root question in this case is whether petitioner had an intention to make a profit from her activities. We are satisfied that she did. She testified categorically, at several points in the trial, that she had such an intention. And her conduct corroborates this. A mere dilettante, or hobbyist, would not in our opinion, have applied himself so unstintingly, as did petitioner to her horsebreeding activities. The fact of petitioner's continuous losses, while it must be and has been considered by us, is not controlling on the question of her purpose and intention to earn profits, if there was reasonable prospect that she would in the course of time, realize profits. The popularity of and demand for quarter horses, and the prices which they brought on sale, were increasing during the taxable years; and petitioner was at that time developing one of the most popular blood lines in this quarter horse field - all of which gave her a reasonable expectation of ultimately operating at a profit. Besides relying on petitioner's loss experience, 155 respondent has placed considerable reliance upon the facts: (1) That petitioner had in earlier years raised and exhibited horses as a hobby; and (2) that in 1960 she signed an application for an amateur's membership in the American Horse Shows Association, Inc., wherein it was stated that the applicant had not engaged in breeding, buying, selling or dealing in horses, either as a means of support or as a method for substantially increasing her income. Respecting the first of these contentions, petitioner testified at one point that she went into the business in 1946, and at another point that she did so in 1952. As we view the record, the latter date is the correct one; for it was then that she began to make substantial investments in equipment, sought the advice of an accountant as to the necessity for setting up formal books of account, and shortly thereafter substantially increased the size of her herd of horses. Suffice it to say that by 1955 (the first taxable year), she was in our opinion clearly not pursuing a hobby but was conducting a business. Regarding respondent's second contention relating to the statement on the application, there is no gainsaying that it is inconsistent*156 with petitioner's contention in the instant case. But that statement must be weighed against the specific evidence to the contrary herein. This evidence, pointing as it does to petitioner's actual conduct of a business of breeding, buying, selling and dealing in horses with a view to profit, weighs more strongly with us than does a conclusory statement on an application blank, which may have been made without careful consideration. For all the foregoing reasons, we decide the present issue for the petitioner. Because a second issue raised by petitioner in the pleadings was conceded by her at the trial, Decision will be entered under Rule 50. Footnotes1. Quarter horses are related to so-called thoroughbreds (i.e., racing horses); but they do not have the thoroughbreds' endurance to run at high speeds for long distances. Quarter horses are favored by contestants for riding in rodeos.↩1. Three of the four horses acquired in 1955 were colts foaled by petitioner's mares. ↩2. One of the four horses acquired in 1956 was a colt foaled by petitioner's mare. ↩3. Two of the three horses acquired in 1957 were colts foaled by petitioner's mares.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624654/	Estate of Anna Scott Farnum, Fidelity-Philadelphia Trust Company, Henry W. Farnum and Charles I. Thompson, Executors, Petitioner, v. Commissioner of Internal Revenue, RespondentFarnum v. CommissionerDocket No. 5424United States Tax Court12 T.C. 629; 1949 U.S. Tax Ct. LEXIS 222; April 22, 1949, Promulgated 222 Decision will be entered under Rule 50. In 1931 the decedent created a trust, reserving to herself all income therefrom in excess of $ 7,500 per annum which was to be distributed $ 2,500 each to her three children. Under the terms of the trust, if decedent survived her children and their descendants, the corpus would have reverted to her or her estate. Held, the value of the trust corpus at her death is to be included in her gross estate under section 811 (c), Internal Revenue Code, as interpreted by Commissioner v. Church, 335 U.S. 632">335 U.S. 632, and Spiegel v. Commissioner, 335 U.S. 701">335 U.S. 701, decided January 17, 1949. H. Ober Hess, Esq., and William R. Spofford, Esq., for the petitioner.Brooks Fullerton, Esq223 ., for the respondent. Arnold, Judge. ARNOLD 629 Petitioner challenges respondent's determination that there is a deficiency of $ 46,770.80 in estate tax. By an amended answer respondent asks that the deficiency be increased from $ 46,770.80 to $ 75,113.48. The issue is what part, if any, of the corpus of a trust created by the decedent is to be included in her gross estate.630 The other question raised by the pleadings was stipulated by the parties. Effect will be given to their stipulation in the computation under Rule 50.FINDINGS OF FACT.The petitioner is the estate of Anna Scott Farnum, deceased. The duly qualified executors are Fidelity-Philadelphia Trust Co., a corporation which has its principal office in Philadelphia, Pennsylvania; Henry W. Farnum, an individual residing at Righters Mill Road, Ardmore, Pennsylvania; and Charles I. Thompson, an individual residing in Chestnut Hill, Philadelphia, Pennsylvania.The decedent, Anna Scott Farnum, was born July 28, 1878, and died testate May 25, 1940.On January 19, 1931, the decedent executed an irrevocable deed of trust, which, upon execution by her, was delivered to W. G. Littleton, then vice president and224 senior trust officer of the Fidelity-Philadelphia Trust Co.On August 22, 1941, petitioner filed the Federal estate tax return for decedent's estate without including any amount in the gross estate in respect of decedent's trust.On May 12, 1944, respondent mailed to petitioner a notice of deficiency in Federal estate tax in the amount of $ 46,770.80 in respect of decedent's estate. It was therein determined (a) that the net value of the corpus of decedent's trust was $ 385,393.80 ($ 392,300.10 less trustees' commissions of $ 6,906.30) as of the date of her death, and (b) that $ 261,816.31 of this amount was includible in decedent's gross estate.By an amended answer filed October 8, 1945, respondent alleged (a) that the net value of the corpus of decedent's trust, $ 385,393.80, should be included in her gross estate for estate tax purposes; (b) that the correct deficiency was $ 75,113.48, and (c) that claim for the additional deficiency was asserted.Anna Scott Farnum was a granddaughter of Thomas A. Scott, who died May 21, 1881. Decedent's mother was Thomas A. Scott's daughter; she was Mariam D. Bickley by her first marriage and Mariam D. Thropp by her second marriage. Thomas225 A. Scott created two inter vivos trusts, and a testamentary trust. Decedent's mother was entitled to the income during her lifetime from each of the three trusts. In each of the three trusts there was a remainder over after the life estate equally to the four children of the life tenant, who were Helen Douglas Page, Anna Scott Farnum, Douglas S. Thropp, and Thomas A. Scott Thropp. The Fidelity-Philadelphia Trust Co., or its predecessor, the Fidelity Insurance Trust & Safe Deposit Co., was trustee in each of the three trusts, which were designated on its books as follows: 631 Trust under deed of Thomas A. Scott datedNovember 26, 1879Mariam D. Thropp Trust No. 1.Trust under will of Thomas A ScottMariam D. Thropp Trust No. 2.Trust under deed of Thomas A. Scott datedMarch 15, 1880Mariam D. Thropp Trust No. 3.Mariam D. Thropp died testate October 4, 1930. The Fidelity-Philadelphia Trust Co., Douglas A. Thropp, and Thomas A. Scott Thropp were executors under her will. Upon her death the three trusts created by her father, Thomas A. Scott, terminated.On January 19, 1931, Anna Scott Farnum owned an undivided interest in the assets that formed the corpora226 of the three trusts that terminated with the death of her mother, Mariam D. Thropp. Those assets consisted of real estate, stocks, bonds, mortgages, and other personalty.On January 19, 1931, decedent was a widow, with three living children, the date of birth of each being as follows: Henry W. Farnum, July 29, 1903.Anna M. F. Thompson, March 2, 1905.Elizabeth Farnum Gates, February 25, 1907.On January 19, 1931, all of these children of decedent were married and living with their respective spouses, except Henry W. Farnum, who was married on February 3, 1933.For many years prior to her death, Mariam D. Thropp had given an allowance to her daughter, Anna Scott Farnum, who in turn had given allowances to her children, the daughters' allowance being $ 200 each per month. When decedent executed her trust deed on January 19, 1931, she wanted to give $ 200 per month, net, to each of her three children out of the trust income. Accordingly, the trust deed provided for annual payments out of trust income of $ 2,500 a year for each child. The decedent expected the additional $ 100 to be consumed by income taxes.Decedent's trust deed of January 19, 1931, appointed the Fidelity-Philadelphia227 Trust Co. and James D. Winsor, Jr., trustees. The trust deed provided, in part, that: * * the said Anna Scott Farnum for and in consideration of * * * Hath granted, bargained, sold, * * * and by these presents Does grant, bargain, * * * [unto the trustees] the money, securities, mortgages and all other property (excepting only the sum of One hundred thousand Dollars ($ 100,000) which has been paid over to Anna Scott Farnum prior to the execution and delivery hereof) held by Fidelity-Philadelphia Trust Company, Philadelphia, Pennsylvania, as successor trustee constituting all the distributive share of principal (excepting only said sum of One hundred thousand Dollars ($ 100,000)) of the said Anna Scott Farnum, * * * [in the three trusts created by Thomas A. Scott hereinbefore mentioned] * * , the principal of all of said trusts being now distributable in accordance with the terms thereof. To Have, Hold, Receive and Take the said money, securities, mortgages and other property 632 hereby granted and assigned, * * * In Trust, nevertheless, for the following uses and purposes, that it [sic] to say:In Trust to invest and keep invested the moneys and personal property in228 such manner as the Trustees shall deem proper, and the same from time to time to call in, sell, assign, dispose of, and again invest as aforesaid; and to collect, receive and recover the income and interest thereof, and after deducting all proper expenses for the execution of this trust, to pay over when and as received and not by way of anticipation the net income thereof as hereinafter set forth:(a) Payment of Income during Lifetime of Anna Scott Farnum.For and during the term of the natural life of Anna Scott Farnum to pay:(1) To Henry W. Farnum (son of Anna Scott Farnum) the annual sum of Two thousand five hundred Dollars ($ 2,500) payable in quarterly installments beginning April 1, 1931.(2) To Anna M. F. Thompson (daughter of Anna Scott Farnum) the annual sum of Two thousand five hundred Dollars ($ 2,500) payable in quarterly installments beginning April 1, 1931.(3) To Elizabeth Farnum Gates (daughter of Anna Scott Farnum) the annual sum of Two thousand five hundred Dollars ($ 2,500) payable in quarterly installments beginning April 1, 1931.(4) The entire balance of net income to Anna Scott Farnum.And in the event any of said children shall die during the lifetime229 of Anna Scott Farnum, leaving issue surviving, to continue to pay the parent's share of income to such issue, equally per stirpes, until the death of Anna Scott Farnum.(b) Division of Principal into Shares and Sub-Shares at death of Anna Scott Farnum.(1) In Trust upon the death of Anna Scott Farnum to divide the principal into as many parts or shares as there shall be children of Anna Scott Farnum living at the time of her death, and children of Anna Scott Farnum then dead represented by children then living, and to sub-divide the share applicable to each such deceased child represented by children then living, per stirpes upon the principle of representation.(2) In Trust to pay over to Henry W. Farnum (if he survive Anna Scott Farnum) as soon as may be convenient, one-half of the amount that may be ascertained to be his share of principal, and the remaining one-half of said amount to continue to be held in trust hereunder and to be considered the share of Henry W. Farnum for all purposes hereinafter mentioned.(c) Payment of Income on Shares and Sub-Shares.In Trust to pay over to the beneficiaries for whom shares or sub-shares may be held, the full income from their respective230 shares or sub-shares until the principal thereof shall be distributed as hereafter provided.(d) Final Distribution of Principal.(1) In Trust upon the death of each child of Anna Scott Farnum for whom a share shall be held under paragraph (b) (1) above, and who shall die leaving issue surviving, to make distribution of the principal of said share to said deceased child's issue per stirpes upon the principle of representation.(2) In Trust upon the death of each child of Anna Scott Farnum for whom a share shall be held under paragraph (b) (1) who shall die without leaving issue surviving, to make distribution of the principal of said share to the person or persons and for such estate or estates as may be provided in the last will and testament of said deceased child; but should any child of Anna Scott Farnum 633 for whom a share shall be held as aforesaid, die without issue and intestate, then and in that event to divide and distribute said share of principal among the then living descendants of Anna Scott Farnum per stirpes upon the principle of representation.(3) In Trust to distribute the principal of any share or sub-shares which may be held for issue of deceased children231 of Anna Scott Farnum under paragraph (b) (1) above, when each attains the age of twenty-one years; provided that if any of said issue of a deceased child of Anna Scott Farnum should die before attaining the age of twenty-one years, his or her share shall be added equally to the shares of other issue of said deceased child of Anna Scott Farnum (including any of said issue to whom distribution shall then have been made); and further provided that in default of such other issue said share shall be divided among the then living descendants of Anna Scott Farnum per stirpes upon the principle of representation.Anna Scott Farnum's will, executed February 17, 1931, bequeathed her residuary estate to Fidelity-Philadelphia Trust Co. and James D. Winsor, Jr., as trustees, and provided for the same division of the estate, the same beneficiaries, and the same shares of income and principal as she provided for in her trust deed of January 19, 1931.On May 25, 1940, all of decedent's children were married and living with their respective spouses. Each child of the decedent had three children, whose names and dates of birth were as follows: Charles I. Thompson, Jr., January 16, 1927.Joseph 232 W. Thompson, 2nd, April 21, 1929.Henry Farnum Thompson, November 30, 1930.Caleb Frank Gates, 3rd May 9, 1932.Betsy Anne Gates, August 18, 1935.Mary Ellen Gates, June 23, 1938.Edith Bringhurst Farnum, February 3, 1935.Anna Scott Farnum, December 16, 1937.Henry Whipple Farnum, July 5, 1939.On January 19, 1931, and thereafter until approximately April 1940, decedent enjoyed excellent health, and during this period she continued a life of normal and unimpaired physical activity.Anna Scott Farnum's shares of the assets in the three Mariam D. Thropp trusts were awarded to her by the several courts on January 6, February 11, and February 13, 1931, and the schedules of distribution in compliance with such awards were filed in the courts on June 2 and July 2, 1931.The trustee of the Mariam D. Thropp Trust No. 2 advanced the sum of $ 4,600 to the decedent from October 4, 1930, to January 1, 1931, and $ 104,200 to her between January 1 and April 1, 1931, $ 100,000 of which decedent had specifically reserved to herself under the trust deed of January 19, 1931. No part of these sums was ever delivered to the trustees under decedent's trust indenture. Except for the $ 4,600 and $ 104,200233 aforementioned, no delivery of former trust assets was made to Anna Scott Farnum or to her trustees under the 634 January 19, 1931, indenture prior to April 1, 1931. The assets transferred in trust by Anna Scott Farnum's trust deed were received by her trustees after March 31, 1931.It is stipulated that the value of the entire corpus of decedent's trust on May 25, 1940, was $ 392,300.10.The omitted portions of the stipulated facts are incorporated herein by reference.OPINION.Respondent contends that the entire corpus of the trust created by decedent must be included in her gross estate under section 811 (c) of the Internal Revenue Code, (a) as a transfer in contemplation of death, or (b) as a transfer intended to take effect in possession or enjoyment at or after decedent's death. As an alternative, respondent contends that section 811 (c) requires a portion of the trust corpus to be included in decedent's gross estate because the transfer was made after the Joint Resolution of March 3, 1931, and decedent retained for her life a portion of the income from the property transferred. The value of that portion of the trust corpus which would be included in decedent's gross234 estate under respondent's alternative contention is $ 222,082.20.Petitioner contends that no part of the corpus of decedent's trust is includible in her gross estate (a) as a transfer in contemplation of death; (b) by reason of her retention of an interest in income for her lifetime; (c) by reason of the existence of a possibility of reverter by operation of law; or (d) as property in which decedent had an interest at the time of her death.Two recent decisions of the Supreme Court, Commissioner v. Church, 335 U.S. 632">335 U.S. 632, and Spiegel v. Commissioner, 335 U.S. 701">335 U.S. 701, decided January 17, 1949, support respondent's contention that the instant transfer in trust was one intended to take effect in possession or enjoyment at or after decedent's death. We shall pass the other contentions advanced by the parties. The Church case held that a trust agreement that reserved a life income to the settlor was intended to take effect in possession and enjoyment at the settlor's death, and the value of the trust property should be included in the settlor's gross estate. The Spiegel case held that where a settlor has conveyed235 away less than all of his property ownership and attributes, present or prospective, section 811 (c) requires the value of the property transferred in trust to be included in the settlor's gross estate.In the Spiegel case the Supreme Court pointed out that its discussion of the "possession or enjoyment" provision of section 811 (c) in the Church case:* * * demonstrates that the taxability of a trust corpus under this provision of section 811 (c) does not hinge on a settlor's motives, but depends on the nature and operative effect of the trust transfer. In the Church case we 635 stated that a trust transaction cannot be held to alienate all of a settlor's "possession or enjoyment" under section 811 (c) unless it effects "a bona fide transfer in which the settlor, absolutely, unequivocally, irrevocably, and without possible reservations, parts with all of his title and all of his possession and all of his enjoyment of the transferred property. After such a transfer has been made, the settlor must be left with no present legal title in the property, no possible reversionary interest in that title, and no right to possess or to enjoy the property then or thereafter. 236 In other words such a transfer must be immediate and out and out, and must be unaffected by whether the grantor lives or dies." We add to that statement, if it can be conceived of as an addition, that it is immaterial whether such a present or future interest, absolute or contingent, remains in the grantor because he deliberately reserves it or because, without considering the consequences, he conveys away less than all of his property ownership and attributes, present or prospective. In either event the settlor has not parted with all of his presently existing or future contingent interests in the property transferred. * * In this case the decedent reserved a life interest in the trust income, which means that section 811 (c), as interpreted by the Church case, requires the inclusion of the trust corpus in her gross estate. Admittedly there is a remote possibility of a reverter in this case. Such a possibility of reverter brings into play the principle announced in the Spiegel case. Upon the authority of these two cases, we hold that section 811 (c) requires the inclusion of the value of the trust corpus in the decedent's gross estate.After the Church and Spiegel237 decisions were promulgated, petitioner filed a motion for further hearing. This motion was set down for argument on March 16, 1949, at which time counsel for and against the motion were heard. After carefully weighing and considering their arguments, it is our opinion that no useful purpose will be served by further delaying our decision on the issue presented. Accordingly, petitioner's motion for further hearing is denied.In redetermining decedent's estate tax liability, consideration will be given to the increased deficiency requested by the respondent.Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624656/	H. Gates Lloyd, Petitioner, v. Commissioner of Internal Revenue, RespondentLloyd v. CommissionerDocket No. 2843United States Tax Court4 T.C. 829; 1945 U.S. Tax Ct. LEXIS 222; February 26, 1945, Promulgated 222 Decision will be entered under Rule 50. Petitioner during the taxable year 1941 was a member of a partnership which became a member of a syndicate. The managers of the syndicate entered into an agreement with a political subdivision of a state to act as agent in bringing about the refunding of the latter's outstanding bonds at lower interest rates. A plan was adopted whereby the new refunding bonds to be exchanged for the old bonds had attached thereto two kinds of interest coupons, A and B. Under the plan the syndicate was also given the right to deal in old and new bonds for its own account. Under this latter provision, the syndicate during the taxable year purchased old bonds, exchanged them for new bonds, detached the B coupons, sold the new bonds with the A coupons attached, and then sold the B coupons at a discount. Held, in determining the partnership's distributive share of the income of the syndicate and petitioner's distributive share of the income of the partnership, the proceeds from the discount of B coupons is not tax-free interest to be excluded from gross income under section 22 (b) (4), I. R. C., but must be considered along with the selling price of 223 the new bonds with the A coupons attached in determining the gain or loss from the entire transaction, and any gain resulting therefrom is to be included in gross income under section 22 (a). Jesse R. Fillman, Esq., Wm. Clarke Mason, Esq., and Owen Biddle, Esq., for the petitioner.William H. Best, Jr.,224 Esq., for the respondent. Black, Judge. BLACK 829 This proceeding involves the determination by the respondent against petitioner of a deficiency in income tax for the calendar year 1941 in the amount of $ 4,054.80.The deficiency is the result of an addition of $ 5,890.52 to petitioner's net income, which addition is labeled "Income from partnership" and is explained in a statement attached to the deficiency notice as follows: "(a) Your taxable net income has been increased in accordance with revised distributable income from the partnership Drexel and Company." By appropriate assignments of error petitioner contests this adjustment.FINDINGS OF FACT.Most of the facts have been stipulated. The stipulation and the exhibits thereto are incorporated herein by reference.Petitioner is an individual residing in Haverford, Pennsylvania. He filed his income tax return for the calendar year 1941 with the collector of internal revenue for the first district of Pennsylvania. In schedule A of his return he reported tax-free interest from all sources 830 of $ 22,912.99; and as a part of item 9, he reported income from the partnership of Drexel & Co. in the amount of $ 86,597.37. 225 During the entire calendar year 1941 petitioner was a member of the partnership of Drexel & Co. of Philadelphia. Drexel & Co. filed a partnership return of income for the calendar year 1941 and reported thereon "Ordinary Net Income $ 429,468.67." Among the many items of deductions and income which made up this net amount, which items were referred to on the return by the partnership as debit and credit items, respectively, were the following:Drexel & Co. 4% participation in net profit of $ 147,641.81 in the City of Philadelphia Bond Exchange Group Account:DR.CR.Group commissions$ 14,680.13Wholly tax exempt interest28,701.86Group expenses$ 3,801.74Joint managers' compensation paid7,107.49Principal loss on bonds sold25,713.21Managers' compensation received (City of Philadelphia Bond Exchange)89,783.26Tax exempt interest (other than City of Philadelphia Bond Exchange)16,141.54The sum of the two items listed above as tax-exempt interest is $ 44,843.40. In schedule J attached to the above mentioned return, Drexel & Co. reported the distributive shares of income of the partnership among the five partners as follows:OrdinaryTax exemptOther incomeincomeinterestH. Gates Lloyd$ 96,693.74$ 10,096.37$ 86,597.37Four other partners332,774.9334,747.03298,027.90Total429,468.6744,843.40384,625.27226 During the calendar year 1941 Drexel & Co. became a member of a syndicate known as "City of Philadelphia Refunding Bonds of 1941, Drexel & Co., Lehman Brothers, Joint Account Managers." The syndicate is sometimes referred to in the record as the "Group" and sometimes as the "Account," but most of the time as the "Syndicate." There were 38 other members of the syndicate, all of which were financial firms located in nine different states of the Union. Drexel & Co. and Lehman Brothers of New York were the managers of the syndicate. Drexel & Co. had a 4 percent interest in the operations of the syndicate. The syndicate was terminated on or about June 15, 1942.The syndicate filed a partnership return of income for the calendar year 1941 and reported a "Net Profit per Books" of $ 147,641.81, in schedule form as follows: 831 $ 131,064,000CITY OF PHILADELPHIA REFUNDING BONDS OF 1941STATEMENT OF GROUP ACCOUNT TAXABLE INCOME FOR THE CALENDARYEAR 1941Proceeds of Sale of $ 15,017,400.00 Bonds$ 16,517,164.46Principal Cost of $ 15,017,400.0017,159,994.59(Loss)$ 642,830.13Group Commissions Received367,003.25(Loss)$ 275,826.88Expenses:Legal Fees$ 50,000.00Advertising14,972.77Composition and Proofs9,196.48Postage and Insurance5,171.14Group Member Expense198.56Telegraph, Telephone and Teletype3,459.80Travel, etc5,816.14Miscellaneous6,228.6695,043.55(Loss)$ 370,870.43Ordinary Net Income for Income Tax Reconciliation to Book Profits:Wholly tax-exempt Interest Received:Bonds held by Account$ 310,700.71 Less Accrued Interest paid on BondsPurchased256,098.87$ 54,601.84 Proceeds from discount of "B" Coupons662,944.60Unallowable Deductions:$ 717,546.44Interest paid on borrowed moneyto carry tax-free bonds$ 21,346.87Joint Managers' Compensation177,687.33199,034.20518.512.24Net Profit per Books$ 147,641.81227 Attached to the return of the syndicate was a schedule of shares of income and credits of the members thereof, as follows:Ordinary NetWhollyNameIncome or NetTax-exemptLossObligationsDrexel & CoProfit$ 67,840.95$ 28,701.86Lehman BrothersProfit65,961.7628,701.8637 remaining membersLoss504,673.14660,142.72Loss$ 370,870.43$ 717,546.44832 (It may be noted from the above two schedules that the syndicate reported $ 717,546.44 as tax-free interest and a loss for tax purposes of $ 548,557.76 ($ 370,870.43 plus $ 177,687.33); that Drexel & Co.'s share of the so-called tax-free interest was 4 percent thereof or $ 28,701.86; that Drexel & Co.'s share of the so-called loss was 4 percent thereof or $ 21,942.31; that when this loss of $ 21,942.31 is considered with Drexel & Co.'s share of the managers' compensation received in the amount of $ 89,783.26, the result is a profit to Drexel & Co. of $ 67,840.95; and that this amount corresponds with the above mentioned items that were reported by Drexel & Co. in its return as follows:Group Commission (4% of $ 367,003.25)$ 14,680.13 Managers' Compensation received89,783.26 Total104,463.39 Deductions:Group expenses (4% of $ 95,043.55)$ 3,801.74Managers' Compensation (4% of $ 177,687.33)7,107.49Principal loss on bonds sold (4% of $ 642,830.13)25,713.2136,622.44 Taxable profit reported by Drexel & Co. from Syndicate67,840.95)228 In the year 1940 the city of Philadelphia, hereinafter sometimes referred to as the city, desired to refund some of its outstanding bonds in order to take advantage of low money rates then in existence. After consideration of other plans which had been submitted, the city by ordinance on June 9, 1941, adopted a "Refunding Plan," hereinafter sometimes referred to as the plan, which had been prepared by Drexel & Co. and Lehman Brothers and was first presented to the city on April 10, 1941.Pursuant to the ordinance of June 9, 1941, the city executed a contract, hereinafter sometimes referred to as the refunding and exchange contract, with Drexel & Co. and Lehman Brothers, acting as joint managers on behalf of the syndicate consisting of themselves and associates as constituted from time to time. In such contract the syndicate agreed to undertake to effect the exchange of new refunding bonds for such old outstanding bonds of the city as might be surrendered in accordance with the terms of the plan and the city agreed to authorize the issuance of such new refunding bonds and to pay the expenses in connection with the issuance. In the refunding and exchange contract the city agreed 229 to effect the exchange of bonds solely through the syndicate. The contract gave the syndicate the right to charge holders of old bonds who desired to accept the offer of exchange a fee of one percent of the principal amount of each new bond issued in exchange, except that the commissioners of the sinking fund of the 833 city should have the option to make exchanges without payment of any commissions, and except that any member of the syndicate in transmitting bonds for exchange only had to turn in to the syndicate a fee of one-half of one percent of the principal amount. The contract also provided as follows: * * It is expressly understood, however, that the Group shall have the right to buy and sell and otherwise deal in both the outstanding and the Refunding Bonds for its own account and at its own risk without restriction.The plan called for the refunding of bonds of various issues of the city aggregating $ 131,064,000 which bore interest at rates varying from 4 percent to 4 1/2 percent and which matured at various dates from February 16, 1952, to August 1, 1977, but which were callable at the option of the city during the years 1942 to 1947, inclusive. The plan provided230 for new bonds to be issued in series A to Q, inclusive, in exchange for old bonds. Under the plan the new bonds provided for interest at the rate provided in the old bonds until the respective first optional call dates of the old bonds, and for interest at reduced rates varying from 2 1/4 percent to 3 1/4 percent thereafter. The new bonds, except series M, which was noncallable, were callable at the option of the city during the years 1948 to 1958, inclusive, and matured at different dates from January 1, 1949, to January 1, 1973.The new refunding bonds were issued by the city in both coupon and registered form. The bonds issued in coupon form had attached thereto two types of coupons, designated respectively A and B. The A coupons represented interest during the life of each new bond at the reduced rate provided for in the plan. The B coupons represented the difference between the new reduced rate of interest and the rate of interest of each old bond, and ran from July 1, 1941, until the respective first optional call date of the old bonds. The purpose of the two sets of coupons was, first, to provide for a reduction in the interest rate only after the respective first optional231 call date of the old bonds and, second, to make it possible for investors to detach the B coupons and thus have instruments carrying a single rate of interest which would be familiar to investors and which would enable the bonds to be traded in on the market, thus providing inducement to the holders to make the exchanges desired by the city.As a sample of all the new refunding bonds issued in coupon form, a series Q bond is attached to the above mentioned stipulation of facts as Exhibit 10-J. The series Q bonds matured on January 1, 1970, with first optional call date on January 1, 1958. They were to be exchanged for old outstanding bonds bearing interest of 4 1/4 percent and maturing on August 1, 1977, with first optional call date on August 1, 1947. The series Q bonds had attached thereto 57 A coupons for $ 16.25 each. Coupon No. 1-A was payable, "unless the bond hereinafter mentioned shall have been called for previous redemption," on January 834 1, 1942, and each succeeding number up to and including No. 57-A was payable, "unless the bond hereinafter mentioned shall have been called for previous redemption," at the end of each succeeding 6-month period up to and including232 January 1, 1970. The series Q bonds also had attached thereto 12 B coupons for $ 5 each, with the printed statement on each coupon saying "being 6 months' interest then due," and one B coupon for 83 cents with the printed statement thereon saying "being 1 months' interest then due." Coupon No. 1-B was payable on January 1, 1942, and each succeeding number up to and including No. 12-B was payable at the end of each succeeding 6-month period up to and including July 1, 1947. Coupon No. 13-B for 83 cents was payable on August 1, 1947. All coupons, both A and B, were payable to bearer. The bond itself (series Q) provided in part as follows:The City of Philadelphia, Pennsylvania, for value received hereby acknowledges itself indebted and promises to pay on the First day of January, 1970, to bearer, or if this bond be registered as to principal, then to the registered owner hereof, at the office of The Philadelphia National Bank, Philadelphia, Pennsylvania, the sum of One Thousand Dollars ($ 1000), and to pay interest thereon at said office from the date hereof to the maturity hereof, unless called for previous redemption, at the rate of Three and One-Quarter Per Cent. (3 1/4%) per233 annum, upon presentation and surrender of the coupons hereto attached (designated "A coupons") payable semi-annually on the First days of January and July in each year, as they severally mature, and in addition, to pay interest at the rate of One Per Cent. (1%) per annum from the date hereof to August 1, 1947, upon presentation and surrender of the coupons hereto attached (designated "B coupons"), payable semi-annually on the First days of January and July of each year until July 1, 1947, and thereafter on August 1, 1947, as they severally mature. Any or all of the aforesaid B coupons may be detached and negotiated prior to maturity without impairing the negotiability of this bond.During the year 1941 Drexel & Co., through membership of one or more of its partners, was a member of the New York Stock Exchange and the Philadelphia Stock Exchange, an associated member of the New York Curb Exchange, was registered under the Pennsylvania Securities Act as a dealer in securities in the State of Pennsylvania and as a broker or dealer in securities under the Securities Exchange Act of 1934, and was a member of the National Association of Security Dealers, Inc. Every other member of the234 syndicate was a recognized and qualified dealer in municipal securities.During the year 1941 approximately $ 80,000,000 of the $ 131,064,000 face value of old outstanding bonds of the city were refunded under the plan.During the year 1941 the syndicate, as agent for the city under the refunding and exchange contract, effected exchanges of old bonds for new bonds, and in this connection it received commissions in the amount of $ 367,003.25.During the year 1941 the syndicate purchased bonds of the city in the face value of $ 15,017,400. The principal cost of these bonds was 835 $ 17,159,994.59. At the time of the purchase of the above described bonds the syndicate paid to the sellers thereof the sum of $ 256,098.87 representing accrued interest to the dates of the purchases. While holding the above described bonds the syndicate received as interest on the bonds the sum of $ 310,700.71.The syndicate during 1941 exchanged old bonds which it had purchased for new bonds in coupon form, that is, with A and B coupons attached. As sufficient blocks of bonds accumulated during the year, notice was given to members of the syndicate that bonds were available for sale. Notices of235 offerings were prepared and circulated among members of the syndicate. The bonds were offered by the syndicate without the B coupons attached.The syndicate detached the B coupons from the new bonds which it acquired in coupon form. Because of the impracticability of distributing the large number of varying types of coupons pro rata to each of the 39 members of the syndicate, the syndicate made arrangements with the Philadelphia National Bank that at intervals when sufficient detached B coupons were on hand the Philadelphia National Bank would discount them on a 1 1/4 percent basis. During 1941 the syndicate sold to the Philadelphia National Bank at a discount B coupons having a face value of $ 666,896.65 and received from the Philadelphia National Bank the sum of $ 647,630.38. During 1941 the syndicate also received the face value of B coupons maturing January 1, 1942, in the sum of $ 15,314.22.During 1941 all of the new refunding bonds of the face value of $ 15,017,400 received by the syndicate in exchange for the old outstanding bonds of like face value that had been purchased by the syndicate as stated above were sold and the proceeds of sales of such bonds totaled $ 16,517,164.46. 236 At least $ 14,441,000 face value of such bonds was sold ex the B coupons. The remainder of about $ 576,400 consisted of those bonds that were issued in registered form and are not here in question.All of the old outstanding bonds of the city purchased by the syndicate were purchased at substantial premiums above par, with the exception of a few bonds which were callable within six months, on which the premium was relatively small. All of the new refunding bonds which the syndicate sold during the year 1941 were sold at substantial premiums above par.Under the terms of the agreement entered into by the members of the syndicate, each member could be called upon to put up for the purchase of bonds the amount of his respective interest in such bonds, but the syndicate did not find it necessary to call upon members to supply the purchase price of the bonds. Drexel & Co. and Lehman Brothers initially made advances for the account of the syndicate, and the bonds purchased were pledged to secure money borrowed from the Philadelphia National Bank. Interest paid by the 836 syndicate to the Philadelphia National Bank on account of such borrowing amounted to $ 21,346.87 in the237 year 1941. As profits accumulated in the account of the syndicate, they were retained in the account and used in connection with the purchase of bonds. The advances so made by Drexel & Co. and Lehman Brothers to the syndicate totaled $ 1,000,000. The total of the loans made by the Philadelphia National Bank to the syndicate was $ 15,899,600, in the form of short term loans paid off from time to time.Upon the audit of the return of the syndicate for the year 1941, the internal revenue agent in charge for the Philadelphia division determined that the "Proceeds from discount of 'B' coupons" in the amount of $ 662,944.60 should be considered as taxable income of the syndicate and not as tax free interest. Upon the audit of the return of Drexel & Co. for 1941 the said revenue agent determined that the partnership income should be increased in accordance with the report made upon the audit of the return of the syndicate, which, as stated by the revenue agent, resulted in changing Drexel & Co.'s "distributive share of the syndicate tax exempt interest from $ 28,701.86, as reported to $ 2,184.07, or an increase in taxable income of $ 26,517.79." The latter figure is 4 percent of $ 662,944.60. 238 The revenue agent also determined that Drexel & Co. was entitled, as a result of this addition to income of $ 26,517.79, to a deduction for net additional accrual of city of Philadelphia income tax of $ 397.27. The net result of these two adjustments was to increase the net taxable income reported by Drexel & Co. of $ 384,625.27 to $ 410,745.79. The revenue agent then determined that petitioner's distributive share of this adjusted net taxable income of $ 410,745.79 was $ 92,487.89 instead of $ 86,597.37 as had been reported by the partnership and by petitioner, or an increase in partnership income of $ 5,890.52. These determinations of the revenue agent were adopted by the respondent in the latter's determination of the deficiency here in question.OPINION.Petitioner is a partner of Drexel & Co., which partnership became a member of the syndicate mentioned in our findings. During the taxable year 1941 the syndicate sold at a discount $ 666,896.65 face value of B coupons for $ 647,630.38. The principal question at issue is whether petitioner's ultimate share of the proceeds of $ 647,630.38 should be included in gross income under section 22 (a) of the Internal Revenue Code, 239 or whether it should be excluded therefrom under section 22 (b) (4) as representing tax-free interest. In the alternative, the respondent contends that if the proceeds from the discounted B coupons be held to represent tax-free interest, then the loss sustained on the sale of the bonds from which the B coupons were detached should be considered as a "short-term capital loss" under 837 section 117 (a) (1) and (3) of the code, and, under section 117 (d) (2), "allowed only to the extent of short-term capital gains."The material provisions of section 22 are set forth in the margin. 1 The parties are in substantial agreement as to the facts set out in our findings. They also agree that there is no decided case directly in point on the principal question here presented.240 The new refunding bonds of the city were obligations of a political subdivision of a state. The A and B coupons attached to these obligations represented the "interest" which the city had agreed to pay on the several dates therein specified. If the syndicate had held the bonds and the coupons until the due date of the latter and then collected the amount stated on the coupons, there would be no question as to the tax-exempt status of such collections. As a matter of fact the syndicate did hold $ 15,314.22 face value of B coupons until they matured and then collected the full face value thereof, and the respondent now concedes in his brief "that the said sum of $ 15,314.22 is tax-exempt interest to the Syndicate under the provisions of Section 22 (b) (4) of the Internal Revenue Code and should be adjusted under Rule 50." But as to $ 666,896.65 face value of B coupons, the syndicate saw fit to sell them. These coupons ran from July 1, 1941, and matured at various dates from January 1, 1942, to August 1, 1947. The syndicate did not hold these coupons until maturity. Almost simultaneously the syndicate purchased old outstanding bonds, exchanged them for new refunding bonds with 241 A and B coupons attached, detached the B coupons, sold the new refunding bonds with A coupons attached at a loss, and then sold $ 666,896.65 face value of B coupons at a discount of 1 1/4 percent and received therefor $ 647,630.38. Under such circumstances, is the receipt of $ 647,630.38 by the syndicate the receipt of tax-free interest separable from the computation of gain or loss on the sale of the new refunding bonds? We do not think it is.The usual import of the term "interest" is "the amount which one has contracted to pay for the use of borrowed money." Old Colony Railroad Co. v. Commissioner, 284 U.S. 552">284 U.S. 552. In Deputy v. DuPont, 308 U.S. 488">308 U.S. 488, "interest on indebtedness" was said to mean "compensation for the use or forbearance of money." It can hardly be said that 838 the $ 647,630.38 in question was received by the syndicate for the use of money it had loaned. After it sold the new refunding bonds it was no longer a creditor of the city as far as those bonds were concerned. It sold those bonds before any appreciable amount of interest, if any, had accrued thereon. 2 We think that in selling the242 B coupons at a discount the syndicate merely sold the right to collect interest in the future, and that the proceeds from such sales must be treated the same as the proceeds from the sales of the bonds themselves with the A coupons attached.243 It is, therefore, our opinion that when the syndicate purchased the old bonds, exchanged them for new bonds with A and B coupons attached, detached the B coupons, sold the new bonds with the A coupons attached, and then sold the B coupons at a discount, it was dealing in property, and the sale price received for that property was the total amount received for the refunding bonds with A coupons attached, plus the amount received for the B coupons. We do not think it is permissible to set apart the amount received for the detached B coupons as exempt interest. In making the above statement it is, of course, to be understood that any interest on either the A or B coupons which accrued while the bonds were in the syndicate's hands and which was collected by the syndicate from the purchasers in the sale of the bonds as a separate accrued interest item, was in fact interest and is exempt from taxation. The Commissioner so concedes.It is our opinion that under section 22 (a) of the Internal Revenue Code and the rationale of Willcuts v. Bunn, 282 U.S. 216">282 U.S. 216, any gain or profit derived from the transactions as a whole must be included in gross income. 244 In determining this gain or profit the proceeds from the discount of the B coupons should be included at $ 647,630.38 instead of $ 662,944.60, for the reason that the Commissioner now concedes that $ 15,314.22 was tax-exempt interest.It is proper to point out, we think, that this is not a case where the city of Philadelphia issued its bonds at a discount, thus making applicable 839 G. C. M. 21890, Internal Revenue Cumulative Bulletin 1940-1, p. 85, where it is ruled that:Where interest-bearing State bonds were purchased by A at a discount and, pursuant to provisions contained in the bonds, they were redeemed in 1938 at a premium and accrued interest prior to maturity, the accrued interest and the discount received upon redemption of the bonds constitute interest upon the obligations of a State and are exempt from Federal income tax under section 22 (b) 4 of the Revenue Act of 1938.In his brief petitioner refers to the foregoing G. C. M. and to G. C. M. 10452, Internal Revenue Cumulative Bulletin XI-1, p. 18, but we do not think that they have any application to the facts which are present in the instant case.None of the245 refunding bonds to which the B coupons were attached were issued at a discount. Therefore, the $ 647,630.38 which is involved in the present controversy did not represent the collection of "discount" as that term is used in G. C. M. 21890 or G. C. M. 10452, supra. Cf. M. C. Parish & Co., 3 T. C. 119, in which this Court, in holding that the amounts there involved did not represent true bond discount, but represented trading profits, relied upon Willcuts v. Bunn, supra.There is no issue in the instant case concerning petitioner's right to exclude from his gross income any interest which had accrued while the bonds were in the hands of the syndicate and which was collected by it during the taxable year. The Commissioner concedes that the $ 15,314.22 par value of B coupons which the syndicate held to maturity and cashed in 1941 is tax-exempt interest, and that amount is no longer in controversy.Petitioner, in support of his contention that the proceeds from the discount of the B coupons in the amount of $ 647,630.38 are tax-free interest under section 22 (b)246 (4) of the code, argues that the transfer of a right to receive income will not change the position of the transferor under the income tax law, either by shifting the tax burden if the transfer is a gift or by altering the character of the income if the transfer is made for consideration, and cites Helvering v. Horst, 311 U.S. 112">311 U.S. 112; Hyman v. Nunan, 143 Fed. (2d) 425; Gibson v. Commissioner, 133 Fed. (2d) 308; and Hort v. Commissioner, 313 U.S. 28">313 U.S. 28. In the Horst case the taxpayer detached unmatured coupons from a bond and made a gift of them to his son, who collected them at maturity. The question there was whether the father or the son was taxable on the interest when collected at maturity. The Supreme Court held that the father was taxable. The Hyman case reached the same result with respect to the donor of the right to receive corporate dividends undeclared at the date of gift. In the Gibson case the taxpayer, as a shareholder, received from a corporation certain warrants entitling her to purchase newly authorized convertible preferred247 stock of the corporation. The taxpayer did not exercise the rights to 840 subscribe, but instead sold them. The question before the court was whether the proceeds of the sale were taxable as a dividend or as capital gain. The decision was that the taxpayer had acquired an option to receive a corporate distribution, not taxable upon the mere receipt of the option, which was realized upon the sale, hence the proceeds were taxable as a dividend. In the Hort case, the lessor taxpayer agreed to cancel a lease in consideration of a lump sum to be paid to the lessor by the lessee. The Supreme Court held that the amount received by the lessor did not constitute a return of capital, but that the lessor was required to report the amount as gross income received. We do not regard these cases as helpful in deciding the issue before us. The effect of petitioner's argument is that, if under certain circumstances the realizations on the B coupons be held to be tax-free interest, then all realizations thereon must likewise be held to be tax-free on the ground that the character of the income from the coupons never changes. That this does not follow is illustrated by Pierce Corporation v. Commissioner, 120 Fed. (2d) 206,248 affirming a memorandum opinion of the Board of Tax Appeals in which coupons attached to defaulted municipal bonds which had accrued before and those which had accrued after the purchase were treated entirely differently for tax purposes. See also R. O. Holton & Co., 44 B. T. A. 202.Petitioner seeks an exemption from tax. "The rule is that, in claims for exemption from taxation under legislative authority, the exemption must be plainly and unmistakably granted; it cannot exist by implication only; a doubt is fatal to the claim." Chicago Theological Seminary v. Illinois, 188 U.S. 662">188 U.S. 662, 672. Section 22 (b) (4) of the code exempts "only interest." United States v. Stewart, 311 U.S. 60">311 U.S. 60. We do not think the $ 647,630.38 in question under the facts narrated in our findings of fact was interest. It follows, therefore, that petitioner's share of this amount is not exempt from tax, and we so hold. It thus becomes unnecessary to consider the respondent's alternative contention.Decision will be entered under Rule 50. Footnotes1. SEC. 22. GROSS INCOME.(a) General Definition. -- "Gross income" includes gains, profits, and income derived from salaries, wages, or compensation for personal service, of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. * * (b) Exclusions from Gross Income. -- The following items shall not be included in gross income and shall be exempt from taxation under this chapter; * * (4) Tax-free interest. -- Interest upon (A) the obligations of a State, Territory, or any political subdivision thereof, * *↩2. Petitioner is not claiming, as such, the benefit of the rule that where municipal bonds are sold between interest dates, and the agreement of sale specifies a division between the principal sum of the bond and accrued interest, the latter will be regarded as being received tax-free. See I. T. 1337↩, Internal Revenue Cumulative Bulletin I-1, p. 29. The bonds here involved all ran from July 1, 1941, and matured from 1949 to 1973, with first optional call dates from 1948 to 1958. As previously stated, the B coupons ran from July 1, 1941, and matured semiannually from January 1, 1942, to August 1, 1947. The syndicate both acquired and disposed of all new bonds and coupons during the latter one-half of 1941. It is thus apparent that very little interest, as such, could have accrued while the syndicate held the bonds. In any event, petitioner is not making any such limited claim for the exemption of any interest that might have accrued while the syndicate actually held the bonds, and if such claim were made the evidence would be insufficient to determine the amount of such accrued interest, if any. Furthermore, the evidence does not show that the sale agreements specified any division between the principal sum of the bonds and accrued interest, and it is not altogether clear as to what may be included in "Wholly tax-exempt Interest Received: Bonds held by Account $ 310,700.71," which the syndicate reported on its return and which the Commissioner has not disturbed.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4624657/	WILLIAM P. WILKIN AND DOROTHY E. WILKIN; DONALD M. MICHIE AND NAOMI E. MICHIE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentWilkin v. CommissionerDocket No. 2045-85United States Tax CourtT.C. Memo 1992-525; 1992 Tax Ct. Memo LEXIS 542; 64 T.C.M. (CCH) 689; September 8, 1992, Filed 542 An appropriate order will be issued, and decision will be entered under Rule 55. Held: The period of limitations upon assessment applicable to a partner's distributive share of partnership items is controlled by the filing of the partner's individual income tax return, as extended by any agreements relating thereto. See Siben v. Commissioner, 930 F.2d 1034">930 F.2d 1034 (2d Cir. 1991), affg. T.C. Memo. 1990-435; Stahl v. Commissioner, 96 T.C. 798 (1991). For Petitioners: Declan J. O'Donnell. For Respondent: Robert A. Varra. WHITAKERWHITAKERMEMORANDUM FINDINGS OF FACT AND OPINION WHITAKER, Judge: This matter is before the Court on petitioners' motion for summary judgment and respondent's cross-motion for summary judgment filed pursuant to Rule 121. 1 Respondent determined a deficiency in William P. and Dorothy E. Wilkin's (petitioners Wilkin) Federal income tax for the taxable year ending December 31, 1978, in the amount of $ 33,673. Respondent determined a deficiency in Donald M. and Naomi E. Michie's (petitioners Michie) Federal income tax for the taxable year ending December 31, 1978, in the amount of $ 20,833. 543 Notices of deficiency were mailed to petitioners on October 31, 1984. Petitioners Wilkin resided in Lakewood, Colorado, and petitioners Michie resided in Golden, Colorado, at the time the petition herein was filed. The issue for decision is whether the period of limitations upon assessment applicable to a partner's distributive share of partnership items is controlled by the filing of the partnership's information return, or by the filing of the partner's individual income tax return, as extended by any agreements relating thereto. 2FINDINGS OF FACT Petitioners were validly subscribed members of Sierra Vista Company (Sierra Vista), a limited partnership, for the taxable year ending December 31, 1978. On April544 15, 1979, petitioners filed their 1978 individual income tax returns. Sierra Vista timely filed its 1978 partnership information return. On January 12, 1982, petitioners Wilkin executed a Form 872-A, thereby extending the time to assess individual income tax against petitioners Wilkin for the taxable year 1978. On December 22, 1981, and on September 6, 1983, petitioners Michie executed Forms 872, thereby extending through December 31, 1984, the time to assess individual income tax against petitioners Michie for the taxable year 1978. Pursuant to Form 872-A, the amount of income tax due for a taxable year may be assessed on or before the 90th day after: (1) Respondent receives a notice of termination from petitioners, (2) respondent mails a notice of termination to petitioners, or (3) respondent mails a notice of deficiency for the applicable period. Respondent neither received a notice of termination from petitioners Wilkin, nor mailed a notice of termination to petitioners Wilkin, for the taxable year 1978. Consequently, as of October 31, 1984, the period of limitations upon assessment had not expired with respect to either petitioners Wilkin's or petitioners Michie's taxable545 year 1978. Conversely, as of October 31, 1984, more than 3 years had elapsed since the filing of Sierra Vista's 1978 partnership information return. On March 23, 1992, petitioners Wilkin and respondent entered into a Form 906C Closing Agreement on Final Determination Covering Specific Matters regarding petitioners Wilkin's distributive share of losses, deductions, and credits attributable to Sierra Vista. Similarly, on March 23, 1992, petitioners Michie and respondent entered into a Form 906C Closing Agreement on Final Determination Covering Specific Matters regarding petitioners Michie's distributive share of losses, deductions, and credits attributable to Sierra Vista. Implementation of the Closing Agreements was contingent, however, upon a final determination that the period of limitations upon assessment had not expired with respect to petitioners Wilkin's and petitioners Michie's distributive share of losses from Sierra Vista prior to the issuance of the notice of deficiency. On March 16, 1992, petitioners filed a motion for summary judgment asserting that the period of limitations upon assessment had expired with respect to their distributive share of losses from Sierra546 Vista prior to the issuance of the notices of deficiency. On April 13, 1992, respondent filed a cross-motion for summary judgment asserting that all issues relating to petitioners' interests in Sierra Vista had been resolved in the Closing Agreements, and that a decision should be entered in accordance with the terms thereof. OPINION The sole issue for decision is whether the period of limitations upon assessment applicable to a partner's distributive share of partnership items is controlled by the filing of the partnership's information return, or by the filing of the partner's individual income tax return, as extended by any agreements relating thereto. Petitioners contend that the period of limitations is controlled by the filing of the partnership's information return. Conversely, respondent contends that the period of limitations is controlled by the filing of the partner's individual income tax return. Respondent agrees that there is no genuine issue as to any material fact relating to the applicable period of limitations upon assessment, and that a decision on this issue may be rendered as a matter of law. See Rule 121(b). Petitioners cite ,547 revg. and remanding , as authority for the proposition that the period of limitations upon assessment applicable to a partner's distributive share of partnership items is controlled by the filing of the partnership's information return. In , the Ninth Circuit held that the Commissioner may not adjust a taxpayer-shareholder's individual income tax return based upon an adjustment to a subchapter S corporation's information return when the period of limitations had run as to the subchapter S corporation's return. . We previously considered and rejected the Ninth Circuit's decision in Kelley in determining the period of limitations applicable to a partner's distributive share of partnership items. In , we held that the filing of a partnership information return does not affect the period of limitations upon assessment applicable to the determination of a deficiency against individual partners of a partnership. Similarly, in , affg. *548 , the Second Circuit held that the applicable period of limitations was controlled by the partners' individual income tax returns rather than by the partnership return. See also , affg. on this issue . We consider , and , to be dispositive of this issue; consequently, we hold that the period of limitations upon assessment applicable to a partner's distributive share of partnership items is controlled by the filing of the partner's individual income tax return, as extended by any agreements relating thereto. In accordance with the holding set forth above, petitioners' motion for summary judgment will be denied and respondent's cross-motion for summary judgment will be granted. An appropriate order will be issued, and decision will be entered under Rule 155. Footnotes1. Unless otherwise indicated, all Rule references are to the Tax Court Rules of Practice and Procedure, and all section references are to the Internal Revenue Code of 1954 in effect for the year in issue.↩2. The taxable year at issue antedates the enactment of secs. 6221- 6233 which provide that the tax treatment of partnership income, loss, deductions, and credits is to be determined at the partnership level in a unified partnership proceeding for partnership taxable years beginning after Sept. 3, 1982.↩	01-04-2023	11-21-2020

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